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Interview by Alexei Yakovitsky, Global CEO at VTB Capital, for Euromoney

3 November 2016
Russia investment banking: VTB Capital faces down the doubters


Russia’s leading investment bank has seen its fortunes fluctuate over the past two years. Alexei Yakovitsky, VTB Capital’s chief executive, talks to Euromoney about Brexit, Africa and state ownership and explains why sanctions have proved more of a blessing than a curse.

Ever since the UK voted in June to leave the EU, the hunt has been on for the canary in the City of London’s metaphorical coal mine – the first big bank, fund or other financial firm to announce definite plans to take its business elsewhere after Brexit.

On October 11, it seemed that it had finally been located in reports that Russia’s VTB Bank is planning to shift its international investment banking operation to continental Europe in response to the UK’s referendum result.

The speed with which VTB moved to refute the story, however, suggests that reports of the death of the canary – and the City of London – may be premature. The following day, on stage at VTB Capital’s glitzy Russia Calling forum in Moscow, group chairman Andrey Kostin is clear.

"We are not going to leave the UK," he tells a packed auditorium of investors and journalists waiting for president Vladimir Putin to put in a belated appearance. "The newspapers misunderstood our position."
On the sidelines of the forum, VTB Capital’s chief executive, Alexei Yakovitsky, is equally emphatic. "Obviously we are making various plans related to Brexit, but at this stage there is no discussion about exiting London," he says. "Given our business model, if we want to be international we have to be in London."

Reports to the contrary, he says, were due to a misinterpretation of remarks by a VTB board member about the group’s plans in continental Europe. VTB has a commercial banking arm in Austria, as well as smaller operations in France and Germany.

"It makes no sense to have three banking licences in Europe," says Yakovitsky. "We are therefore looking at restructuring and potentially closing down certain locations."

Frankfurt looks to be the likely choice for VTB’s new regional hub, while Vienna – "the centre of central and eastern Europe", as Yakovitsky notes – will retain origination capabilities. "Ultimately, the target is to end up with one European balance sheet," he adds.

He is adamant, however, that neither Frankfurt nor any of the other European cities being touted as contenders for London’s financial business post-Brexit – Dublin, Paris, and Amsterdam – will be able to replace the UK capital as a centre for investment banking.

"What makes London a financial hub is a whole range of things – Anglo-Saxon law, the English language, the talent pool, the business environment for setting up investment funds," he says. "It took decades to turn London into what it is today, and it would take decades to turn some other location into what London is now."

When it comes to servicing the Russian client base, there is absolutely nothing that global banks are able and willing to do right now and we are not.

Yakovitsky is particularly enthusiastic about the UK’s flexible labour laws, which he sees as a prerequisite for successful investment banking. "It is a very people-intensive business," he says. "It’s about efficiency, quick turnover of people. You hire somebody, they don’t work out, they move on."

As he notes, however, a flexible labour code alone is not enough to create a financial hub. "Moscow is a big city and the labour law here is fantastic," he says. "Russia is a very right-wing, capitalist place. But can I find western-trained compliance officers or lawyers with western and Russian expertise in Moscow? No, they are in London.

"The DNA of the financial industry only exists in London, New York and maybe Hong Kong. It doesn’t exist in Europe."

In words that will be music to the ears of the UK’s more business-minded Leave voters, Yakovitsky argues that Brexit could actually boost London’s appeal for banks. "I believe everything that underpins and enables London as a financial centre will remain, more or less, while everything that is Brussels – such as the idea of an excessive cap on bonuses – will go," he says.

Headcount reductions

VTB Capital’s global operations have been headquartered in the UK since 2008, when the state-owned Russian group first created its investment banking arm. The firm’s two main international business lines – selling Russian assets to overseas investors and putting cash to work in frontier markets – are both led from London.

How successful these have been is not entirely clear. VTB Capital tends to talk a good book when it comes to its international operations, but repeated rounds of lay-offs in both London and New York suggest they have not proved as profitable as had initially been hoped. From a peak of 550, staff numbers in London are down to 350, and Yakovitsky says further reductions are likely.

This is partly due to the almost total absence of Russian firms from global capital markets in the two years following the imposition of western sanctions – of which VTB Bank is itself a target – and the collapse of the oil price. Yet the first big headcount reductions were announced in April 2014, barely two weeks after the annexation of Crimea.

Assessing VTB Capital’s other international achievements, however, is not easy. The bank claims to have established successful lending franchises in southeastern Europe and sub-Saharan Africa, thanks to a combination of operational flexibility and a willingness to deploy balance sheet in markets underserved by western lenders.

These attributes are particularly valued by African borrowers, says Yakovitsky. "In Africa, you need to be able to move fairly fast and to have a commitment that many global banks have lost," he says. "How many US banks have someone at senior level making the case for lending $1 billion to the government of Angola? And how many weeks will it take to convince everyone on the risk committee to do it? We can step in and fill this void."

Evidence of VTB Capital’s activities in these regions, however, is limited. Dealogic data shows no involvement by the bank in syndicated lending in the Balkans since May 2014, while the main public signs of its involvement in Africa consist of a series of big loans to the governments of Angola and Mozambique. A VTB Capital spokesperson says other deals have been done in Africa but they are "not in the public domain".

Unfortunately for the bank, one such private loan did become public earlier this year in less than auspicious circumstances. In April, the government of Mozambique was forced to admit to $1.4 billion of previously undisclosed borrowings by its interior ministry and two state-controlled firms. These included a $535 million loan by VTB to Mozambique Asset Management (MAM) to finance the building of two shipyards.

In May, with Mozambique’s public finances in crisis, MAM missed a $178 million payment on the loan. VTB Capital has done its best to downplay the default. Yakovitsky stresses that the bank was not involved in originating the loan and sold more than 90% of the facility to other parties.

The sanctions years have been the best for us in terms of investment banking. He is also upbeat about the prospects for a positive resolution to the settlement dispute. "The story is not over yet," he says. "The government hasn’t said they won’t pay. It has become political, unfortunately, but we are trying to tackle it. At this stage, there’s no reason to believe it won’t work out."

Even if the debt is honoured, however, it has already added to the damage done to VTB Capital’s reputation among international investors by its involvement in another Mozambique government deal.
Fund managers who bought $850 million worth of bonds issued by state-owned firm Ematum from Credit Suisse and VTB Capital in 2013 were outraged to learn that part of the proceeds had been used for military purposes rather than, as advertised, to build a tuna fishing fleet.

They were even more incensed when, having agreed to a restructuring of the bonds into sovereign debt in March, they discovered that the Mozambique government had failed to disclose the full extent of its borrowings from the two banks to the IMF, which promptly suspended lending to the country.

Widespread reports suggest that the UK’s Financial Conduct Authority is investigating if Credit Suisse and VTB Capital misled investors in relation to both the issuing and restructuring of the Ematum bonds. The FCA declined to comment.

Yakovitsky does not address the Ematum issue directly. He does, however, offer an indirect defence of VTB Capital’s activities in Mozambique.

"We know that Africa is one of the riskiest regions in the world," he says. "Our competitive edge is that we are an emerging market bank and we are prepared to do business other banks won’t do. That increases our pricing power and we are able to charge for the increased risk."

VTB Capital also emphasises its presence in Asia, which was boosted two years ago in line with Russian policymakers’ much-vaunted 'pivot to the east’ following the imposition of western sanctions. Yakovitsky admits that the anticipated flood of Russia-China business has been slow to materialize but notes that a pullback by European banks in the region has created unexpected opportunities for VTB.

"We suddenly found ourselves helping the Chinese on Europe, because they aren’t getting pitches from European banks," he says.

Last September, VTB Capital was one of three advisers on the $920 million acquisition of Turkish port operator Fina Liman by a Chinese consortium. The group has also been active on outbound M&A from Turkey, advising Yildirim Group on the purchase of a Portuguese port operator last autumn.

 Last man standing

If its international record remains patchy, VTB Capital has gone from strength to strength in its home market over the last three years. A mass retreat from Moscow by western banks, combined with a pullback from investment banking by leading domestic competitor Sberbank, has left the firm as nearly the last man standing in Russia.

Last year, VTB Capital accounted for nearly 40% of all M&A activity in the country and around 30% of global equity and debt capital market deals by volume. By contrast, in the first four years of the decade, the bank won just 12% of bond market business – less than JPMorgan – and 17% of equity placements.
"The sanctions years have been the best for us in terms of investment banking," says Yakovitsky. "Activity has slowed down and our clients are doing less, but our market share pick up has been substantial because of the reduction in competition."

Changes in the nature of investment banking in Russia since the start of the sanctions regime have also favoured VTB Capital.

He adds: "Deals are smaller than they were historically and very domestic. To service this business you need plenty of people on the ground. You have to have deep penetration into the regions and into the industrial sectors. You need to be having broader conversations with clients."

What exactly VTB is talking about to its Russian customers has been the subject of much speculation. The bank, which has received a record R1.2 trillion ($19.3 billion) of state support since 2008, is widely believed to lend in accordance with Kremlin wishes rather than commercial realities.

These accusations were addressed by Putin and VTB chairman Kostin in a jovial and unconvincingly spontaneous exchange on stage at the Russia Calling forum. "The western media says we are under your thumb," said Kostin. "They say you call us and give us instructions."

To which Putin responded that if the Kremlin was interfering in the running of state-owned banks then they would be lending more to the real economy. The audience tittered dutifully.
President Vladimir Putin (r) and VTB Bank's chief executive Andrey Kostin at the annual VTB Capital Russia Calling forum in Moscow.

In response to the same charges, Yakovitsky says state ownership does play a role in the sustainability of VTB Capital’s business model. "But it’s not what people think," he says. "No one is pressuring companies to work with us. It’s just that being state-owned means we have more support, more resources and better capital adequacy."

Whatever the truth of the matter, it is hard to believe that VTB Capital has not benefited from the massive increase in state control over the Russian economy in the past decade. In 2005, the public sector accounted for 35% of the country’s GDP. Today, the figure is closer to 70%.

The bank has certainly become the go-to house for deals deemed too risky by westerners. When the Russian government returned to the Eurobond market in May for the first time since the imposition of sanctions, VTB Capital acted as sole lead on the transaction after US officials warned off western banks.
The $1.75 billion bond had a relatively muted response from international investors, partly due to Euroclear’s initial refusal to clear it and partly to the extreme haste with which it was launched – a precaution, apparently, against further interference by the US State Department.

By contrast, VTB Capital’s tap of the bond in September attracted more than $7.5 billion of orders. Some debt bankers were sceptical of claims that the deal had been entirely placed with foreign investors, given the large quantities of Russian cash located in offshore jurisdictions. Nevertheless, it seems clear that global funds did account for a substantial amount of demand.

Yakovitsky says that the deal’s success shows that VTB Capital is today more than a match for global investment banks, at least when Russian assets are concerned.

"The global banks have broader reach, obviously, but when it comes to clients who invest in Russia we have the same reach," he says. "When it comes to servicing the Russian client base, there is absolutely nothing that global banks are able and willing to do right now and we are not."

As further proof of this, Yakovitsky cites the $818 million Alrosa privatization in July, which VTB Capital and Sberbank jointly placed. "We sold that to dozens of international investors," he says.
Again, cynics might point out that only 10% of the deal was placed with US buyers, while half went to the stateowned Russian Direct Investment Fund and its sovereign wealth fund partners.

Yakovitsky also appears to contradict his own claims to be able to equal the reach of global investment banks when he later comments that VTB Capital today deals with "75%to 80% of the international accounts we traded with before sanctions".

At the same time, there is no doubt that the balance of power in Russian investment banking has swung from western to domestic players. Yakovitsky sees this as payback for the years when the global banks had the market largely to themselves.

"Russians love foreigners and historically Russian clients always preferred international banks," he says. "When we started it was an uphill battle for us to prove that we are 'civilized people’. Now it’s the turn of western banks to prove themselves, because they haven’t shown full commitment to this market."

He has no doubts, however, that the global banks will be back – indeed, he adds, in the longer term Russia will need them. "We need competition to push us to innovate and develop, and Russian companies will be able to raise even more money if they are," he says.

"When everyone is here it means times are good. It’s pretty sad that we are alone now, even if it’s good for our profit margins."

VTB Capital

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