Russian Capital Markets

The objective of this paper is to describe the composition of the three major capital markets in Russia: Public Equity, Debt, and Private Equity. Our study focuses on the most critical issues that these markets must successfully confront to move forward and validate the renewed interest they have recently garnered. Rather than relying upon subjective opinion and conjecture, we employed a variety of quantitative metrics from data collected on each market to support our conclusions. Our in-country meetings helped us in augmenting our analysis with information that is not in the public domain and provided insight and primary commentary to current and future market tendencies.

Public Equities

The Russian equity market began to take shape in the second quarter of 1994 following the peak of the privatization program, which was launched in 1993 and aimed at making most of the Russian enterprises public in a short period of time. In the first round of privatization in 1993, each Russian citizen received a free privatization voucher valid for use (either directly or via privatization funds) in privatization auctions. As a result of these auctions, shares in Russian businesses were thinly distributed throughout the population, with virtually everyone suddenly a shareholder.

However, it was the second phase of privatization launched in the second half of 1994 that shaped the equity market as it is now. It involved the sale of thousands of sizable stakes in the Russian enterprises to both domestic and foreign strategic investors via various auctions and tenders. The most common mechanisms included investment tenders and commercial auctions, which usually included significant investment conditions, with little revenue actually generated for the budget.

In late 1995, control over many of the largest Russian companies was transferred away from the government to influential financial-industrial groups (FIGs) and in some cases to the companies' management, through the controversial shares-for-loans scheme. Shares were given in trust in exchange for loans to the federal government: none of these were repaid, and the lenders took ownership of the stakes. The scheme involved controlling stakes in major Russian companies such as Lukoil, Surgut Holding, Norilsk Nickel, Sidanco, Yukos, and SibNeft.

In 1996 privatization went up a gear, and the government announced the third phase concentrating on "targeted" sales of sizable blocks in Russia's largest companies. The sale of a 25% +1 stake in Sviazinvest to the Mustcom consortium for $1.9Bn in July 1997 is the most notable example, and was the largest privatization deal in Russia so far.

The August 1998 crisis led to the privatization process being postponed. Nevertheless, as the market has since started to recover, interest in those stakes still in government hands has returned and there are calls for a continuation of privatization.

Market Structure

Secondary market trading got off to an immediate start after the first stage of privatization was completed. Market infrastructure—including the establishment of registrars, stock exchanges, and brokerage companies—developed steadily over the next three years. Initially exporting industries (oil & gas, metals, and pulp & paper) and utilities (power generation and distribution, telecoms) attracted the most attention, although another group, consisting of consumer goods and retail companies, was later discovered. This second category still makes up a small part of the market, but the number of newcomers continues to grow.

Exhibit 1.1: Breakdown of the Russian Market Capitalization by Sector, April 2001[1]

Exhibit 1.2: Breakdown of the Russian Market Capitalization by Company, April 2001[2]

The majority of trading in Russian shares continues to be on an over-the-counter basis, with organized exchanges gradually gaining popularity. The RTS and MICEX are becoming the two main rivals to become the primary Russian equity exchange. The electronic Russian Trading System (RTS) is a dealer-driven market modeled on the American Portal system, established by the Professional Association of Equity Market Participants (PAUFOR) at the end of 1994. Russia's most successful market infrastructure project, the RTS has raised liquidity and improved market transparency. Currently it includes 372 stocks representing 239 listed companies, covering virtually the entire Russian equity universe with the exception of GazProm. The Moscow Interbank Currency Exchange (MICEX) originally specialized in currency and debt trading. Since March 1997 it has also been trading equities, although initially it accounted for less than 5% of total registered equity trading volume. A favorite platform for many domestic investors (nonresidents still prefer to use the RTS), MICEX has managed to increase volumes significantly, thanks to the rebound of domestic interest in the equity market and the active use of leverage by Russian brokers. MICEX trading is mostly concentrated in the more liquid shares, with LIES accounting for about 90% of total turnover. GazProm domestic shares are not listed on RTS or MICEX and the majority of the trading in this company is conducted on the Moscow Stock Exchange (MFB), essentially a one-stock exchange.

Foreign investors are able to trade in Russian securities within the U.S. or Europe without the need to deal directly in unknown foreign capital markets through American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs). Using ADRs, an investor in the U.S. who is interested in buying shares in, for example, Gazprom, may do so by simply calling any local broker dealing in ADRs, rather than having to place his order on a stock exchange in Russia. ADRs and GDRs allowed Russian companies to access previously unavailable international capital markets, and over 50 companies have issued ADR or GDR (primarily OTC) so far. Currently all of the Russian ADRs are trading at par with corresponding domestic issues, with an exception of Gazprom [3] for the reasons explained below.

The Russian government imposes certain restrictions on the acquisition and ownership of Russian companies by foreign investors. For example, foreign participation in Russian banking (both foreigners holding bank shares and setting up their own structures) is regulated by the Central Bank of Russia (CBR), based on a sector-wide ownership ceiling of 12%. Apart from banks, only a few companies place restrictions on foreign participation. The most prominent example is GazProm, which limits nonresident holdings to 9% of Charter capital. In effect this limit is actually lower, as foreigners may only buy shares through a depository receipt and do not have access to the underlying shares. The depositary receipt currently accounts for about 2% of the company.

Indices

Among the multitude of indices tracking the Russian market, the six listed below are the most actively used. All are capitalization weighted, with the major differences being the number of companies included and adjustments made for liquidity and free float.

Exhibit 1.3: Overview of key Russian Equity Indices[4]

Index	Provider	No. of stocks	No. of issuers	% of market covered	Starting date	Treatment of Gazprom
RTS	RTS, Interfax	77	60	94%	1-Sep-95	Not included
Moscow Times	Skate-Press	50	50	87%	1-Sep-94	Domestic price
ROS	CSFB	30	30	76%	1 -Dec-93	ADS price
MSCI Russia	MSCI	11	8	68%	30-Dec-94	ADS price
RTX	OETOB	8	8	65%	8-Oct-97	Not included
IFCI Russia	IFC	9	9	48%	3-Feb-97	Not included
AK&M	AK&M	49	49	-	-	Included

The manner in which GazProm is included leads to significant distortions, both because of the company's size and its peculiar two-tier market structure, where foreign investors only have access to the approximately 2% of the company that trades in the form of ADSs. The remaining Charter capital trades domestically at a large discount to the ADS. Some indices (e. g. the IFCI) have strict requirements on the free float available for investors, and thus exclude GazProm. Others include it based either on the domestic or ADS price. Given the low liquidity of many stocks included in the indices, pricing methodology can also have a key impact. The most commonly accepted method is to take the average between the best bid and best ask on the exchange. The RTS is an important exception, as it is based on the weighted-average price of actual deals registered in the system. Russia's weight in the emerging markets universe is 2.7% according to the MSCI EMF index and around 2-3% under IFCI methodology.

Regulation

The Russian government put in place a general legal framework for the market in place, and it is governed by both the Law on the Securities Market and the Law on Joint-Stock Companies. The Federal Securities Commission (FSC) acts as the market watchdog and has the authority to fine companies and to nullify any improper securities issue. However, to date many other kinds of violation by issuers are only subject to civil proceedings.

The National Association of Equity Market Participants (NAUFOR) has started to play an important role in improving corporate governance through court cases against companies that abuse regulations, by initiating legislative actions, and by establishing transparency and information dissemination standards. Working closely with NAUFOR, the Russian Trading System (RTS) has introduced a set of requirements for being listed, including regular financial results according to IAS or US CAAP and timely public announcements of corporate actions.

Given the basic framework was in place, it was expected that securities regulation would become much more effective. However, poor enforcement and legislative loopholes remain, highlighted by several high-profile corporate governance violations. In response, the FSC has outlined measures that would ensure stricter enforcement and set in motion legislative reform that would further improve shareholder protection. However, we believe significant political effort is still required, and analyzing the corporate governance culture at any particular company remains a crucial part of making investment decisions in Russia.

Current situation

Since the financial crisis of 1998 when foreign investors withdrew their money from emerging markets in a “flight to quality”, the market slowly recovered during 1999, as prophecies of doom (hyperinflation, social unrest and renationalization) turned out to be exaggerated.

Exhibit 1.4: Russian market performance, RTS Index, March 11, 1996- April 6, 2001 [5]

Improvement in the economy was helped by oil price recovery from record lows, and things were looking significantly better by the end of the year. GDP grew by 3.2% in 1999, inflation was 36.5% and the trade surplus amounted to $33.5bn. The federal budget deficit was much improved at 1.7% of GDP. The market also recovered, rising by a massive 252% on the year. The RTS index gained 35% in December alone thanks to results of the Duma elections were the communists lost their control of the Russian parliament. President Putin and the Government led by Prime Minister Kasyanov have shown that they are indeed committed to deep reforms. Among other achievements, they have managed to get the long-awaited new Tax Code through the Duma in just 5 months, something previous governments have failed to do in 7 years. The government economic team, led by German Gref, the Minister of Economic Development and Trade, has developed a long-term economic plan, which calls for accelerated economic reform and targets economic growth of at least 5% a year for the next decade.

Despite the relatively healthy macroeconomic situation and the reform-oriented government, the market has not been as strong as expected: the AK&M domestic issues index declined 15.5% in 2000, while AK&M ADR index declined 39.5%[6]. Public equity market in Russia is currently almost inactive, with daily trading volumes of $5-15 M down from a pre-crisis level of $50-100 M, on a total market capitalization of about $50 Bn [7]. With only 9 companies accounting for more than 90% of the volume, it is clear that most of the trading represents short-term speculation.

Exhibit 1.5: Trading Volumes Compared with Other Eastern Europe Countries [8]

The absence of strategic investors and lackluster performance of the market can be explained by a number of factors. First of all, investors want to be sure that this is the right time to invest in Russia. Having experienced so many false starts, a lot of investors are wary about investing in Russia again and want to see some concrete results before committing any money. Secondly, recent instability on world markets has dampened growth prospects for the Russian market, which closely follows NASDAQ: correlation coefficient between NASDAQ and AK&M’s domestic issues index was as high as 0.93 in August 2000[9]. It's hard to see a strong Russian market in the short term when the US market is showing such volatility and relative weakness. Additionally, Russian companies continue to demonstrate lack of transparency in operations and reporting, being slow to adapt GAAP/IAS reporting standards. Most market participants are short-term driven, and institutional investors such as insurance companies or pension funds are still not present [10].

However, the most important issue investors are focused on is the corporate governance concern (minority shareholder rights, renewed government activism by the tax police, etc) rather than political instability or slow-motion macroeconomic collapse loomed on the horizon of the Russian equity market. Now that neither of these two issues is any longer at the top of the list of worries about the market, investors have instead shifted their focus to corporate governance issues, which encompass minority shareholder rights, as well as renewed government activism by the tax police, general prosecutor and Audit Chamber. Managers have not developed the habit of making decisions based on shareholders’ interests, and courts do not often protect shareholders’ rights. The unfortunate result of this problem is that the Russian companies are trading at levels below or only barely above those at which it opened for the year, with few prospects for significant improvement in the short term.

Currently, companies comprising well over half of the total market capitalization of the Russian market are under corporate governance clouds:

UES: The restructuring program of Russia's monopoly power provider, which is also the Russian equity market's most liquid stock, continues to plague United Energy Systems (UES). Repeated attempts by CEO Anatoly Chubais to reassure minority investors that their interests will be respected in the restructuring process have resulted only in escalating skepticism on the part of minority shareholders. The dissolution of a committee whose aim was to facilitate dialogue between minority shareholders and UES management means that there is now no formal vehicle for communication between the two groups. Calls from minority shareholders for the resignation of Chubais – who, until only months ago, was widely perceived as their savior – are steadily growing louder. Meanwhile, pressure on Chubais is also rising from the government, which has been conspicuously quiet about the restructuring program – although the Duma didn't hesitate to condemn the restructuring program in a nonbinding resolution recently. The investigation into the early 1990s privatization of UES, while highly unlikely to yield any concrete result, adds yet another layer of uncertainty.

LUKOIL: The recent announcement of an investigation into tax evasion at LUKoil is – in some ways – precisely what many investors in Russia hoped for when Putin promised to crack down on the oligarchs to decriminalize the corporate sector and improve the investment environment in Russia. While the arrest of Media-MOST head Vladimir Gusinsky badly misfired (insofar as it was intended as a measure to trim the power of the oligarchs), the raid of LUKoil (and, similarly, AvtoVAZ) sent the signal that the Putin administration will take no prisoners in trying to bring about higher levels of law-abiding behavior and transparency. But in the meantime, minority investors in LUKoil are left to wonder whether they are receiving a fair return on their money – which was already in question even before the launching of the tax police investigation.

Norilsk Nickel: The office of the general prosecutor recently launched an investigation into the privatization of Norilsk Nickel. A number of reassessments of the famously crooked privatizations of a collection of Russian companies have taken place over the past several years with virtually no practical implications. But while the specter of renationalization remains extremely remote, any examination dampens sentiment and gives the market another cause for worry.

Although the long-term benefits to minority shareholders of a true cleansing of the Russian business environment are clear, increased volatility and uncertainty will likely be the key short-term implications. Companies targeted by the general prosecutor's investigations or tax police raids suffer from significantly increased uncertainty – and when many of the traded companies of the Russian equity market are potential, or even likely, targets of governmental inquiries, there are few places for portfolio investors to put their money confidently. As a result, dedicated Russia investors should, in the short term, focus on those companies that are relatively clean (i.e., solid tax payment record, few skeletons in the closet, low profile), such as Surgutneftegaz (Oil & Gas), SeverStal (Steel), Golden Telecom (Telecommunications). On the other hand, global investors who can afford to wait until the dust settles in the Russian equity market, and for investigations to run their natural course, will likely remain on the sidelines.

Yukos, one of the largest Russian Oil&Gas companies, may serve as a good example of the dramatic effect of the corporate governance issues on the value of companies in Russia. Prior to 2000, the company had been known as one of the worst in terms of investor relationships. Last year Yukos took a number of steps to improve: it has consolidated its affiliated structures, increased transparency by implementing GAAP reporting, improved its dividend policies, invited foreign investors to serve on the board of directors, and changed its corporate charters to prevent share dilution. Yukos was included in the MICEX stock exchange and RTS trading system, and is planning to issue ADRs. Following the implementation of these initiatives the company’s market value increased 8 times during year 2000. [11]

Fixed Income

This section of the paper examines the development of the Russian corporate debt market. In general, businesses can raise money: by borrowing money from a bank, by selling equity, and by issuing bonds. It is important for a country to have developed all three capital market options so that entrepreneurs and corporations can have assured access to capital. This so-called “three-legged” approach disperses risks more widely and enhances the financial system’s ability to cope with shocks. Currently Russia is making progress towards establishing a well functioning corporate bond market. This progress is seen in two areas of the corporate debt market, Veksels and corporate bonds.

Veksels

Veksels are promissory notes issued by enterprises, banks, and governments with specified maturity and discount rates[12]. They are the main money surrogates used in Russian and the EBRD estimates that the face value of the stock of outstanding Veksels is approximately 10% of GDP, or up to US$ 20-25 billion in 2000[13]. The Veksel market, although still relatively immature, provides issuers with a short-term capital source that provides relief for working capital fluctuations. Several market professionals see the market evolving over the future and continuing to provide short-term finance to Russian companies.

Along with equities they are the only standard registered securities in Russia[14]. There are two main types of Veksels, commodity and financial:

· Commodity Veksels are promissory note that cannot be redeemed for cash, and instead can be redeemed for the production of the issuer. For example, Irkutsenergo Veksels, promissory notes issued by the power company in the Irkutsk Region, can only be redeemed for energy.

· Financial Veksels, as the name implies are more similar to Western promissory notes and are redeemed n cash upon maturity.

Although there are many types of Veksel structures, they typically have maturities ranging from 6 months to 2 years, may or may not pay a coupon, and are sold at a discount to face value. The discount to face value represents several factors of the Veksel: underlying issuer credit risk and general market benchmark yield.

There are three main types of issuers, enterprises, banks and municipalities. In 1998 it was documented that approximately 80% of the outstanding Veksels were issued by enterprises, a fact that was verbally verified by several traders of Veksels in March 2000[15]. Banks are the second largest issues of Veksels, with between 15-20% of the total outstanding Veksels. Municipalities also issue Veksels and make up the remainder of the Veksel market.

Veksels are issued for two primary reasons: First, and until 1998, they were issued to manage seasonal working capital variations and liquidity problems. For example, agribusinesses would issue Veksels to finance seed purchases and use either the crop and cash generated from the crop to repay the Veksel at harvest time. Second, and primarily a function of the 1998 financial crisis, Veksels are used when enterprises are in severe liquidity crisis or close to financial insolvency. Many Veksels were issued during the crisis by enterprises and used to pay suppliers.

Veksels are traded in an OTC market with the major Moscow based banks acting as market makers. Alfa-Bank, Renaissance Capital, Sberbank, and several other Moscow based financial institutions were cited as major participants in the market making of Veksels. Normally, issuers will use one of these banks to organize the underwriting and repayment of the Veksels as well. Although Veksels are registered with the Russian SEC, their secondary trading market is not formalized and information regarding the market for Veksels in General and particular issues is not formally organized or kept in any central location. Therefore, the following table, which describes basic characteristic of Veksels, was generated through interviews with Alfa Bank and Troika Dialog.

Exhibit 2.1: Key Commercial Terms of Veksels [16]

Term:	½-21½ years. Majority approximately ½ year.
Coupon:	Zero and Fixed Coupon
Discount:	5-10%
Typical size:	Up to US$60-80 million
Settlement:	Physical cash or commodity settlement
Registration/type:	Russian SEC
Exchange:	OTC
Pricing:	www.megasoft.ru
Yield	Banks – 30% Speculative Traders – 100%

There are two primary types of Veksel investors: large financial institutions and speculative Veksel trading firms. The bulk of the Veksel investor base is comprised of financial institutions such as Alfa-Bank, Renaissance Capital, Moscow International Bank and Sberbank. However, smaller speculative trading firms have raised private capital to speculate in the Veksel market[17]. Our interviews with the director of the Alfa Bank Veksel operations suggested that the smaller, more speculative firms are able to earn real rates of return approach 100% p.a., while the larger financial institutions are only able to earn 30% p.a. The following table outlines the returns as of March 30, 2001:

Exhibit 2.2: Major Veksel Returns[18]

Vexel Issuers / Maturity	1 month	3 months	6 months	12 months	15 months or more
GazProm	17.0%	19.0%	23.0%	26.5%	27.0-28.0%
TNK	15.0%	16.5%	20.0%	23.0%	-
Mezhregiongaz	-	-	-	30.0%	32.0-35.0%
Sberbank	12.0%	15.0%	17.0%	19.0%	20.0-22.0%
GazPromBank	17.0%	19.0%	23.0%	26.0%	27.0-28.0%
MDMBank	15.5%	17.5%	-	-	-
RosBank	16.0%	18.0%	-	-	-
EuroTrust	16.0%	18.5%	-	-	-

While the table shows only major Veksel returns, which have fallen in the last quarter, he maintained that the smaller issues have returned close to 100% over the previous year. Furthermore, he attributed this differential in yield to the larger amounts of capital employed by the financial institutions.

Although the Veksel trading and issue volume declined after the 1998 financial crisis, most of the Veksel trading and investing professionals feel that firms will continue to use them primarily as a means to fund short-term working capital fluctuations. They also believe a more formalized market structure will evolve leading to greater transparency in Veksel pricing and transaction. Although this will lower effective yields, it will allow more issuers to access the market, because more investors will be willing to participate in the more evolved transparent market. From an issuer’s perspective, may professionals feel that Veksel issuance can e used as a stepping-stone and precursor to a corporate bond issue (i.e.they see the Veksel as a way to introduce issuers to investors). From a market making and underwriting prospective, most players believe, the Veksel market will continue to be the domain of Russian domestic banks, and that foreign banks will not be interested or able to service the market.

Corporate Debt

The Russian corporate debt market can be characterized into two general components: corporate bonds and corporate banks loans. The market can be further segmented into Rouble and hard-currency debt[19]. This section will focus on the Rouble denominated corporate bond market for the following reasons. First, the hard-currency denominated debt segment is relatively small, with few non-sovereign or non-municipal issuers. Second, the corporate bank loan market is relatively small, and few banks, aside from a few large Moscow-based institutions have the capability to make proper credit assessment assessments required for bank debt[20].

Unlike the Veksel market, the corporate bond market is very immature and has not had any significant new issue or trading volume. Estimates by investment banks estimate the total value of outstanding corporate debt to be between RUB 20-45 billion[21]. However, they also predict significant growth in the number of new issues over the near term. A Rouble denominated corporate debt bond is developing due to several factors[22]: First, the government Rouble dominated bond (GKO/OFZ) yields are being squeezed[23] to the point where they often trade at a negative carry. Second, larger industrials, in particular in the energy sector, are trying to build a public credit history. Third, companies need capital to build out their business plans (telecommunications firms). Fourth, firms that have hard-currency denominated liabilities are repurchasing them to mitigate foreign exchange risk and are using Rouble denominated debt to repay foreign currency denominated debt. Fifth, most banks do not have the capability to conduct credit assessments to underwrite loans. Finally, there is excess Rouble liquidity in the banking system, and bonds will provide an investment vehicle for major Russian domestic bank assets. Given these factors, the head of fixed income at Troikya Dialog estimates that the total market size will grow to RUB 250 billion in 3 years.

Potential new issuers include oil and gas producers, telecommunications operators, agribusinesses, food and beverage processors, and financial institutions. Issuers are plagued with several problems. A banker at Renaissance capital estimates that there are approximately 10 issuers ready to issue Rouble bonds with a face value of US$10-100m each over the next few months[24]. First, each issuer is required to pay 0.8% of face value to the Russian SEC. Second, like equities, corporate bond investors face a number of issues related to the underdeveloped state of the Russian economy. The largest of these problems is poor corporate governance and enforcement of the legal structure that underpins debt financial instruments.

The first problem can be overcome by coupling the bond issue with an imbedded call option that is defaulted on. An issuer can default on the option without triggering a cross-default on the underlying bond. In addition to structuring the bonds differently, underwriters are reducing the fee structure so that new issuers are paying between 1-2% of face value of issued bonds as an underwriting fee[25]. The second problem is more obtuse, and will rely on the development of precedents to assure investors that they can safely invest in Russian corporate bonds. However, in the interim, several new developments have taken place that show that investors and issuers alike are trying to address this issue. First, ANE Rating and S&P have signed a strategic alliance to develop a domestic rating system[26]. One banker at Troika Dialog believes that S&P will eventually buy out its partner and develop a rating agency specific to Russia that will help differentiate domestic credits (instead of everyone being CCC- under the current S&P system, they will use relative ratings within Russia). Second, rating agencies are rating Russian companies on their corporate governance performance. Aeroflot was the first Russian company to apply for the rating and received a 5.3 out of a potential 10 points. This is a significant development for the corporate bond market because it will give potential investors a means to compare issuers on corporate governance performance.

The investor base for Rouble-denominated corporate bonds is primarily domestic and is comprised of Russian banks, pension funds, and insurance companies. Sberbank and Moscow International Bank were often cited as predominant investors. However, smaller regional banks would also be interested in bonds because they provide a more liquid investment vehicle than Veksels and give an improved yield when compared to GKO/OFZs. Key factors in maintaining the investor interest in corporate bonds include excessive liquidity in the banking system, few new GKO/OFZ issues, and a relatively stable Rouble.

In general, most of the bankers involved in the development of the corporate bond market believed that it would grow to 5-10 times its current size over the next 3 years. This growth will be predominately driven by the excessive liquidity and lack of sovereign new issues. At first the market will have a domestic orientation, with Russian financial institutions will being the primary investors in the market. Foreign banks and investors will not participate in the market at first because alternative emerging markets will have better returns. As the market matures and if it is able to demonstrate stability, foreign investors may return. Russian investment banks such as Troika Dialog, Renaissance, and Alfa Bank will make the market, and will capture most of the underwriting fees[27].

Private equity in Russia__________________________________________________________________

Private equity, otherwise referred to as venture capital, is essentially long-term equity capital invested in new or rapidly developing enterprises. Traditional debt financing, which precludes issuing ownership, is not always a viable alternative for emerging enterprises because they generally lack the collateral, track record, or earnings to secure a loan. Accordingly, private equity is the lifeblood of entrepreneurs.

Over the past 10 years, as Russia has transformed itself from a centrally controlled Soviet system to a modern market-driven economy, a completely new class of domestic entrepreneurs has emerged. To wit, there are approximately 870,000 small businesses in Russia today, comprising almost 30% of the total number of enterprises and contributing 10-12% of Russia’s annual GNP.[28] In addition, entire Russian industries have undergone privatization and are now seeking opportunities for re-investment and consolidation.

In contrast to these appealing developments, Russia continues to be capital-starved. Operating loans, if granted, tend to be short -term in nature and usually demand oppressively high interest rates. As addressed in other sections of this paper, financing through corporate bonds or the public equity market are not realistic options for the vast majority of established companies. Retained earnings, therefore, provide the primary source of enterprise finance in Russia. Consequently, re-investment in existing firms has been highly limited in recent years and enterprises are forced to harvest existing assets.

Exhibit 3.1: State of fixed assets in the Russian economy [29]

	Depreciation of gross carried assets	Renewal rate	Disposal rate
1992	46.8%	2.8%	2.8%
1993	49.3	1.8	1.2
1994	47.9	1.5	1.4
1995	47.9	1.3	1.3
1996	40.9	1.2	1.1
1997	51.5	1	1.5
1998	53.6	0.9	1.5
1999	55.6	1	1.5

These factors, combined with the economic fallout from Russia’s disastrous financial mismanagement in 1998, have significantly depressed the valuations placed on many Russian industrial enterprises. Indicators such as these point to a wide variety of seemingly attractive private equity investment opportunities in Russia. Nevertheless, the tempo, size and scope of private equity investments in Russia remain decidedly conservative.

Taking this current state of affairs into consideration, our analysis of the Russian private equity market focused on:

Identifying the key factors that have thus far impeded private equity investments from flourishing;
Assessing how on-going portfolio investments are grappling with these market challenges;
Providing pointed commentary on current trends in this sector basis our in-country meetings with several market participants.

Barriers to investment

Gavril Romanovich Derzhavin, a famous 18^th century Russian poet and thinker, once was asked to sum up the Russian people in one word, and he responded – voruyut – (they) steal. As unfortunate as this dated description may seem, it aptly encapsulates the common view on foreign private equity investing in Russia in the 21^st century.

Private equity investing entails taking partial ownership in portfolio companies and actively managing those investments to a profitable liquidation and exit. Access to accurate information for pre-investment financial due diligence, a sound framework for corporate governance, and a reliable legal system for recourse are central requirements for investments. At present, Russia has yet to establish a comprehensive set of checks and balances to protect investors’ rights. In particular, serious contradictions exist between Russian and GAAP accounting standards, corporate governance covenants are ambiguous and incomplete regarding minority shareholder rights, and the commercial Arbitration Court tends to rule in favor of the party that pays the largest bribe.[30] The playing field, therefore, strikes many potential market participants as being far from level and few guarantees exist to protect private equity investors from being fleeced.

“There is almost zero interest in Russia and the former Soviet Union as regards private equity. The legal system is too uncertain for a business that relies on enforceable contracts and often has to defend minority shareholder rights.”[31]

Beyond these most rudimentary conditions, Russian tax legislation requires a significant overhaul to properly reflect a taxation system that is consistent with a market-driven economy and to motivate profit making in official operations. Case in point, although the stated corporate tax rate in Russia is 35%, effective tax rates for even seasoned honest businesses average 50-60% because of the myriad of expenses that are not recognized as tax deductible costs under the current tax code.[32] Among other problems, this situation further complicates a potential portfolio company’s task to achieve an acceptable after-tax profit rate and cash flow in order to trigger a premium internal rate of return, as private equity investing demands.

Because all current private equity investments in Russia rely heavily upon foreign capital, these shortcomings will remain serious detractors and will prevent this market from achieving any level of critical mass. Indeed, Russia not only lacks the legal and tax infrastructure to mitigate many of the basic risks associated with private equity investing, it also does not possess a sufficient level of support from domestic investors. Insurance companies, employee pension plans, endowments and banks provide approximately 80% of capital committed annually to private equity funds in the United States. In contrast, fundraising in Russia is both underdeveloped and limited by government regulation and Russian law. For example, Russian pension funds are only allowed to invest in state-guaranteed securities, bank deposits, real estate, and the public equity market.[33] Furthermore, since the 1998 financial crisis, fixed income investments have proven to be a lucrative and relatively low risk outlet for many Russian insurance companies. Until the rates of return on Russian treasury bills firmly drop below inflation rates, these investors will not be interested in investigating other long-term domestic investment vehicles, regardless of the diversification a private equity fund may add to their assets.[34] As long as Russian investors do not take substantial involvement in the private equity arena, this market will continue to be perceived as a capitalistic club only for foreigners. To the further detriment of this market, and as experience has shown in a multitude of other industries in Russia, serious reform only begins when local champions lead Russian legislators toward change.

The last major, and perhaps most important, challenge to private equity investing in Russia today is the overall lack of sufficient exit options to liquidate a fund’s position in a given portfolio company. Private equity funds must eventually sell their shares in order to return both the initial investment and earnings their limited partners have garnered from this form of investment. The traditional paths for exit opportunities used the United States and Western Europe, such as initial public offerings or sale to a strategic investor have yet to be tested on a broad scale in Russia. As illustrated in the public equity portion of this paper, the Russian IPO market is virtually stagnant. In addition, few local benchmarks have been established in the Russian investment banking M&A industry to ensure acceptable valuations for enterprise sales. Although multinationals have already demonstrated a strong willingness to consider portfolio company acquisitions, the breadth of the domestic M&A market is extremely limited.[35] Granted that the Russian market is still very much in a developmental stage and that the duration of most private equity investments is 5-7 years, the general absence of a proven set of exit options is arguably the gravest limiting factor for attracting interest in this form of investment.

Measuring on-going private equity funds

Despite these hurdles, knowledgeable investors are pursuing private equity investments in Russia today. By relying on local expertise and hard-won best practices, these funds have invested in both new enterprises and established industries that are currently undergoing restructuring. Our group selected two markedly different private equity investors to profile for our study – Quadriga Capital Russia GmbH & Co KG and the Jensen Group. Our intent in choosing these two funds was to analyze how the traditional formula of private equity investing performs in Russia, represented by Quadriga with the financial support of the European Bank of Reconstruction and Development (EBRD), as well as to investigate a more non-traditional strategy, as represented by Jensen and its current focus on real estate as an investment vehicle.

Quadriga [36]

In 1997, Quadriga Capital, based in Germany, was selected to manage several of EBRD’s Regional Venture Funds (RVFs), primarily in central Russia and the Leningrad Oblast, to include the city of St. Petersburg. RVFs provide investments in Russian private sector enterprises that have a maximum of 25% state-ownership. The preferred minimum investment for these funds is $300,000 and the maximum is usually $3,000,000. The central focus of these funds is to invest in Russian firms that have a strong position in the domestic market. Foreign ownership or partnerships as well hard currency earnings are not a prerequisite for an investment target. Sponsoring private equity groups, such as Quadriga, co-invest alongside EBRD in portfolio companies. Besides maintaining comprehensive reporting and returning to EBRD its initial capital outlay plus any profits, the sponsoring funds receives a standard 2-3% management fee and 20% carry on all investments. EBRD also covers all costs incurred by the sponsoring group for pre-investment due diligence. Put simply, Quadriga is in an excellent position to learn the nuances of private equity investing in Russia with EBRD’s full financial support and may selectively pick the more attractive portfolio options for its own risk. The value of this relationship from EBRD’s point of view is that RVFs will foster significant progress in the formation of small enterprises in Russia by establishing a proven network for Russia’s entrepreneurs to access the capital.

At present, Quadriga maintains offices in Nizhny Novgorod, Yaroslavl, and St. Petersburg. A core group of ex-patriot investment experts, along with a team of local professionals, manage Quadriga’s portfolio investments. Quadriga currently holds $50 million of investments, $30 million in EBRD funds and the remaining $20 million from its own limited partners, in 20 portfolio companies. Partly due to EBRD stipulations and also in agreement with Quadriga’s investment philosophy, the fund does not purchase majority positions in its portfolio companies. For all investments, Quadriga subscribes to a target 35% internal rate of return in US dollars with a 4-5 year investment duration. Based on its success to date in identifying promising portfolio companies, and despite having completed few exits, Quadriga is planning to close a new $200 million fund within the next year.

To mitigate the risks associated with private equity investing in Russia, Quadriga imposes a number of creative conditions on portfolio companies. Firstly, in terms of due diligence, all potential targets must prepare their accounting records to GAAP standards and complete a rigorous audit conduct by a Big Five firm. In addition, Quadriga solicits the services of premium international legal and consulting firms, such as Baker & McKenzie and the Intermatrix Group, to review the target company’s chosen development strategy. At the time of investment, the target company must also be entirely debt free. Quadriga pays special attention to formally outlining and agreeing to potential exit strategies at the outset of a given portfolio investment. Specific terms include set deadlines upon which Quadriga may sell its shares back to the portfolio company at a price to be determined by Quadriga at the time of offer. If the portfolio company does not accept Quadriga’s offer within three months, Quadriga will then have the right to purchase the controlling packet of shares in the portfolio company at the same stated price. Under this scenario, Quadriga would then aggressively market the business to a strategic investor. Initial public offerings are addressed in Quadriga’s contractual agreements with portfolio companies, with substantial voting rights allocated to Quadriga should such an option be pursued. Although Quadriga is a minority shareholder in its investments, it demands blocking voter rights for all financial and operational transactions of significance and board representation. Perhaps most importantly, Quadriga takes a hands-on approach to managing its investments and plays a central role in monitoring the financial health of these companies on a monthly basis.

Case study: Nizhpharm [37]

A clear example of the attractive portfolio companies that Quadriga has compiled to date is its investment in the Nizhny Novgorod company, Nizhpharm. This 75-year-old pharmaceutical factory is one of Russia’s main manufacturers of pills, ointments, and suppositories. In 1994, Nizhpharm was privatized and a young entrepreneur, Mr. Andrei Mladentsev, succeeded in securing a controlling interest in this enterprise. In short order he restructured the firm and terminated its previous management. Over the next four years, with the help of international legal, accounting and consulting firms, Mr. Mladentsev rebuilt the factory’s business and operational strategies and cultivated a more attractive network of suppliers and customers. Sales followed a steady 50% growth rate during this period and gross margins improved by over 40%. Nevertheless, Nizhpharm required a significant capital injection to continue its remarkable growth rate. Equipment and manufacturing line overhauls had become Nizhpharm’s main limiting factors to growth. Nizhpharm was unsuccessful in obtaining a long-term loan at acceptable lending rates, and retained earnings and cash flow, while relatively strong, would not be sufficient to finance this phase of the factory’s development. Nizhpharm, therefore, decided to look to foreign investors for the capital required and found Quadriga.

In 1998, Quadriga invested $10 million in Nizhpharm and received 25% of the company’s stock and two seats on its eight-member board of directors in return. Quadriga’s management viewed this investment as particularly attractive for several reasons. Firstly, Nizhpharm’s management team was young, aggressive, and well attuned to Western business practices. This latter point was clearly illustrated by Nizhpharm’s mandate of incorporating the business recommendation it had received from international consulting firms, its progressive policy on reporting accounting results in both Russian and GAAP formats, and its reliance on Baker & McKenzie for legal counsel. Furthermore, Nizhpharm had developed a strategy that would lead to sustainable competitive advantage on the domestic market because its costs were significantly lower than imported products. By revamping a major portion of its production facilities, Nizhpharm would narrow the quality gap in its products with Western competitors to essentially zero.

Quadriga’s investment provided Nizhpharm with distinct benefits beyond a simple capital infusion. Because Nizhpharm, as pharmaceutical manufacturer, is exempt from import VAT, Quadriga structured the vast majority of its $10 million investment in the form of imported manufacturing equipment. Had Nizhpharm taken cash and then purchased this same equipment already on the Russian market, it would have faced an immediate 20% mark-up on these same pieces of equipment. Furthermore, Quadriga has played an instrumental role in further aligning the business and sourcing talented professionals to fill out Nizhpharm’s management team. Lastly, the political goodwill Quadriga has been able to transfer to Nizhpharm because of EBRD’s ties to this deal have assisted the plant in avoiding a number of clashes with regional and federal agencies.

It should be noted that the opportunity for strong returns both Quadriga and EBRD recognized in Nizhpharm was strong enough to compel them to break with their standard policy of a maximum $3 million investment. Although Quadriga is still at least three years away from any planned exit strategies, this decision seems to have been well made. Several multinational pharmaceutical companies have already expressed great interest in acquiring Nizhpharm. Valuations, based on current cash flow projections, could also put Nizhpharm in a position for an initial public offering of $250 million by 2003. Time and the liquidity of the Russian public markets will dictate the exit path Quadriga eventually pursues, but achieving a 35% IRR is well within the realm of reason.

The Real Estate Market in Russia

The real estate market in Russia can be interpreted through a number of issues. While investments in property are secure in many markets and constitute a major portion of most company’s assets, the market and regulations in Russia make property investments challenging and risky in nature. The Russian Constitution and Civil Code now uphold the right to own private property, however reform of these laws continue to be the subject of national debate. Therefore real estate investments may prove to create additional risks through the possibility of future reform.

The rules and regulation vary by region. For example, in Moscow a lessee must pay for the right to lease any land in excess of the area of an existing building. In St. Petersburg, the level of rent is determined by the office of the governor for state issued leases.[38] These levels differ by the location of the site and also by the intended type of activity of the lessee. Private leases in St. Petersburg are negotiated in a manner similar to the system used in many western countries. In general, the longest non-industrial lease will run a maximum of 5 years. This reduced length is caused by the uncertainty in regulations and valuations.

With respect to the ownership of land, the Russian Civil Code states that only a federal law can establish land ownership. While there is no Land Code in Russia, ownership in some cases has been granted. When a foreign investor attempts to purchase land, they are usually required to take a lease on the land.

With respect to the ownership of buildings, any foreign entity or individual may own buildings in the Russian Federation. While these entities may not own the right to the land underneath the building, they have the right to possess, use, and dispose of the property at their discretion. Types of building classification are basically residential or non-residential. While construction rights require state permits, the restrictions are reasonable compared to Western standards.

On July 22^nd, 1998, Russia established a law on mortgages that significantly improved the value of a mortgage as a valid instrument for creditors in securing their investment. Almost all types of property are eligible for a mortgage. In order to validate a mortgage, the agreement must be registered with state authorities and certified by a Russian notary.

While many of the improvements made in recent years have helped establish a system that will enable increased real estate investment, the inevitable future revision of the system make investment returns uncertain. Any firm investing in or purchasing real estate in Russia must consider the regulations in the region and consider the risk to reward tradeoff.

The Jensen Group [39]

The Jensen Group is an excellent example of a firm in the midst of regulatory issues and fluctuations in the real estate market in Russia. Located in St. Petersburg, The Jensen Group is made up of 22 employees and currently owns approximately $15 million in real estate property. The Company was created in a similar fashion to a private equity firm in that they accept private investments from individuals to invest into a fund, which in turn invests in properties in St. Petersburg. Steven Wayne, the founder of Jensen group, was an investment banker in Moscow since 1992. He realized an opportunity to enter the real estate market in St. Petersburg and had the right contacts and entrepreneurial vision to form a new venture. It was evident to him that many westerners had begun entering St. Petersburg as the business atmosphere became energized in the mid-nineties and lacked sufficient commercial and residential space.

Jensen’s investments are typically split 50% in residential and 50% in commercial property. When they were created in 1994, the real estate market in Russia was in a boom state and profits on rehabs and leasings to western companies and expatriates were lucrative and opportunity seemed endless. All tenants have been westerners with the exception of retail tenants. In the first few years the Jensen Group created a strategy of purchasing buildings in established neighborhoods of St. Petersburg, renovating and updating the properties to western standards, and leasing the buildings primarily to foreigners doing business in St. Petersburg.

In building a business in a developing capital market, Jensen found that the most effective way to gain control of property without government interference was to obtain a GBR certification on a building. The GBR, a state issued certificate of ownership, along with a Russian notary gave Jensen enough security in ownership to move forward with renovations. After the devaluation of the ruble in 1998, the market collapsed and margins tightened. One the positive side, real estate ownership and value deflated less than that of other capital markets and even worse, the collapse of Russian banks.

The Jensen Group continues to investigate new opportunities and to maintain their current properties but has experienced limited returns on investments as of the past two years. This is due to the devaluation of their real estate assets as those assets value has followed the slowing of the economy. They have targeted an IRR of 30% and hope to double in size every few years. While Jensen met these goals through the mid-nineties, they have had difficulty doing so after 1998 because of the uncertainties and the cautious nature of their investors.

While the future of the real estate market in Russia is uncertain, Jensen Group has invested in other areas such as software maintenance and consulting. As the real estate market has slowed, Jensen has used the additional time and resources to create a group of highly talented software professionals. This new direction signifies not only the uncertainty in the real estate market but also the optimism of new business ventures in Russia. The real estate market in Russia has many outstanding opportunities with obstacles of every variety.

“The real estate market in Russia is not a result of the relationship between the supply and the demand, but mainly is an outcome of the government policy”.[40]

Current trends and dispelling common opinion

As our two case studies illustrate, significant opportunities exist today for private equity investing in Russia. At present, Russia does not fit the traditional template that investment funds are accustomed to seeing. Nevertheless, Quadriga and the Jensen Group have found manageable solutions to the challenges this young market presents and are positioned to garner substantial returns. A number of other firms have recently begun to look seriously at investing in Russia for these same reasons. Indeed, by the end of 2000 it was estimated that just over $2 billion dollars have been raised for private equity investing in Russia – an increase of over 30% from 1999.[41] While no accurate data currently exists on the exact breakdown of private equity investments in Russia by sector, EBRD’s portfolio profile arguably illustrates the overall trend for investing, in that the vast majority of active funds rely on EBRD for some portion of capital.

Exhibit 3.2: EBRD private equity investment portfolio by industry as of June 2000[42]

Already in 2001, several funds have demonstrated their commitment to developing this market and a new and more bullish attitude is being promoted in direct contrast to established investor opinion. Many predict the number of dollars committed to Russian private equity investing to continue to grow at a steady pace, with the majority of attention now being placed on developing the Russian technology sector, as Quadriga is now gearing up to target. Much of this newly found investment optimism must be attributed to the relative stability of the Russian economy and the progress many private equity shops have made on the learning curve of conducting business in Russia.

“To date, especially after the August 1998 meltdown of the Russian economy, we’ve had effective demand for capital. After the devaluation of the rouble, that cleared the decks. It brought values into focus . . . As the economy itself was getting sorted out, you figured out how the formula for private equity could be used in that economy. Now we have that formula.”[43]

Given the recent focus of worldwide investors on Technology, Telecom, and Media (TMT), the software market is currently an attractive buy, specifically because low start-up costs and the rapid rise in revenues suggest a fairly rapid break-even. As Alexander Andreev, a technology analyst at Brunswick UBS Warburg in Moscow, points out, “software is one of the most attractive sectors in Russia because its growth is not limited to the domestic market.”[44] For example, the American Insurance Group of the US and Central European Trust, a UK-based investment boutique, that launched Excell Communications this year a fund aimed at investing up to $100 million dollars in internet business,[45], is bullish on the TMT in Russia.

Most of the private equity companies in Russia would invest under majority stake condition only (51% of the voting shares or more) due to corporate governance problems and control issues that are often difficult to attain in heavily monopolized and closely held infrastructure and natural resource industries. As a result, domestic funds such as the Sputnik Group are focusing their portfolio investments on the insurance, technology, shipping, and forestry companies.[46] Likewise, the new Delta Russia Fund plans to use its $150 million fund to invest in TMT and consumer product companies.[47] With the Russian consumer market becoming more powerful and focused towards new convenience and specialty goods, there are great opportunities available for a quick turnaround. Some investors are focused on the consumer products and other traditional industries.

Russia currently presents a tremendous private equity opportunity because almost all industrial enterprises are significantly under-priced as indicated by several analysts, with no apparent financial resources to take use of this chance. If the assumption is made that Russian economy will strengthen in the next three to five years, then direct investment today can generate a significant return tomorrow. Even now, almost all domestically oriented consumer industries (food processing/packaging, pharmaceuticals/healthcare) have become less dependent on exports.

In support of traditional investing in Russia Kurt Geiger, head of financial institutions at the EBRD, stated ”there is a renewed interest globally in traditional industries.”[48] Hence it is not a surprise to see EBRD directing its funds primarily towards companies with a domestic market focusing on consumer needs with food and food related companies.[49] However, the Bank’s “key areas of growth are the automobile, chemical, metallurgical and agribusiness industries, large companies in the natural resource sector, and Russian high-tech companies.”[50]

A recently founded Baring Vostok Capital Partners fund, a third-party private equity arm of ING Asset Management, has a capitalization of approximately $200 million invested in oil and gas, telecommunications, forestry, consumer products and information technology companies.[51] Having taken Vimpelcom, GS, and Golden Telecom, three Russian telecom companies, public on NASDAQ, Baring Vostok has seen good returns in the telecommunications sector. Baring Vostok is also attracted by oil, gas and forestry companies, as they are relatively easy to compare with similar companies in other emerging markets and there is no shortage of trade or financial buyers for them.

With the overall attractiveness of the Russian market it is not a surprise that larger funds are not afraid to diversify into industries such as oil - an industry that has been criticized for not honoring minority shareholder rights, barring tremendous corporate governance risk. For example, the AIG-Brunswick Millenium Fund, a consortium between AIG and Brunswick UBS Warburg, is a $290 million fund that is developing a diversified portfolio that includes investments into several sectors including: telecommunications, oil and gas, technology and services, retail, and consumer goods.[52]

Although returns may greatly vary in Russia, it is a market that has recently outperformed all emerging markets in the growth of the public equity market. Nevertheless, private equity investing in Russia is not for the faint-hearted. It is obvious that a number of honest firms have been created within the last five to ten years with the best of intensions, being to make money, but abide by the law. Based on the current state of the Russian legal system, to be successful in this market requires a tremendous amount of business acumen and general good luck. While some of the firms we visited implied returns in excess of 500% on selected investments, it was noted by all that a sound management team and business plan are only the first step in a successful business venture.

In contrast to public equity or debt financing, private equity has the advantage of taking a hands-on role in the development of portfolio companies. By taking an active role in an investment or actually sitting on the board, these firms have the ability to make decisions and act as an internal consultant in the firms they invest in. This strategy also gives a private equity firm a better understanding of what is happening with their investment to help identify when an early exit strategy is warranted. The returns that competent private equity specialists may reap through actively guiding their portfolio companies are substantial. Although there may still be some truth to Derzhavin’s characterization of Russians, both Quadriga and the Jensen Group illustrate in clear terms that there is a wealth of opportunities and sound partners available today in Russia. Therefore, the more sophisticated private equity investors would be better served by pursuing these opportunities while also subscribing to Peter the Great’s management philosophy: - Dovyeryat no provyeryat – Trust but check.

Conclusions____________________________________________________________________________

The state of the current Russian economy can be compared to that of the US economy in the post-depression era, with the inclusion of technology and education. While the devaluation of the ruble illustrates an enormous setback, downturns are necessary in the growth of an economy and education in governance policy. It is very clear, only three years after the crisis, that capital markets and other industries have remained through turns in the economic cycle. A great deal of this loyalty is based on a love of the Russian culture and way of life. As noted by many of our speakers, this lifestyle can be hard on a foreigner and therefore they must have the drive and enthusiasm to live and thrive in Russia.

Opportunities are plentiful but only with the right tools, contacts, and luck a firm will accomplish spectacular financial results. While many of the firms visited had grand visions regarding their future, only a handful made successful exits of their investments. Very few have made substantial profits post-crisis, but many seem very optimistic speculating the coming decade. Firms that have been and will continue to be successful employ intelligent hard working individuals who understand the Russian way of doing business and believe in and can create their own future.

In each case studied, contacts play a primary role in business success. A firm must understand the business climate in the region they are doing business. They also need government support, which is difficult without a high ranking official looking out for their interests. The background of such contacts is important in that business contacts cannot be affiliated in any way with the mafia. Firms in the capital markets sector will not tolerate illegal activity and therefore will not associate with a known member of the Russian mafia.

Provided a firm is able to assemble an intelligent, strong management team and gain the contacts necessary in the line of business practiced, the possibility of success is increased, but the future of the firm is also contingent on luck. As the market economy evolves, Russian law and regulations are constantly up for review and inevitable revision. The possibility of making or loosing meaningful profits in the capital markets is strong in an economy that is changing at such a rapid pace. A firm must maintain an understanding of the changing environment and be prepared to avoid pitfalls and take advantage as opportunities arise.

The Russian capital market environment has now experienced the first full cycle of boom and bust. The rebound can be attributed to Russian’s will to thrive, and their ability to leverage the support from foreign investors. The progression of the capital markets in Russia is inevitable, and the only question outstanding is who will secure the leading position, and who will be destroyed through the process.

Appendix 1: Interview Notes_____________________________________________________________

Alfa Bank

Interviewer:	Jim Argalas, Michael Chookaszian, Michael Teplitsky, Dmitriy Veremeyev
Interviewee:	Andrew Taneyev, Director Promissory Notes, Alfa Bank
Date:	March 14, 2001
Subject:	Promissory Note Market

Andrew Taneyev is the director of Promissory Notes operations at Alfa-Bank. There his responsibilities include managing Alfa-Banks outstanding promissory note operations (settlement, issuance, repurchase). He was previously a trader of promissory notes at a trading firm.

Promissory notes, also called Veksels, are, along with equities, the only legally pre-registered securities in Russia.

Term:	1 month – 2½ years. Majority approximately ½ year.
Coupon:	Zero Coupon
Discount:	5-10%
Typical size:	Various
Settlement:	Physical cash settlement
Registration/type:	Bearer bond
Exchange:	OTC
Pricing:	www.megasoft.ru
Yield	Banks – 30% Speculative Traders – 100%

Issuers & Uses

The notes are used to finance working capital requirements and are often used by issuers as payment to suppliers. In a typical transaction, the issuer will pay for supplier services by giving the supplier payment in Veksels. The supplier will then redeem the Veksel by selling it to a bank. Typically, the note will be discounted as follows:

Issuer (Face): 100

Supplier – Bank: 90-95

Veksels are used for several reasons. First, they overcome the lack of a sufficiently large monetary base. Second, they allow the issuing firm to minimize taxes.

Gazprom is the largest issuer of Veksels with 50-70% of the total outstanding market face value of Veksels. Major issuers include large Russian conglomerates and banks.

The total market size of outstanding Veksels has grown significantly over the last 5 years from approximately US$ 200 million to US$ 2.0-5.0 billion.

Liquidity & Market Making

Once in circulation, the bank will trade the Veksel with other banks and speculative trading firms. There is no formal exchange for Veksels, however Andrew likened the market to the US High Yield market. Pricing is available through an informal Internet reference pricing system, www.megasoft.ru. However, the pricing is often out-of-date, and is non-binding. Major participants in the trading of Veksels include Alfa, Menatep, Sberbank, and others. Average weekly trading volume is approximately US$ 20 million/week (although Andrew said the annual volume was US$1.0 billion/year earlier in the conversation). CSFB has also taken a relatively large stake in Veksels. Typical trading companies will have a portfolio of US$10-15 million.

Troika Dialog

Interviewer:	Jim Argalas, Michael Chookaszian, Brett Duffy, Michael Teplitsky, Dmitriy Veremeyev
Interviewee:	Sergey Sidorov, VP Fixed Income, Troika Dialog
Date:	March 14, 2001
Subject:	Domestic Fixed Income (Promissory Notes, Corporate Debt)

Sergey Sidorov runs the fixed income operations at Troika Dialog, a prominent Russian investment bank. Previously he was at Deutsche Bank focusing on the sales and trading side of fixed income instruments.

Sovereign Fixed Income Market – GKO/OFZ

The following table summarizes the characteristics of the RUB denominated domestic sovereign debt:

Market Size	RUB 250 Billion (USD 9-10 Billion) face value outstanding
Daily Trading Volume	RUB 0.5 Billion
Maturity	Minimum: 2-3 months Maximum: 2-3 years
Coupon	10% – 25%
YTM	Beginning 2000 – 70% Today 20-22%, as low as 17%
Exchange	MICEX
Settlement	T+1

No immediate plans for new issuance

Currently trading at capacity

No possibility for shorting

Negative carry situation today driven by large liquidity in domestic banks (because of high oil prices), lack of fixed income instruments to invest in, full loan exposure limits

Sterilization hard to accomplish because of lack of financial instruments

Veksels

In our brief discussion regarding Veksels, Sergy felt strongly that the market was not a focus for Troika because of a lack of infrastructure, physical settlement (possibility for forgery), and looseness of the product. However, he did support our previous discussion in that the main issuers included Oil & Gas (Gazprom), Financial Institutions (Sberbank) and energy companies. In addition, he also mentioned that the governing law for Veksels was international (Geneva) law. He also estimated that they currently yield 500 basis points over the OFZ market.

Corporate Debt – “Business A la Russia”

A corporate debt market is developing due to several factors: First, the government ruble dominated bond (GKO/OFZ) yields are being squeezed[53] to the point where they sometimes trade at a negative carry. Second, larger industrials, in particular in the energy sector, are trying to build a public credit history. Finally, some companies actually need capital to build out their business plans (telecommunications firms) or repay foreign currency denominated debt.

Potential new issuers include oil (Sibneft), telecommunications, Agribusinesses (AGROs), Food Processing (Baltica Beer, Aeroflot), Telecommunications (MGTS) and Financial Institutions (VneshTorgBank, MDM-bank). Issuers are plagued with several problems. Issuers are plagued with several problems. First, each issuer is required to pay 0.8% of face value to the Russian SEC. Second, the market is still young. Sergey estimates that the total market size is about RUB 25-30 billion today, with the potential to grow to RUB 250 billion in 3 years.

Investors are primarily domestic financial institutions: insurance companies, banks, and pension funds.

Because the market is relatively new, pricing is still being developed. However, Sergey estimates that Siberneft will issue at the OFZ rate + 200 basis points. He cautioned against using the recent TNK/Siberneft bonds placed at a 10% yield, when market conditions would have required a 70% yield. The bonds were placed to expatriate RUBs through s-accounts. Sergey estimated that 5%-10% of dollar mass in Russia is held in s-accounts. Currently, an offshore market is as large as the pre-crisis domestic market.

Loan Market

Because of the failure of Russian banks during the crisis, very few banks are left today, diminishing the level of competition between banks[54].

Municipal Domestic Bonds

Several municipalities have issued both USD and RUB denominated bonds. However, Sergey believes that only the St. Petersburg and Moscow municipals are relevant today. St. Petersburg is issuing RUB denominated debt to buy back its USD denominated eurobonds. It is not having very man y difficulties doing this because it has an exemplary credit history (never defaulted on its debt). Moscow on the other hand, is viewed as being more risky. In general however, they seem to be viewed as less risky than corporates, have little secondary liquidity, and are taxed the same as corporates.

New Developments

· Rating Agencies: ANE Rating and S&P have signed a strategic alliance to develop a domestic rating system. Sergey believes that S&P will eventually buy out its partner and develop a rating agency specific to Russia that will help differentiate domestic credits (instead of everyone being CCC- under the current S&P system, they will use relative ratings within Russia).

· Development of swap market: Deutsche Bank & CSFB currently have a 6-8% implied USD/RUB swap rate

· Arrangers are willing to reduce fees (approx 1%) for increased yields (bonds are being held, rather than sold down)

Players

· Brokerages – Troika Dialog

· Purchasers - Russian Commercial Banks

· Arrangers – Deutsch, CSFB, Chase, ING, Credit Lyonais

Equity Markets

· Market capitalization of $50 Billion.

· Daily turnover: $5-15 Million.

· Private investors through offshore accounts are among the major players

· Short-term driven

· Institutional investors (pension funds, insurance companies) are still inactive

· Corporate governance is #1 problem. Some exceptions include UKOS (Oil&Gas), SeverStal (steel), Golden Telecom. The companies not plagued by the problem are traded at a premium.

EBRD Moscow

Interviewer:	Jim Argalas, Michael Chookaszian, Michael Teplitsky, Dmitriy Veremeyev
Interviewee:	Dragica Philipovic-Chaffey, Director, Russia Team, EBRD
Date:	March 16, 2001
Subject:	Capital Markets - General

EBRD Background

Dragica is the director of the EBRD’s Russia team in Moscow. We met with her and her PR associate. The EBRD is a development bank owned by western governments that makes investments in the emerging European economies in order to promote the development of free markets. Over 25% of the EBRD’s portfolio is in Russia, with 15% of that portfolio in private assets. It has an ongoing commitment of approximately EUR 3.4 billion to invest in Russia over the next few years.

Private Equity

Background

The EBRD has 10 private equity funds through its Regional Venture Funds (RVF) program. They focus on promoting industries where import substitution is possible (food processing would be an example of this type of investment). Each RVF has a maximum investment size of approximately USD 5 million, although they can co-invest with other RVFs. The EBRD, as an institution will also make equity investments, buy focuses on larger transactions.

Investment issues

Corporate Governance – S&P recently developed a new product that reports on corporate governance issues in Russia. The EBRD will often ask a company to work with S&P as a pre-requisite to investment.

Credit Risk - TBD

History

The RVFs were originally formed to restructure old Soviet enterprises. They were managed by foreigners, depending on donor source (i.e. if the grant came from Germany, then the managers were German). The Crisis put most of the RVFs in a work-out framework. Post crisis, the number of RVF management companies was reduced.

Project Finance

· GM-AvtoVaz: EBRD co-invested in the GM-Avtovaz JV, with a USD 40 million equity stake, and a USD 100 million syndicated loan. GM invested a significant amount of cash, and Avtovaz invested approximately USD 100 million “sweat” equity.

· Rocket Company: The EBRD is investing in a rocket launching company. The deal has not been finalized, but it would include a loan of approximately USD 10 million from the International Moscow bank for a 3 year term and an EBRD loan of 70 million with a term of 7 years.

General

· Monsenergo is trying to issue RUB bonds to buy-back its eurobond issue.

· “Russian market has added value in growth, has negative value in execution.”

· Good plans get funded

· Sberbank has large amounts of cash that needs to be invested

· Severstahl

· 100% Russian owned

· Pre-export financing (working capital loan)

· 80% export focused

Brunswick UBS Warburg

Interviewer:	Jim Argalas, Dmitriy Veremeyev, Michael Teplitsky
Interviewee:	Loren Bough, Director, Brunswick UBS Warburg
Date:	March 16, 2001
Subject:	Capital Markets - General

Fixed Income Background

Pre-crisis:

· Most fixed income instruments had maturities of 2-3 years.

· Regions and smaller corporate borrowers had access to Ruble denominated debt markets.

Post-crisis:

· Most, if not all Ruble denominated debt that was issued pre-crisis has failed and is currently trading at default rates of ~5%.

· As a result of the crisis, international interest in Russian corporates has dried up.

· There is interest in oil producers, but they currently have excess cash and do not need to issue for financial reasons.

Triggers for renewed interest in corporate debt issuance

· Decline in oil and mineral prices

· More investor comfort with smaller corporate borrowers

· Negative real yields on government bonds (GKOs)

Fixed Income Issuers

If a combination of those events occurs, investors in Ruble denominated corporate debt would in clued Russian insurance companies, pension funds, and banks.

Order of new issuers of corporate debt:

· Firms that have significant export earnings (e.g. oil companies, mining companies)

· Large market capitalization companies (e.g. utilities, telecoms, nationally recognized companies)

· Smaller market capitalization companies (if ever)

UBS strategy for development of corporate bond market

· UBS plans to get 20% of new issue market

· The market will not develop for at least 12-18 months

· Foreigners are not planning to enter the market due to low volumes and margins

· Development will be led by Russian banks because they will arrange new issues and will invest their holdings in the new issues

· Currently, new issues are held by arrangers as if they were bank loans

Currency Outlook

· Foreign exchange market needs to develop with longer time positions

· Currently, high volatility makes pricing uncompetitive

· Lack of domestic investor base leads to volatility

Sovereign Debt Comments

· Ability of Russia to repay Paris Club debt depends on oil prices:

· 18-20 US$/bbl Urals price breakeven

· Lower oil prices will lead to potential rescheduling, loans will not be forgiven

· US$ Eurobonds will be repaid

Major players

· Foreign: UBS, CSFB, MSDW, Salomon, Merrill Lynch

· Russian: Troika, ATON, UFG, Renaissance, Alfa

Yield YTD 2000-2001

· Fixed Income: 50-60%

· Equities: 20-25%

Sputnik Group

Interviewer:	Jim Argalas, Brett Duffy, Dmitriy Veremeyev, Michael Teplitsky, Michael Chookaszian
Interviewee:	Sergei Riabtsov, Director, Sputnik Group
Date:	March 20, 2001
Subject:	Private Equity

Background

The Sputnik group has separated from Interros, a large Russian banking and industry holding. It raised approximately US$ 1.0 billion in commitments before the 1998 crisis. After the crisis, US$400 million in commitments were not enforced and the companies that the fund had invested in were revalued.

The group does not have a sector focus and has invested, as of the second half of 2000, in insurance, technology, shipping, and forestry companies. In addition to the Russia focus, it has established a technology investment arm in London, www.inventures-europe.com as a result of a merger with an East-coast consulting company. Sputnik owns a controlling stake in Inventures-Europe.

Russia Experience

· Sputnik has over almost 10 year of experience in Russia, including its independent arms-length relationship with investment bank Renaissance Capital.

· It has significant relationships with high-level government personnel and considers itself “plugged-in” to the Russian business-government relations.

· It has an active board that is included all investment decisions.

Investments

Sputnik currently has 8-12 investments in its portfolio, with 4 exits to date. Investments include KievStar (a leading Ukranian cellular company), Europa-plus (a leading radio station), Afisha (an entertainment magazine), a packaged products software company ($1-5M investment). Exits include SvyazInvest (a major telecommunications company in Russia), Sidanko (Oil&Gas), BeeLine (Russian cellular company). Sputnik has $300-400M of assets under management.

Funding

Sources of funds for Sputnik:

· Soros

· Harvard Endowment

· Other

The Sputnik group plans to start raising the next fund this year, with a target of $200-250M in commitments. The next fund will be most probably either technology-focused or a “blind” pool.

Investment Criteria

· Primarily MBO/LBO transaction model.

· $1-10M entry price for the early stage investments, which can go higher when making a mature investment with 5-6 other companies co-investing.

· Significant controlling ownership stake (51%, sometimes blocking minority holding)

· Most difficult elements of transaction include handling “front-office” issues: replacing CEO, CFOs. Will often install Sputnik personnel in those positions.

· In-house legal, IT departments support investment team.

· Investment size ranges from US$ 1-50 million depending on stage of investment (early/late stage)

· No specific target sector: Currently insurance, technology, software, media, shipping, and forestry are the focus industries. Sputnik has expressed its pessimism about Internet sector in Russia, giving lack of demand as main concern.

Financials

· The fund targets 50% returns, US$ terms.

· The compensation structure is close to the industry and is estimated at 2% management fee and 20% carried interest (over a certain hurdle rate).

Use of Leverage in Transactions

· US$ loans available from ING, UBS. Not common, unless very large transactions with large corporates

· RUB loans available from Russian banks. Available for shorter terms only (less than 2 years).

Exit Methodology

· Has made 4 successful exits, all of them have been M&A/trade sales. Sees this method of exiting as most probable. IPOs is not a viable opportunity due to lack of demand for public equity stakes in Russian companies. Sputnik estimates there’ll be at most 5 such exits on the market in the next 5 years, all traded on Western exchanges.

· Is currently pursuing an IPO for KievStar.

Plans

· Fund should be closed by 2004, with all exits complete

· Start raising the next fund in 2001; target size: $200-250M.

· Development of own M&A advisory business.

Competition

· Baring Vostok

· AIG Warburg

· Delta

· TPG Aurora

· Private Russian investors

The Jensen Group

Interviewer:	Jim Argalas, Michael Chookaszian, Brett Duffy
Interviewee:	Kelly Rivers, Managing Director and Vice President, The Jensen Group
Date:	March 23, 2001
Subject:	Real Estate Market in St. Petersburg and the Russian Federation

Background

Steven Wayne had been an investment banker whom dealt with many foreign clients out of New York, but had an interest to move into Russia with an entrepreneurial venture. He moved to Moscow and continued to work with clients abroad from 1992 – 1994 when he realized an opportunity for a real estate venture in St. Petersburg. He had a significant number of investors from his previous life to build a strong fund with the ability to purchase buildings in upscale, westernized neighborhoods.

Pre-crisis:

· Real Estate market is booming and prices continue to rise

· Jensen builds number of properties from 2 – 10 in a few years

· Renovate and lease properties with strong financial rewards

Post-crisis:

· Real Estate market collapses following other financial instruments

· Value of Jensen properties decline and many tenants non-renew or in some cases break leases due to decrease in business

· Most Jensen investors choose to sit tight on their investment with the expectation that the market will rebound.

Triggers for renewed interest the real estate market

· Decline in prices after crisis has created demand

· New mortgage issuers and laws have increased private purchases

· Many untapped opportunities in other locations throughout the Russian Federation

General

· Has targeted IRR of 30% & plans to double in size every 3-4 years

· Properties split 50% Residential, 50% Commercial

· GBR certificate – government issued ownership deed. GBR is the most secure method of finalizing ownership and all legal rights

· All western tenants with the exception of retail

· Condo possibilities, many wealthy individuals with cash (many possibly mafia)

· 22 current employees. Have increased systems staff over the past year – possibility of future consulting business as spin off

Appendix 2: Bibliography_______________________________________________________________

Bloomberg Financial Systems: Fixed Income Data Referenced.

“Control Key to Investing in Russia,” Rueters, February 12, 2001.

“Doing Business in Russia,” Baker & McKenzie, Moscow and St. Petersburg, April 2000.

“Economic Situation and Investment Climate in Russia,” American Chamber of Commerce, prepared 2001.

“Finance for SMEs,” EBRD, Autumn 2000.

“Forecast: Real Estate Market in Russia 2001,” Simeon Mitropolitski, International Real Estate Digest, January 2001.

“Forging Ahead,” The Wall Street Journal, November 29, 1999.

“INTERNATIONAL CAPITAL MARKETS: Stable Rouble encourages debt market 10m-100m OFFERINGS EXPECTED”: Financial Times; Mar 30, 2001, Robert Cottrell.

Interview Notes, Alfa Bank, Andrew Taneyev, Director Veksel Operations, Moscow, March 14, 2000.

Interview Notes, EBRD, Dragica Philipovic-Chaffey, Director, Russia Team, Moscow, March 16, 2001.

Interview Notes, Sputnik Group, Sergei Riabtsov, Director, March 20, 2001.

Interview Notes, The Jensen Group, Kelly Rivers, Managing Director, March 23, 2001.

Interview Notes, Troika Dialog, Sergei Sidorov, Vice President, Fixed Income, Moscow, March 14, 2001.

Interview Notes, UBS, Loren Bough, Director, Moscow, March 16, 2001.

“Legal Structure of Venture Capital Investment in the Russian Federation,” Baker & McKenzie, prepared 2000.

Letter of Intent between JSC “Nizhpharm” and Quadriga Capital Russia GmbH & Co. KG, July 24, 1998.

Nizhpharm 1999 Annual Report.

“Private Equity,” The 1999 Guide to Russia Supplement, Euromoney, September 1999.

“Rubles From the Rubble,” The Washington Post, July 18, 1999.

Russian Equity Guide 2000/2001, Brunswick UBS Warburg, Ben Carey, UBS, Moscow, 2000.

Russian Venture Capital Association White Paper and Working Documents, prepared April 2000.

“S&P Test Flies Governance Rating on Aeroflot,” St. Petersburg Times, March 22, 2001.

“Selling Land in Russia is Like Selling Your Soul,” by Simeon Mitropolitski, International Real Estate Digest, October 2000.

“Strategy for the Russian Federation,” EBRD, prepared October 2000.

“Understanding Barter in Russia,” European Bank for Reconstruction and Development, Simon Commander, Christian Mumssen, EBRD Press, London, December 1998.

“Venture Capital in Russia,” Russian Venture Capital Association, prepared 2000.

“Venture Fund Targets Russia,” The Financial Times, January 28, 2001.

“Wild East Attracts Respectable Interest,” The Financial Times, December 1, 2000.

Zenit Bank Investment Monitor, Moscow, March 30, 2001.

[3] Loren Bough, Director, Brunswick UBS Warburg

[4] RTS; CSFB; OETOB; Moscow Times; IFC; MSCI; Brunswick UBS Warburg estimates; AK&M

[7] Sergey Sidorov, VP Fixed Income, Troika Dialog

[9] AK&M; Loren Bough, Director, Brunswick UBS Warburg

[10] Sergey Sidorov, VP Fixed Income, Troika Dialog

[12] “Understanding Barter in Russia,” European Bank for Reconstruction and Development, Simon Commander, Christian Mumssen, December 1998, page 3.

[13] Russian Equity Guide 2000/2001, Brunswick UBS Warburg, Ben Carey, 2000, page 21.

[14] Interview Notes, Alfa Bank, Andrew Taneyev, Moscow, March 14, 2001.

[16] Interview Notes, Troika Dialog, Sergei Sidorov, Vice President, Fixed Income, Moscow, March 14, 2001.

[17] Average speculative Veksel fund size was estimated to be approximately US$10-20 million.

[18] Zenit Bank, Investment Monitor, March 30, 2001, page 7.

[19] Hard currency issues are normally USD, Euro, or Euro-derivative denominated.

[20] “INTERNATIONAL CAPITAL MARKETS: Stable Rouble encourages debt market 10m-100m OFFERINGS EXPECTED”: Financial Times; Mar 30, 2001, Robert Cottrell

[21] Interview Notes, Troika Dialog, Sergei Sidorov, Vice President, Fixed Income, Moscow, March 14, 2001.

[24] “INTERNATIONAL CAPITAL MARKETS: Stable Rouble encourages debt market Dollars 10m-100m offerings expected”: Financial Times; Mar 30, 2001, Robert Cottrell

[25] Interview Notes, Troika Dialog, Sergei Sidorov, Vice President, Fixed Income, Moscow, March 14, 2001.

[26] “S&P Test Flies Governance Rating on Aeroflot,” St. Petersburg Times, March 22, 2001.

[27] This is a function of smaller deal size, large domestic retail presence. Most Russian banks have a larger presence domestically and do not have the overhead foreign banks must carry.

[28] EBRD “Strategy for the Russian Federation,” prepared October, 2000 and Russian Venture Capital Association White Paper, prepared April, 2000.

[29] American Chamber of Commerce “Economic Situation and Investment Climate in Russia,” prepared 2001.

[30] Based on comments from Mr. Jim Hitch, Managing Partner, Baker & McKenzie, St. Petersburg, Russia, March 21, 2001.

[31] Ms. Joanna James, managing director of central European operations for Advent International, as quoted in The Financial Times, December 1, 2000.

[32] Based on comments from Mr. Eivind Djupedal, member of the board of directors, American Chamber of Commerce, Moscow, Russia, March 16, 2001.

[33] Russian Venture Capital Association, “Venture Capital in Russia,” prepared 2000.

[34] Based on comments made by Mr. Sergei Sidorov, Vice-President Fixed Income, Troika Dialog, Moscow, Russia, March 14, 2001.

[35] Based on comments made by Mr. Eugene Jaffe, Director Corporate Finance, Alpha Bank, Moscow, Russia, March 14, 2001.

[36] Based on comments and materials provided by Mr. Kendrick White, Managing Director, Quadriga Capital Russia GmbH & Co KG, Nizhny Novgorod, Russia, March 22, 2001.

[38] Based on comments and materials provided by Mr. James T. Hitch, III, Managing Partner, Baker & McKenzie, Bolshaya Morskaya, 57 190000 St. Petersburg, Russia, March 23, 2001.

[39] Based on comments made by Mr. Kelly Rivers, Managing Director, The Jensen Group, 10 Canal Griboedova, Suite 2, St. Petersburg, Russia. March 24, 2001.

[40] “Forecast: Real estate market in Russia 2001,” by Simeon Mitropolitski, International Real Estate Digest, January 2001.

[41] EBRD “Strategy for the Russian Federation,” prepared October 2000 and Russian Venture Capital Association White Paper, prepared April 2000.

[42] EBRD “Strategy for the Russian Federation,” prepared October 2000.

[43] Comments made by Ms. Pat Cloherty, chairman of the board of the US-Russia Investment Fund, as reported in “Venture fund targets Russia,” January 28, 2001.

[44] “COMPANIES & FINANCE INTERNATIONAL: Russian developers try to lure investors: Software groups are looking to international venture capitalists, says Astrid Wendlandt” Financial Times, Feb 16, 2001, Astrid Wendlandt.

[45] EUROPEAN PRIVATE EQUITY & VENTURE CAPITAL: Wild east attacks respectable interest: EASTERN EUROPE by Stefan Wagstyl: Investment by US pension funds in private equity in Europe’s frontier markets highlights the region’s attractions.” Financial Times, Dec 1, 2000, Stefan Wagstyl.

[46] Interview Notes, Sputnik Group, Sergei Riabtsov, Director, Moscow, March 20, 2001.

[47] “COMPANIES & FINANCE INTERNATIONAL: Private equity fund targets Russian companies VENTURE CAPITAL DELTA RUSSIA FUND HOPES TO RAISE 150m AND TO BE INVESTING BY MID-YEAR.” Financial Times, Jan 29, 2001, Elizabeth Wine.

[48] EUROPEAN PRIVATE EQUITY & VENTURE CAPITAL: Wild east attacks respectable interest: EASTERN EUROPE by Stefan Wagstyl: Investment by US pension funds in private equity in Europe’s frontier markets highlights the region’s attractions.” Financial Times, Dec 1, 2000, Stefan Wagstyl.

[49] EBRD “Building Value at the Frontiers of Private Equity: The European Bank’s Regional Venture Funds and Post Privatization Funds,” p. 8.

[50] EBRD “Strategy for the Russian Federation,” prepared October 2000 and Russian Venture Capital Association White Paper, prepared April 2000, p. 20.

[51] “Baring Vostok Close to Target,” Securities Data Publishing: BuyOuts, Feb. 19, 2001, Angela Sormani.

[52] AIG Millenium Fund’s website: http://www.aigcapitalpartners.com/millenium.html.

[54] There are only approximately only 5 banks left – Sergi Sidorov