Russia has gone from totalitarian communism to being home to the fifth highest number of UHNW individuals. But how is wealth management developing in the country? This article examines recent trends.

In two decades, Russia has gone from the face of totalitarian communism to having the world’s fifth highest number of ultra high net worth households, according to the Boston Consulting Group's latest world report. Moscow, formerly the heart of the Soviet Union, has become the city with the most billionaires in the world. According to Forbes, the city has now 79 billionaires, up from 58 in 2010 and way ahead of New York City, the runner-up, with 59.

Russia has a short history as a non-totalitarian state. In the early years, under Boris Yeltsin in the 1990s, corruption acted as break on economic growth. When Vladimir Putin, president between 2000 and 2008, introduced a flat rate of income tax of 13 per cent in 2001, it helped to bring chunks of the economy in from the shadows, according to Yevgeny Volk, vice president of Russians for Tax Reform, part of the World Taxpayers’ Association.

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At the end of last month, Putin, now prime minister, and Dmitry Medvedev, the president, announced that they intend to swap jobs next year. Because of the lack of alternatives, the election in March is seen as a mere formality. Presidential terms in Russia have been extended from four to six years, meaning that Putin could be in the Kremlin until 2024. His critics fear that he will prioritise expensive military programmes instead of focusing on modernising and reforming the economy.  

In his first speech as a presidential “candidate”, Putin said that the wealthiest should contribute more, suggesting that the flat income tax rate, which is still at 13 per cent, could come to an end. “It would be a popular measure but rich people will try to find loopholes, and a lot of money will go offshore,” Volk told WealthBriefing. “The Russian mentality is to a great deal egalitarian and paternalist. They don’t like rich people; they don’t like those who work hard.”

“By then (in 2001), it was the lowest flat rate of income tax in Eastern Europe and a breakthrough for encouraging businesses to pay real taxes,”  said Volk. “But coupled with the social tax (contribution of 34 per cent paid by employers), this flat tax did not have the effect people expected.”

Volk said that both Macedonia and Georgia now have lower flat rates of income tax than Russia.

Egalitarian spirit

Volk fears that a reintroduction of progressive tax system will lead to drain of entrepreneurs. “They feel that their money and themselves are safer elsewhere, because Russian laws are often changing and are subject to political manipulation, as the case of Khodorkovsky has shown,” Volk said.

Mikhail Khodorkovsky, once the country’s richest man, was put in prison in 2005 for alleged tax evasion, and many international organisations have expressed concerns about his imprisonment.  

Whether wealthy individuals are safe or not, there is no question about where the high net worth market is going. “There are different figures on how many millionaires there are in Russia, but the one we consider to be right is between 200,000 and 300,000 families, so it’s a fairly large market on an international scale,” said Robert Idelsons, chief executive and chairman of M2M Private Bank, the only bank in the country that deals exclusively with high net worth individuals.

M2M has had a banking licence since the 1990s, but changed course completely in 2008 when it altered ownership. One of the four major shareholders is the UK businessman Peter Hambro, owner of Petropavlovsk, formerly Peter Hambro Mining, which changed its name in 2009 to better reflect its Russian focus. 

Aggressive growth

M2M has €600 million (about $826 million) in assets across roughly 800 clients. Idelsons describes the private banking divisions at the big local banks such as Alfa Bank, VTB24 and Sberbank, along with Swiss giants such as UBS, Lombard Odier and Credit Suisse, as its main competitors.

“In wealth management solutions, local banks in Russia tend to focus on the Russian market, and I think that is a big handicap because it makes their wealth management very risky and one-sided, because all of their assets are invested in Russia, which is an emerging market and a fairly risky market,” Idelsons told WealthBriefing.

“We are trying to offer a global perspective through international asset allocation to our clients,” said Idelsons. “We have an asset management company in Latvia, which was started in April this year, where we have a team which manages the international part of the onshore portfolios.”

M2M has an aggressive growth target of 20 per cent a year over the next three years. The plan is supported by the fact Idelson believes Russia will grow its economy by between 4 and 6 per cent for the next five years, a forecast in line with those made by the Economist and SEB, Sweden’s biggest bank, which both believe that country will achieve a growth rate above 4 per cent in 2012 and 2013.

Rich in natural resources - and entrepreneurs? 

There is no secret that the success of the Russian economy is dependent on the price of oil, which currently trades at about $110/barrel. “I just attended a conference which was well-attended by Russian officials, including Mr Putin, and their stress test scenario suggested that the price of oil would be at $60/barrel, that is the worst case scenario the government is considering here,” said Idelsons. “So if we’re talking about levels below $50, that is a nightmare scenario for everyone.”

However, as a result of the inflationary environment, commodity prices are unlikely to fall and Daniel Bergvall, Russia analyst at SEB, believes that the oil price will stay at its present level for the next two years.

The high price of oil was manifested in the fact that Russia boasted a trade balance of $177.7 billion in August, higher than China's. However, it is worth noting that the Russian stock market has fallen from an index level of over 2,000 in April this year to close to 1,200 earlier this month.  Roger Törnkvist, fund strategist at SEB, attributes the drop to the international economic crisis which has led to investors fleeing all forms of risks. As a result, the three Russia-related funds managed by SEB have all taken big knocks in recent months.

But the situation is far from gloom and doom, and another Scandinavian player, Saxo Bank, the Denmark-based online trading specialist, opened the doors to an office in Moscow earlier in October. “Everybody is having a rough ride now and Russia is one of the places we believe in in the long-term,” Lars Seier Christensen, the firm’s co-chief executive, told this publication. “I do believe that the market is sophisticated enough for our service. Russia has begun using the internet for transactions. Do I think there are millions of clients for us there? No. But do I believe there are thousands? Possibly.”

Finally, Idelson, who is Latvian, says he believes wealth creation in Russia goes beyond the price of oil. “I think that this country is really great not because of its natural resources but because of its entrepreneurial spirit. I face it every day, this country has really bright people, and it’s a shame that they cannot realise their potential on an international scale because of the difficulties they face in their home country,” he said, referring to the need for reform in the young free economy.