Will Too Many Brokers Spoil The Borscht?

After surviving its first bull run and crash, Russia's young equity market is entering a new phase. With prices and liquidity on the rise, a flood of new players, both Russian and foreign, is launching new brokerages and investment banks. The result is likely to be a fierce battle for the fledgling business of bringing capital-starved Russian companies to the international markets and for corporate finance deals at home.

The flurry of activity began with the move of maverick broker Boris Jordan, who quit CS First Boston's Moscow operation in April to set up his own brokerage outfit with a Russian bank. Jordan had almost single-handedly channeled hundreds of millions of dollars of foreign investment into Russian equities in 1994, giving CSFB a dominant two-thirds of the market. His defection opened the way for others to set up new operations, in advance of an expected wave of Russian companies seeking foreign capital through public share offerings, American depositary receipts listings, and convertible bond offerings. "The days of CSFB having 70% of the market are gone forever," says Konstantin A. Melnikov, vice-president of brokerage house RinacoPlus. "The business is more equitably divided now."

MIXED SIGNALS. The new players want to grab a piece of a trading and underwriting business serving Russian blue chips and selected smaller companies. But there may be a shortage of business to go around. Russian officials recently decided to retain large government stakes in some companies most interesting to foreign investors, such as Gazprom, Rostelekom, and key oil companies. If the Cabinet goes along with the decision to scale back privatization, it could hamper plans by Lukoil and others to issue convertible bonds.

Despite the mixed signals from the government, newcomers are moving ahead (table). Morgan Grenfell Investment Services, ING Bank, and CSFB are the only global investment banks building large local operations. But others are testing the waters by going after advisory contracts. Salomon Brothers Inc. on June 19 signed a contract to act as financial adviser to Mosenergo, Moscow's electric utility. Merrill Lynch & Co. is advising the government on how to gain access to the Eurobond markets.

Meanwhile, ING is putting more resources into the Russian market. In March, it launched Russian depositary receipts representing shares of six companies. Trades can be settled on European markets, avoiding reregistration hassles in Russia.

The high cost of setting up a Russian operation has not been deterring newcomers. In April, Boston-based Pioneer Group Inc. paid $10 million to buy a controlling stake in First Voucher Fund. Russia's giant Menatep Bank spent the same amount in May to create a brokerage arm led by U.S.-trained management.

Menatep is on the leading edge of what is likely to be a wave of Russian banks entering the securities business. Boris Jordan has not yet revealed his Russian partner's identity, but traders believe he is joining up with Russia's Uneximbank. Says Gerard de Geer, chairman of Brunswick Ltd., a Moscow-based brokerage: "It's good for the market that Russian banks are coming in. A market without any strong domestic players frequently results in a backlash of antiforeign legislation."

As the securities markets mature, banks have no intention of being the wallflowers. They need the new business: Now that inflation and interest rates have fallen, their revenues from loans, Treasury bonds, and currency speculation have been dropping. Banks are also looking for new ways to spend the big pool of capital they have been building up over the past few years. "In Russia, the crowd mentality is very strong. Fairly soon, every bank will create a securities business," says Henry G. Zingerman, president of First Professional Bank, one of the few local banks that created a brokerage arm last year.

Foreign and Russian players agree that the brokerage business will ultimately be dominated by locals. Russian brokerages are already strong enough to go hunting for acquisitions in the West: On June 12, Russia's C.A. & Co. acquired a controlling stake in Boston-based Atlantic Securities & Capital Management Inc. But unless the authorities smooth the way for more privatizations, all competitors may find themselves fighting over a pie that's smaller than they thought.

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