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Fallout from Ruslan and Cyprisia

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Iain Morse assesses the consequences of the Cyprus bailout for the banking and wider financial services industries

‘Ruslan and Cyprisa’ could be the title of a lost Glinka opera, a tale of doomed love between a rich Russian seducer and a dark eyed Mediterranean maiden. We have heard from all sorts, mainstream media, German parliamentarians, off-record EU ‘briefings,’ about how Cyprus long provided a haven for ‘dodgy’ Russian money. The moral of this story is that ‘dodgy’ Russians must now pay the price for Cyprus’s state of financial deshabille, while the island itself undergoes a morally restorative economic de-tox.

A more considered view says the truth lies elsewhere; try ‘Beware Greeks bearing gifts’.
But first some history.

Cyprus set out its stall as a low-cost, flexible offshore financial centre from the late 1970s, attracting private money from emerging economies. The strategy was to provide services associated with private company formation and domicile, and a full range of related banking and security services. Cyprus never tried to be an investment fund warehouse, like Luxembourg.

It joined the EU in 2004 – and the euro in 2008 – with few questions asked about whether its role as an offshore financial centre could be tolerated long-term within the EU. The presence of Russian money dates back to a 1998 double taxation treaty signed with Russia while Boris Yeltsin was president. This served the interests of newly rich Russians seeking to export their capital to a place of greater safety. The ‘two-legged’ Russian settlement system, with onshore transfer of securities and offshore transfer of relevant monies, facilitates this; up to two-thirds of daily onshore Russian equity and bond trades are accompanied by offshore money transfers. Under the same treaty, corporation tax, at 20% in Russia, could be halved to 10% by Cyprus incorporation.

The press narrative of events around the Cyprus bailout is that Russia could have come to Cyprus’ rescue, but took offence when excluded from bailout talks by the ECB and Germany. Perhaps, but let’s remember that president Putin has imprecated against the export of capital from Russia and is in the early stages of an anti-corruption drive. Prime minister Medvedev talked about ending the double taxation agreement while the Cyprus banks were closed to withdrawals. Simultaneously, Putin has issued two presidential decrees, requiring state officials to declare foreign assets such as real estate, and to close foreign bank accounts, repatriating their cash within three months. Putin has also questioned why so many Russian companies list abroad while ordering the renovation of Moscow’s financial infrastructure including the merger of its two stock exchanges a year ago.

In other words, the punitive loss suffered by Russians holding cash in Cyprus suits Putin well. It also plays to a developing theme in the EU, against ‘casino banking’, whatever that might mean. Meanwhile, facts are emerging around the insolvency of Cyprus’s Laiki Bank, now merged with Bank of Cyprus, itself also needing a bailout. Consultants Alvarez and Marsal are investigating for the Cypriot Parliament. Some of their findings are already being leaked by local politicians. These point to Greece, not Russia, as the cause of Cyprus’s problems.

Laiki Bank’s liabilities are currently put at a hefty €9.2bn, a major part of the cost of the Cyprus bailout. It is believed that the bulk of these liabilities come from the earlier haircut on Greek government bonds owned by Laiki, as well as loans to Greek businesses and real estate. Until 2006, Laiki Bank was part owned by HSBC, which sold its interest to the Greek Marfin Investment Group. Through a further series of deals the Greek Marfin Group ended up owning 95% of the Marfin Egnatia Bank which, in turn, owned Laiki. In 2011, Cyprus’s three main banks, Bank of Cyprus, Marfin Laiki, and the Hellenic bank, all passed EU-wide stress tests coordinated by the European Banking Authority (EBA) in collaboration with the European Central Bank (ECB).

It is too early to say yet what will be left of Cyprus’s post-crisis financial services industry. The bailout comprises €10bn from the EU, IMF and other lenders, €7-7.5bn from privatisation and corporation tax, and €5.9bn from the ‘levy/tax’ on bank deposits.
According to the Cyprus International Financial Services Association (CIFSA), Cyprus banks are to reduce their total operating size to 3.5% of  GDP. This rose from under $10bn in 2000 to no less than $24.7bn in 2011 due to foreign activity. Presumably it will shrink rapidly, as will the permitted operating size of the banking sector. Corporation tax has been increased to 12.5% and a capital gains tax will be introduced.

At the time of writing, Laiki Bank depositors with more than €100,000 in uninsured accounts are likely to lose nearly all their assets; the exact amount remains to be determined. Depositors in Bank of Cyprus are likely to lose up to 45-60% of the same. Part of their cash will be ‘exchanged’ for shares, part held in an interest-free buffer fund against further write-offs. All other Cypriot banks have to pay a one off levy equal to 9.9% of deposits of €100,000 or more. Meanwhile, all depositors can draw no more than €300 per day, export no more than €1,000 from the island and require central bank permission to use more than €25,000 in onshore transactions.

There are some 320,000 companies domiciled in Cyprus, against an indigenous population of around 860,000 people. These companies are nearly all privately owned, established to benefit from the country’s tax regime. What we don’t know in any detail is the impact of the deposit haircuts on these companies. Many own Russian-listed equities and bonds, private companies domiciled in Russia, and sundry other assets, but some will presumably also have substantial deposits in Cypriot banks. A cottage industry of lawyers and accountants, including many from the UK, has grown up around company formation and servicing. More of this may survive than is expected but only time will tell.

The Cyprus stock exchange continues to function with full listings for 110 companies, a further 17 on its secondary market. There are 17 custody banks, of which Hellenic, Cyprus and Popular are the main local providers. Among global custodians only BNP Paribas, HSBC and Citibank have a direct presence. Russian Alpha Bank is also a custodian and broker on the exchange. Bank of Cyprus is also in the market but operates its custody business from Athens.

The retail and business banking sector is diverse. There are branches of several Russian banks, and half a dozen from the Middle East, as well as others from the EU. Other banks, including SocGen and several Greek banks, have full subsidiaries, and there are four banks, Bank of Cyprus, Cyprus Popular, Hellenic and USB with partial or complete listings on the Cyprus Stock Exchange.

The current view from Cyprus is pessimistic. “Things are bad and they will get worse,” warns Maria Petsa, head of the market and listing division at the Cyprus Stock Exchange.
At least the weather is good.

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