James Owen explains how firms can mitigate the risks of deceptive business practices in Russia
Grey practices represent a significant but often overlooked source of risk to foreign companies in Russia. They are the practices which lie beneath the surface of everyday business activity, often occurring under the radar of the Russian authorities or beyond the gaze of the sometimes oblivious, unsuspecting or simply time-pressed foreign investor.
Grey practices are designed to deceive another company or regulatory agency within or outside the law, and to maximise profits through deception. They are, by their very name, intangible and shady, a way to describe the mechanisms involved in tax evasion schemes, one-day companies, black cash and offshore ownership structures.
These are the practices which may not at first sight appear clearly and explicitly illegal, but can very quickly turn from grey to black, as many foreign companies have found to their cost. For example, grey practices play a key role in concealing conflicts of interest and attempts to defraud, in facilitating money laundering and in generating the cash that is used to pay bribes and kickbacks.
Like corruption, many foreign companies are unaware of their direct – and indirect – exposure to grey practices in Russia, and as a result to criminal prosecution in their home jurisdictions. Tighter international (and domestic) regulation and more proactive enforcement are only increasing this exposure. However, unlike corruption, grey practices are specifically enterprise or company-level financial mechanisms. They help to fuel corruption, but also propel much of the embezzlement and fraud that so often turns legitimate business deals into regulatory minefields.
Russia certainly does not have a monopoly on grey practices. That they flourish here as they do, however, reflects the deep-rooted opacity and lack of accountability at the heart of the country’s business environment. It might be a cliché, but many government ministries and industry sectors operate virtually as private clubs in Russia, where trust is critical and higher reliance is placed on personal relationships rather than on the laws and contracts which tend to underpin corporate dealings in more developed markets. This lack of openness creates the breeding ground for grey practices.
Where then does this leave foreign companies?
In something of a paradigm shift, many are now confronting these risks by examining their business models and strategies in a different light. Some, for example, are increasingly making the step toward taking much greater control over – and liability for – their activities in Russia, by moving to a direct import model that by-passes the third parties, distributors or agents they once relied upon. The thinking behind this is that if a company wants to achieve transparency in their distribution channels, then it needs to ‘go direct’, and base itself onshore in Russia. This is not an easy process, not least in the logistical demands that setting up an ‘in-country’ distribution and warehousing network presents. However, it does enable foreign companies to take greater control over their operations and thus their exposure to grey practices.
Perhaps the best way for companies to mitigate the risks in Russia’s business environment is to send the right internal and external messages. Companies should implement – and enforce – strict internal compliance policies and codes of conduct. To stand most chance of success, these policies require the commitment and buy-in of the CEO and senior staff. They should also be understood at every level in the company, whether the company’s employee is based in the Kazakh steppe or in the glittering tower-blocks of Moscow City. Companies also need to take the proactive steps to understand the reputation of their clients, partners and competitors. By sending the right external messages, companies can reduce their exposure to grey practices and, most interestingly, bring about higher standards of behaviour in the market as a whole.
Grey practices clearly present a difficult set of challenges to foreign companies doing business in Russia. These short-cuts, loopholes and financial sleights-of-hand represent a daily headache and, at their most extreme, pose significant operational, reputational and regulatory risks. However, they should not force companies to pack up and leave Russia, difficult as it may be to bridge the gap between the local pressures on the ground and tighter domestic and international regulation. Many foreign companies are continuing to make a great success of their investments and operations in the country, particularly those which institute best practice internal compliance policies and seek to understand the local operating environment. Foreign companies should look to take advantage of this market, but to do so with care and discrimination. The Russian business environment remains, despite everything, an attractive long-term investment.
James Owen, is a senior consultant in Control Risks’ Moscow office.