The arrest of Michael Calvey on February 14 on “large-scale embezzlement” charges sent shockwaves through Russia’s investment community.

One of the best known, most successful and personally well-liked figures in the Russia investment community, Calvey has been both a savvy investor and at pains to keep his head down. He never comments on politics and is known as a straight shooter.

The success of his fund Barings Vostok Capital Partners (BVCP) relies entirely on smart calls and it has made a string of “home runs,” as US citizen Calvey has told me in a string of interviews over the years. He invested in incumbent mobile phone operator VimpelCom at its launch, before it was called VimpelCom, and turned a $5mn investment in Yandex when it set up into a $4bn stake when it eventually IPO’d in 2011, among many other good calls.

News swept the markets
The news of Calvey’s arrest quickly swept the markets in London and then New York. “What in God’s name is going on over there with MC?” a well-known fund manager in New York asked me in an email after she woke up to the news. “Yes—this is a crucial juncture as it will tell everything you need to know by which way it goes.”

The consensus is that Calvey’s arrest is “business as usual” in a Russian corporate dispute. Calvey is in jail accused of illegally under-pricing shares in the regional retail bank Orient Express Bank (OEB, aka Vostochniy Bank), in which Baring holds a 52.5% stake. The bank ran into trouble in 2015 following the heavy devaluation of the ruble and was recapitalised by the shareholders in 2018. BVCP is accused of illegally making $37mn from the pricing.

An argument sprung up between Barings and its Russian partners, Artem Avetisyan and Sherzod Yusupov, minority shareholders in Vostochniy, over valuations and stakes, as the recapitalisation came with a new issue of shares, now the subject of an arbitration case in London.

All this is a pretty normal part of business, as arguments often come out of a rescue from a difficult position. What is unusual is that a court issues an arrest warrant and a leading fund manager and his team get arrested. At least it is unusual elsewhere, but it is par for the course in Russia.

‘100,000 in jail on trumped up charges’
The Presidential Ombudsman for Business Boris Titov told bne IntelliNews in an interview that he believes there are over 100,000 businessmen in jail on trumped up charges connected to business disputes rather than any illegal activity.

Investors are now waiting to see what will happen next. There are two options. Either the Kremlin steps in and quashes the case (in some face saving way, as the government pretends it can’t simply order a court to do anything). Or Calvey remains in jail and loses control of OEB.

If Calvey were Russian he could simply buy his way out of jail, although now he is in pre-trial detention that would be very expensive. But foreigners, especially ones that have staked their reputation on being clean, can’t do that and that is the vulnerability all foreigners working in Russia have when facing off against ruthless Russian partners. Variants of this theme are regular occurrences when Russian oligarchs abuse the legal system while their hapless foreign partners try to fight a genuine legal defence. The foreigners almost always lose.

At this point it could go either way. Russian First Deputy Prime Minister and Finance Minister Anton Siluanov said “Don't break the law,” when asked about the Calvey case on the sidelines of the Russian Investment Forum this week.

However, head of the Russian Fund for Direct Investment (RDIF) Kirill Dmitriev and a former fund manager himself as well as Titov both came out publicly saying they would personally vouch for Calvey.

Commentators were quick to dub the arrest as a Browder 2.0, in reference to former Hermitage Capital Management fund manager Bill Browder, who fell foul of the Kremlin and had his visa revoked.

Since the death of Hermitage’s lawyer Sergei Magnitsky, Browder has campaigned tirelessly against the Kremlin, sponsoring the Magnitsky Act that can be used by governments to punish corrupt Russian officials. In his most recent remarks, just days before Calvey’s arrest, Browder testified to the UK Foreign Select Committee claiming it was impossible to do business in Russia without being shaken down because it is a fundamentally corrupt country.

Does it matter?
Does Calvey’s arrest matter? Yes and no. It is very unlikely that Calvey and his partners are guilty as charged. Apart from anything else the amount of money they are accused of stealing—$7mn each if shared between five people—is laughably little.

The Calvey affair will clearly give Russia’s image yet another bloody nose, but its nose was already bleeding. Russian President Vladimir Putin will inevitably be blamed personally and the government will be accused of trying to grab more banking assets, just as it was after taking over the troubled Garden Ring banks in the autumn of 2017.

But while the government is almost certainly not directly responsible, it is responsible indirectly given its failure to build institutions, protect property rights and establish an independent judiciary. Instead Putin relies on his “vertical power” system, which is based on personal client-sponsor relations. The system is easier to manage but is open to abuse. Avetisyan reportedly has ties to the Federal Security Service (FSB) that he made use of in this corporate showdown.

The irony of the affair is that before Calvey’s arrest Moody’s returned Russia to “investment grade” on the back of a string of record breaking macroeconomic results in 2018. The macro case may be gold-plated, but Calvey’s arrest shows the political risks make Russia a rotting fish. And the fish rots from the head, as the Russian saying goes.

The prospects for a quashing of the case are made worse as the Kremlin seems to have given up on the hope of attracting significant western investment. It knows that bond investors and big firms like German engineering firm Siemens or the US carmakers will come anyway because of Russia’s strong macro fundamentals and its 147mn-strong consumer market—by far the biggest in Europe.

Equity investors? They are not really that important to Russia’s development. It is noticeable that despite the extensive reforms in the financial sector there are still no domestic institutional investors to speak of—a gaping hole in the financial edifice. The Kremlin has already put all its effort into wooing Asian and Arab investors, who care less about corporate governance and don't attach strings or sanctions to their investment dollars.

Will equity investors pull out?
Will the dedicated foreign-based Russia equity investors, like my US fund manager friend, pull out if Calvey stays in jail? Probably not. The outcome would probably see some of BVCP’s clients redeem their investments; Browder’s Hermitage Capital Management, once the largest fund in Russia, was effectively destroyed by Browder’s problems.

Investing in Russian equity has always been a rollercoaster ride. Another famous fund manager (who doesn't like to be quoted) quipped that Russia’s equity market is always the best performing in the world—or the worst.

It is hard to see how any more damage could be done to Russia’s investment case following, but not limited to, the Browder affair or the fate of Yukos owner Mikhail Khodorkovsky. But there is so little being invested already that the blip caused by the Calvey affair probably won’t be enough to move the needle. Russia’s equities already trade on a special “Russia discount” that comes on top of the regular emerging markets discount, to account for problems like the political risk and poor corporate governance. All Calvey’s arrest says is that Russia is a very risky place to invest and things can go badly wrong, no matter how hard you try to keep your nose clean. But we knew that already.