Samy Muaddi and Willem Visser of T. Rowe Price investigate the challenges that come with investing in Russia, and how to build 'oligarch risk' into models.
In April of this year, aluminium producer Rusal's bonds plunged more than 60% after the US Treasury announced sanctions against seven high-profile Russian businessmen and 12 of their companies.
Emerging market corporate bond investors are no strangers to governance risk, but Russia's landscape brings its own set of challenges. Recent developments in Specially Designated Nationals (SDN)  sanctions by the US Treasury have brought Russian governance into sharper focus, meaning analysis of sanctions risk is increasingly important.
But how can analysts build ‘oligarch risk' into their models?
We recently conducted an exercise that combined qualitative and quantitative information in a systematic framework to arrive at a risk-adjusted fair value for nine Russian companies. The objective of our analysis is not just to avoid tail risk, but also to put a price tag on risk and make relative valuation judgements - both among Russian companies and relative to opportunities in other regions.
Step 1: Profiling the oligarchs
With the support of the Kremlin, roughly 25 oligarchs control 80-85%  of corporate Russia. It's important to understand who these influencers are and to what extent their interests are aligned with those of bondholders. We scored each oligarch on several criteria:
1. Political connections. Business benefits tend to accrue among members of Putin's inner circle. Is the connection to Putin family, business, or political?
2. Historical behaviour. Information about how oligarchs climbed the ladder and dealt with competitors can tell us something about how emotionally invested they are in their companies' survival.
3. Capital allocation. Are investors treated fairly? Is the sponsor using the business to fund their own needs? In 2015 the Kerimov family, which had a 40% stake in Polyus Gold, took the company private . To service debt and interest requirements of the loan that financed the transaction, the Kerimov family has been reliant on shareholder distributions from Polyus Gold. The divergence of interests between shareholder and bondholders has reduced scope for credit metric improvement.
4. Net worth and asset diversification. The larger and more diversified the oligarch's asset base, the more able they will be to extract funds from other businesses if the company needs a cash injection. Two who score well on this are Severstal's Alexei Mordashov and USM's Alisher Usmanov.
5. Other information. How extravagant is the oligarch's lifestyle and how erratic their behaviour? Mikhail Prokhorov's flamboyant lifestyle has been perceived as one of the contributing factors behind the divestment of his stake in Norilsk Nickel. 
Step 2: Assessing sanctions exposure
Russia's unique environment calls for a second filter based on sanctions-specific factors. We ranked oligarchs based on factors that come up on the Treasury's radar or have previously been a trigger for sanctions.
1. Political connections. Putin's inner circle includes names such as Gennady Timchenko , a long-term judo friend who set up the oil-trading firm Gunvor, which was unlikely to have been accomplished without political connections.
2. Ownership. Does the oligarch fall foul of the US Treasury's Office of Foreign Assets Control (OFAC) 50% rule? If so, any company in which the targeted oligarch controls >50%, automatically becomes sanctioned. Mordashov scored highest on our scale of bondholder-friendliness, but his 77% stake in Severstal leaves the group exposed to higher sanction risk.
3. Fraudulent activities. Has the oligarch been charged with fraudulent activity? One of the US Treasury's seven designated oligarchs was Polyus Gold's Suleyman Kerimov , who allegedly failed to pay taxes and laundered funds through the purchase of villas. He has been cleared of the allegations.
4. Cost of sanctions to the US. Sanctions on some companies would increase commodity costs or cost of doing business for US enterprises, while others would have less impact.
5. Facilitating Cronyism. We believe oligarchs that have been rumoured to have facilitated illegal transactions or helped to embezzle funds for politicians are at higher risk of sanction.
Step 3: Scenario analysis
Based on our analysis of their sponsors, we assigned to each of the nine companies in our study a probability of a Rusal-type scenario where sanctions escalate. The table below shows an edited extract from the study.
Building governance factors into relative valuations not only helps us assess opportunities within Russia, but it also provides regional perspective. Compared with the Russian companies that we identified, for instance, several firms in Latin America and Asia have similar credit ratings and balance sheet fundamentals - and offer similar yields - but without the corporate governance concerns.
Despite recent volatility and negative news flow, we still believe Russian corporate bond valuations are under-pricing sanctions risk. Against this backdrop, we are maintaining minimal exposure to corporate Russia.
 SDNs' assets are blocked and US persons are generally prohibited from dealing with them.
 Based on an assessment of their wealth relative to the total Forbes list of the world's billionaires.
 Source: Financial Times (https://www.ft.com/content/201894b6-678d-11e5-97d0-1456a776a4f5)
 Source NY Times (https://www.nytimes.com/2007/07/08/business/yourmoney/08nickel.html)
 Source: CNN (https://edition.cnn.com/2014/03/21/business/russia-sanctions-targets/index.html)
 Source: US Department of the Treasury (https://home.treasury.gov/news/press-releases/sm0338)
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