The Panama Papers cannot do much damage to the reputation of Putin and his friends, and they have not exposed criminal activity by prominent Russians. But they shed light on a fundamental problem: not even elites trust Russia’s economic, legal, or political system.
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To use a concept from the terminology of psychology, Russia is in denial. It has been in denial for decades about the massive usage of offshore companies by businessmen, investors, and managers. It is unwilling to acknowledge that government policies are to blame for the flight of Russian business to offshore jurisdictions, a practice that is common in many African countries but believed to be less so in Europe.

Now the leak of the so-called Panama Papers, with detailed information about offshore assets held by senior Russian officials, is an uncomfortable reminder of how deep-rooted the practice is in Russia.

For many years, the official position internationally on offshore deals has been that they are frowned upon, but not considered illegal. Registering assets in offshore companies is viewed as an inevitable consequence of a market open to foreign investment and free movement of capital.

The use of offshore jurisdictions is regarded as an unwelcome attempt to evade taxes or hide illicit revenues. This is why the Russian government has established complex (and inconsistent) requirements for financial reporting on offshore assets, requirements that are not backed by audit or accounting capabilities. This is also why Russia has repeatedly toyed with the idea of a tax amnesty to bring assets back to Russia.

There is certainly some volume of illicit funds going from Russia into offshore zones. But there are also many perfectly legal transactions done for tax purposes. Tax optimization is considered completely legitimate in most developed countries, provided that the underlying transactions are not fictitious.

The evidence suggests that the individuals “exposed” in the Panama Papers weren’t trying too hard to hide. There are no multi-layer trusts, no funds with complex shareholding structures, and no companies from truly lax jurisdictions such as Belize and the Congo. The Caribbean jurisdictions can’t be described as “uncharted waters.” They are very heavily regulated. The convoluted schemes that have been revealed were generally used for the mundane purposes of obtaining completely legitimate loans and safeguarding funds.

We have learned, for example, that Russia’s state-controlled VTB bank has issued unsecured loans to an offshore entity. VTB has actually issued many unsecured loans. These were reflected on its balance sheet and backed by reserves with a 1:1 ratio. VTB has the right to make such decisions. It issued loans to a company affiliated with Yury Kovalchuk, a billionaire and a member of Russian President Vladimir Putin’s “inner circle.” What better security is there?

And the notion that there can be “secret ownership” is a fairy tale. In Russia, as in most countries, public companies must disclose their ultimate beneficiaries at least once—when banks buy shares for these individuals.

To a certain extent, the Panama Papers investigation results even flatter Putin’s inner circle. All that the evidence from millions of files has shown so far is that “they are just like all the others,” divesting assets to offshore jurisdictions. It would be a stretch to say that the revelations have damaged the reputation of Putin and his friends, when similar revelations are being made about thousands of businessmen in Russia and in other countries.

For sure, the Panama deals have exposed some unsavory truths, exhibiting the full gamut of problems in Russia’s bureaucracy: unprofessional lawyers, ill-conceived transactions, barely-rectified mistakes, unnecessary complications, and needless violations of regulations or laws.

But the main importance of the leaks lies elsewhere. They shed light on what is perhaps the key problem, which is “Why do they do it?” Why do these kinds of people—Putin’s close friends, billionaires, the owners of leading Russian banks and corporations—need to operate through offshore companies when they are not even trying to hide assets, evade taxes, or finance illegal operations but are simply conducting business as usual (even though that “as usual” implies protectionism and favoritism)?

This answer is simple. No one trusts Russia’s economic, legal, or political system—not even Putin’s closest friends. In fact, perhaps they trust these least since they know them best.

Russia has a system that even its most privileged members are afraid to use within the bounds of the law. They are so fearful that they conduct perfectly legitimate transactions offshore, even if this means huge expenses on lawyers and minor violations of the spirit and the letter of the law.

In 1991, Russia set out to build a new market economy that would support entrepreneurship, foster national growth, and improve the well-being of its citizens. It was willing to accept the pitfalls of the market economy that all young capitalist countries face, including insider privatization, the emergence of oligarchs, and the merger of the business elite and the regime.

Instead, over the past twenty-five years, a toxic environment has been created in Russia: choked by bureaucracy, fettered by a catastrophically flawed legal system, subject to the whims of the military-security establishment, dominated by monopolies, and besieged by a culture of disregard for the law.

Normal businessmen—not to mention foreign investors—cannot function properly in this environment. Even Putin’s closest friends severely limit their exposure. They nip in to get a loan and then move the funds offshore; they buy businesses and then deposit the shares with a Panamanian company; they deliver goods and then pay for them offshore again—even if this means being subject to British laws, toeing the line of compliance protocols, navigating U.S. sanctions, and risking exposés by investigative journalists.

The Panama Papers pose no risk to their Russian targets, but one can hope that they will enlighten those few individuals who are in control in Russia (as well as the thousands of lesser beneficiaries of the status quo) about the system they have created for themselves. Even though they have complete control of Russia, they are afraid to operate in their own country.

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The article was originally published by Carnegie Moscow Center

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