The rush to Russia
A determined push by the Russian government to open up the country’s capital markets and make Moscow an international financial centre is gradually gaining ground. But the Moscow Exchange faces a fierce fight as it attempts to claw back Russian listings business from the London Stock Exchange’s hugely successful international order book.
Russia is the world’s seventh biggest economy, according to statistics provided by Russian broker Otkritie. The country’s obvious attraction is its energy market, including oil and gas, which have contributed to massive Russian companies such as Rosneft and Gazprom. With a population of 142 million, Russia is a major European market that spans the bridge between the European and Asian timezones.
In November, one major obstacle to foreign investment was removed when Russia established a central securities depository, NSD. Under US Securities and Exchange Commission rule 17F7, US investors have to place assets with a depository. Without a CSD, settlement arrangements for Russia were widely viewed by outsiders as complicated, expensive and inefficient. A CSD provides transparency over securities ownership and can help reduce risk in the event of a bad trade.
Equally important for the future is the planned switch of the entire Russian market to T+2 settlement later this year. At present, Russia operates a T+0 settlement cycle, which means that trades settle immediately at the point of the transaction. This system is a major obstacle to many foreign investors, because the seller must be able to pay at the moment of the transaction. Most of Europe uses T+3 settlement, with the exception of Germany, which operates on a T+2 basis. But the Moscow Exchange is due to move 20 of the most liquid stocks from its MICEX order book to T+2 settlement in March, with the remainder due to follow by the end of July.
“Everyone is looking at Moscow,” said Emmanuel Carjat, chief executive at TMX Atrium, the market data and connectivity business of Canada’s TMX exchange group. “The spectrum of interested parties ranges all the way from long-only investment managers to high-frequency traders.”
TMX Atrium launched a new low-latency link from Frankfurt to Moscow in January, clearly aimed at capitalising interest on western investors in accessing the Russian market.
Tug of war
However, there are also problems. At the Moscow Exchange, there has only been one IPO in Russia in the two years between January 2011 and January 2013, according to figures provided by PricewaterhouseCoopers. Over the same period, there were 14 Russian IPOs in total – of which eight were on the LSE. Most of the 46 Russian companies listed at the LSE use global depository receipts, but there is a select group of eight that have opted for a premium listing. Dual-listings both in Russia and in London are also very popular. The IOB also lists 10 companies from Kazakhstan, six from Ukraine, two from Georgia and one from Turkmenistan; the top most traded stock on the LSE is now Russian energy giant Gazprom. Russia’s political leaders have been quick to comment on the need to reform the country’s domestic market to attract more listings business.
“This is a sign that Russian companies are forced to go abroad to look for money to finance their development,” admitted Vladimir Putin, president of Russia during a speech on financial markets on 25 January. “This is sad. We have taken a number of measures to improve the financial infrastructure of late. Our task is to make the Russian stock market
Russia’s payment systems under scrutiny
With the outgoing head of Russia’s central bank saying that $49 billion – around 2.5% of GDP – was illegally paid out of the country last year by an organised crime group, the suspicion with which the whole of the country’s banking system is viewed by outsiders might seem to have some justification, writes David Bannister.
Like so much else in the country, the payments system is undergoing considerable modernisation, with new legislation – the National Payment System Law – covering the infrastructure brought in 2011 and introduced in stages, ending in September last year.
NPS “is intended to ensure the legal regulation of modern payment and settlement services, which have emerged as a result of the nation’s technological and informational development,” according to the Kremlin.
It establishes legal and organisational foundations for a national payment system, regulates the procedures for rendering payment services, and determines the requirements to the organisation and operation of payment systems, as well as procedures for supervising and monitoring the national payment system.
Under the law, all payment service operators have to be licenced by the central bank (it also monitors all payments, which is where the $49 billion figure came from).
The law will cover the creation of a national payment system and the issuing of a single identity and payment card to all Russian citizens that enable them to receive social security and pension payments, as well as to pay taxes and purchase products in ordinary shops.
The NPS principally addresses new forms of payment that existing legislation didn’t cover, particularly electronic forms and – after amendment – mobile payments.
One of the central aspects of the new law was the introduction of multilateral netting, and changes to the rules relating to bankruptcy to protect the system against failure of a participant.
More problematic for international players, the NPS also brought in restrictions on cross-border payments – “The Federal Law defines the procedures and features for conducting electronic monetary transfers, including a payment system operator’s right to involve operating centres located outside of Russia for granting operational services to payment system participants,” says the Kremlin.
Originally it was intended to force international operators like Visa and MasterCard to become local players, with in-country processing centres, but this was later amended.
Payment card penetration in Russia is actually relatively low, at only 5%. According to the Central Bank of Russia, retail payments account for only 10% of card transactions, the remaining 90% being cash. Traditionally a totally cash-based society, Russia’s transition to cashless payments is very slow, especially outside of large cities.
competitive in the full sense of the word, make it attractive for Russian and foreign market players. It has to meet business’ demands and also be up to our new and more ambitious economic development goals.”
On 15 February, Moscow Exchange launched its own IPO on the Moscow market as the spearhead of that effort to encourage Russian companies to list on their own market. The IPO raised approximately $500 million and brought the company a valuation of $4.2 billion. But domestic liquidity is limited, with only 1.5 million out of a total population of 142 million participating in the stock market, according to Otkritie figures. Russia’s relatively small pension market has been contrasted with other former Soviet-bloc countries such as Poland, which enacted a compulsory contribution pension system in the 1990s that ostensibly covers all of its 38.5 million inhabitants, creating a far larger domestic fund market. By comparison, pensions account for just 4% of Russian GDP.
Furthermore, the IPO only represented the sale of a minority stake in the Moscow Exchange – around 10%, according to Berenberg Bank. Since some of the major buyers were Chinese and Russian sovereign funds, the transaction could be seen as one branch of government buying another, according to Pras Jeyanandhan, analyst at Barenberg. Meanwhile, Berenberg’s research indicates that the exchange is earning around 80% of its profits from high-margin interest income – leaving Moscow Exchange “looking more like a bank” than an exchange.
“Moscow collects deposits from clients to clear and settle,” said Jeyanandhan. “These balances have been increasing. The exchange provides treasury services, then puts those resources in the market and earns interest. Recently, they’ve added more risk to the equation by buying corporate funds. All that revenue goes straight to the exchange’s bottom line – no other exchange earns so much from this source. But as T+ settlement is coming, we would expect that revenue stream to decrease in future.”
To help draw in foreign investors and drive up liquidity, the Moscow Exchange has upgraded its matching engine and capacity. According to Russian broker BCS, it is providing much more granular information and much better co-location, hosting and networking facilities than it used to. The company currently has 120,000 retail clients on its books, but its figures also show that the Russian equity market is still registering average trading volumes below $1 billion per day – well below the $8 billion recorded for derivatives contracts and $14 billion for FX transactions.
The lack of an institutional market in Russian equities has been highlighted by BCS as one of the main challenges for the Moscow Exchange, whose domestic clients primarily consist of retail investors. The need for pension reforms in Russia to increase domestic flows has also been identified by Moscow’s rival the London Stock Exchange as a key necessary step if Russia is to expand Moscow’s appeal as an investment centre.
“You need a strong domestic market to attract international investors,” said Jon Edwards, deputy head of primary markets – emerging markets at the LSE. Edwards is personally responsible for developing the London Stock Exchange’s business in Russia and the CIS, a group of countries closely associated to Russia that includes Belarus, Kazakhstan and 7 other post-Soviet states. “It has been estimated that pension reforms could inject as much as $34 billion of funds into the Russian equity market. That reform is much-needed.”
Other perennial issues that concern long-term investors in Russia include the rules around corporate governance, treatment of minority investors and the strength of law. In the US, many mutual funds hold stock via trusts, which are not recognised under Russian law. Some market observers note that while the Russian market’s planned move to T+ settlement later this year should appeal to the tier one banks, that will not solve the core comfort issues for the buy-side.
“It’s not always the changes that get the headlines that count,” said Tim Bevan, director of prime services sales at BCS. “Recent changes in corporate actions law are also especially relevant. But let’s not kid ourselves – corruption is still rife at every level of economic activity in Russia. This is not a one-year or 18 month project. We are talking about fundamental, in-the-DNA changes. It will take at least five years.”
According to Edwards, part of the problem is that institutional investors from abroad need a mandate to invest in Russia, which many funds do not currently have. To trade in Russia, a company needs to be a Russian entity. All the major global banks have Moscow-registered entities that enable them to meet that requirement, but smaller brokers may not. That leaves them no alternative but to buy depository receipts in London. “The listing rules in Russia need to be more aligned with international best practice, and there needs to be more English language disclosure to attract foreign investors,” he said.
Not everything is black for the Moscow Exchange, however. Bevan notes that much of the flow on the Moscow Exchange and the LSE’s IOB is actually arbitrage between the two – so the competition over business need not necessarily be seen as a “nihilistic one-horse race”. Furthermore, although the Moscow Exchange’s habit of setting aggressive deadlines and then missing them has damaged its credibility in some circles, the admission of Russian OFZ government bonds in February 2013 and equities next year into the Euroclear system should
Banking at a crossroads
While foreign-owned banks face challenges entering the Russian markets, the local players are engaged on aggressive expansion strategies, both internally and in neighbouring Central & Eastern European countries, where they are starting to take share from Westerners.
Western European banking groups lost some market share in Russia in 2011, according to study from Raiffeisen Research, which it says can be largely attributed to the strong performance of locally owned players and/or larger state-owned banks such as Sberbank and VTB. It is also the case that banks like Sberbank and VTB have a strong deposit funding base in the retail and/or corporate segment, a position that helps them to outpace the overall market average in times of scarcer funding.
In the specific case of Russia, some mid-sized locally-owned banks like Alfa Bank and Nomos Bank have also expanded much more strongly than most of their Western European peers, says Raiffeisen
The foreign-owned players among Russia’s Top50 banks were expanding rapidly until 2008, when their market share peaked at 10.7% and has declined since then, says the report, but adds that this ought to be treated with a degree of caution. “The largest portion of the pre-crisis growth posted by foreign-owned banks took place via acquisitions and most of the acquired banks were rapidly growing loan books prior to the change of control; as a consequence, the figure was inflated somewhat,” it says.
Raiffeisen is one of the three large foreign-owned banks in Russia, along with Société Géneralé and UniCredit, all of which are “firmly maintaining their position within the Top 10”.
In its 2012 report, A Chessboard Strategy for Russia’s Banking Market, AT Kearney says that the market can be described in two words: “consolidation and adrenalin”.
According to AT Kearney, the Russian banking industry will have grown 16% between 2009 and 2015, and while this is a slowdown compared to the 27% CAGR reported from 2005 to 2010, there is more room for growth.
“Over the past six years, consolidation has resulted in some 300 banks being taken over by large state-owned or international institutions,” the report’s authors note. “But there’s also a kind of frenetic, thrill-seeker side to the Russian banking market, most apparent in very little transparency, lots of governmental involvement, fluid regulatory environment and capital flight. In short, this is not a market for the timid – it is dynamic and changing rapidly. Banks seeking success in Russia need not only a well-thought out game plan, but also the flexibility to adapt to unforeseen events.”
That said, it goes on to foresee two potential futures: “continuing domination by state-owned banks with minor banks playing a minor role; or dominance by many large state-owned and private banks, with niche and smaller banks making up a second level”.
Which of these futures plays out will largely depend on the approach of the Russian Government, it concludes.
Still a need for Kremlin-watching, then.
make a positive difference for investors. The OFZ bond market is worth $100 billion, according to figures provided by Baring Asset Management. Other observers were more bombastic in their predictions.
“The 7 February milestone marks a new era in the ability of Russia to fund its growth and development through the international capital markets,” said Frederic Hannequart, chairman of Euroclear Bank. “Industry experts are predicting new foreign capital inflows to Russia in the region of $20 billion. Euroclear Bank is proud to become part of the new Russian financial centre by making OFZs eligible for Euroclear Bank services.”
But besides the details and practicalities of investing in equities and other asset classes, there is another issue. Corruption and allegations of government complicity in human rights abuses inevitably tarnish the image of Russia as a viable location for an international financial centre. Undoubtedly, there are sections of the government that are trying hard to improve Russia’s image.
“The international financial centre [Moscow] will be used to attract and allocate Russian and foreign investment capital,” said Dmitry Medvedev, prime minister of Russia in a speech in February. “We’ll have to create an effective and stable regulatory environment, which will encourage the creation and development of modern financial products and services for all investors, and which will ensure high standards of corporate governance and, of course, the protection of investor property rights and interests.”
At the same time, however, those efforts are undermined by cases such as lawyer Sergei Magnitsky, who was arrested after he alleged that Russian officials were implicated in a tax fraud scheme. Magnitsky was held for one year on fabricated charges before being beaten to death, according to Russia’s Presidential Council for the Development of Civil society and Human Rights.
“The cases of former Yukos chief Mikhail Khodorkovskyand his colleagues Platon Lebedev, Vasily Aleksanyan, Svetlana Bakhmina and others awakened the world to Russian justice under Putin,” said Bruce Misamore, former chief financial officer of Yukos in a letter published in the Moscow Times earlier this month. “Magnitsky and the corruption exhibited by the Russian administration in everything associated with that case are indicative of complete lack of a rule of law.”
Yukos had its assets frozen by the Russian government in 2003 following a tax reassessment which claimed that the company owed $27 billion. In 2006, the company was declared bankrupt. The company’s assets were subsequently bought up at low prices by government-owned companies; former owner Khordokvsky was arrested and imprisoned. The Parliamentary Assembly of the Council of Europe condemned these actions as manufactured for political reasons and a violation of human rights. It is also alleged that Svetlana Bakhmina was effectively the victim of a political vendetta against Yukos and its employees. Bakhmina served three years in harsh prison conditions where she was denied contact with her young children; colleague Vasily Aleksanyan was also imprisoned until forcibly released following a decision by the European Court of Human Rights, which found Russia in violation of four articles of the European Convention on Human Rights. Aleksanyan died later the same year, at the age of 39. Khordokovsky is still in prison.