Russia: Markets welcome Euroclear approval

Depository law proves final hurdle; OFZ spreads tighten on foreign buying

Euroclear Bank has been granted access to Russia’s central securities depository (CSD), opening the way for a substantial step-up in foreign participation in the country’s domestic bond market.

The move, announced by the Federal Financial Markets Service on October 3, will allow Euroclear for the first time to offer post-trade settlement services in Russia and is the latest in a series of reforms designed to increase the accessibility of local markets for international investors.

As such, it has been welcomed by market participants. "We expect Euroclearability to have a positive impact on the local market in that it will promote competitiveness and liquidity, which should benefit both foreign and local investors," says Alexander Ovchinnikov, vice-president for fixed-income research global markets at Sberbank CIB.

Russia’s local bond market has in recent years lagged behind its developing world peers in foreign investor participation, with non-resident holdings of domestic government bonds (OFZs) estimated at less than 10%, against 30% or more in markets such as Mexico.



Removing obstacles

Since 2011, however, the Russian authorities have been working to remove the technical obstacles to investing in the country’s bond markets as part of a wider drive to establish Moscow as an international financial centre.

Key reforms this year have included allowing over-the-counter transactions in OFZs, previously only tradable via the Micex exchange, and the adoption of legislation introducing the concept of beneficial ownership to Russia.

Further legislation finalizing the appointment of the National Settlement Depository as Russia’s official CSD – another essential precursor to Euroclearability – had been due to be passed at the start of July but was still pending in mid-October, prompting some local bankers to speculate that Euroclear would be unable to begin settlement activities before year-end.

Stephan Pouyat, Euroclear’s head of product management global reach
Stephan Pouyat, Euroclear’s head of product management global reach
However, Stephan Pouyat, Euroclear’s head of product management global reach, says the bank is still optimistic of hitting its fourth-quarter target for the inauguration of its Russian operation, citing recent remarks by president Vladimir Putin on the importance of finalizing the process as evidence of "the political involvement in the project and the strong political will behind it".

Also yet to be resolved is the question of which instruments will be settled by Euroclear when it begins operating in Russia. The bank has been granted approval to handle Russian corporate bonds and securities issued by international borrowers in the domestic market, as well as OFZs and municipal debt.

Bonds from non-domestic issuers will not be part of the first roll-out, and corporate debt might also be excluded in the interests of rapid implementation.

"We want to move quickly and efficiently in offering Euroclear Bank services for Russian assets," says Pouyat. "The target is to try to start with all instruments that are compatible with the OFZ scheme. However, if some instruments are not compatible, in terms of fiscal and reporting requirements, we might remove them from the first phase of the project so as to avoid a postponement of the launch.

"It’s all a question of how complex the potential differences are between the two asset classes. For the time being, we are expecting greater clarity from the Russian authorities on tax and disclosure requirements to take a final decision."

He adds that Euroclear is also awaiting clarification on whether bonds issued by state-owned companies such as Gazprom and Sberbank will be treated as pure corporate debt or as full OFZ equivalents.

Despite the uncertainty, however, local bankers agree that the move to Euroclearability will do much to change the perception of Russian fixed-income markets among global investors. "It will take time to educate international investors on the specifics of the local market, but any dedicated fixed-income investor will now have to pay attention to Russian domestic bonds," says Michael Workman, head of fixed income at Otkritie Capital.

Response

Markets have taken a positive view of the announcement, with spreads on OFZs tightening by as much as 50 basis points across the curve during August and September – a move that has been primarily driven by foreign investors, according to Andrey Podobed, head of fixed income at Russian broker BCS.

"Most international accounts that already have exposure to Russia have definitely increased their allocation to take advantage of the expected Euroclearability premium," he says.

Indeed, non-resident participation levels are so high that Podobed suggests "it may be a case of buy the rumour, sell the fact" – particularly given that the recent reduction in OFZ yields has priced domestic investors, such as banks and insurance companies, out of the market.

Jan Dehn, chief strategist at emerging market specialist fund manager Ashmore, agrees that the move to Euroclearability should not in itself be seen as a reason to move into the Russian domestic bond market. "It is clearly a technical improvement, but there’s also a broader story here, which is that the local market is attractive in its own right," he says. "You get a good rate of carry and you have a central bank that is moving with quite a high degree of determination towards inflation targeting."