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In the same way that 1996 was the year of the fixed income markets, 1997 will be the year of the equity markets. While we are witnessing domestic fund transfers from the fixed income market to the equity markets, the primary driver of the equity markets is the increased weighting and re-allocation of funds being applied to Russia by Western emerging market investors. While the GKO/OFZ market and the equity market are each capitalized at about $40 billion, the daily volume on the GKO/OFZ market in January 1997 was $800 million, and the volume on the RTS for the whole of January – a record month – was $900 million. Despite the revaluation already witnessed in the last 12 months in the equity markets, there is still enormous value to be found. Demand follows liquidity, and the market is developing both depth and breadth. Settlement systems still require attention, in particular the need to settle on a delivery against payment basis.This would reduce the time, cost and risks currently associated with settlement. An ever growing universe of potential equity investors is rapidly awakening to the attractions of investing in Russia. The bull market, which charged with a vengeance over the New Year holiday, caught domestic brokers and players in Moscow napping. Bull runs in Russia have traditionally coincided with the onset of spring, and gentler weather with which to brave company visits.This January’s exhibition confirms Russia’s arrival into the ranks of established emerging markets destinations, suitable for annual fund flows switching between other eastern European countries or other emerging market locations. The New Year surge, which has demonstrated very little in the way of “pause for thought”, was led by the blue chips and those companies showing greater liquidity. Since demand has been primarily western-generated, initial focus has been towards those companies where ADR programmes have been or are expected to be created. The lack of liquidity has led to rapid price increases, with supply struggling to meet demand. Domestic investors have been more sceptical about the sustainability of the bull run, having lost when the bull turned rapidly to bear in early July 1996. A large weight of domestic capital remains toying with the possibility of making a partial switch from the GKO market, in view of the much reduced yields in that market. This year promises to be an even more active year than 1996. More and more investors, brokers and the all- important back offices have been diligent and understand the requirements and processes of investing in Russia. We have seen progress in trading, corporate behaviour and overall market infrastructure, but the lack of progress in reducing the paper trail and methods of settlement remains the single largest hindrance to efficient domestic trading – evidenced by the increasingly large role played by the depository receipts market. In 1997 we expect the oil and gas, telecoms and electricity sectors to retain their near monopoly position over investors’ interest. Over time we expect to see increasing moves to lesser known names within these three sectors, and thereafter to new sectors. The banking sector continues to try to “emerge”, despite central bank restrictions still in force against foreign investors. Industry will be called upon to support the reconstruction needed to rebuild the economy in the coming years, and companies with exposure to utilities and infrastructure construction can expect to see recovery in the medium term. Russian indices performance Jan 1996-Feb 1997
Most traded stocks
Russian trading system The Russian Trading System (RTS), introduced onto the market in 1995, remains the single most important development in the infrastructure of the equity capital markets. The RTS and the broker-dealer association NAUFOR have created a Russia-wide stock market with uniform rules for market participants. Members of NAUFOR have the exclusive right to use the RTS – the US NASDAQ-like computerized trading system – for quoting and trading purposes. The system, which consists of almost 90 stocks on level 1, has made an important contribution to price transparency, increasing liquidity and helping to reduce bid-offer spreads. Recorded volume on the system continues to grow, reaching a monthly record in January 1997 of almost $900 million, with a record for the day on January 21 of $80 million. Although the enforcement of recording trades is not yet perfect, and the volume figures do not reflect the weight of trading in ADRs and by non-NAUFOR members, the trend is positive and gives a strong indication of the increasing activity in Russian equities. Depository receipts The development of depository receipts programmes for corporates has focused attention on and developed liquidity in those issues. This process began in November 1995 with Mosenergo’s Rule 144A issue and has since progressed strongly. Recent programmes have included Gazprom, Vimpelcom, Tatneft, Surgutneftegaz and Irkutskenergo. In October 1996, Gazprom became the first Russian company to be listed on the London stock exchange. Its American depository shares (ADS) programme raised more than $429 million from 27.25 million ADS at an issue price of $15.75 per ADS. Each ADS represents 10 underlying shares of Gazprom. The company has succeeded in distinguishing the local market – where considerable restrictions continue on trading and where the shares remain at around 45 cents – from the foreign market, where the current price for the same shares is around $2.30. The ADS issue was more than five times oversubscribed, indicating the existence of considerable capital with potential to be mobilized into investing in Russia for the right story. In December 1996, Vimpelcom, a four-year-old Moscow cellular phone start up, made its debut on the New York stock exchange with a Level 3 ADR issue. Its share price soared immediately from $17.50 to $29.00 and its market capitalization amounted to $750 million, almost one-third of the vastly larger Rostelecom. A $120 million issue of American depository shares in Tatneft, representing 10% of the company’s shares, began trading on the London stock exchange in December 1996. Most recently in January 1997, Level 1 ADR programmes became effective for both Surgutneftegaz and Irkutskenergo. The central bank of Russia (CBR) continues to restrict the number of depository receipts that Russian banks are allowed to issue, because of the general fear that they deprive the securities market of capital. To date almost no bank shares have actually traded as ADRs. Menatep, Inkombank and Vozrozhdeniye have had their ADR programmes approved by the US SEC, and by the CBR for up to 3% of the banks’ authorized capital, but the ADRs have not yet traded. In addition to ADRs, various other derivative structures have been produced by a number of market participants. ADRs
Other trading Preferred shares Trading in preferred shares began on the RTS in September 1996, and there are now 13 companies whose preferred shares trade on the level 1 system. Trading volume for preferred shares has been growing steadily, as investors are attracted by the idea that the large discounts on preferred shares to common shares will continue to evaporate. RTS-2 Trading over RTS-2, the electronic trading system for second-tier stocks, began in late December 1996. The new system lists common and preferred shares of 70 issues, all of which are less liquid than their RTS level 1 counterparts. Listing on RTS-2 has dramatically increased liquidity and narrowed spreads. While the new system uses the same operating technology as the RTS, it differs primarily in the stringency of its listing and trading requirements. NAUFOR has made several amendments to its trading rules for announcing quotations and determining market makers over the system. Among the stocks there are 50 from the electricity, telecom and oil sectors. According to the new NAUFOR rules, the minimum lot size in RTS-2 will be reduced to Rb5 million ($900), compared with $5,000 in the original RTS. In RTS-2, quotations are also listed in dollars. Market makers will bear responsibility for supporting share quotations. Government activity in the capital markets The government’s participation in the capital markets, whether direct or indirect, as part of its privatization or capital raising programme, has already been significant. Its main activity in late 1996 was the sovereign Eurobond issue and the sale of a stake in Unified Energy System (UES). The success of the sale in November 1996 of $1 billion five-year sovereign Eurobonds yielding an interest rate of 345 bp above US T-bills with the same maturity, attracted increasing attention to Russia and in turn to the equity markets. After abandoning a planned convertible issue in UES, the Russian government auctioned an 8.5% stake in the company in December 1996 to a consortium of banks closely associated with Gazprom. The stake sold at 9 cents per share, resulting in proceeds of $330 million for the government. Major plans for 1997 involve Svyazinvest, Lukoil and another sovereign Eurobond issue. The government has transferred a 38% stake (51% of voting shares) in Rostelecom to Svyazinvest, with a planned sale of 49% in 1997 to both domestic and foreign investors. The government is also planning to sell up to 15% of its shares in Lukoil during 1997. The stake is scheduled to be sold through an investment tender. Settlements and supervision FSC versus CBR The Russian securities market is still struggling to establish a reliable and reputable infrastructure. The Federal Securities Commission (FSC), under its chairman Dmitry Vasiliyev, is trying hard to resist control of the securities market passing to the banking sector. The banks, led by their regulator the central bank, are in turn lobbying for more control of the sector. Under the new criminal code, which came into effect on January 1 1997, banks will no longer have the right to conduct operations with corporate and non-governmental securities unless they are given a license by the FSC. First deputy prime minister in charge of the economy, Vladimir Potanin, is aiming to ensure that banks remain licensed to stay in the markets. The Moscow Interbank Currency Exchange (MICEX) and the central bank have meanwhile announced the creation of a new National Depository Center, with the aim of trading and making a market in blue chips by the end of 1997. DCC NAUFOR and the Depository and Clearing Company (DCC) have recently begun testing a simplified clearing and settlement system for corporate securities in two stocks, Lukoil and Surgutneftegaz. The new system will match trades concluded on the RTS, and then forward batch reports to the DCC. The DCC will then electronically verify trades with the counterparts and subsequently record all changes in ownership. The DCC will act as nominee shareholder and provide a centralized method of recording share ownership. Since the DCC has promised but failed to deliver on previous occasions, a wait and hope approach should be adopted for the new system. Listing requirements In addition to RTS-2, NAUFOR is currently pursuing other initiatives to upgrade the standards of the market. The listings committee is developing a number of listing requirements, which will include notification of corporate actions and mandatory release of financial statements. Registrars The FSC has already licensed about 150 companies to act as shareholder registrars. The number of registrars is not expected to exceed 200. The National Registry Company (NRC) has continued to absorb the registers of more companies, including recently those of Norilsk Nickel and Vimpelcom. The ministry of telecommunications and the Bank of New York have approved a new registrar, Registratorsvyaz, for the Russian telecoms industry. Rostelecom, which is planning an ADR issue, will employ the new registrar. Custody International custodians have served to reduce investors’ risks in dealing with registrars. In addition to such majors as Chase Manhattan, Credit Suisse and ING, local bank Unexim Bank is qualified by the US SEC to act as a custodian. Corporate supervision The FSC recently forced Surgutneftegaz into making amends for its controversial share issue in October 1996, in which Surgut Holding raised its stake in its production subsidiary Surgutneftegaz to 43.5% from 38% after acquiring an entire new issue of shares at a discount. Surgutneftegaz has been required both to change its share charter to give shareholders pre-emptive rights over future share issues, and to pay an additional sum for the shares. This action was a victory for the FSC, proving that it does have some influence in protecting shareholders’ rights, despite having no authority to force Russian companies to comply with the law. Financial reporting In late 1996, Mosenergo was the first Russian blue chip to release its financial results for 1995 audited according to US GAAP. We are increasingly seeing that companies are restating their Russian accounts, whether audited or unaudited, to comply with either IAS or GAAP. We expect to see this develop further in reporting on 1996 results. Indices The RTS index and the Moscow Times index (MTI) remain the two principal indices in widespread use. The RTS remains narrow based at 24 stocks, while the MTI has a wider base of 50 stocks, including several less liquid issues. In addition to these there are a number of other local and international indices. The International Finance Corporation (IFC) is adding Russia to its family of investable indices from February 1997. This follows Russia’s inclusion by the IFC into the Global index series in September 1996, and the Global Composite (IFCG) in early January 1997. Later in the year, perhaps by September, Russia could be included in the influential IFC Investable Composite (IFCI Composite). Once added to such an index, Russia would merit a weighting of at least 2%, on a par with India. The Global and Investable indices differ primarily in their targeted users, with the IFCG more accurately reflecting the perspective of domestic investors, while the IFCI is geared towards the emerging market investment community and is significantly more representative. Both indices will allow emerging market investors to compare market capitalization and performance in Russia with the country’s global competitors for capital. In December 1996, Morgan Stanley launched its own stand-alone Russia index, consisting of 14 stocks. Russia may join the MSCI Emerging Markets Free index, which is mirrored by many funds, as early as May 1997. Mutual funds Domestic unit investment funds have been officially launched in Russia. To date funds have been registered and launched by a small group of fund management companies including Pioneer First Voucher, Troika Dialog Asset Management, Credis and Pallada. The initial funds have all concentrated on government securities. Equity funds are expected to be created during 1997, and are likely to become an increasingly important source of funds for the market. Sectoral Breakdown of the Indices
Breakdown of RTS index Jan 1996-Jan 1997
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