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Opinion

Capital markets: The Russian winter will endure

Russia’s capital markets face a difficult future. Even if the will for change is there, it will be a long and difficult process.

Russia is an outlier in emerging Europe in terms of GDP growth prospects. As Morgan Stanley notes, Russia, unlike other countries in the region, has a low level of external debt, a strong current-account surplus, and a high level of foreign-currency reserves.

However, high oil prices, and barriers to change within the government, mean the country is increasingly dependent on mineral exports and the public sector. As greater perceived corruption is a partial effect, Russia’s capital markets are underperforming.

Even before protests around disputed elections last month, the average price-to-earnings ratio in Russia was 5.4, compared with an emerging market ratio of 8.7, according to Troika Dialog.

The migration last month of RTS’s cash equity business to Micex should make the Russian capital markets more attractive to issuers. The merger of the two exchanges is an important step in boosting Moscow’s status as a financial centre.

However, just as the merger was completed, Polymetal and Evras became the first Russian companies to join London’s benchmark FTSE 100 index – a big blow to Moscow. The two firms (both commodities stocks) became eligible for inclusion in the index after upgrading their listings in London from global depositary receipts.

A new law in Russia came into effect on January 1 allowing the creation of a central securities depository. Foreign buyers will be able to open an account directly at the depository from July, widening the range of potential investors.

But partly thanks to Russia’s undeveloped pension and insurance market, stocks will still enjoy greater liquidity in London – particularly if they are included in the main indices. Even in 2011 the vast majority of listings by Russian firms were made in London or New York. Other Russian firms are also seeking to move premium listings to London, including Eurasia Drilling, Polyus Gold and potash firm Uralkali.

UK investors now fret that Russian minerals stocks – whose earnings are very volatile thanks to global commodity-price movements – will begin to dominate London’s exchange and benchmark index. One counter-argument is that every exchange has its personality, and commodities are becoming more important globally.

Certainly this is Russia’s loss: the City of London should not complain that foreign firms want to list in London. But the level of transparency and governance at Russian corporations is a valid concern. Investors are, at the very least, correct to expect companies with a premium listing in London, particularly those included in the FTSE 100, to have a minimum free float and a majority of independent directors.

Yet part of the reason Russian companies are moving to London is the extra protection of UK rules and regulations compared with the less-predictable Russian environment (or the perception of this). Indeed, unaccountable decision-making within the corporate sector in Russia is a reflection of what happens within the equally shaky state structures.

Russia’s capital markets, along with its non-oil private sector, will likewise continue to disappoint until there are more checks on the power of individuals in Russian institutions. As in the Middle East, frustration at the lack of these balances is now spilling out onto the streets – causing further short-term damage to investor appetite.

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