Russia remains an enigma to many. Blessed with huge natural resources - most of which are becoming more and more valuable as the world consumes more energy - significant private and institutional wealth and plenty of attractive domestic and international companies that international investors want to be involved with.
Russia remains an enigma to many. Blessed with huge natural resources - most of which are becoming more and more valuable as the world consumes more energy - significant private and institutional wealth and plenty of attractive domestic and international companies that international investors want to be involved with.
Yet its reputation means that the most conservative international funds don’t want to get involved. While it has cleaned itself up over the years, many observers still consider it to have significant problems with corruption, patronage and a lack of a strong regulator.
Yet it is too big to ignore.
“We’re in 10 countries, primarily the Nordics and the Baltics,” says Ulf Noren, global head of sub custody at SEB. “Russia is a bit of a hybrid. There are some connections, it used to be part of one union [with the Baltics], there are similarities in language and culture. But it’s a much more complex market and its size exceeds all other markets.”
“We are positive on Russia, it’s a country with a large number of natural resources and generally a high inflow of investment funds,” continues Noren. “But we remain cautious.”
Investment continues to pour into the market, however - it didn’t suffer as badly as other major markets during the downturn and returns have generally been good. Scandinavian and central European funds consider it a major domicile, while interest from Asia and North America remains strong.
“The interest from investors is here,” says Natasha Sidorova, director and head of securities services at ING Commercial Banking Securities Services. “The market is still not mature and remains well undeveloped.” Sidorova adds that much of what is attributed to outside investment, however, is fromSPVs. “A lot of the non-resident investment comes from Russian SPVs established abroad,” she explains.”
Growth
It’s easy to forget that this is still such a young market - if it were a person, it still couldn’t buy alcohol anywhere except in Russia. As the markets liberalised, both international and domestic providers saw the potential and started offering as many services as possible. Sidorova estimates there are now around 700 institutions offering custody services in one form or another.
“The number of participants cannot be justified by the size of the market,” she says. “It is a huge market but the number of participants is even huger. It’s not just about the number of custodians, but also of other market participants - brokers, registrars and so on.” As well as ING, which has around $150 billion of the $1 trillion market under custody, and SEB, major international players include Citi, J.P. Morgan, UniCredit and Deutsche Bank.
As well as ING, which has around $150 billion of the $1 trillion market under custody and SEB, major international players include Citi, J.P. Morgan, Unicredit and Deutsche Bank. Together they make up around 80 per cent of the international business. Each has its own area of expertise - ING specialises in servicing European and US custodians, SEB has a hold on the Nordic and Baltic markets, Citi is mostly US brokers, while Deutsche concentrates on its own programme along with domestic clients.
“We started offering custody services in Russia in 2008, just before the Lehman crash - at the moment we are sticking to sub custody in the market,” says Noren. “You need to build up a considerable compliance organisation to serve the Russian community.”
You can find about 700 banks or broker dealers with a custodian licence, but most of them will only do the custody for their own organisation,” continues Noren. “When it comes to cross border investment, when foreigners look at Russia, they more or less exclusively look at the international banks, which limits the choice to around 10.”
“There is a difference in service levels between domestic and international banks,” says one local. “Generally the international banks service other developed markets so they know to provide a service level at that end - they know what to strive for. And if you do provide services in developed markets you are likely to have a bigger IT budget and a central organisation based outside Russia, which is likely to improve service levels. That said, the two or three largest Russian custodian banks have excellent service levels.”
Sidorova adds that some of the major Russian banks have made great strides in recent years. “It used to be the case that within a Russian bank no-one spoke English, but that situation has changed. The state owned banks have another advantage of being better capitalised and having better liquidity, also due to a lot of support received during the crisis.”
Regulation
There remain issues with the reputation of Russia as a centre for international investment, as well as problems with an infrastructure that is not always compatible with international standards. There’s no globally-recognised RTGS system in place, for example, and SWIFT messaging is limited.
“Russia still tends to be less trusted than the majority of major overseas markets,” says one international fund manager. “You have to get a grip on how the system works. Even if you are a majority owner or a significant shareholder, if your interests are different to other shareholders you could end up being sued in the Siberian courts and end up having to sell your stake at a low price - there are many stories of this happening in the past. There is also the constant fear of instability.”
Noren points to the registrar system, which is due to change in the future, as another potential stumbling block. “There are too many registrars and many of them deal with requests in a different fashion.”
The country still has a significant amount of physical documentation, and there have been issues in the past with falsification of those documents.
One of the major debates within the industry is over the power of the regulators. While laws are in place, many believe the regulator has neither the teeth nor the political power to enforce them. The tradition of political patronage that was common during Soviet times has remained as the country became a democracy, leaving some people and companies a bit more ‘equal’ than others in the eyes of the law.
“There are plans to create a super regulator who will oversee the whole securities market,” explains Noren. “When that happens, it should bring in more consistency and level the playing field. It’s a very positive step.”
“We’ve been under the impression that a lot of things are going to happen shortly,” says Sidorova. “But then the situation suddenly changed. There has been a number of statements from a very high level but they have not been developed. The changes in regulation have been discussed for so long that there is a danger that if there is no progress by autumn, foreign investors will not trust the market any more.”
The lack of a CSD is also scaring off international players. At the moment, there are plans for two separate depositaries run by the two main stock exchanges, Micex and RTS. But a proposed merger between the exchanges will, it is hoped, lead to the faster completion of a single CSD. The model the regulators are looking at appears to be similar to that used by CREST, which will allow registrars to remain at the centre of the market. This is not the most popular choice amongst the international community, who are no fans of the registrar system, but influential locals - including the oligarchs - are keen to see the system remain in place.
Russia is changing for the better, but progress remains slow. “I gave a speech last year on the creation of an International Finance Centre in Moscow,” says Noren. “In it I said that Russia already had an IFC, now it needs to work to make it a good one. The plan is for Moscow to be an IFC by 2020. It could be done quicker, but we’re talking Russia here.
“A year ago I would have said I’m pessimistic about whether Russia will meet the 2020 target, but the past few months have been very encouraging with a number of actions to get to the target. There have been a lot of actions on transparency, governance and so on, and there are senior figures within the country who are driving the changes.”
Accessibility for foreigners is improving - DvP and RvP in roubles is now allowed in roubles, and that’s going to bring in international trade.
“There are three things I would like to see happen that I believe will drive the market forward,” says Noren. “First is the merger between RTS and Micex. Then there’s the creation of a CSD with the regulation in place to make use of it mandatory. And finally the creation of a super regulator goes ahead and is empowered within the securities markets. If they happen, Moscow will be a powerful IFC by 2020.
