Russia

This fantastic market has attracted a lot of attention for many years. Reasons for attention have varied but except most spectators unity about the excellent opportunities there has very often been a bi-sentence starting with ‘if only…’’

By Ulf Norén, Global Head of Sub-Custody, SEB

• If only we could see further market place consolidation
• If only a CSD, hopefully just one, could be created
• If only all the manual parts of the registration chain could go away, errors would diminish
• If only we could evaluate Corporate Action information independently by f ex a Golden
Source for such information
• If only we could be reasonably sure of equal treatment for investors
• If only there was an option for true DVP in all relevant currencies
• If only the currency restrictions were a bit less stringent
• If only the possibility for cross border arbitrage was available in the depository market to
a greater extent
• If only a tiny bit of predictability was added
• If only the tax laws were less severe and more harmonized with developed markets
• If only Russia would create a super regulator instead of several competing ones and let
regulations shape instead of laws
• If only entry requirements could be loosened up somewhat so that it is possible start up
quickly in times when interest for the market is hot
• If only national protectionism could be downscaled – all is so political
• If only a national, accepted nominee recognition could come about
• If only a less complicated Proxy Voting regime could be introduced, more of our client
base would open up for investments

As written in this Newsletter in April and latest in October 2010, there are still issues to address and most of these are related to lack of transparency, foreign shareholder discrimination, local infrastructure risk, substantial bottlenecks when it comes to registration and account opening, severe inconsistencies surrounding corporate actions announcements and processing and lack of operational/administrative efficiency across the lifecycle of a transaction.

Though, since last time our distinct impression is that Russia has been changing in a positive direction in almost every aspect. This article will mainly focus on the positive drives. It is, though always wise to have a cautious approach as it time upon time again has been proven that it is fairly easy to talk but much more difficult to walk. Having said that, it is our opinion that the determination showed, not least by President Medvedev, will mean that Moscow indeed will achieve the objective of becoming an international finance centre – and well before the target year of 2020. If we are right in believing that the trend is positive, many things will also change for the positive in how Custodians operate – more established ‘’westernised’’ features to follow in all fields of post trade operations.

Politics
In the beginning of July,2011, in connection with the St Petersburg Economic Forum, President Medvedev focused on a high number of improvements to Russian investment environment that he instructed the authorities to implement by September 1st. Our interpretation of that is that the necessary proposals shall be ready by then as there is a general 6 months period from approval to implementation. And longer than that for enforcement. The measures include further privatizations, equalization between state employees and privately employed executives in terms of legal responsibility for mistakes, tougher anti-corruption laws, further polishing of the court system with a focus on judges roles, removal of cross-border issuance barriers for Russian issuers (big improvements in the proposal but still questionmarks surrounding f ex voting), CSD Law(!) and removal of entry barriers, including foreign institutions account opening requirements. Other proposals included enhanced disclosure procedures. In terms of corporate disclosure, The Russian regulator, FFMS, has announced plans for issuers compulsory publication of specific corporate information(reports, corporate action info) on the web sites of authorised information agencies. Increased responsibility will be placed with these agencies to determine authenticity of information. The new disclosure rules are extensively more detailed than previous and regulate in detail f ex: AGM’s and EGM’s, insolvency and default issues, larger corporate transactions, cross border instrument issuance and threshold reporting in 9 layers.

All this well in line with ever stronger ambitions to realize the Moscow International Financial Center agenda.

This is doubtless all-over positive measures but, as always, it is also now wise to see how this is going to be shaped. One example is the statement on privatization were strategic companies are excluded but, by all means, a successful implementation might provide to be helpful in loosening the leach the government so far has held at tight with the strategic companies. This shall be read in the context of the government’s final decision in late 2010 on a 5 year privatisation plan where up to 900 companies could be wholly or partially privatised, including parts of Sberbank, RZhD, Rosneft, VTB and Aeroflot. The market has also seen relief in the view of foreign ownership of strategic companies and can now be allowed an aggregated shareholding of up to 25% of such companies.

Trading
On 04 October 2010 a new draft law was presented to the parliament in which government securities will become tradable on MICEX Stock Exchange as well as Russian Trading System (RTS), something that will be a great simplification for investors and a generally improve liquidity quite a lot.

MICEX has presented their proposal for new listing and delisting procedures where they reduce the complex listings with 5 lists plus a list for unlisted securities. The restructured listing system consists of a list for bluechips (A-list) with approximately 30% of the companies qualifying and a B-list for the rest. The unlisted securities will be taken out at a later stage, following legislative changes. Within the proposal was also the admission of foreign companies, under certain conditions, for MICEX listing.

One of the absolute biggest pieces of news coming out of Russia lately is the planned merger between MICEX and RTS. Already in October 2010, MICEX announced that they ‘’might start negotiating with RTS and start purchasing shares’’. In January, the President instructed the Central Bank to sell its nearly 30% shareholding before June to pave way for the merger. Details of the merger conditions was first announced in February and after a lengthy negotiation process, the Framework agreement was signed in the end of June. It is widely seen as the most important step in getting Russia up to speed in the global competition among exchanges and other trading facilities. Scale advantages, tariff policies, IT- and product development are all obvious potential areas of benefit from this deal. In this transaction, MICEX was valued at slightly in excess of RUB 100 Billion while the value of RTS was set at RUB 35 Billion. A joint management team under the command of MICEX President Ruben Aganbegyan has already been formed.
The deal is subject for approval by the Federal Antimonopoly Service and extraordinary general meetings of shareholders of MICEX and RTS scheduled for August 2011. If approval is granted, an IPO is planned to take place in 2013.
Following the merger announcements, MICEX decided to assimilate its trading hours with the ones at RTS. This will mean that main regime trading from September 1st will start half an hour earlier (between 10 AM and 7 PM). As a consequence, pre-trading session now will begin at 0945AM. Trading in the Repo and negotiated trades market starts at 0930AM.

We expect the FFMS rule to disbanding the blocking that prevented foreign brokers to conduct both buy and sell transactions in the same security on behalf of clients to improve liquidity and have more foreign end investors showing a Russian appetite. This will now be handled by way of introducing new and unique identities of underlying clients. In terms of heavier administration, it is a different story!

RTS announced plans for further expansion in Russia and CIS and to develop further in Ukraine and Kazakhstan. The combined entity now has set it’s target on unifying Russia, Belarus, Uzbekistan, Kazakhstan and Ukraine. There is a lot of logic, especially in the access field, supporting the ambitions. As long as they do not steal energy away from developing a strong Russian marketplace.

In the end of 2010 and following audit criticism, RTS included Aniti Money Laundering, procedures into their procedures. All efforts in this space (and in Insider Trading space as well) are welcome elements to increase cross border investor confidence. Exchanges in Russia where also subjected by FFMS to introduce systems to monitor suspicious trading and trade abuse.

CLEARING
President Dmitry Medvedev has signed a federal law on clearing and clearing activities, defining the concept and functions of a central counterparty in the markets and the Federation Council approved on February 2. This Law will come into force on January 01, 2012. The Federal Law determines the procedure for clearing; requirements with reference to the legal form of clearing organizations, the reconciliation of clearing activities with other activities, as well as requirements to governing functions and employees of the clearing organization, the capitalisation of the organization; the legal status of a central counterparty, measures aimed at reducing risks (creation of special funds, including a guarantee fund); competence of the regulatory body - the federal body of executive power in the field of financial markets (Russian Federal Financial Markets Service) in the field of licensing of clearing activities, suspension and revocation of licenses, as well as the appointment of a temporary administration. In classical terms of volume advantages, a CCP in Russia might not be priority one but in terms of risk reduction benefits, it is warmly greeted.

CSD
The Russian market infrastructure lags behind and the lack of a CSD is indeed a problem. And, yes, it would help a lot to introduce one. The chosen model where registrars still have a role is not to the personal taste of the author but there are obvious reasons for the construction, looking at how the political and financial powers are distributed in Russia. As an obstacle for the IFC-plan, this is a fairly major one. As the draft law does not make the CSD mandatory, it will – unless pragmatism is widely used – have difficulties in being recognised as an eligible CSD internationally. The merger between MICEX and RTS will also be very meaningful in supporting a positive development. Our analysis tells us that accessibility will be better, the liquidity concentration beneficial and it might also attract some part of the Russian equities (around 15%) that are traded outside of Russia. We think that this will also catalyse some speed up of the development. We have to remember that the market only is some 15 years old and there is a lot to deal with.

The FFMS withdrew the license of Central Moscow Depository, one of the dominant registrars, effective 01 February and in connection with that DCC took over responsibility for the deposited assets. NSD reduced its fee schedule on the value based fee for corporate, municipal and government bonds twice in 2010, first by 10% and then by 20%.
A small but nevertheless welcome change was DCC’s introduction of tolerance level that allows matching of settlements where the deviation in DVP settlement consideration is no bigger than USD 25.00 or RUB 700.00

Of all the focus points in President Medvedevs statement, we find the CSD part the most interesting and parallel to that naturally also the introduction and recognition of the foreign nominee concept. The latter will with some certainty contain a number of qualification requirements including certain supranational points. What is known up until now does not look like undue barriers and will be met by most regional- and global custodians as far as we can judge. Possible exceptions to this can be liability obstacles, disclosure obstacles – especially here, the indications are that a multitude of official as well as private authorities and organizations will have the right to ask for disclosure of shareholder information.

The bridge improvement (as of early July) between DCC and NSD will definitely be important in order to raise experienced service quality. The bridge in this case consists of mutual inter-depository accounts and the improvements can shortly be described as: The number of issuers eligible increased with some 25% to 159, the deadline to submit transfer orders has been extended with more than 2 hours to 6.15PM, the previous three sessions where orders were processed have been replaced by continuous processing between 10AM and 6.35PM and reporting confirmations issued every half hour. This will mean that Custodians can issue the result of bridge transfers at the most 40 minutes after sending instructions which will make transaction position management much more reliable and proactive exception management a lot more meaningful. A centralisation of all settlement and depository functions to one legal entity would be a significant step towards a CSD in the Russian market.

ASSET SERVICING
The amendments to the Tax Code clarifies that cross border investors will not be subject to capital gain tax in Russia when disposing of Russian listed equities. In early part of 2011 it was though announced that disposals of holdings in non-listed or any kind of high-tech companies will not trigger capital gains tax, provided that the shareholders have held the stocks more than 5 years.

The Ministry of Finance outlined a few improvements in a draft document that in its turn will be important when the future tax legislation is constructed. We have detected a few areas of which the planned action to make Brokers, Underwriters, Custodians, Asset Managers and Depositories VAT exempt (current 18% VAT is imposed on fees) is the most important competitive action. Also the so far less detailed statement on favourable fiscal treatment for holders of Eurobonds issued within Russian legislation and by Russian issuers might be important.

Early first quarter a new federal law, clarifying income distribution (announcement and pay out rules) practice. In this law a set maximum time frame of 60 days from announcement to payment was established and, furthermore, shareholders right to claim unpaid dividend was set to three years, unless statutes of a company would allow it to be extended to 5 years. Saying something about some irregularities of the Russian market is the exception to the 3 year rule ‘’…the 3 year rule is final unless the shareholder has been prevented to claim through threats of force or violence’’.

LEGAL
A revision of the Disclosure rules has been approved by the State Duma dealing with disclosure both on issuer and on investor level. On the issuer side, we deem most items to be positive for the cross border investor. The issuers will need to disclose information on substantially more items in comparison to existing rules and most of them provides additional transparency and adds safety to the investment. On the investor side part of the rules mainly concerns substantial shareholdings. In this fairly limited part of the cross border client base, new obligations inevitably will add some complexity to an already complex process but on the other hand seem fairly helpful also when it comes to such shareholders rights in times of conflicting opinions. Amendments to the Mutual Fund legislation makes it possible to create and list ETF’s.

Less beneficial in building foreign trust was the decision to make the State exempt from the duty of mandatory offers to minority shareholders when exceeding 50% ownership in companies.

REGULATORY
In March, FFMS, published it’s intention to increase investor protection levels by mandating the Broker Dealer community to protect client funds with own money. Two mainstream routes have been discussed, either through use of collateral or by paying interest for use of funds (although the latter do not give additional protection, rather a financial equalisation).

Merger of Federal Financial Markets Service and Federal Insurance Supervision Service: On March 4, 2011 Russia’s president Dmitry Medvedev signed the order on liquidation of the Federal Insurance Supervision Service (FISS) and distribution of supervisory powers between the Federal Financial Markets Service (FFMS) and the Bank of Russia. The Federal Financial Markets Service will be given former control functions of FISS over insurance marker participants while maintaining the FFMS’ original control functions over financial markets, except for auditing and banking business. All legislations procedures regarding merger ordered to be completed in 2 months and so shall be the distribution of missions between FFMS and the Ministry of Finance. The creation of a super-regulator is by us interpreted as positive and will help both enforcement and implementation as less agendas come into play.

Also in March, the previous head of FFMS, Vladimir Milovidov resigned and Dmitry Pankin was appointed new head. His previous role was Deputy Minister of Finance.

In March FFMS published a final draft of the order on insider information. The order contains most of the issues which fall under disclosure of information in possession of issuers’ owners and employees, asset management companies, stock exchanges, professional market participants, information and rating agencies, etc.
The latest draft by the FFMS contains changes which more clearly specify what insider information is. Requirements will be slightly eased for brokers and asset management companies. For example, all information on clients’ orders exceeding 100 million rubles (or 0.2% of the volume of issued securities) will be seen as insider information. To compare with, earlier any information on clients` orders was seen as insider. The same is applied to assets of management companies and operations with exchange-traded goods and currencies.
The following decisions of company’s management bodies are supposed to be considered insider information: General Meeting convocation and its decisions, Board of Directors decisions regarding company’s management, securities and payments relating to securities, approval of internal documents and related party deals. This takes Russia somewhat closer to more developed markets and now need to ensure a consistent reaction to breaches.

This artice was written 31 August 2011