Russian market reform: Progress has been slow, but we’re on the right track
By Tim Bevan, Head of International Prime Brokerage Sales at BCS Financial Group.
The concept of the creation of Moscow as an international financial centre was approved in 2009. Only at the end of 2011 were specific milestones announced, and only this year are we experiencing real change.
Aggressive deadlines set by The Moscow Exchange were missed, overshadowing the true complexities of what is being attempted and achieved. Things happen slowly in Russia, but they do evolve. A lot of tangible changes are happening, which are perhaps being undervalued by the market and worthy of a second look.
Problems that have thus far kept international participants out of the Russian market are being resolved, and are improving the risk/reward of trading in Russia. Three core areas of improvement, particularly for equity market participants are the post-trade environment, changes in corporate actions and the move to T+2.
Custody and settlement
In the past, the post-trade environment has meant that before an asset manager or broker could deal with locals, their legal and operational departments had to acclimatise to the local set up.
A non-standardised settlement cycle, the complexity and uncertainty of passing through shareholder rights on top of operational bureaucracy, were probably the biggest cost and risk factors keeping international participants out of the local market.
In April this year, the National Settlement Depository became fully operational and removed a large proportion of the above concerns. We now have a legally recognised and regulated Central Securities Depositary (CSD). This delivers a mandatory settlement structure with the CSD as the only nominee at registrars; mandatory electronic data interchange between CSD and all counterparts and mandatory reconciliation between CSD and registrars with CSD records prevailing. In short, legal surety and operational clarity.
Additionally, changes in local market legislation enable Russian custodians to open securities accounts for foreign nominee holders. Further clarity is also expected with regards to tax treaty rates and voluntary corporate actions processing, which will further streamline processes.
The biggest single issue in the corporate actions space has been retrospective record dates, especially in regards to dividends.
At the point when dividends were announced at the general meeting, the record date had already passed some months earlier. Historically, the gap between record and payment date could be up to five months and chaotic in terms of claims processing and accurate pricing.
A new law requires a second record date, for receipt of dividends, to be announced no earlier than 10 and no later than 20 days after the general meeting – and the pay date can be no later than 25 days after the record date.
From Jan 1 2014, we will have a much clearer pricing environment for Russian equities with a standardised ex, record, pay date mechanism.
The equity market structure in Russia has also proved difficult to accommodate by international participants. The model has been on of pre-delivery insofar as that the executing broker has to have the assets (cash or stock) on its account at the exchange before it can execute a trade. There has traditionally been no concept of splitting custody and execution. The only way to achieve OTC transaction and settle to third party custodians has been to finance the transaction from trade date to settlement date.
Not only has this introduced significant financing costs into execution, but has created a dependency on the stock loan market just to conduct normal trading activity (not just short selling).
This is now being address with a major market infrastructure change; the move to T+2. In terms of migrating to the new model, T+2 was launched in parallel with the T+0 in late March, and was expanded to the top 50 in early July. The full migration (and switch off of the T+0 platform) is scheduled for early September.
There are a number of finer points to be ironed out, but two key achievements are the move to partial margining, which will mean a reduction in financing and clearing costs of up to 85%, and 100% cash margining which will introduce the ability to freely trade a much broader range of stocks without the need to pre-locate.
A new model emerges with separately identifiable exchange fees, clearing costs, settlement costs and broker commission. With these changes this is beginning to look like a standard market model. Additionally, each of these costs can be verified and checked, which means growth in transparent, cost-plus models being offered to the market.
We’re seeing a number of other tangible changes beyond the equity market including increased off-shore trading of RUB and the adoption of sovereign bonds (OFZs) into Euroclear, to the launch of fixed income derivatives and the launch of new instruments such as the first Russian ETFs.
All of this builds a very convincing case that we are witnessing a serious game change. Things happen over time and we’re not expecting major changes over night; there are still significant risks, for example, real improvement in corporate governance will require a change in grassroots culture and require the political will to tackle vested interests. What we are seeing is the establishment of a new platform on which a more developed and sophisticated financial markets sector can grow. We can confidently say that the costs of trading are coming down and there will be a marked increase in international participation over the next 6-12 months from both the buy- and sell-side. We expect a broadening of liquidity further down the equity order-book, RUB and RUB-denominated assets to increasingly be part of the global collateral pool, and a more developed derivatives market.
2013 represents a major milestone in the evolution of the Russian capital markets from the full deployment of NSD to the restructuring of the equity market and the changes to dividends represent fundamental, structural change and provide real impetus for further market reform.