Unifying Emerging Markets
Grigoriy Kozin, Director, Head of Prime Services at Otkritie Capital International Limited examines lessons that can be learnt from Russia by other emerging markets.
It is relatively easy for international clients to access the Russian market compared with other emerging markets. This is partly due to the role of brokers such as ourselves who are based in London. At Otkritie, we serve mainly international institutional clients and we take steps to alleviate the difficulties of trading in Russia.
When talking about emerging markets, there are three key components which make the markets more accessible and attractive to international clients. The first is the macroeconomics of the country; the political situation and the resulting impact on liquidity. In Russia there are a diversified set of asset classes but the current geopolitical situation in Russia, the drop in the oil price and the devaluation of the ruble, mean that cash equity does not look very attractive in terms of valuations, and as such we have seen a sharp drop in volumes.
At the same time however, geopolitical turbulence usually brings with it increased volatility to the FX markets. As a result of this, the Moscow Exchange moved focus to a range of FX products such as FX SPOT and FX futures which became main revenue bringers for the exchange. This volatility leads to a huge increase in turnover in that part of the market, and as such this is currently one of the main areas of interest to international clients, specifically hedge funds and proprietary trading firms.
Since 2011 there has been a dramatic turnaround in the volumes of index futures versus FX futures: on the Russian market, index futures used to have a market share of more than 75% and FX around 15%. But this year, index futures only make up 20% of market share and FX futures are now responsible for more than 70% of volume.
It is difficult to see how other emerging markets could follow this practice, as the volatility of FX is closely related to wider monetary policy. The Russian central bank is trying to maintain relatively independent monetary policy, which helps with confidence in trading, even if it has spurred on the volatility.
By way of encouraging liquidity and trading in other areas, the Russian markets recently started to develop exchange traded funds (ETFs) which are now a fast-growing investment vehicle. We believe that for international clients who would like experience of the Russian markets, these ETFs could be an interesting product with which to start trading to mirror the index. There are Russian index-based ETFs and ETFs based on Russian Euro bonds either hedged into the ruble or hedged into dollars, and this is a rapidly growing area for us.
The second of the three key components is infrastructure; both trading infrastructure and wider market and settlement infrastructure. The Moscow Exchange has made huge improvements over the last five years in terms of ease of access for international clients. Five years ago, there was T+0 settlement with full pre-funding. There was no central depository and there were many infrastructure problems which meant that, for international clients, the Russian market was an inconvenient place in which to trade. So in 2012, a central depository was launched. Shortly thereafter in 2013 central counterparty was introduced on the Moscow Exchange it achieved T+2 settlement cycle with partial pre-funding. They subsequently opened the door for the European clearing houses so that clients could clear their trades with international clearing houses.
All these factors made the Russian market a much more convenient place to trade for international clients. The regulators and the Russian exchange helped to close the market structure gaps between the Russian and the European markets. This is a valuable lesson for other emerging markets; best practices, especially those of a large neighbouring regulatory area such as Europe, should be adopted to help ease trading across those markets. However, there are still a number of things that the Moscow Exchange needs to do in order to attract more international clients. Official global clearing membership was introduced in 2014 on only one market (of three) and it should have been introduced across all markets in order to reduce the risk for market participants trading on the Moscow Exchange.
The third component is legislation and taxation. Together with the Moscow Exchange, we are working hard to introduce best practices in terms of regulation of the financial sector and of legislation into Russia. The Central Bank is doing a reasonable job in this regard in terms of regulation.
Taxation in Russia, compared with other emerging markets, is relatively straightforward. It is in line with the approaches announced by the Organisation for Economic Cooperation and Development (OECD), so it is generally unified with the European approach. Again, there is still much work to be done here, specifically relating to the taxation of listed derivatives and other assets, but we are moving quite fast and in the right direction.
The progress made over the last five years has been significant. New legislation is being developed to regulate dividend payments, which will make it simpler to understand when and where dividends are paid. This is happening with the help of the Moscow Exchange and our international clients and obviously, the brokers who are bringing international clients into Russia.
Otkritie Capital International is required to be fully MiFID II compliant given that we are a UK regulated broker, but as such the benefits of unifying regulatory standards between Europe and other emerging markets are clear to us. The Russian central bank does seem to be moving in the same direction in terms of its regulation. In 2015, the Central Bank signed a memorandum of understanding with IOSCO which seeks to drive global cooperation and increase transparency when clients are undertaking cross-border operations.
However, as a European broker we have many more concerns about MiFID II compared with those of local Russian brokers or local Russian market participants. Overall, we can see that the borders between the Russian and international markets are becoming less pronounced. One of the main goals of the Moscow Exchange is to bring back liquidity to local markets, rather than having so much of the volume traded through GDRs. A couple of years ago, more than 50% of most liquid stocks was traded internationally in forms of ADRs and GDRs. Now what we see is increasing volumes moving back into local shares which means that even for international clients and large funds seeking to invest in Russia, it becomes more convenient to trade locally rather than to trade internationally.
Sooner rather than later, Russian markets will become more like developed markets than emerging markets. Removing sanctions will help of course and will boost the economy. For example, with FX settlement, one of the biggest problems is that the Russian ruble is not a CLS-clearable currency which means it requires larger limits for banks to settle rubles and usually, it takes more time settle than CLS clearable currencies. This development would significantly help integrate Russia more deeply into international financial markets.
In conclusion, first of all, there needs to be clear commitment on the part of the government to help international clients. It needs to be reflected through better legislation and taxation approaches for international clients. In addition, the local market has to learn from experiences of other international markets in terms of market infrastructure. Provided that the economy is affordable for clients it will bring international investors.
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