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. Last Updated: 07/27/2016

Failed Fund Raises Regulation Concerns

A mutual fund managed by the St. Petersburg subsidiary of SBS-Agro, Russia's third largest bank, has collapsed, raising concerns about the lack of Central Bank regulation.

SBS-Agro's financially troubled subsidiary Petroagroprombank had managed an open-end mutual fund that was registered with the Central Bank. Investors began demanding their money back from the fund earlier this month after the Central Bank suspended Petroagroprombank's banking operations.

The mutual fund now says it cannot pay out 5 million rubles ($827,000) that it owes to about 1,200 small investors because the money was invested in second-tier St. Petersburg enterprises, which cannot be sold because of the downturn on Russia's stock market.

A spokeswoman for SBS-Agro in St. Petersburg said investors had been warned of the risks. "We have a prospectus that explained to investors that they might not only earn profits, but also suffer losses at any time," she said.

But the case highlights potential problems with Central Bank rules regulating mutual funds.

The Federal Securities Commission, or FSC, Russia's stock market watchdog, has spent several years developing strict legislation on domestic mutual funds, known by their Russian acronym, PIFs. But the Central Bank won a major turf battle with the FSC last summer when it was granted the right to license banks to create a parallel system of mutual funds, known as OFBUs.

"The OFBUs problem is that not everyone understand how it works," said Andrei Orekhov, director of asset management at MFK-Renaissance. Investors buy shares in OFBUs at banks and often think they are no more risky than bank deposits, he said.

Moreover, unlike PIFs, OFBUs face no limits on the percentage of assets they can invest in high-risk instruments, such as second-tier stocks. Petroagroprombank did just that, pouring most of the fund's assets into St. Petersburg companies that trade irregularly.

When the market took a turn for the worse, Petroagroprombank was left sitting on the stock, which was hard to value and impossible to sell.

SBS-Agro, which bought 40 percent of Petroagroprombank last December, stepped in Feb. 18 to help the bank compensate its mutual fund investors. But instead of bailing out the bank with cash, it offered investors preferred shares in SBS-Agro equal to their investments in the failed mutual fund.

Despite having given Petroagroprombank a license to operate the fund, Central Bank officials in Moscow and St. Petersburg were unaware of the problems surrounding the fund when contacted for this story but said they would investigate the case.

They said, however, that SBS-Agro's plans to compensate investors with its shares violated Central Bank rules.

"The funds must pay [investors] in cash," said an official in the Central Bank's department for control of bank activities on financial markets.

Analysts also questioned the valuation of the stock that SBS-Agro is offering as compensation. SBS-Agro's press service said its preferred stock is traded but conceded that it is highly illiquid.

An SBS-Agro spokesman said the bank would buy back its shares from investors in the fund who want cash up front, but because of the lack of liquidity, it would pay only 50 percent of the "market price."

One analyst said, however, that SBS-Agro's preferred shares were likely to produce high dividends. "Promised dividends are higher than interest on deposits," said Andrei Yashchenko, head of research at the Moscow brokerage Montes Auri.