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. Last Updated: 07/27/2016

Invisible Market

Suppose the New York Stock Exchange delisted a third of its stocks and Wall Street simply shrugged. That's what happened in Moscow earlier this year, when the Russian Trading System switched off trading in 112 stocks of the 358 on its books.

RTS's decision - made because these firms had failed to file their accounts on time with the Federal Securities Commission - caused almost zero reaction: The Moscow Times Index of 50 leading stocks barely budged and the business community simply shrugged. Why?

These days, the Russian stock market is extremely narrow, so much so that just four companies - Unified Energy Systems, LUKoil, Surgutneftegaz and Gazprom - make up most of the market.

And the stocks that trade - the four mentioned above and a handful of other equities - do so at tiny volumes. Average trading volumes are $10 million to $15 million a day, a far cry from the $80 million to $100 million a day that changed hands right up until last summer. Even after solid gains this year, the stock market is still worth a mere 25 percent or so of its value back in 1997.

While the rise and fall of the Dow Jones affects general consumer confidence as well as business expectations, the Russian stock market is a sideshow. It doesn't matter much to anybody outside of the foreign and domestic brokerage industry.


A closer look at the Russian market shows that 80 percent of all trading by volumes has been reduced to just three RTS stocks - Unified Energy Systems, LUKoil and Surgutneftegaz - and a fourth stock, domestic Gazprom shares. The gas giant's local shares, which offer a 74 percent discount to the shares which back Gazprom's American Depository Receipts - certificates that trade on foreign exchanges including the NYSE - are listed on the Moscow Interbank Currency Exchange and other bourses which are not a part of RTS.

RTS does plan to list Gazprom from mid-December provided it can come to terms with the St. Petersburg Stock Exchange, which will conduct settlements to avoid technical obstacles that prevent RTS from trading Gazprom stock.

The trading system's own RTS index carries a total of 46 stocks - 27 ordinary and 19 preferred - all of which are traded on its exchange. Meanwhile, The Moscow Times Index consists of the ordinary shares of the 50 most liquid companies, including Gazprom.

Both indices have had to adapt their composition and framework in the wake of the 1998 crash to deal with the massive drying up of liquidity in the equities markets.

This lack of liquidity has made the market vulnerable to even the slightest changes in demand. It also opens the door to market manipulations.

For example, Rostelecom was one of a couple of stocks that outperformed the rest of the market in recent weeks. But its major gains had little to do with any perceived improvement in the firm's performance or prospects. Rather, a couple of buyers from the United States placed buy orders with their brokers and that was enough to send the stock price up by significant amounts.

Such a situation acts as a drag on any major improvement in overall stock prices. If the market starts to move up and major investors get interested, they find themselves paying a premium to market price if they place a relatively large purchase order.

The only exceptions are, of course, the four stocks mentioned earlier, which are relatively stable operations that have a sizable free float and a reliable cash stream.

Any other stocks would also be very open to price manipulation. And while no instances of such machinations have been proved, traders are extremely cynical whenever thinly traded stocks suddenly bloom.

Last Wednesday, $33.7 million worth of Sibneft changed hands on the MICEX.

Sibneft, an oil major believed to be controlled by shadowy tycoon Roman Abramovich, has a small free float - with all but 9 percent or so of its $1.42 billion of equity in the hands of a series of shell companies that are reportedly Abramovich's tools for controlling the company.

Given the company's overall lack of transparency and the fact that Wednesday's trade represented about a quarter of the Sibneft shares available for trading, analysts were quick to smell a rat.

"This deal represents capital flight, not real investment," Troika Dialog brokerage reported in its daily report Thursday.

Sibneft, which has been accused of this kind of manipulation before, declined to comment on the allegations.

"We do not comment on normal market practices. ... We do not comment on share trading," said Gregory Barker, a Sibneft spokesman.

However, even if no one is taking advantage of the situation in such a manner, the market's low liquidity means that investors could find themselves locked in if the market takes a turn for the worse.


As a result of all these concerns, the fact that Russia's stock market is again a world beater is one of the country's best kept secrets.

Russia is now in the same league as Zimbabwe and quake-shaken Turkey - all three countries have seen the value of their leading stock indices more than double since Jan. 1, 1999, according to the International Finance Corporation, the private sector lending arm of the World Bank.

The trio's gains make the 1999 performance of Wall Street - the Dow Jones is up 19.6 percent for the year so far - and London - where the FTSE is 12.2 percent higher than it was on Jan. 1 - look tame and dull by comparison. This kind of large, volatile change in value is exactly the sort of phenomenon that made "emerging markets" popular earlier this decade - back before the carnage of 1997 and 1998 brought home the downside to investors.

Of the three, Russia is well out in front - the IFC's investables index for the country has increased by 151 percent in 1999. Other Russia indices tell the same story, with the MT Index up 138 percent for the year, while the RTS index has merely doubled, up 100.2 percent.

When you look at the wider economic picture - which has been surprisingly rosy - this performance could seem to make plenty of sense, especially considering the depths to which both the economy and the market had slumped in the wake of last year's crash.

The country's improved macroeconomic performance has been making headlines. Russia's leaders are crowing about increased industrial output, cooling inflation and have started to predict that the economy will actually grow this year.

The trade surplus surged to $27 billion in the first three quarters of the year and could reach a whopping $37 billion by year's end. And the fiscal deficit so far this year is lower in ruble terms than in 1998 - despite the ruble losing 75 percent of its value.

But the stock market's rejuvenation has rarely made headlines. And the funny thing is that if you talk to traders, they very rarely volunteer these kind of trends as being behind the rise of the stock market.


Instead, they talk about two factors, oil and global fund management techniques - both of which are phenomena essentially outside of Russia's control. Much like Nigeria and Venezuela, Russia depends very heavily on oil.

Mexico went through a similar experience but its economy went through a rapid process of change in the last 10 years. The share of services and manufacturing sectors in the economy has increased, reducing its reliance on oil, though Mexico's fiscal revenues are still vulnerable to oil prices.

Last year's crash exacerbated this trend by undermining consumer demand and scaring away many foreign investors.

Meanwhile, world oil prices have soared - up from below $10 a barrel in February to above $25 a barrel this month.

Oil is now bringing more than $1 billion every month into the Russian economy, according to the Russian Statistics Agency (as the State Statistics Committee is now known). If in January oil exports brought in about $700 million, by August it brought in $1.4 billion.

This inflow of dollars is filling up government coffers. It is also making more domestic money available to buy stocks.


However, the foreign money that is buying into Russian equity is not showing much interest in the oil question. Indeed, Russian fundamentals have little to do with many investors' reasons for buying Russian stocks.

"So far [Russia] has been a failed economy," said Dan Lubash, head of European emerging markets with Merrill Lynch (London).

No one is fooling themselves that the average Russian stock will provide dividends or even much of a say in the way the company in question is run.

Instead, the country's equities are used to round out global fund managers' high risk portfolios, traders and analysts say.

"The Russian stock market is a reference of risk appetite," said Lubash. "It expands the risk profile."

Turkey is in the same category of risk-takers as Russia, he added.

Sooner or later, if you track global indices you will find your attention focused on Russia even if you think that fundamentals are rotten.

The recent influx of fresh funds in Russia merely reflects only changes in appetite for risk among emerging markets investors, not changes in investment climate in Moscow, traders said.

Positive change in global outlook this autumn pushed emerging markets to new highs and finally some buying trickled into Russian equities.

In all a total of 1,298 stocks are included in the IFC Composite Investable Index. Eastern Europe makes for 68 places on the list, out of which Russia is represented by only nine companies.

"The way global markets work forces fund managers to buy stocks," said Dmitry Kulayshenets, trader with MFK-Renaissance.

Even if the risks associated with a particular set of investments are sky-high fund industry managers have to buy rising equities in order to avoid the stigma of underperforming the IFC index and other tracking devices for emerging market stocks.


The market does still serve some purpose for the Russian corporate sector. For one thing, it is a useful tool for gauging risk relative to peers and for helping to raise funds from strategic investors.

When Vimpelcom sold a 25 percent stake to Norwegian telecom operator Telenor for $162 million this spring, the agreed price was based on the stock market quotes.

A more devious example was occurred in September, when investment company Energocapital placed the St. Petersburg Bank of Reconstruction and Development on the B list of the Russian Trading System.

RTS officials simply shrugged their shoulders, saying most probably the bank would soon be delisted for not being able to meet liquidity requirements. Since Sept. 20, when the stock appeared on the screens, not a single transaction has been registered in RTS.

But Energocapital had not been overly interested in seeing the bank's shares trade.

"We listed the bank under request of one of our clients, who seeks to determine the real price of the stock," said Alexei Savatiugiugin, first deputy director with Energocapital. "Our client wants to avoid usual allegations that the stake had been sold at below-market price."

The bank itself was at first less than pleased that its stock appeared in RTS. Officials at Energocapital said this was because they did not warn the bank about their plans. RTS rules allow any broker to ask for the listing of a particular stock.

"We are neutral because you can hardly expect anything from this market," said Vladimir Vasiutin, head of depository with the bank.


One of Moscow's brokerage houses wrote in October that next year, the Year of the Dragon according to the Chinese calendar, could more appropriately be dubbed the Year of the Russian (Siberian) Tiger.

While the market looks more like a pussy cat than a tiger - even a tiger cub - it is nevertheless poised for growth.

"I am very optimistic about this market for next year," said James Fenkner, equity strategist with Troika Dialog.

Merrill Lynch has also forecast market growth in the medium term.

And in the long run things are a bit brighter because economic logic will force Russia to follow the right course, according to some analysts.

"Russia needs to attract substantial investments to renew and improve its capital stock," said Arnab Das, sovereign credit strategist for Europe at JP Morgan (London).

He and others cited Uneximbank as an example of how companies could react to meet the requirements in the capital markets. While many had expected that Vladimir Potanin's Interros group would simply abandon Uneximbank - and its creditors - to their fate, the holding firm has instead struck a restructuring deal with foreign investors.

"They want to give life to Rosbank," said Fenkner.

Rosbank, founded by Interros after the 1998 crisis, had been experiencing difficulties getting some letters of credit due to unresolved dispute of Uneximbank with its creditors, said an investment banker who declined to be named.

However, Uneximbank dismissed allegations that the restructuring had only gone through because it would help Rosbank.

"Uneximbank intended to honor its liabilities from the very start," said Tatiana Ongotoeva, spokesperson for Uneximbank.

In the longer run the fate of the market will depend on the course the reforms follow.

"The question is whether it will be Indonesian-like capitalism or transparent Western-type of capitalist society," Fenkner said. "It is just that in Russia it has gone from a very low base."

The political ambitions of the Russian elite should also encourage further transformation.

"To be a major global player in the world economy and financial markets, in a way that is commensurate with its political status as a nuclear power with a UN security veto, Russia should probably have an economy closer to $1 trillion," said Das from JP Morgan.

Currently, Russia's gross domestic product is less than $200 billion, of which the oil industries make up less than 5 percent. Its budget is about 60 percent of the budget of New York City.


2 markets compared

Benchmark peer figures


Market cap $15.2 trillion $24.38 billion

Largest company $424 billion $6.0 billion

Tenth largest company $153.4 billion $379 million

Daily turnover** $793.5 million $5.3 million



Source: NYSE, RTS


IFC Figures

Top 3 IFC investable indexes


Russia 151.0%

Zimbabwe 116.7%

Turkey 112.9%

Source: IFC

Number of stocks in IFC investable indices

India 95

Brazil 83

Indonesia 40

Poland 32

Hungary 13

Venezuela 12

Czech Rep. 9

Russia 9

Jordan 7

Slovakia 5

Sri Lanka 5

Zimbabwe 5

Source: IFC