Stock market infrastructure. Rating of investment companies, 2006

Mikhail Vashchenko, Olga Sosnina

Global leaders on demand

Continuous fight of FFMS (Federal financial markets service) to return the market of Russian securities back to Russia has been unexpectedly supported by London. Still, the local stock exchange infrastructure is obviously provincial in its nature.

The recent events have been helpful enough to make another step to strengthen our sovereign financial system. In April the British FSA (Financial supervision administration) has made public its intention to toughen rules for foreign companies’ IPO, laying special stress on the former CIS countries. FSA has made reference to poor quality of corporate governance in such companies, low level of protection of minority shareholders and absence of transparent information.

The step, in the opinion of many observers related to problems of PricewaterhouseCoopers’ Russian office, will assuredly restrict activity of Russian placements in London. And it will involuntarily contribute to long-lasting efforts of FFMS to pull the stock market back to Russia. Recent notable Russian initiatives include an increased shoulder for qualified investors (ratio of investor’s assets to sum of assets borrowed from a broker for marginal operations with securities) from 1:1 to 1:3, a stipulation about Russian depositary receipts (RDR), a demand to place locally at least 30% of shares of Russian IPO companies etc.

At first glance the Russian stock market itself is ready to fit the bill. Assets attracted by management companies went up by 60% (from 675 bln rubles to 1 trln rubles). In 2006 total turnover at the largest Russian venue – MICEX (Moscow interbank currency exchange) almost doubled (from 26.5 to 52 trln rubles). At such rates MICEX may reach the level of leading world trading venues within five years (diagram 1).

Diagram 1. At current dynamics the Russian market may catch up with Western trade venues by 2012. Stock exchange turnover.

But to be in line with the leader’s ambitions the market should be adequately structured to maintain such an encouraging rate. And that is where a real snag is.

Developed stock markets are based on investment structures, providing full range of services: corporate financing, asset management, services of brokers and analysts. The Expert RA study has found out complete absence of such structures in Russia. The fifteen year old market has still been profoundly segmented. A commonly used term "investment company" may mean all sorts of things. Niche players are in abundance: leaders in certain areas, as a rule, are unnoticed in adjacent segments. A number of companies, at least positioning themselves as a full cycle investment company, do not exceed several dozens.

At least some of these companies should join the ranks of world leaders – for FFMS plans to be implemented. Otherwise the market transfer to Russia would not bring us one step closer to establishing a sovereign financial system. Officials are well aware of this. Initiatives to set up a mega-regulator, a mega-bank, a mega-depositary are meant to fill infrastructural gaps of the Russian market and explained by absence of a sufficient number of global, universal players. But the results are still out of sight.

Playing big

Area of corporate financing is the most lucrative and prestigious field of activity for investment companies. Only "big-shouldered" companies are present at the segment. They include Western investment banks, Russian commercial banks from the list of top ten national banks by assets, and a couple of leading investment companies.

There is a strict "division of labor": IPO, M&A — "ground" for Western investment banks, placement of bonds — for large local banks and sometimes for investment companies. And it stands to reason.

Fight for liquidity In 2005 15 companies made their first public offering for over 4 bln dollars, mostly in London. In 2006 IPO was offered by 27 companies for over 18.9 bln dollars. Only 5.5 bln dollars out of the sum was attracted in Russia proper (see diagram 2). The explanation lies in low capacity and low liquidity of the local market. Leadership in attracting investments to Russia and other countries belongs to London - LSE\AIM. Partly the reason is that recently LSE\AIM has been too liberal to candidates for the listing and made certain "dumping". This year the situation promises to change due to the regulator’s initiatives. Russia has a chance. But the chance may be used by somebody else, too. The US Treasury has been reconsidering the IPO rules at the American market to make them more lenient and return leadership to NYSE.

Diagram 2. The Russian market liquidity may be increased by returning assets from abroad. IPO 2006 distribution over stock exchanges

IPOs have been made by large-scale Russian companies out of the Expert-400 first hundred. The Russian market capacities and financial abilities of the majority of Russian investment companies are not sufficient to "digest" placements of over 400 bln rubles. Sberbank’s example easily confirms it. The Bank has made IPO only in Russia with limited access of non-residents and "lost" additional 5-7 bln dollars. As a matter of fact, the Bank was strongly assisted by the Central Bank, which partly exercised its preferential right to buy – otherwise the result would have been even worse.

It seems that so far issuers gain more profit in Western venues, regardless of extra costs. But in the West they have their own rules and investors. No wonder, Western investment banks Morgan Stanly, Goldman Sachs, Deutsche UFG, Credit Suisse dominate in the area of IPO placement at the Russian market. The situation is not exceptional at all. An example of the stock exchange in London testifies to the fact: a placement of over 400 mln dollars rarely happens without domineering engagement (exceeding 80%) of such transnational banks. The Russian government plans to establish a mega-bank on the basis of the Foreign Economy Bank, but the situation would not be changed overnight. The foreign companies have been at the market for so long, their experience and authority is so overwhelming – these parameters are of paramount importance for organizing IPO.

The situation with M&A looks quite similar. Public mergers and acquisitions feature big volumes, hence inevitable attention of Western players. Besides, an image component of a deal is very important for their clients. And being consulted by a large investment bank like Goldman Sachs implies: your deal is interesting, and you have money to pay for the service.

As to bond loans, the situation for Russian investment banks is better. Says Anton Starsky, UNIVER, a head of an analytical department: "Russian investment companies fully dominate over foreign ones in organizing and servicing bond issues. They 1) know specifics of conducting business in Russia, 2) show flexibility in preparing documents in line with the Russian legislation, 3) offer lower rates for their service. Organizing and servicing bond issues is significantly less expensive for placement organizers than in case of IPO". So far the segment is of no interest to Western players. Expenses and efforts are almost similar to IPO, but the return is ten or even hundred times lower.

So far the niche of servicing bond loans has been occupied by commercial banks. There is one problem, though. A bank for an issuer is pretty often both a creditor and a placement organizer. Presently the conflict of interests is of no worry to the market: everybody understands that pretty often a bond loan is nothing more than a regular bank loan.

Asset management problems

Asset management specialists also belong to the stock marker elite. But the segment, as distinct from corporate finance, is dominated by Russians. Not by Russian banks (as in placement of bonds), but by divisions of "experienced" investment banks.

The reasons are the same: a small scope of business and high costs. Broadly speaking, the situation may be described as follows: leading management companies presently are staffed with 100 persons to manage 10 bln rubles, and to make the Russian market interesting for Western investment companies the model should be turned the other way around – 10 persons manage 100 bln dollars. So far Western players have shown interest in the Russian market of asset management mostly for image purposes to get a certain starting ground for possible future expansion.

The Russian market of trust managing, having no serious competition from Western companies, may be characterized by extensive growth. A number of managing companies has exceeded 300. The companies may be divided into two groups, by priorities: investment funds and managing funds of institutional investors (pension funds, insurance companies). Each group has its own approach. Investment funds provide for standard approach to investing money implying clear and transparent schemes. Institutional investors prefer individual treatment. Each pension fund and insurance company has its preferences and specifics.

But the servicing quality in the both areas remains practically unchanged, at the level of a couple of years ago. The main problem in managing funds of institutional investors is transparency of activity in management companies. Such companies do disclose information about unit funds, which is obligatory. Other areas of activities of management companies are terra incognita. National Securities Market Participants committee does its best, companies make all sorts of announcements, but GIPS* is still observed by only one (!) company. No wonder that due to such lack of information management companies are pretty often selected by institutional investors behind the scenes, not in the process of an open competition. Companies prepared to participate in open tenders are very far from being numerous. Says Sergey Lookin, Capital management company, a head of a department of institutional investors: "The issue for us is very simple: we participate and do it openly. We are a reputed, reliable (recognized by rating agencies) and well-performing company and reach final rounds and win in all sorts of competitions including state ones. For many years we have paid top-level attention to dealing with institutional investors and have no plans to change our priorities in future".

As to unit funds, clients of majority of companies, same as a couple of years ago, may only be offered a basic set of three strategies, like funds’ nomenclature, shares, and mixed bonds. Sector-specific funds are still quite few, despite urgency of the idea. Such service may be presented by 10 companies only.

Problems of brokers

A sector of broker’s servicing is totally and completely dominated by local investment companies and broker houses. The investment activity has had the longest record in Russia, starting since the end of the 1980, and the voucher privatization made a number of brokers in Russia exceed one thousand. But it was only in 2002-2003 that the group of leading brokers was really composed. Currently over 1400 brokers have been registered by FFMS, but only over 600 have been active at MICEX. Efficiency is barely over 40%. For comparison: the similar indicator at LSE is about 80%. And even stock exchange active broker houses can not offer diverse services for their clients. There are many players at the market, mostly specializing in one or two areas. Lists of leaders in trading bonds, shares and derivatives overlap in minimum degree — Troika Dialogue and Kit Finance investment bank are the only companies present in all the three areas of the trade services sector.

Limited liquidity of the Russian market is the main problem for brokers. The market is too small for international broker houses.

At most, 15 issuers may be rated "blue chips", over 40% of deals have been made at the over-the-counter market — under such circumstances it is critical to have specialists capable of fair quoting and ensuring trade in securities. But a number of companies with firm quotes over more or less broad range of securities (at least three dozens) are frightfully limited. MICEX-registered market-makers offer only 34 securities, RTS — a bit more (42).

Actually, to get a "quality service" a client needs a company ready to be a market-maker for him and work with him over a broadest possible list of securities. For instance, Antanta Capital supports firm quotes over 840 (!) securities. Says Evgueny Kogan, Antanta Capital investment company general director: "We position ourselves as one of the leaders at the stock market of the "second echelon". We follow the situation in more than 1000 companies. We use systemic approach and have top-notch professionals on our staff with special knowledge of low-liquidity stock. Our analytic department is one of the best at the market of average capitalization. We quote lots of securities and consider it our competitive edge, well-recognized by our clients. Meanwhile we have been gradually departing the "second echelon" specialty and strengthening other business areas, since our goal is to become a major and powerful player providing all the range of services".

Since the basic market of securities is underdeveloped there is no point discussing the market of securities. But at the Western venues the market of derivative financial instruments takes the largest share of trade. For instance, in Chicago (СМЕ) 27 futures and 13 options have been traded only for indexes. So far such figures are quite exotic for Russia, and companies rather deal in derivatives for image and training purposes. Clients’ turn over and deals at their own expense are totally absent. As to FORTS, futures are traded for 22 basic assets, and options — only for 11.