The freeze thaws: An insider’s guide to trading Russian shares and what happens next
By Jamie Colvin 02 Sep, 2022 at 14:14
Six months after Russia’s invasion of Ukraine unleashed a volley of sanctions, some trading in Russian shares has still been possible behind the scenes, a market source has told Citywire.
Trading in Russian bonds by Western investors has resumed in recent weeks, facilitated by most major investment banks, after the US Treasury gave the green light in late July to those winding down positions.
The situation with equities has remained more opaque, with more marginal participants. But despite the appearance of Western investors being frozen out of the market, in reality, some trading has been possible, a Russian specialist explained to Citywire Funds Insider.
In response to sanctions and Russia’s own restrictions on ‘unfriendly nations’, which were introduced on a rolling basis from late February, the vast majority of funds with money in Russia sat on their assets and valued them at zero or close to zero. Trading in most Russia or Emerging Europe funds remains suspended, though increasing numbers of strategies have announced plans to close and, eventually, return what can be realised to investors.
US asset management giant BlackRock, for example, wrote down its Russian securities from $18bn to $1bn in March. The firm has since closed two exchange-traded funds in May, iShares MSCI Eastern Europe and iShares European-listed Russia, and returned any proceeds from non-Russian holdings, such as Polish stocks, in June. Investors still have the right to any future realisations from Russian asset sales, it is understood.
Another approach is to split affected funds in two and ‘silo’ the Russian assets, as Schroders has done with its Emerging Europe fund.
Among asset management and trading sources, none of whom wished to be quoted or named, most agreed that decisions on what to do were now out of fund managers’ hands and were being made by compliance teams. But one specialist said approaches other than embracing the asset freeze had been both legal and possible – facilitating an exit from Russia or even making money for clients – and gave an insider’s guide to how it worked.
It was initially possible to sell Moscow-listed assets ‘over the counter’, or off the exchange, to local Russians at knock-down prices who would then sell them on, the source said. They emphasised it was a tricky trade to execute, with few people doing so, given compliance measures with banks and regulators.
However, Russia’s creation of internal ‘S’ class bank accounts – a tit-for-tat measure designed to freeze foreign investors’ assets in response to Western sanctions – has effectively curtailed this. If an investor could sell local Russian shares now, the cash would be received in roubles and frozen in an ‘S’ account, which would not be able to leave Russia. When the West lifts sanctions, these accounts (also known as ‘C’ accounts) will be unlocked, the source said. The timing of that is clearly open-ended and could take years, however.
Depositary dilemma
Another recent development has been the conversion of American depositary receipts (ADR) and similar global instruments into Moscow-listed shares.
Depositary receipts are certificates issued by banks that represent shares in a foreign company but are traded in generally more liquid Western markets. They have been a common way to invest in Russia, as well as playing a key role in the Chinese market.
At the end of March, US bank BNY Mellon allowed holders of DRs in 20 Russian companies, including Gazprom and Norilsk Nickel, to cancel them and liquidate their frozen holdings, the Financial Times reported. In May, Sberbank ADRs were forcibly converted into underling local shares, in another example.
Large asset managers including ABN AMRO, Baillie Gifford, BlackRock, Brandes, Franklin Templeton and JPMorgan all confirmed some of their DRs had been converted into Russian shares. There is no suggestion any have been involved in actively trading.
Citywire’s specialist source said the conversions of DRs into Moscow-listed shares had been a mixture of voluntary and involuntary, with a dilemma for investors. The advantage of having a Moscow-listed equity rather than a DR is that their ownership and status is clearer, even if they are frozen in an ‘S’ account.
On the other hand, the DR remains a transferrable security, although the bank administering the DR may decide to liquidate it and return the cash, which will be at a considerable discount to what it is worth, the source said, and most likely a larger discount than if an investor had negotiated the deal themselves.
US law firm Morgan Lewis has also written that DR holders cannot exercise any voting rights or receive dividends with respect to the underlying shares. However, unpaid dividends may be claimed if you surrender the instrument and receive the underlying shares.
Selling DRs at around an 80% discount to Russian buyers has been possible, according to Citywire’s source, and would have made some sense for those with small positions who wanted to exit. They emphasised that selling DRs to Russians was still possible, but the window would soon close as they are all forcibly converted into local shares. Other long-term possibilities may include sales in markets like the Middle East or Hong Kong if Russian companies relist in those venues.
What happens next?
In terms of the situation when Russian equity trading fully reopens to Western investors, the same source said they expect many will effectively pile back into the market and they are already receiving opportunistic enquiries from hedge funds and private investors. But they added that what will happen to the massive amounts of shares foreign investors have written down and are sitting on, what level they will be sold at and to whom remain open questions, with massive arbitrage opportunities.
Daniel Wood, an emerging market debt specialist at US firm William Blair, told our sister site Citywire Selector that international hedge funds had been key buyers of Russian debt since bond trading was allowed again, with Williams Blair offloading its remaining positions at an 80% discount.
Another source working in emerging markets investing emphasised that decisions on what to do with Russian assets would now be out of portfolio managers’ hands at most fund groups. Instead, they are being made by compliance and legal departments, who are likely to sell out as soon as there is a straightforward route, at almost any price. With holdings written down to zero, the message to fund investors is effectively: forget about these positions.
In terms of future buyers, they were more sceptical that investors will return en masse to the market, but said buyers in China, the Middle East and India – playing by a different set of rules – will likely be happy to participate in what will effectively be a fire sale.
The Russian equity market itself has struggled since local trading began again in late March, with a fractional reopening to ‘friendly’ nations which have not levied sanctions on Russia from 8 August.
The Moex index has fallen 35% in local currency in 2022, according to Refinitiv data, although Gazprom provided a boost this week as the state-owned energy giant posted a record first-half profit and, after cancelling its 2021 dividend, planned an interim distribution of more than $20bn.