Weekly 12 June 2022

Stock market reeling

Hello! This week we look at millions of struggling private investors amid the wreckage of Russia’s financial markets. Not only have most lost money, but the chances of recouping losses fades with each week. Russia’s Central Bank last month froze a large batch of shares in foreign companies in which Russians invested more than 2 trillion rubles ($35 billion) – and they now look to be permanently frozen. In addition, Central Bank head Elvira Nabilullina made it clear Friday there is a de facto ban on share trading via foreign brokers.

Two million affected

During the pre-war stock market boom in private investment, Russian exchanges and brokers actively promoted foreign securities. And investors were eager to sign up: in the second quarter of 2020, foreign investments amounted to just 0.3 trillion rubles, but by the end of 2021 it was 0.9 trillion rubles. Foreign securities – stocks and bonds – represented 31 percent of all Russian brokerage assets, according to figures from the end of last year.

Few could have imagined that these funds would suddenly be blocked. But that’s exactly what happened last month when the Central Bank ordered the St. Petersburg Stock Exchange (the main platform in Russia for private investors) to block foreign securities. The move affected all securities whose storage and settlement passed through the National Settlement Depository (NSD). The only exceptions were foreign shares issued by Russian companies HeadHunter, Yandex, Ozon, Cian, TCS Group and Fix Price.

International securities settlement house Euroclear ceased operations with the NSD and blocked its account back in March. But last week’s Central Bank freeze orders definitively separated freely-traded foreign securities from those which are now not tradable. The Central Bank restrictions impacted 995 foreign issuers out of more than 1,650 that previously traded on the exchange. Fortunately, some popular stocks – including Tesla, Apple and Microsoft – were not affected because they were not stored at NSD.

In addition, the NSD was hit by EU sanctions earlier this month, ending any prospect of unfreezing the securities in the near future.

The St. Petersburg Stock Exchange said that, in monetary terms, 14 percent of all portfolios were blocked. According to Viktor Tunev, head analyst at Ingosstrakh Investments, the restrictions affected most exchange clients. But the number of frozen investments for each individual depended on the make-up of portfolios: The Bell spoke to one investor who had seen 10 percent of her portfolio frozen, and another who had seen 96.5 percent frozen.

Ownership rights are unaffected. However, dividends will accumulate in Euroclear accounts and securities can only be sold to Russian residents in special deals. These will only be possible at a discount, and will entail significant practical difficulties.

The main problem for those seeking to get rid of frozen shares is finding buyers, said Konstantin Asaturov, director of the securities department at Sistema Capital Management, and, even if a buyer is found, the discount will likely be over 50 percent.

The Central Bank argued that the freeze was implemented out of concern for investors: “the decision is intended to protect the rights and interests of investors and minimize their risks,” the regulator said in a statement. However, no compensation for investors has yet been proposed. Consultants approached by The Bell said the only option was to await the lifting of sanctions. They warned that any legal action was unlikely to be successful.

Foreign brokers banned

Nabiullina announced Friday an unpleasant surprise for another group of investors – those who trade using foreign brokers. Speaking at a briefing, Nabiullina explained that withdrawing funds raised from trading shares with foreign brokers without approval from a special government commission would be regarded as an offense under a presidential decree introduced a few days after the start of the war (it forbade residents from crediting foreign currency to their foreign accounts without the commission’s permission).

Nabilullina’s announcement represents a de facto ban on trading shares, bonds and other securities via foreign brokers. Violations of currency laws result in fines of up to 100 percent of the value of the transaction. In April, parliament approved the first reading of a bill to reduce the fine to a maximum of 40 percent, but it has not yet passed a second reading.

Back on April 28, the Central Bank stated it was possible to transfer funds from such transactions to foreign accounts without special approval. But just over a month later, the regulator released another note explaining that approval was, indeed, required (The Bell has seen the text of both documents). After Nabilullina’s words Friday, the relevant changes were made to the Central Bank’s online FAQ about the operation of the financial system. In a group on messaging app Telegram for Russian-speaking clients of leading foreign broker Interactive Brokers, the U-turn sparked a wave of indignation.

It’s difficult to know how many Russians use foreign brokers, but there are probably tens of thousands. Interactive Brokers estimated in April that it had up to 20,000 Russian-speaking clients. But numbers could even have risen since then – the freezing of foreign shares on the Petersburg exchange meant opening an account with a foreign broker was, for a few weeks, the only way to continue investing in foreign securities.

Foreign currency drain

The consequences of Western sanctions continue to limit opportunities for investments – and not only on the stock market. Russia’s biggest banks last week introduced commission charges for foreign currency accounts. Some – like Tinkoff Bank announced it openly – others did not. The logic is obvious: commissions encourage clients to withdraw funds because the banks have nowhere to store foreign currency and, if there are more sanctions, there is a risk the foreign currency in client accounts could be blocked.

Tinkoff Bank’s announcement that its commission on foreign currency accounts would be 1 percent a month – or 12 percent a year – made headlines. However, similar charges have been introduced by seven of Russia’s top-20 banks.

Put simply, it is no longer profitable for banks to handle foreign currency assets – there is nowhere to put the money. “Since neither the Central Bank, nor other Russian banks can, or even wish, to invest in U.S. Treasury Bonds or other dollar-denominated products, keeping foreign currency in accounts means operating at a loss,” said expert Asaturov.

What can be done with the currency that banks are trying to get people to withdraw? For most Russians, the alternatives are real estate, gold, or conversion into rubles. The most reliable way to secure a guaranteed return is to invest the funds in ruble accounts (annual rates of up to 11 percent can still be found at some banks), according to Igor Alutin, manager of the Finuslugi project for the Moscow Exchange. For all the logic of this advice, however, it’s unlikely to appeal to people who wanted to keep their savings in foreign currency.

Of course, one obvious solution is to put dollars or euros into deposits safe from commission charges or negative interest rates. But banks are getting rid of their foreign currency positions not only because of existing Western sanctions – they are also worried about new restrictions. Investment company Aton sent its clients a letter Thursday warning that all Russian banks could be forced to block foreign currency accounts if, for example, payments service SWIFT was shut down for every bank (as proposed by the European Union). Another measure that could lead to a block on a significant part of foreign currency transactions in Russia would be sanctions against the National Clearing Center through which the Moscow Exchange conducts its foreign currency activities.

In the event of sanctions against the NCC, currency in broker accounts will be frozen, predicted Sistema Capital’s Asaturov. What happens to foreign currency in bank accounts is a more complex issue. “That’s a big question since this currency, even if it escapes blocking, becomes worthless: it will not be possible to transfer it anywhere, and it will not be possible to withdraw,” Asaturov added. “The only solution is to convert into rubles or another currency with the bank’s approval. But first, it is not clear why the bank would want these dollars and, second, the exchange rate is clearly going to be much worse, even if such an exchange is possible.” A source in one of Russia’s largest banks identified possible sanctions against the NCC as a reason for introducing commission charges.

What does it mean?

The best advice for investors in the Russian market can be condensed into three points: 1) if you hold foreign currency, transfer it to a foreign account and invest there; 2) if you have no foreign currency, take advantage of the current exchange rates to buy it and send it abroad; 3) withdraw it into cash, take a break and see what the situation looks like in a few months.

“The Russian market is not for investors,” one analyst told The Bell. We can only guess how many of the 17 million Russian private investors have reached the same – possibly permanent – conclusion in the three months since the first Western sanctions.