Ben Aris in Moscow -
World domination is off the Kremlin's agenda since the fall of the communism, so they have adopted a new, more modest, ambition: domination of the world's capital markets.
Maybe that's overstating the case a little, but making Moscow a global financial powerhouse which can trade punches on equal terms with the likes of New York, London or Singapore has clearly gone to the top of the Russian political agenda since the start of the year. And Micex is the exchange that's going to fulfil this ambition.
The goal of beefing up Russia's capital market to improve its efficiency and attract more money is not new. What is new is the sheer political weight that stands behind the decision. Making Moscow an International Financial Centre, or IFC as the Kremlin has dubbed it, was dramatically moved up the policy pecking order during Vladimir Putin inauguration speech as prime minister: "Futures, options, forwards, credit notes... However strange those may be, market participants are forced to operate within the rules of foreign international laws, including the British ones."
An economic neophyte when he took over the reigns of power in 2000 as president, Putin made the new goal clear in a speech remarkable for its detail and financial jargon.
The juggernaut has quickly gather momentum and by August, the Ministry of Economic Development and Trade, which has been the pointman for pushing through a raft of economic reform, came out with a detailed plan for the change.
Putin's comments should be taken at face value and if the Kremlin's track record on prime ministerial objectives is anything to go by, these reforms will be rapid and wide ranging. In 2004, then-PM Mikhail Zubkov said: "Bank reform is top of the political agenda," unleashing a wave of initiatives that have transformed the sector.
"Turning Moscow into an IFC is a big ambition, but a healthy and achievable one," argues Alexey Rybnikov, CEO of the Moscow Interbank Currency Exchange, better known as Micex. "We can grow as long as we attract new issuers and new investors. Therefore, we have to centralise if we are to remain competitive," he tells bne in an exclusive interview.
Micex to the fore
Micex will play a key role in the changes, as it has already quietly captured nearly all equity and bond trading in Russia.
Ask any foreign investor what is happening on the Russian stock market and (apart from groaning) they will likely quote the latest Russian Trading System (RTS) index numbers, not the Micex Stock Exchange (SE) index. The RTS was set up at the inception of the equity market in the mid-1990s by market players and, as it quotes its prices in dollars and settles most of its trades offshore, it has been the exchange of choice for foreign investors, who dominated early trading. Micex, by contrast, trades, quotes and settles onshore in rubles.
However, following the financial crisis of 1998 the game changed as Russian investors - especially banks - began heavily investing in Russian stocks - the only security that has been earning real returns for most of the last decade. Add to that the appeal of the strongly appreciating value of the ruble, and investors have been migrating to Micex in droves.
Domestic banks and brokerages account for half of Micex's turnover, with domestic retail investors (including mutual funds) making up another 20%. The rest is made up by foreign investors who have increased their share 10-fold in just the last two years, says Rybnikov.
Micex SE was relatively late into the game. Equity trading was launched on the exchange in 1997, but the Micex SE was only spun off as a separate entity in the group in 2004 when it went head to head with the RTS. The watershed came at the start of 2007 when the newly liberated Gazprom shares were added to Micex's big board. "All the liquidity in Russia was concentrated on Micex, except one stock - Gazprom. But once the trading the shares were liberalised and added to Micex, soon even the liquidity in this stock has migrated to Micex," says Rybnikov.
The Micex SE may have been a late starter, but with an average daily turnover of $6bn between January and February this year, it already accounts for over 90% of all exchange-based equity trades in Russia and over three-quarters of all domestic trades - though most of the over-the-counter trading still takes place on the RTS. Put another way, there are some 30-50 trades on the RTS every day, whereas there are 200,000 transactions a day on Micex.
Average daily volumes have pretty much doubled every year since 2003 and were up to $1bn in 2007 to reach $6bn a day over the first two months of this year, which was an especially volatile period. At the same time, the market's capitalisation is up 15-fold between 2003 and 2007 to top $1 trillion, with the biggest listed share - Gazprom ($298bn), Rosneft ($86bn), Lukoil ($71bn) - all seeing similar increases.
The story with the debt trading, which was Micex's initial focus, is similar. "Some 70% of Russia's total traded debt [including Eurobonds denominated in other currencies] takes place on Micex," says Rybnikov. "Micex is the centre of liquidity and pricing for all Russian assets. Even if you add the OTC market, then the exchange still accounts for over half of all the trades. "
Micex dominates not only trading in Russia, but also in the entire region. Even taking into account the more advanced economies of Central Europe, Micex already accounts for 60% of all equity trading between Berlin and Beijing and is the 17th largest exchange in the world, claims Rybnikov.
This is where the Kremlin's plans for an international investment hub come in. The size and daily volumes of trading on Micex already dwarf those of the other exchanges in the region in places like Kyiv and Almaty. Moscow is the natural venue for IPOs for companies across the region, but currently companies are unable to list in Moscow. London and Warsaw have been actively courting companies from across the region, but current legislation bars foreign companies from listing on the Russian exchanges. However, that will change soon and then Micex will, "actively go after these companies once the restrictions are lifted," says Rybnikov.
Micex is also building bridges with other exchanges: it has already tied up with the London Stock Exchange to make trading easier and is supplying Ukraine's PFTS with the technology for its trading system. More recently, Micex entered into cooperation agreements with Belarus' Stock exchange as this market begins to open up. "We can add real value for foreign issuers - big liquidity, an interesting investor pool," says Rybnikov. "All foreign investors that want to buy shares via our domestic market can do so. Some foreign fund and investors are restricted and can't invest into Russia, but they are in the minority. For large companies now, there is little difference investing in Russia or London."
But Moscow's big selling point is its geographical location: it is unique in that because of Russia's range of time zones, Moscow traders can play the markets in New York, London, Singapore and Hong Kong all on the same day.
At the start of August, the Ministry of Economic Development and Trade released a draft plan that sets out the criteria for creating an international financial capital in a document entitled "Guidelines for Establishing the IFC." The MEDT concept is based on the principle of easy access and the minimum of registration and licensing procedures for investors, issuers and financial institutions operating within the framework of the center and a taxation system that will be able to compete with foreign jurisdictions.
For example, the proposals include a deferral in tax charges for private individual investors who lost money on their investments. Equal taxation on operations with securities will be ensured for Russian and foreign traders. And all professional market participants will be exempt from several taxes on operations performed on the market, including VAT, profit tax, dividends and interest payment on traded securities - although the detail of much of this still has to be settled.
More attention will be also paid to strengthening the protection of ownership rights, improving risk management system and creating the infrastructural institutions to support the market. Furthermore, special-purpose courts may be established in Russia for, "a rapid and fair treatment of conflicts" that may arise among the IFC members.
Like most big sector-wide reforms in Russia, this process has been building for a while. Usually an idea is adopted and work on changing the rules begins, with some laws drafted or changed. When the process gathers pace, at some point the Kremlin publicly adopts the programme.
For example, even before Putin upped the stakes in January, after more than a decade of discussion a draft law against insider trading had been drawn up and was submitted to the Duma, which will read it in the autumn. Likewise, the long-awaited central depository is moving closer to appearing and laws to create Russian Depository Receipts - a proxy share that allows foreign companies to list in Moscow - have already been adopted. But there is still a lot to do and further progress will be made harder by the mesh of conflicting interests amongst the state and private participants in the equities markets.
The obvious next move is to merge Micex with the RTS, as well as their depositories - the National Clearing Company and the Depository Clearing Company. But as the former is owned by the state and the latter owned by market participants, agreeing on how to do this is going to be very difficult. "The question we are facing now is what model does Russia want to follow for the future development of the Russian market? Do we want a market that is competitive on an international basis or do we want one that is internally competitive? We have to be clear about what we want," says Rybnikov. "Consolidation is high on the political agenda. The government is about to present a plan on how this consolidation will work. The current global crisis has a silver lining as it will push the government to work even hard to continue the reforms and development of the domestic capital markets."
Equity culture club
An equity culture is on the rise in Russia, but still has a long way to go. Micex has seen the number of individual accounts double twice in the last four years, rising from just over 60,000 in 2005 to top 400,000 individual accounts as of the start of this year.
Just the top-five asset management companies now have RUB463bn ($20bn) under management as the domestic retail investor starts to become a palpable force on the equity markets. Yet a higher proportion of the Chinese population are invested in their domestic equity markets than in Russia, despite Russian income per capita being three to five times higher than Chinese.
"Part of our job at Micex is to educate the people to the benefits of investing for their long-term future," says Micex president Alexander Potemkin.
To find out the state of play, Micex commissioned a survey, asking the question: imagine that you have 100,000 roubles (approx. $4000) which you don't need to spend for everyday needs. What would you do with it?
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