Ben Aris in Moscow -
The management of Russia's Moscow Exchange arrived in London this week on a roadshow ahead of its IPO on February 15. What they are selling is not just a stock exchange, but a diversified business that is in many ways unique.
Widely seen as Russia's leading stock exchange, Moscow Exchange is actually an unusually diversified business for an exchange, which means it has managed to earn steadily increasing profits that have been largely unaffected by the 2008 crisis, let alone the notorious volatility that plagues portfolio investment in Russian stocks.
Trading stocks and bonds made up only 34% of Moscow Exchange's operating income in the first nine months of 2012. The biggest single business on the exchange is foreign currency trading, which accounts for 80% of the aggregated trading volumes by value and, at just under a third, was the single biggest contributor to the operating income in the same period.
It's all in the name: Micex, the name before Moscow Exchange merged with Russia's other exchange RTS, stands for "Moscow Interbank Currency Exchange". The exchange was set up in 1992 as the money market platform for the banking sector and also for the Central Bank of Russia (CBR) interventions on the currency market used to control the exchange rate as well as provide support to the banking sector in times of crisis. Neither of these jobs is typical for an exchange and 20 years later its forex business still provides Moscow Exchange with a steady stream of income.
It only took on equity trading in the second half of the 1990s and came into its own when the government decided that domestic Gazprom shares could only be traded on the then Micex after it removed the so-called ring fence - special rules that prevented foreigners from buying locally listed shares - around what was then Russia's most valuable company.
In all, the exchange trades five asset classes: in addition to stocks, bonds and currencies, it is also a platform for repurchase deals with fixed-income instruments and also the burgeoning derivatives business.
And as well as handling the issuance and trading of assets, the exchange also unusually offers all the post-trade services of settlement, clearing and depository services as a single unified operation - more steady revenues for the exchange irrespective of what else is happening in the country, which together make up 16% of its total income.
The advantage of having such a diversified business is that the exchange's income has risen pretty consistently over the last six years, despite the huge swings on the on trading floor, even during the worst of the 2008 meltdown, when the value of stocks traded on the exchange plummeted by about 75%. "Moscow Exchange keeps making money no matter what is happening on the exchange itself," says one banker close to the business who didn't want to be named. "When share prices tank, then derivatives spike. And the volumes of forex trading continue to grow no matter what else is going on in the country."
Forex trading remains the exchange's cash cow with volumes rising by a compound average growth rate of 24% since 2009 to top RUB295.5 trillion in 2012. And currency-trading volumes will only increase now the restrictions on foreign investors buying bonds directly on Moscow Exchange from their trading desks around the world are removed in February.
However, the fast growing business line is derivatives trading. Following the 1998 financial crisis, the central bank ruled that derivatives were regulated by the same rules as casinos, as Russian banks attempted to wiggle out of some $40bn worth of forward contract obligations signed with foreign investors who had bought them to protect themselves from the very devaluation that actually happened.
Things have gotten better since then - a new law on investment was passed in 2002 that created the foundation of a real derivatives market and another covering futures trading was introduced in 2006. (All the casinos in Moscow have also since been closed and banished to remote regions in Russia's interior.)
The derivatives business is booming. Because of the lack of domestic institutional investment in Russian stocks, investors have become increasingly keen to hedge against the perennial volatility and part of the goal of merging Micex with the RTS exchange in 2012 was to further deepen the derivatives business, which now makes up 18% of the exchange's income.
The exchange still quotes both the RTS and Micex indices, which are now identical in terms of the basket of stocks and their weighting, except the RTS is denominated in dollars and used as a basis of hedging, while the Micex index is denominated in rubles. Last year, 43% of all the derivate contracts written were against the RTS' value and worth a total of $3.8bn, making this derivative amongst the top six biggest derivative products in the world.
All in all, Moscow Exchange reported revenue of RUB15.9bn ($530m) for the first nine months of 2012, a 36.7% increase on the same period a year earlier, with net profits up by just under a quarter to RUB6.4bn ($213m). Going forward, the exchange is travelling through Europe, the US and the Russian regions (as this will be a Russian IPO on a Russian exchange after all) telling investors that the future looks even brighter.
The Kremlin is pushing to create an international financial centre (IFC) in Moscow, but the ultimate goal is to win back Russia's equity business from London, the preferred destination for most of Russia's biggest IPOs.
Russian companies already account for 18% of the London Stock Exchange's total capitalisation, according to Russian President Vladimir Putin, but the president said in January that from this year he wants all the IPOs planned as part of the government's privatisation drive to be held on the Moscow, not London, exchange. A few days later, Andrei Kostin, CEO of VTB Bank, dutifully announced that VTB would sell its next tranche of a reported 10% on Moscow Exchange, not the LSE. More will follow.
It will take a long time before Moscow Exchange can seriously threaten the LSE's appeal for big Russian companies wanting to float. But the listing of Moscow Exchange and the new drive to promote domestic listings is another step along the road to creating a full-fledged Russian capital market that can serve both pensioners and Russian companies looking to raise capital. It should also provide Moscow Exchange shareholders with some good and steady dividend payments in the process.
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