The merger of two stock exchanges and work to bring operations into line with international standards gives Moscow the potential to claw back Russian equity offerings from other markets.

After a first half distinguished by the number of postponed offerings, the second half of 2012 proved relatively hopeful for Russian equity capital markets (ECM). Sberbank’s blockbuster $5.2bn secondary offering, twice oversubscribed, set the tone in September. Then mobile operator MegaFon raised $1.7bn through an initial public offering (IPO) in November 2012.

Both shares are, at the time of writing, trading up compared to their listing price. This provides an optimistic curtain-raiser to 2013, and the Russian government could begin to accelerate its privatisation programme. Potential candidates include IPOs of shipping company Sovcomflot and diamond miner Alrosa, plus a fresh secondary offering from number two bank VTB.

From the private sector, rail freight company NefteTransService announced plans to list at the start of 2013. Privately owned Promsvyazbank postponed an IPO in the fourth quarter of 2012. Promsvyazbank chief financial officer Alexandra Volchenko says there is investor appetite for the stock and the listing will take place once demand looks set to allow an offer price within the current owners’ targeted range.

There is one further important IPO prospect – the Moscow Exchange itself. The exchange announced in January 2013 its intention to list, with Credit Suisse, JPMorgan, Sberbank and VTB Capital as joint global coordinators. According to Moscow Exchange chief executive Alexander Afanasiev, the planned IPO “marks a crucial step on our path to greater transparency and openness as a company, as well as bringing governance fully in line with best international practices. This will become a key factor in strengthening Moscow’s position as an international financial centre and will make Russia’s financial market more attractive for both Russian and international investors.”

Improved market protocols

Even while the Russian ECM scene was quiet at the start of 2012, the completion of a merger between the two Moscow stock exchanges, Russian Trading System and Moscow Interbank Currency Exchange, laid the groundwork for greater progress in the future. The combination of the two exchanges ended the split liquidity that had undermined the market.

It also allowed the establishment of a central securities depository, which creates more reliable settlement architecture for Russian equities. The Moscow Exchange, as the merged entity is called, will also switch settlement protocols in the first quarter of 2013 from delivery versus payment, to T+2, allowing buyers to make payment two days after the trade.

“Some institutional investors were prevented by their mandates from buying equities on the Moscow Exchange on a delivery versus payment basis, because it exposed them to counterparty risk,” says Edward Conroy, a portfolio manager for the $530m HSBC GIF Russian equity fund. He says fund managers would look for whichever market can offer the best liquidity. While blue-chips such as Gazprom or Sberbank tend to have good liquidity on both Moscow and London listings, liquidity tends to congregate on one exchange for stocks further down the capitalisation scale.

Strong market sentiment at the start of 2013 suggests a better year for IPOs than 2012 or 2011, when jitters over the eurozone in particular dampened investor appetite for risk assets generally. With the largest Russian stocks mainly a play on global natural resource prices, Moscow share prices tended to correlate closely to US and European investors’ volatile risk appetite. If more Russian companies list in 2013, this will begin to paint a clearer picture of whether the Moscow Exchange can live up to its aspirations.

London reliance

The presence of two Russian investment banks among the exchange’s IPO global coordinators underscores the maturing of the country’s financial sector. Issuers have become less reliant on foreign banks to access capital markets. But so far, this has not translated into less reliance on foreign stock markets.

Most large issues, including the Sberbank and MegaFon deals in 2012, include an offering of global depository receipts (GDRs) to allow foreign investors to access shares via a major international market. This is usually London, although some Russian technology and telecom stocks such as mobile operator MTS have listed American Depository Receipts in New York to tap into the large pool of US investors who specialise in that segment.

“Russian companies, especially the largest ones, want to support the creation of a genuine international financial centre in Moscow. The question is whether they also need to list GDRs to bring in enough international investors, and at the moment the answer is yes,” says one ECM banker.

Move to Moscow

Two factors could change that situation. First, the authorities have made it clear that they expect companies listing under the privatisation programme to do so in Moscow – although this does not explicitly rule out GDRs. The second factor is the shift to T+2 settlement.

“Many international investors are already set up to trade in Moscow, and now they will not need to pre-fund their buying, which will make them more comfortable to trade locally. What it needs is someone to make the first move in terms of a large company listing solely in Moscow without GDRs,” says Nick Koemtzopoulos, head of emerging market ECM for Europe, the Middle East and Africa at Credit Suisse.

To date, coal miner Raspadskaya launched a Moscow-only IPO in 2006 that raised $317m, and a number of power companies created after the break-up of Unified Energy System of Russia in 2008 followed suit. But none so far has been large enough to establish a trend.

Unsurprisingly, the Moscow Exchange itself has indicated that its IPO will take place purely on its own platform, including its offering to institutional investors from the US and Europe. The proposed deal could be about $500m, and if successful it could mark a sea change for Russian IPOs.

One further element could strengthen Moscow’s position. In the final quarter of 2012, European post-trade provider Euroclear was authorised to begin clearing Russian ruble-denominated government bonds (OFZ). This prompted an immediate tightening of yields, as foreign investors will be able to clear the OFZ issues more easily, opening the market to a wider audience. Mr Afanasiev has indicated that Russian equities might become eligible for Euroclear in 2014, which could usher in a similar increase in international demand.

Seeking local investors

However, for the Moscow Exchange to deepen its role in financing the Russian economy, the country will need to develop a greater local investor base. The private pension and insurance sector is still at a very nascent stage, with the majority of pension savings accumulated in a fund managed by state development bank Vnesheconombank. This fund is almost entirely invested in government bonds, and returns have routinely underperformed Russian inflation.

Government policy will play an important part in facilitating improvements in the local asset management industry but, at present, the trend could be in the wrong direction. The Russian government passed a law in November 2012 that cut workers’ contributions to the Vnesheconombank pension fund from 6% of salary to 2% – although those saving with private asset managers will continue to pay in 6% of salary.

The limited nature of the local asset management industry is evident from the breakdown of participants in the primary listing market. According to bookrunners, more than 90% of orders on the MegaFon IPO came from investors based outside Russia, which is normal for Russian IPOs. This increases the correlation of the Russian market to foreign sentiment on issues unrelated to Russia, such as the eurozone crisis or US fiscal policy debates.

Even when international risk appetite is strong enough to support blue-chip IPOs, the lack of local investors could pose a problem for listing second-tier companies. There is a 25% limit on the proportion of a company’s stock that can be packaged into GDRs. For a smaller company, this would mean a very small allocation outside Moscow, which could be very illiquid, deterring foreign investors. One alternative is to place the entire listing directly on an exchange such as London’s mid- and small-cap market AIM. But this might make it more difficult to attract investors with Russian market expertise.

“A listing on AIM would not be part of the MSCI Russia Index, since it is not a local market listing. That means captive Russian benchmark investors are lost, but it might suit, for instance, smaller mining stocks that are the focus of resources index investors instead,” says Mr Conroy.

Russia’s top listed companies are global players with worldwide name recognition that can choose where and from whom to raise equity. The progress of the Moscow Exchange toward international best practice may enable such blue-chips to launch Moscow-only offerings. But second-tier companies may still remain in limbo between a foreign investor base that lacks information and a domestic investor base that lacks depth.

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