Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Back to the futures

Futures and options trading in Russia is making a tentative comeback since its curtailment in the wake of the 1998 financial crisis. Ben Aris in Moscow reports.There are few places in the world where the future is less certain than in Russia, but maturing valuations of Russian stocks means an increasing number of investors are willing to bet on it.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Russia’s first futures market was established in 1992 in St Petersburg but attracted little interest. What trading that did exist was brought to an end by the 1998 financial crisis. After lying dormant for much of the past decade, the futures market is growing fast.

Russia’s booming economy has left the double whammy of 1998’s default and devaluation behind it and a second attempt to set a futures market was launched in 2001 based on the remnants of the St Petersburg market. The Russian Trading Systems (RTS) futures market, known as FORTS, now accounts for 98% of Russia’s futures and options contracts, but still bears some scars from the financial blow-out.

Futures and options trading has only really started to take off in the past year. After plunging from a record 571 in October 1997 to an all-time low of 38 in October 1998, the leading RTS index clawed back all its losses in the past four years and was well into the 600s by this summer.

In August the market suddenly re-rated and the index soared to over 1000, smashing any technical resistance as investors put political fears inspired by the Yukos affair behind them and acknowledged Russia’s sparkling macroeconomic numbers. By the start of November the market had sold off sharply before recovering to 980, but investment houses are confident the RTS will end the year at the 1000 mark.

Return to health

Russian stocks have caught up with most of their emerging market peers and most of the Russia-specific risk has been whittled away. The leading blue chips trade at valuations on par with, or even at a premium to, the best companies in other emerging markets.

But the market remains very volatile. Despite the massive gains between August and November when the market rose from 784 on August 1 to a new record of 1052 on October 4, it then suddenly collapsed again to 882 only two weeks later before slowly recovering to 980 at the start of November, which analysts consider to be its “fair” value.

The days of triple-digit returns are on the wane but this continuing volatility has investors looking for ways to lock in some of the massive gains that are still to be made playing the RTS, and futures and options are a natural choice.

At the same time, since Russia scored a hat-trick of investment-grade ratings from the three leading agencies, the Russian equity capital market has seen the arrival of more conservative investors such as US pension funds and traditionally cautious Asian investors who are looking to the still young futures and options market to smooth out some of the lumps in returns.

“The futures market is the fastest growing market in Russia. The prices of securities have matured in the last few years and the market is looking for ways to reduce its risk. Investors are starting to hedge their investments and derivatives are the best way to hedge risks,” says Roman Gorunov, vice-president of the RTS.

The number of products is still very limited. It is only possible to buy single share futures or options in only seven of Russia’s most liquid stocks: UES, Gazprom, LUKoil, Rostelecom, Surgutneftegas, MMC and Norilsk Nickel (and there is talk of including Sberbank and Russian Railways).

More recently the RTS started offering a futures and options product for a basket of three-year Moscow City bonds, the benchmark bonds of Russia’s fixed income market, and there is a little trading in the dollar/rouble future exchange products.

But by far the most popular is the RTS index futures product, which accounts for 98 out of 100 contracts as it provides a convenient hedge against big shocks that pull the whole market down; the sell-off in October was partly caused by worries over changes in US interest rate policy and affected all of Russia’s stocks equally. The RTS index future is a basket of 50 stocks in which no single stock has a weighting of more than 15% of the total and so is a useful hedge against broad market-moving events.

“We hope that index product will be popular and help the development of the single stock market, which will then offer more opportunities like arbitrage. Other products like an interest rate future are also in the works,” says Mr Gorunov.

Battle of the exchanges

Russia’s future trading is all concentrated on the RTS’s FORT market, which accounts for 98% of the volumes and the rest taken up by a few small regional exchanges. While the futures trading on the RTS is already equivalent to half of the RTS daily turnover on the main market, RTS has already lost its lead as the premier exchange to its rival MICEX (Moscow Interbank Currency Exchange) and accounts for only 10% of Russia’s total turnover of stock trading.

Despite the attraction of hedging investments in this risky market, the uptake is slow. Mr Gorunov reports that it usually takes a year from the first conversation with customers about futures to the first signed contract. Russian investors are still on a steep learning curve.

Investors are cautious as their experience with exotic Russian instruments left them with burnt fingers in the past.

The original market was set up taking western futures markets like Chicago as a model. But the 1998 crisis was a huge setback as instead of protecting investors from risk, the system simply collapsed.

In the run-up to the crisis both foreign and Russian investors had been ploughing money into the state domestic T-bills, the now-notorious GKOs, which were earning over 200% by the time of devaluation. Foreign investors tried to hedge against fluctuations in the rouble by signing forward contacts with Russian banks locking in an exchange at the time the bond matured.

What did the most damage to Russia’s financial system, when the rouble devalued on August 17, 1998, was not the government’s default on its obligations and the moratorium it slapped on settling international obligations, but Russian banks’ decision to renege on their forward contracts.

Regulation of exchanges at the time was superficial and each of Russia’s half-dozen exchanges was left to its own devices. As the domestic capital market went into a tailspin, the system simply stopped functioning as most exchanges just closed their doors.

“Last year’s Yukos affair influenced investors and created the desire to hedge risks, but the 1998 default had no effect as the derivative market failed to perform its hedging roll. At that point the market was not well developed enough to accept the risks that materialised,” says Mr Gorunov. “The market was wild then.”

Crisis legacy

Futures are still struggling with the legacy of the financial crisis. The law covering derivative products is vague and after devaluation Russian banks successfully argued that forward contracts were a form of gambling, as defined by Russia’s civil code. The courts agreed that foreign customers had “bet” on the rouble exchange rate and “lost” when the rouble collapsed, allowing the banks to wriggle out of their obligations.

The ruling set a precedent, which still defines the legal status of futures today. All derivative products remain gambling in the eyes of the law and so investors have no legal protection in the case of default. No one signs forward contracts in Russia anymore, and if they do, then the deal is done abroad and secured with assets in another country.

However, while many reforms have been put on the back burner until after the 2008 presidential elections, reforms to the financial sector are going ahead full steam. At the start of November, the Duma passed new laws making initial public offerings easier. Laws regulating the exchanges are already in effect, supervised by the independent and market-minded Federal Service of Financial Markets (FSFM).

More reform is on the way. Oleg Vyugin, director of the FSFM, recently proposed a comprehensive raft of changes to the law to fill the lacunas covering the securities markets.

New rules to define derivatives as something other than lottery tickets are due to go before the Duma before the end of the year and in October Mr Vyugin put up changes to the civil code that would make forward contracts enforceable. The changes may even force Russian banks to honour their 1998 vintage forward contracts worth billions of dollars.

Mr Gorunov says: “First of all, implementation of these amendments will provide bigger benefits to the forward market. It will also make entrance into the Russian market easier for foreign players who still mistrust Russian legislation covering this part of the market.”

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe , Russia