7Section 3. Financial markets and financial institutions
3.1. The stock market recovery 1
In 2017, the Russian stock market once again reaffirmed its reputation of being one of the most volatile in the world. In contrast to the situation in 2016, when Russia's stock market, in terms of its rates of return, set a world record among the other 36 stock markets included in the analysis, in 2017 it joined the group of outsiders. Over that year, the RTS Index gained only 0.1 percent vs. 52.3 percent in 2016, and the MICEX Index (MOEX Russia Index)2 at year-end demonstrated a negative rate of return of 5.5 percent, while over the previous year it had gained 26.8 percent (Fig. 1). The different movement patterns of the two Russian indexes with the same issuer portfolio can be explained by the higher rate of return of the RTS Index (which is denominated in foreign currencies) relative to the (ruble-denominated) MOEX Russia Index that it displays in response to the weakening USD-to-RUB exchange rate.
After the global financial crisis of 2008, Russia's stock market segment taken up by domestic issuers has never fully recovered, which is manifest in the negative accumulated rate of return of the RTS Index as the foreign-currency equivalent of the value of long-term domestic saving. The compound annual growth rate of the RTS Index over the 11 years encompassing the period from the pre-crisis year 2007 through 2017 amounted to -6.6 percent per annum (Fig. 2). Out of the stock market indexes of 36 countries, lower return rates (relative to the RTS Index) were demonstrated only by the indexes of Greece and Cyprus, the two countries that in the early 2010s were in the epicenter of the eurozone financial crisis. Over the same period, the MICEX Index was demonstrating a positive mean rate of return of 1.1 percent per annum, largely thanks to the ruble's weakening over a long-term horizon.
1 Sections 3.1-3.8 are authored by Alexander Abramov, IAES-RANEPA.
2 From November 27, 2017, the Moscow Exchange's MICEX Index was renamed the MOEX Russia Index.
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The low recovery rates of Russia's stock indexes after the 2008 crisis can be explained by the structural problems in the Russian economy, and by its dependence on the global prices of mineral resources. This specificity becomes distinctly visible if we compare two recovery scenarios - the domestic stock market recovery after the crisis of 1997-1998, which was cyclical in nature, and that after the 2008 crisis, which was structural. Formally, both those crises followed the same scenario: the collapse of stock indexes in response to plunging oil prices, depreciation of the ruble and foreign speculative capital outflow, followed by their recovery alongside rising prices of oil, stabilization of the ruble at a lower level, and the return of foreign portfolio investments. However, after the crisis of the late 1990s the stock market indexes rebounded relatively promptly, while now, 10 years after the 2008 crisis, the RTS Index still has not fully recovered. The essence of the current problem is that, for objective reasons (the shale oil and gas revolution due to the advent of new technologies, the progress in energy saving, etc.), prices of oil have failed to rise to their pre-crisis level, and some experts believe that they will not recover to that level in the foreseeable future.1 Consequently, the necessary conditions for growth of Russia's stock market and its full recovery have been structural reforms in the Russian economy and qualitative changes in its investment climate.
The two recovery scenarios, mentioned earlier, of Russia's stock indexes are illustrated in Fig. 3 and 4. After its downfall in 1998, the ruble-denominated MICEX Index regained its pre-crisis quotes in just 8 months, largely due to the 5-fold depreciation of the ruble (Fig. 3). For the RTS Index, it took nearly 5 years (58 months) to recoup all its losses, and it happened thanks to the recovering prices of oil. Russia's stock market had fully recovered only by H2 2003, and this coincided with Russia being assigned an investment grade rating by international rating agencies (Moody's - as of 8 October 2003; Fitch's - as of 17 November 2004; and S&P's - as of 31 January 2005). The investment grade ratings triggered an inflow of foreign portfolio investments and foreign loans.
Relative to its June 2008 level, the MICEX Index (MOEX Russia Index) recovered in 7.5 years, or 92 months; the RTS Index, after nearly 10 years, or 115 months, has regained only 50.8 percent of its pre-crisis quote as of March 31, 2018 (Fig. 4). The weak growth of both these indexes was influenced by the slow recovery of oil prices. Besides, the delayed recovery, after 2008, of the ruble-denominated MICEX Index in contrast to its behavior in the aftermath of the 1997-1998 crisis can be explained by the more moderate decline of the ruble over the recent decade compared with its breathtaking downfall in the late 1990s. Over the period from May 2008 through March 2018, the ruble plunged 2.4 times, compared with its previous 5-fold depreciation.
1 In the next few years, oil prices are going to stay at a moderate level, thus demonstrating a 'New Oil Reality', as Rector of the RANEPA Vladimir Mau put it (Mau, V. To remember the 1980s. Vedomosti, February 16, 2016). The International Energy Agency allows that, given the rising shale oil production factor and growth of the electromobile industry, price of oil may well stay at USD 50-70 per barrel until 2040 (IEA. World Energy Outlook 2017, Russian version, p. 9).
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Source: own calculations based on data released by the Moscow Exchange and the Bank of Russia.
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Fig. 4. The movement of the USD-to-RUB exchange rate, the RTS Index, and the MICEX (MOEX Russia) Index from May 2008 through March 2018 (May 2008 = 100 percent)
Source: own calculations based on data released by the Moscow Exchange and the Bank of Russia. 80
As shown in Fig. 5, after the 1997-1998 crisis and the plunge of oil prices to 31.1 percent of their pre-crisis record high of December 1996, the period of their full recovery lasted 3 years, or 36 months. So far, as of March 2018, over the 115-month period (or 9.6 years) since its peak of USD 133.90 per barrel in July 2008, to this day Brent prices have climbed to only 40.7 percent of that level. In absence of any notable structural reform shifts in the Russian economy, it is the stagnating oil prices that account in the main for the slow pace of recovery of the RTS Index.
—•—Russia 1997-1998 ^^ Russia 2008-2009
Fig. 5. The growth rate of the price of Brent crude oil during the financial crises in Russia (peak price =100 percent), as of March 2018
Source: own calculations based on data released by IFS IMF and the International Energy Agency.
Against the backdrop of the previous short-term financial crises around the world (in the USA in 1987, 2000 and 2007; in Mexico in 1994; in Indonesia, Brazil and Russia - in 19971998), which lasted for 5-6 years, the current downturn of the RTS Index, followed by its slow 118-month long (9.8-years) recovery, has already become a record (Fig. 6). This crisis, which is being experienced by Russia alongside some other developing countries, has evolved into a medium-length one.
A W-shaped trajectory of an index recovery is typical of the countries where financial crises were caused by structural disproportions in the national economy, as exemplified by South Korea in 1989 and the US market for shares in hi-tech innovation companies in 2000 (Fig. 7). Those crises lasted for 183 and 177 months respectively; however, both stock indexes are now above their pre-crisis highs. As shown in the graph, the current trajectory of the RTS Index, which after the 118 months elapsed since May 2008 reached the point of 50.8 percent of its pre-crisis record high, largely follows the recovery trajectories of KOSPI and NASDAQ.
The longest crisis cycles in the history of stock markets are the slump in the US stock market triggered by the Great Depression of1929-1933 and that in the market for Japanese shares from 1989 onwards. The recovery of the stock index Dow Jones Industrial Average (DJA) in the
USA after the Great Depression took 303 months, or 25.3 years. In 2015, that record was broken by the Japanese index NIKKEI-225, which as of March 2018 had been unable to recover its initial quote for 339 straight months (or slightly more than 28 years), amounting to only 55.1 percent of its average-monthly record high of 1989.
— ^--USA - 1987 -»—USA - 2000 -O—Mexico - 1994
—•— Russia (RTS) -1997 -*— Indonesia - 1997 ....... Brazil - 1997
Russia (MICEX)-2008 -■— USA (DJIA) -2007
Fig. 6. The depth and length of short-term financial crises around the world, as of February 2017 (peak = 100 percent)
Source: own calculations based on data released by the Moscow Exchange, Factiva, and www.finance.yahoo.com
As shown in Fig. 7 (the area inside the dotted line), the current value of the RTS Index is now at the fork point, beyond it may follow either the recovery trajectory of KOSPI and NASDAQ after a medium-term crisis, or plunge in accordance with the Japanese scenario, where the stock index recovery lasts for an indefinitely long period. In a medium-term crisis, the market recovers alongside the disappearance of those structural problems that has triggered it in the first place: in South Korea it was financial stability regained by domestic banks, non-financial companies and households; in the USA, it was a new wave of innovations and investment in innovations. A typical situation under a long-term crisis scenario is when the accumulated structural problems, for a variety of reasons, cannot be resolved in the framework of government economic policy. In this sense, there is a risk that the recovery trajectory of the RTS Index may indeed follow the long-term crisis pattern, because the structural problems that have piled up across Russia's economy have so far been dealt with in a slow fashion.
—•-USA-1907 USA-1929 -Japan-1989 • Korea 1989
—Russia (RTS) -1997 ---USA-NASDAQ-2000 -K-USA (DJIA) -2007 Russia (MICEX)-2008
Fig. 7. The depth and length of long-term financial crises around the world, as of February 2017 (peak = 100 percent)
Source: own calculations based on data released by the Moscow Exchange, Factiva, and www.finance.yahoo.com
Among all the BRICS members, slow stock market recovery has been an issue not only for Russia, but also for China (Fig. 8). The indexes of the Johannesburg Stock Exchange (JTOPI), the Indian Stock Market (BSE Sensex), and the Brazilian stock index Bovespa regained their pre-crisis quotes over 44, 70, and 114 months respectively. In 2016, the list of recovered stock indexes in the BRICS group was joined by the MOEX Russia Index. The Shanghai Composite Stock Exchange Index (China), on the contrary, over the previous 125 months since its November 2007 plunge had gained only 53.2 percent of its pre-crisis peak level. The similar recovery patterns displayed by the RTS Index and the Shanghai Composite Stock Exchange Index can be explained by a variety of factors. The stock prices in both indexes are denominated in relatively stable currencies (USD and Yuan), and so the factor of national currency depreciation cannot be used as a growth level, as in the case of JTOPI, BSE Sensex, Bovespa, and MOEX Russia. At the same time, similarly to the RTS Index, the Shanghai Composite Stock Exchange Index reflects the existing structural problems, in particular the presence of bad debt on the balance sheets of major national financial companies alongside the measures designed to toughen the domestic financial market regulation by the Chinese authorities.
Thus, the slow recovery of the Russian stock market during the post-crisis decade was, for most part, the upshot of multiple problems in the Russian economy coupled with instability of the national currency's exchange rate. However, the stock market is also strongly influenced by its certain internal development factors.
RSA (JTOPI-2008); India (BSE Sensex-2008); Brazil (BOVESPA)-2008;
44 months; 112.9 percent 70 months; 104.3 percent 114 m0nths; 91.8 percent
—O— China (Shanghai composite) 2008 -*— India (BSE Sensex)-2008
----— Brazil (B0VESPA)-2008 Russia (MICEX)-2008
—.—Russia (RTS-2008) — — RSA (JT0PI-2008)
Fig. 8. The depth and length of the current financial crises in the BRICS countries, as of February 2017 (peak = 100 percent)
Source: own calculations based on data released by the Moscow Exchange, Factiva, and www.finance.yahoo.com
3.2. The stock market
The year 2017 saw some important positive developments in the domestic stock market: the IPO-SPO sector demonstrated a revival relative to the previous year; the market activity of households increased, first of all thanks to the advent of individual investment accounts; the basic broker activity standards were adopted; the volume of exchange market transactions increased, albeit slightly, in absolute terms. At the same time, the downward trend displayed by the number of listed issuers of securities could not be reversed, and the stock market liquidity and capitalization indices could not be significantly improved.
In its competition with the other global exchanges for the listings of shares issued by Russia's biggest market players, the Moscow Exchange has managed to hold its leading position as a major center for transacting, settlement and pricing with regard to these financial instruments. After the merger of the two Russian exchanges in late 2011, the relative share of the Moscow Exchange in the total volume of these transactions increased from 41.2 percent in 2012 to 48.7 percent in 2017 (Fig. 9). Over the same period, the relative share of the main rival of Russia's exchanges - the London Stock Exchange (LSE) - on the contrary, shrank from 48.8 percent to 39.4 percent; that of the other foreign exchanges increased from 10.0 percent to 11.9 percent.
A notable development in the market for Russian issuers of shares in 2017 was the listing, on the main market of the LSE, of the global depository receipts placed by EN+ GROUP PLC (controlled by Russian billionaire Oleg Deripaska and registered in Jersey Channel Islands) to the total value of USD 1.5 billion.
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Note. Out of all trading modes on the Moscow Exchange, our calculations here include only data on the volume of market transactions.
Fig. 9. The relative shares of stock exchanges in the volume of trade in equity financial instruments issued by Russian JSCs over the period from 1998 through
February 2018, percent
Source: own calculations based on data released by stock exchanges.
One serious issue typical of the equity financial instruments issued by Russian companies traded on various stock exchanges around the globe is the dramatic shrinkage, over the past few years, of the volume of market transactions, which has been pushing up the liquidity risk premium demanded by the investors in a given company. As shown in Fig. 10, the aggregate volume of market transactions in these equity securities on all exchanges shriveled from USD 1.1 trillion in 2011 to USD 0.3 trillion in 2017, including from USD 0.6 trillion to USD 0.1 trillion on the Russian exchanges.
One of the key issues faced by the stock exchange market for equity securities issued by Russian JSCs has been its low liquidity. In 2017, by its volume of equity market transactions, the Moscow Exchange came 28th among the 82 world exchanges in the World Federation of Exchanges' database, having moved one place down relative to its 2016 index.
Nevertheless, the low exchange share market liquidity represents a problem not only for the Moscow Exchange, but also for the organized market in the majority of countries around the world. In 2017, the total volume of equity market transactions on all the exchanges amounted to only 92.7 percent of the exchange liquidity index for 2007 (Table 1). Such a situation was typical of the global exchange trade centers like the USA, Japan, the UK, Germany, Australia, Hong Kong, and major international exchanges like NASDAQ OMX Nordic Exchange and Euronext. Significant growth of their stock market volumes could be observed only on the two Chinese exchanges, where the aggregate trading volumes increased 2.7 times. Russia's stock exchange market differs only by its more pronounced liquidity shrinkage, as the volume of trade
in equity securities on the Moscow Exchange in 2017 amounted to only 26.4 percent of its 2007 level.
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Fig. 10. The volume of trade in equity financial instruments issued by Russian JSCs on various stock exchanges over the period from 1998 through February 2017,
millions of USD
Source: own calculations based on data released by stock exchanges.
Table 1
The movement of the value volume of market transactions in shares on major stock exchanges in 2007-2017 (2007 = 100 percent)1
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
USA (NYSE and NASDAQ) 100 120.1 72.6 71.0 71.7 54.2 54.3 65.5 69.9 66.2 60.3
China (two exchanges) 100 63.0 128.9 132.8 106.9 81.8 124.9 198.0 674.2 314.4 274.5
Japan 100 87.3 61.2 63.2 66.3 57.5 103.9 86.8 88.3 89.6 92.7
UK 100 89.0 62.9 63.5 65.7 50.8 51.7 64.1 60.2 52.9 53.9
Euronext 100 84.7 42.7 44.5 47.1 34.8 36.7 43.1 45.8 39.0 42.9
Germany 100 95.5 45.1 48.4 52.3 37.9 39.7 43.7 46.3 38.9 44.1
Hong Kong 100 77.3 70.1 74.1 71.5 54.7 65.5 75.3 105.2 66.8 96.9
Canada 100 105.3 75.5 83.0 93.5 82.3 83.2 85.4 71.9 71.3 75.5
Australia 100 77.5 57.9 77.1 86.8 67.9 63.9 58.6 58.0 59.7 60.2
Russia (MOEX - market transactions) 100 89.0 77.3 75.5 95.2 55.8 44.0 46.0 25.8 23.6 26.4
NASDAQ OMX Nordic Exchange 100 84.5 48.8 52.6 58.0 41.1 43.8 50.6 52.9 49.8 56.2
Total, all members of World Federation of Exchanges (WFE) 100 103.1 77.7 83.2 89.0 69.8 77.2 87.5 90.7 95.7 92.7
Source: own calculations on the basis of data released by the World Federation of Exchanges and the Moscow Exchange.
1 Including transactions in securities issued by foreign companies on the corresponding stock exchanges. 86
For the reasons mentioned earlier, the explanation for the low liquidity phenomenon observed on the Moscow Exchange should be looked for among the factors that are common for the majority of other stock exchange markets around the world. Meanwhile, there is no commonly recognized reason behind the plunging liquidity indices on the world stock markets. Besides, their plunge, most likely, has been caused by several factors.
In response to the 2008, administrative constraints were imposed on risky transactions in securities, including toughening of regulation with regard to biggest market makers, in particular the introduction of requirement that the capital of banks and some other financial units should be increased when they choose to take additional risks when dealing in financial instruments.1 One example is the enactment of the Dodd-Frank Act in 2010 in the USA, whereby banks were restricted in their ability to carry out risky operations and required to hold a higher percentage of their assets in cash.2
The effects of cyclical factors have made less profitable the traditional 'active management' investment strategies, such as stock-picking, market timing, and sectoral investment. Against this background, passively managed portfolios have become more attractive in the eyes of investors due to their lower costs, and the big collective investment markets (e.g., in the USA) demonstrated a reorientation of investors' money flows from actively managed equity funds to index funds.3 Consequently, the continuing reduction in the turnover rate of securities held in the portfolios of US mutual funds and other portfolio investors4 likewise translated into liquidity shrinkage.
And finally, yet another reason may be the growth of mistrust towards exchange markets due to a negative impact of high-frequency trading (HFT), strengthening of segmentation of share markets in the developed countries due to accelerated growth of alternative stock exchange systems,5 etc.
In Russia, the liquidity shortage issues that were common to all world stock market were further aggravated by the ruble's depreciation, the geopolitical risks that emerged in 2014-2016, and by the deficient market regulation system that prevented domestic institutional investors from developing properly (one example being the pension savings freeze in 2014-2016).
By its market capitalization index in 2017, the Moscow Exchange was 22nd among the 78 world exchanges entered in the WFE database. Its capitalization index amounted to USD 623.4 billion, which represents a plunge by 2.0 percent relative to 2016.6
In contrast to stock indexes, the movement pattern of the market capitalization index is shaped not only by changes in stock prices, but also by the number of share issues listed on the
1 About the post-crisis regulation effects on the propensity of market participants to take risks and on the liquidity of different financial instruments see. e.g., PricewaterhouseCoopers. Global financial markets liquidity study. August 2015.
2 For more details, see, e.g., IMF Financial Stability Reports released in October 2012 and October 2015.
3 For example, according to Morningstar, investors pulled USD 318 billion out of actively managed US equity funds in 2016, and USD 7 billion in 2017. At the same time, net inflows into passively managed US equity funds amounted to USD 487 billion in 2016, and USD 693 billion in 2017. (Morningstar. Tom Lauricella. Tracking U.S. Asset Flows in 11 Charts. 01-20-18).
4 According to Investment Company Institute (ICI), in 2016, the asset-weighted annual turnover rate experienced by equity fund investors was only 34 percent, well below the average of the period 1984-2016 which had amounted to 57 percent. (Investment Company Fact Book, 2017. ICI, 57th Edition, p.38).
5 Lewes, M. Flash Boys: A Wall Street Revolt / Michael Lewis; Translated from the English. Moscow: Alpina Publishers, 2015, p. 51.
6 Over the same period, the market capitalization index of Russian public companies increased from RUB 32,740 billion in 2007 to RUB 35,896 billion in 2017, or by 9.6 percent.
national exchanges. As shown in Table 2, the market capitalization indices of Russian companies after the 2008 crisis have been recovering at a slow pace. In 2017, the recovery rate in US dollar terms amounted to only 41.5 percent of the 2007 level. Over the same period, the market capitalization indices of practically all major stock exchanges around the world were significantly above their pre-crisis level of 2007.
Table 2
The movement patterns of market capitalization indices, calculated in US dollars, on major stock exchanges in 2007-2017 (2007 = 100 percent)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
USA (NYSE and NASDAQ) 100 58.3 76.7 87.9 79.5 94.9 122.2 133.9 127.5 139.1 163.3
China (Shanghai SE ) 100 38.6 73.2 73.5 63.8 68.9 67.6 106.4 123.1 111.1 137.8
Japan (Tokyo Stock Exchange) 100 71.9 76.3 88.4 76.8 80.3 104.9 101.1 113.0 116.9 143.7
UK 100 48.6 89.8 93.9 84.9 88.3 115.1 104.3 100.8 90.9 115.8
Euronext 100 49.8 68.0 69.4 57.9 67.1 84.9 78.6 78.3 82.7 104.0
Germany 100 52.8 61.4 67.9 56.3 70.6 92.0 82.6 81.5 82.3 107.5
Hong Kong 100 50.1 86.8 102.1 85.1 106.7 116.8 121.8 120.0 120.3 163.9
Canada (TMX Group) 100 47.3 76.7 99.3 87.4 94.2 96.7 95.8 72.8 93.4 108.3
Australia (Australian SE) 100 52.7 97.2 112.0 92.3 106.8 105.2 99.3 91.4 101.4 116.2
Russia 100 26.4 57.3 91.7 72.9 71.8 69.3 34.4 26.2 42.3 41.5
NASDAQ OMX Nordic Exchange 100 45.3 65.8 83.9 67.8 80.1 102.1 96.3 102.0 101.4 123.4
Source: own calculations on the basis of data released by the World Federation of Exchanges and the Moscow Exchange.
The stock market capitalization level depends not only on macroeconomic factors and the investment climate, but also on the performance of biggest corporations. The bulk of Russia's stock market capitalization has been created by a limited number of companies. In 2015, the top ten public JSCs taken together accounted to 46.1 percent of total market capitalization; as demonstrated by the period-end result of Q1 2018, their relative share jumped to 62.5 percent (Table 3). Meanwhile, in recent years, Russia's top four public corporations - Gazprom PJSC, Rosneft PJSC, Sberbank PJSC, and LUKOIL PJSC - have been tensely competing for leadership in terms of their market capitalization indices. In 2015, the indisputable and longstanding leader was Gazprom PJSC with its market capitalization index of RUB 3.2 trillion; second came Rosneft PJSC (RUB 2.7 trillion), followed by Sberbank PJSC and LUKOIL PJSC (RUB 2.2 trillion and RUB 2.0 trillion respectively). By the year-end result of 2017, the highest market capitalization index among Russian companies was demonstrated by Sberbank PJSC (RUB 4.9 trillion), while Gazprom PJSC with its market capitalization index of RUB 3.1 trillion was pushed to second place. As shown by the period-end result of Q1 2018, the highest market capitalization index of RUB 5.8 trillion was demonstrated by the same unrivaled leader -Sberbank PJSC, while Gazprom PJSC (RUB 3.4 trillion) was pushed to third place by the only private company on that list - LUKOIL PJSC with its market capitalization index of RUB 3.4 trillion.
Rosneft PJSC, which had topped the Russian stock market in 2016 with its market capitalization index of RUB 4.2 trillion, according to the period-end result of Q1 2018, came only fourth, its market capitalization index amounting to RUB 3.3 trillion.
Table 3
The market capitalization indices of Russia's top 10 public joint-stock companies
from 2015 through Q1 2018
Issuer 2015 Issuer 2016 2017 Q1 2018
capitalization, billions of rubles Relative share, percent capitalization, billions of rubles Relative share, percent Issuer capitalization, billions of rubles Relative share, percent Issuer capitalization, billions of rubles Relative share, percent
1 Gazprom PJSC 3,226 8.5 1 Rosneft PJSC 4,240 11.2 1 Sberbank PJSC 4,859 13.5 1 Sberbank PJSC 5,479 14.2
2 Rosneft OJSC 2,715 7.2 2 Sberbank PJSC 3,710 9.8 2 Gazprom PJSC 3,074 8.6 2 LUKOIL PJSC 3,386 8.8
3 Sberbank PJSC 2,184 5.8 3 Gazprom PJSC 3,635 9.6 3 Rosneft PJSC 3,072 8.6 3 Gazprom PJSC 3,377 8.7
4 LUKOIL PJSC 2,001 5.3 4 LUKOIL PJSC 2,916 7.7 4 LUKOIL PJSC 2,823 7.9 4 Rosneft PJSC 3,343 8.6
5 NOVATEK OJSC 1,808 4.8 5 NOVATE K OJSC 2,379 6.3 5 NOVATEK PJSC 2,048 5.7 5 NOVA- TEK PJSC 2,255 5.8
6 Norilsk Nickel PJSC 1,452 3.8 6 Norilsk Nickel PJSC 1,589 4.2 6 Norilsk Nickel PJSC 1,701 4.7 6 Norilsk Nickel PJSC 1,704 4.4
7 Surgutnefte-gas OJSC 1,220 3.2 7 Surgut-neftegas OJSC 1,105 2.9 7 Gazprom Neft PJSC 1,162 3.2 7 Gazprom Neft PJSC 1,406 3.6
8 Magnit PJSC 1,052 2.8 8 Magnit PJSC 1,031 2.7 8 Tatneft PJSC 1,035 2.9 8 Tatneft PJSC 1,334 3.5
9 VTB Bank (PJSC) 1,026 2.7 9 Gazprom Neft PJSC 1,024 2.7 9 Surgut-neftegas OJSC 991 2.8 9 Surgut-neftegas OJSC 1,021 2.6
10 Gazprom Neft PJSC 729 1.9 10 VTB Bank (PJSC) 960 2.5 10 NLMK PJSC 885 2.5 10 NLMK PJSC 865 2.2
Capitalization, all issuers, MOEX 37,748 100.0 Capitaliza -tion, all issuers, MOEX 37,748 100.0 Capitalization, all issuers, MOEX 35,896 100.0 Capitalization, all issuers, MOEX 38,651 100.0
Capitalization, top 10 issuers 17,412 46.1 Capitalization, top 10 issuers 22,591 59.8 Capitalization, top 10 issuers 21,650 60.3 Capitalization, top 10 issuers 24,170 62.5
Source: own calculations on the basis of data released by the World Federation of Exchanges and the Moscow Exchange.
In 2017, the Moscow Exchange, by its number of listed companies, ranked only 39th among the 78 exchanges included in the World Federation of Exchanges' reports. It still retained the same place in 2016. Fig. 11 shows the movement pattern of the number of companies listed by the MICEX and the Moscow Exchange (its legal successor) over the period 2006-2017. These indices demonstrate that after the merger of Russia's two largest exchanges (MICEX and RTS), the number of listed companies hit its record high of 293 in 2012. Then, in 2013-2017, it began to steadily decline. In 2017, this index amounted to only 234, or 80.0 percent of its 2012 level. The main reasons for the shrinking number of listed companies were as follows: OMPK OJSC, RAO Energy Systems of the East PJSC, Krasnoyarsk GES PJSC, Fort OJSC, and Pharmstandard PJSC requested to be delisted; Otkrytie FC Bank PJSC, Transaero Airlines OJSC, Razgulay PJSC, Platforma Utinet.ru PJSC, and Idzhat PJSC were delisted for reasons of bankruptcy and reorganization in the framework of bankruptcy procedures; for LIVE OFFICE OJSC, Selestra OJSC, etc. delisting was recommended by the exchange; another reason was the reorganization of public companies into private entities as a result of their purchase by strategic investors, which was not followed by the entry of new companies on the exchange market for investment resources.
The problem of the shrinking number of companies listed on the Moscow Exchange has to do not only with the continual delisting, but, more importantly, the low number of new companies desiring to launch a public offering. In 2017, the Moscow Exchange, by its number of newly listed companies, ranked only 39th among the 62 exchanges submitting to the World Federation of Exchanges their new listing statistics. The number of new companies listed on the Moscow Exchange increased from 4 in 2016 to 5 in 2017. Meanwhile, according to the WFE statistics, the number of newly listed companies per stock exchange was 37 in 2016 and 48 in 2017.
300
250
200
150
100
50
284
293
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Note. Data for the period 2006-2011 are taken from MICEX's reports; data for 2012-2016 - from the Moscow Exchange's listing reports.
Fig. 11. The number of companies listed on the Moscow Exchange in 2006-2017
Source: own calculations based on data for 2006-2008 released by NAUFOR (Russian National Association of Securities Market Participants) in Russian Stock Market: 2015 Events and Facts; and data for 2009-2017 released by the World Federation of Exchanges.
In 2017, according to data released by the National Settlement Depository (NSD), it opened issuer accounts for 636 joint-stock companies, and that number is much lower than the number of currently listed issuers. This fact point to the existence of an untapped potential for listing more new companies on the exchange.
The downward trend in the number of listed national issuers of shares could not be reversed even after the enactment, from September 1, 2014, of the amendments to the RF Civil Code and the alterations to Federal Law of February 26, 1995 'On joint-stock companies,' which was augmented by the new Article 7.1,1 whereby it was established that, in order to obtain the status of a public joint-stock company, prior to the entry of the official documents concerning its new legal status into the single state register, a company must sign a contract with an organizer of trade concerning its shares being listed on the exchange.
0
1 In accordance with Federal Law of June 29, 2015, No 210-FZ.
From July 2017, the Moscow Exchange, with the support of the Corporation for the Support of Small and Medium-sized Entrepreneurship (SME Corporation), the Industrial Development Fund (IDF), the Russian Direct Investment Fund (RDIF), the Russian Export Center (REC), the RF Ministry of Economic Development, the RF Ministry of Industry and Trade, and the Bank of Russia, launched its Growth Sector in order to attract small and medium-sized businesses and help them raise capital via the exchange. This will probably translate into an increasing number of listed new companies and involving them in the public investment market.
Shares on the Moscow Exchange are traded in its three main segments: the stock market; the futures market; and the money market (repo transactions). The universality of the Moscow Exchange is its major competitive advantage over many other foreign exchanges. In an ideal model, the stock market should attract capital in the form of medium- and long-term investments, the futures market should help in hedging against the risks associated with such investments, and the money market should maintain an appropriate liquidity level for the participants in trading. The merger of the RTS and MICEX in late 2011 and the creation, in 2017-2018, of a single account and trading pool servicing the participants in trading on several markets, created even better advantages for the clients. As a result, a participant in trading can use a single account to handle transactions with different instruments in different segments of the financial market.
However, the situation with the development of different market segments for trading in shares is still far from being perfect. Contrary to expectations, the consolidation, in 2011, of the two Russian exchanges failed to trigger an accelerated growth of the futures market segment (FORTS) of the RTS due to the inflow of new liquidity from the MICEX. Other financial market infrastructure segments and the broadening range of its participants. The stock market, instead of expanding, lost some of its potential to the money market in the form of repo transactions. At present, the exchange market is dominated by short-term speculative deals, including repo.1
Shortly after the merger of the two exchanges, the futures market's share in the total volume of equity financial market transactions increased from 46.7 percent in 2010 to 64.2 percent in 2015 (Fig. 12, Table 4). However, in 2017, in response to the accelerated growth of the money market (repo), the relative share of the futures market shrank to 54.4 percent. A more dramatic plunge was demonstrated by the relative share of the market (auction) spot trades - from 19.8 percent in 2010 to 5.3 percent in 2017. The relative share of repo transactions, on the contrary, increased from 26.7 percent in 2010 to 39.7 percent in 2017.
In order to create a well-developed domestic equity market on the basis of exchanges, it will be necessary to provide it with more sustainable sources for financing its growth, by reducing the role of short-term resources redistributable between market participants through repo transactions, and promoting instead an accelerated growth of spot trades and stocks futures oriented to the medium- and long-term strategies of different groups of investors (domestic institutional and private investors, foreign investment and pension funds). In view of the shrinking relative share of repo transactions in the stock exchange market from 39.7 percent to 31.0 percent in Q1 2018 as a result of the lower-key activity on the money market of several banks whose licenses were suspended or revoked by the Bank of Russia, as well as the new opportunities for market participants to finance their operations by settling through the clearing
1 Repo is used as a money-making instrument that increases opportunities for brokers and their clients to borrow money against the collateral of shares.
center, it can be hoped that the stock exchange market will be evolving towards a better-performing model.
100
90
80
60
50
40
30
20
10
■ Main market - market transactions
□ Main market - NTM
□ Derivatives market (Forts)
□ Main market - repo transactions
□ Moscow Exchange - Classica and Standart
Fig. 12. The structure of markets for shares and derivatives on the Moscow Exchange from
January 2005 through February 2018
Source: own calculations based on data released by Russian stock exchanges.
Table 4
The structure of financial markets for shares on the Moscow Exchange from January 2005 through February 2018
§ 70
0
2005 2010 2015 2016 2017 Jan-Feb 2018
Market transactions (auction market) 56.7 19.8 6.0 4.6 5.3 8.1
Repo transactions 15.1 26.7 29.4 31.8 39.7 31.0
NTM 9.8 1.5 0.4 0.4 0.5 0.1
Moscow Exchange - Classica 1 and Standart 4.4 5.4 0.0
Derivatives market (formerly Forts) 13.9 46.7 64.2 63.2 54.4 60.7
Total 100.0 100.0 100.0 100.0 100.0 100.0
Source: own calculations based on data released by Russian exchanges.
Fig. 13 and 14 show the structure of the equity market on the Moscow Exchange broken up into market transactions (anonymous auctions), negotiated trades (NTM) and repo transactions. A typical feature of that market has been the accelerated growth rate of the money market segment in the form of equities repos, which has been visible since mid-2006, with a short pause during the 2008 crisis. The relative share of this type of transactions in the total volume of trading in on the Moscow Exchange increased from 18.5 percent in 2005 to 85.9 percent in 2017 (Fig. 13). The essence of this phenomenon is that in conditions of low long-term return rates of investment in shares in the domestic market2 and low investment demand for shares
1 Trading in the Classica sector was officially terminated by the exchange from August 3, 2015.
2As was demonstrated in Fig. 2, over the 11-year period from 2007 through 2017 the return rate of the MICEX
Index was 1.1 percent per annum, and that of the RTS Index was negative -6.6 percent per annum.
displayed by domestic investors, repo market repo participants, by resorting to leverage, could increase the return of their shares. At the same time, the programs launched by the Russian monetary authorities after the global financial crisis of 2008 and the Eurozone crisis of 20112012 with the purpose of ensuring the sustainability of banks and system-forming non-financial organizations produced a situation where some financial market participants acquired significant spare funds that they were ready to invest in the money market.
The accelerated growth in the equities repo market alongside liquidity stagnation in the market transactions and NTM segments resulted in a dramatic contraction of the share of market transactions in the total turnover on the main equity market on the Moscow Exchange. It fell from 69.5 percent in 2005 to 13.2 percent in 2017 (Fig. 13). The relative share taken up by the NTM segment likewise shrank from 12.3 percent in 2005 to 0.9 percent in 2017.
□ Auction (market) mode DRepo mode "Negotiated trades mode
Fig. 13. The structure of trades in shares on the Moscow Exchange's Main Market from January 2005 through February 2018, percent
Source: own calculations based on data released by the Moscow Exchange.
In Fig. 14, it can be seen that changes in the main equity market structure on the Moscow Exchange were produced, for most part, by the accelerated growth in the equities repo market alongside liquidity stagnation in the market (auction) transactions and NTM segments. Over the period from 2005 through 2017, i.e., in 13 years, the value volume of transactions in the auctionHOM market jumped from RUB 2.8 trillion to RUB 8.3 trillion, or 3 times; the volume of transactions in NTM - from RUB 0.5 trillion to RUB 0.8 trillion, or by only 60.0 percent; and the equity repo market turnover increased from RUB 0.7 trillion to RUB 61.5 trillion, or 87.9 times.
After the merger of the two exchanges in 2011, a number of events took place that triggered an accelerated growth of equity capital market in comparison with the spot market shares. The
sudden foreign capital outflow in May 2013 in response to rumors that the US Federal Reserve was planning to raise its key rate (known as Taper Tantrum); the introduction of sectoral sanctions from July 2014; and Russia's sovereign credit rating downgraded below the investment grade by two out of the three global rating agencies (S&P and Moody's) in January-February 2015, which had a very negative effect on the attractiveness of Russian market for shares in the eyes of investors, at the same time conduced to Russia's monetary policy easing and an inflow of liquidity into the domestic repo market in the form of a variety of financial instrumentsB, including shares (Fig. 14).
Meanwhile, another important event - the completion of the MICEX Equity & Bond Market's switchover to a T+2 settlements cycle in September 2013, which had been expected to trigger an inflow of new money from foreign investors into the stock market, - in fact, failed to produce any notable effects on liquidity in the market transactions and NTM segments. However, this could be prevented by some objective factors that restricted the entry of foreign investors into the domestic market, such as the introduction of sectoral sanctions in July 2014 and Russia's downgraded sovereign credit rating by international rating agencies. These developments have confirmed the hypothesis, put forth by the Bank of Russia, that the behavior of non-residents on Russia's stock exchange market, which exerts a strong influence on its liquidity, is largely determined by global factors, and not local ones,1 because the switchover to a T+2 settlements cycle is more likely to be a specifically local factor.
Fig. 14. The volume of trades in shares on the Moscow Exchange's Main Market from January 2005 through February 2018, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
1 Money Market Review. Information and Analytical Materials, Bank of Russia, No 4, Q3 2016, p. 15.
Fig. 15 shows the volume of trades in shares, less that of repo transactions. The graph clearly outlines two active growth periods: from 2005 through May 2008, when the domestic equity market was rapidly expanding in response to carry trading strategies and an inflow of foreign investment funds with their speculative strategies; and from March 2009 through September-October 2011, when the returns on equity were demonstrating a recovery growth after the financial crisis of 2008. From the year-end of 2012 - that is, the first year after the merger of two exchanges - the volume of market transactions demonstrated practically a zero growth rate, despite certain internal and external developments that could influence the exchange market's behavior.
It seems that, when elaborating new strategic documents addressing Russia's domestic stock market, special attention should be paid to the issue of creating appropriate conditions for a positive shift in the liquidity situation specifically in its market trades in shares segment. To achieve this goal, it will be necessary, first of all, to promote accelerated development of nonbank financial organizations (private pension funds (PPF)), collective investment funds, life insurance companies, asset managers, brokers, and investment consultants). The measures designed to develop this particular segment of the stock market are described in detail in the Report of the Center for Strategic Research titled Reform of Financial Markets and Nonbanking Financial Sector.1
Fig. 15. The volume of market and negotiated trades in shares on the Moscow Exchange from January 2005 through February 2018, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
1 Danilov Yu. A., Abramov A. E., Buklemishev O. V. Reform of Financial Markets and Non-banking Financial Sector. CSR, Moscow, July, 2017. See http://csr.ru/wp-content/uploads/2017/07/Report-Financial-markets-v2-web.pdf
The accelerated growth in the equities repo market poses certain threats. First of all, no information is publicly available as to how reliably the existing risks are being managed in this segment, especially the risks associated with those transactions that are settled inside broker companies and banks. The basic indicators of the scale of repo operations and the risks for their participants are disclosed neither by the regulator not by the brokers actually handling them. The public has no access to information concerning the asset coverage ratios1 of brokers' or their clients', nor concerning the scope of the use of financial levers in equity deals by brokers, nor concerning the integrated asset turnover ratios of brokers' clients. Moreover, non-bank broker companies, in contrast to asset managers or private pension funds, are not required to release their financial reports drawn up in compliance with the IFRS, from which their estimated risks could be learned.
The plunge of the volume of repo transactions from September 2017 onward (Fig. 13 and 14)2 was triggered by two factors: the bailout by the Bank of Russia of Otrkitie FC Bank from May 2017 and the accelerated growth of repo transactions with general collateral certificates (GCC) issued by the National Clearing Center (NCC). The reorganization of Otrkitie FC Bank reduced its short-term demand for borrowed funds that used to be satisfied through repo deals, as now it has been supplied with cheaper resources from the Bank of Russia via a non-market channel. And the advent of GCCs, together with the direct access to that market segment granted to major non-financial companies possessing surplus liquidity, has turned that instruments into a market source of cheaper short-term resources for financial companies, and so it has replaced the other, more costly mechanisms, including equity repo transactions.
As shown in Fig. 16, the monthly volume of equity repo transactions shrank from RUB 5.9 trillion in September 2017 to RUB 3.4 trillion in February 2018, or by 42.4 percent. Over the same period, the GCC repo segment, on the contrary, increased from RUB 0.8 trillion to RUB 1.9 trillion, or 2.4 times.
In Fig. 17 and Table 5, the structure of equity deals with the participation of private brokers and state-owned enterprises (SOE) is shown.3 As before, the bulk of trades in shares on the Moscow Exchange is carried on by private brokers; however, their share shrank from 79.8 percent in 2016 to 60.2 percent in 2017; meanwhile, in February 2018 the share of private participants in trading once again rose to 68.2 percent.
A notable phenomenon in recent years has also become the increasingly prominent role in equity deals on the Moscow Exchange of broker companies affiliated to big foreign banks (GIB-subs).4 In spite of the tricky geopolitical situation and sectoral sanctions, the segment taken up by GIB-subs increased from 6.3 percent in 2016 to 9.2 percent in December 2017, and to 11.0 percent in February 2018. This is an indirect indication of the growing interest of foreign
1 The asset coverage ratio is the ratio of the current value of marketable assets functioning as collateral in repo transactions carried on by a broker or a broker's client to the total current value of their securities.
2 The relative share of repo transactions on the stock exchange market contracted from 88.4 percent in September 2017 to 78.9 percent in February 2018.
3 As of 2016, the study sample of state-controlled entities participating in trading on the exchange, was as follows: Sberbank of Russia, Sberbank CIB, VTB, VTB Capital and its affiliates, VTB-24, Gazprombank, Russian Agricultural Bank, Sviaz-Bank, KIT Finans, VEB. From August 2017, that group was joined by Otkrytie FC Bank; from September 2017, by B&N Bank and Rost Bank; and from December 2017, by Promsvyazbank.
4 Our sample is as follows: Goldman Sachs, Deutsche Bank, UBS, ING Bank (Eurasis), Credit Suisse (Moscow), Raiffeisenbank, Citibank, UniCredit Bank, CB J.P. Morgan Bank International, Rosbank, Barclays Capital LLC, Merrill Lynch, Morgan Stanley Bank, HCBC Bank.
investor - clients of GIB-subs - in the shares issued by certain Russian market players, especially in view of the continuing strengthening, over the last few years, of the ruble relative to the US dollar.
18 000 16 000 14 000 12 000 10 000 8 000 6 000 4 000 2 000 0
2016 2017
Ruble-denominated bonds (federal and corporate) Equity repos ---Repos with NCC and GCC
Fig. 16. The volumes of repo deals using equities, ruble-denominated bonds and general collateral certificates (GCC) on the Moscow Exchange from January 2005 through
February 2018, billions of rubles
Source: own calculations based on data released by the Moscow Exchange.
The relative share of state-controlled companies in the total volume of equity transactions on the exchange jumped from 20.2 to 39.8 percent, and then slid to 31.8 percent. This movement pattern can be explained by the reorganization into SOEs of the formerly private entities like Otkrytie FC Bank, B&N Bank, Rost Bank, and Promsvyazbank, where temporary administration teams were set up by the Bank of Russia in order to review and correct their activities. At the same time, these banks, as a result of the implementation of special programs aimed at increasing their capitalization and their financial recovery, are no longer in need of the more expensive repo deals as a sources of money, and this change is reflected in the February 2018 statistics.
Previously, a surge of SOEs' activity on Russia's stock exchange market could be observed whenever it was undergoing a difficult phase in its evolution - for example, in late 2008 and H1 2009, when special centralized loans were issued through Vnesheconombank (VEB) for the support of the domestic stock market. Another peak of their activity on the organized equity market occurred over the period 2011-2015 when, due to the restrictions on borrowing on the global capital market imposed on Russian financial organizations - first as a result of a crisis in the Eurozone, and then by way of sectoral sanctions, the Bank of Russia had to resort to active refinancing of banks through repo transactions, including with shares in Russian companies offered as collateral. Over that period, the aggregate share of SOEs and the Bank of Russia in the total volume of trades in shares increased from 26.4% in 2010 to 41.0% in 2013, and thereafter shrank to 23.5% in 2015.
100
90 80 70 60 50 40 30 20 10 0
005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
■ Bank of Russia ■ State-controlled entities other than Bank of Russia □ Other participants in trades
Fig. 17. The relative shares of private broker companies and SOEs in equity trades on the Moscow Exchange over the period from August 2005 through February 2017, percent
Source: own calculations based on data released by the Moscow Exchange.
Table 5
The relative shares of private broker companies and SOEs in equity trades on the Moscow Exchange as of the end of reporting period, percent
2005 2010 2011 2012 2013 2014 2015 2016 2017 Feb 2018
Bank of Russia 0.0 0.0 7.9 7.5 3.2 3.3 0.0 0.0 0.0
SOEs 9.9 26.4 35.8 30.3 33.5 25.8 20.2 20.2 39.8 31.8
Other equity market participants 90.1 73.6 64.2 61.8 59.1 70.9 76.5 79.8 60.2 68.2
of these:
GIB-subs* 7.3 8.9 4.8 5.7 6.3 9.2 11.0
* GIB-subs are companies affiliated to global investment banks, granted the status of a legal entity under legislation of the Russian Federation, and licensed to act as brokers in the securities market. Source: own calculations based on data released by the Moscow Exchange.
Fig. 18 demonstrates the structure of equity transactions on the exchange relative to their final beneficiaries - i.e., investors.1 As can be seen from the graph, private dealers and nonresidents account for about a half of all equity deals; however, the relative share taken up by non-residents is much higher than that of private dealers. At the same time, their proportional distribution has remained approximately the same since 2013. The relative share of resident individuals slightly declined from 6.1 percent in December 2016 to 5.9 percent in December 2017, and then increased to 9.4 percent in February 2018. The relative share of non-residents over the same period increased from 36.8 to 37.3 percent, but then plunged to 35.6 percent.
1 These data, calculated on the basis of available public exchange statistics, are far from being perfect. They do not show separately the net relative shares of domestic private investors and non-residents in market transactions and NTM. Besides, the group of non-residents does not include the affiliations of broker companies through which the latter frequently borrow money and then lend it to their clients. However, on the whole these data make it possible to estimate the relative shares of private dealers and non-residents in trades in shares on the Moscow Exchange.
So far, it can be assumed that there is no visible sustainable growth trend displayed by the relative share of domestic private investors in the equity market on the stock exchange. However, in this connection it should be remembered that in 2016-2017, citizens received additional incentives for investing in shares issued by Russian companies in the form of individual investment accounts (IIA) and certain categories of exemptions from personal income tax. However, in order to ensure comprehensive involvement of households in investing in the stock market, it will be necessary to de-freeze the pension saving system, create adequate conditions for the development of corporate and individual pension plans, and promote collective investment schemes.
100 90 80 70 60 50 40 30 20 10 0
Fig. 18. The structure of investors participating in trades in shares on the Moscow Exchange from January 2005 through February 2018, percent
Source: own calculations based on data released by the Moscow Exchange.
Although domestic competition represents one of the most acute issues of Russia's stock market, it is relatively weakly outlined in the official reports of government bodies, both in terms of methodological approaches to its assessment and the quality of empirical data. Therefore, in this review we are going to discuss only some of its aspects.
Fig. 19 demonstrates the movement of the Herfindahl-Hirschman Index, or HHI,1 on the Moscow Exchange's Equity & Bond Market from January 2005 through February 2018. As estimated by the Federal Antimonopoly Service (FAS) of the Russian Federation, the market
1 The market concentration Herfindahl-Hirschman Index (HHI) is defined as the sum of squares of the volumes of participation of each participant in trading on an exchange: HHI = (D1) 2 + (D2) 2 + ... + (Dm) 2, where Di is the per cent market share of i th participant; i = 1, 2, ..., m.
has a low concentration if HHI is below 800; moderate concentration if 800 < HHI < 1,800; and high concentration if HHI is above 1,800.
Over the entire observation period, with some rare exceptions that occurred during the 2008 crisis, when the Bank of Russia was compelled to resort to repos where shares were used as collateral, and also in 2016, the HHI for the transactions on the Moscow Exchange's main equity market remained stable at a level of approximately 500, which means that this market segment was low-concentrated. The trends observed in the market for bonds followed their own patterns, and we can distinguish three periods there, over each of which HHI behaved differently. From August 2005 through August 2011, the HHI for the bonds market was hovering around 500, demonstrating signs of a low-concentrated market. From September 2011 until early 2015, when the Bank of Russia conducted a substantial number of repos using bonds as collateral, the HHI for this segment of the equity exchange market moved into the interval between 800 and 1,800, which is typical of a moderately concentrated market. As the volume of refinancing channeled by the Bank of Russia into the banking system by means of repo transactions began to decline, from February-March 2015 the bonds market once again became low-concentrated, with the HHI close to 500. From September 2017, when several big banks began reorganization procedures, the HHI for bonds dived below the corresponding index for shares, which point to a high competition level in the domestic bonds market. Some surges of the HHI over that period occurred in December 2015 and December 2016, in response to the placement, by PJSC Rosneft, by massive issues of its corporate bonds.
2 500 -,
2 000
1 500
1 000 1..................................tt.........................................fl...................•.........--..........t.....i.........................i......
_ _800_ J_____II ¿¡_#_____«_L
500 klhr^
Launch of Bank of Russia's interventions in repo market |
Reorganization of Otkritie FC
1 800
..........1 11 M,y» t-.........
: m »V Vv*
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
2017
- Shares
- Bonds, total
Fig. 19. The Herfindahl-Hirschman index, based on volume of trades in shares and bonds
on the Moscow Exchange (all trade modes)1
Source: own calculations based on data released by the Moscow Exchange.
0
1 As from August 2015, the Moscow Exchange no longer discloses its by-category data on trades in corporate, regional and government bonds, and releases only aggregate data on deals involving all types of bonds, and considering the fact that information on OFZ transactions has been released by the exchange only from February 2012, our calculations of HHI values rely on a number of assumptions. For the period prior to February 2012, the HHI for the bonds market incorporates only trades in corporate and regional bonds, and from February 2012 onwards it incorporated all types of bonds.
The main channels whereby the equities market conveys its impact on economic growth is through primary offer of securities by companies as a way of attracting investment resources, as well as through merger and takeover deals.
As follows from Table 6, in 2016-2017, in spite of the difficulties in attracting foreign investors created by sectoral sanctions, there was a noticeable revival in the market for IPO-SPOs launched by registered in Russia or operating in RF territory. In 2017, there were IPO-SPOs by 12 companies to the total value of USD 4.4 billion; a year earlier, such deals, to the total value of USD 2.1 billion, were completed by only 7 companies. Meanwhile, the segment of merger and takeover deals continued to demonstrate a decline, and an annual shrinkage in the total number of deals over the period 2014-2017. In 2013, the volume of completed merger and takeover deals amounted to USD 156.1 billion, and in 2017 it tumbled to USD 31.4 billion.
Table 6
The parameters of market for shares in Russian companies (billions of US dollars)
Capitalization Secondary market, including on foreign exchanges IPO-SPOs of shares Investment in fixed assets of capital generated by IPOs Volume of closed merger and takeover deals
Bn USD as percent of capitalization as percent of IPO volume
2000 41 47 0.5 0.2 0.5 40.0 5.0
2001 75 49 0.2 0.1 0.1 50.0 12.0
2002 106 87 1.3 0.2 0.2 15.4 18.1
2003 176 188 0.6 0.2 0.1 33.3 32.4
2004 230 541 3 0.1 0.0 3.3 27.1
2005 549 374 5.2 3.2 0.6 61.5 60.2
2006 1,057 914 17 3.2 0.3 18.8 61.9
2007 1,503 1,687 33 3.6 0.2 10.9 127.7
2008 397 1,983 1.9 2.1 0.5 110.5* 117.0
2009 861 1,156 1.7 2.0 0.2 117.6* 55.7
2010 1379 1,431 6.3 2.4 0.2 37.9 55.1
2011 1,096 2,222 11.3 2.6 0.2 23.1 94.3
2012 1,079 1,931 9.5 3.1 0.3 32.6 72.7
2013 1,041 1,801 9.0 3.1 0.3 34.4 156.1
2014 517 1,739 1.7 3.1 0.6 182.0* 58.7
2015 393 997 0.6 0.9 0.2 150.0* 56.9
2016 635 1,154 2.1 0.7 0.1 32.0** 41.7
2017 623 1363 4.4 no data no data no data 31.4
* the value is above 100% because part of capital invested in fixed assets could be generated by way of private offering of shares; ** the amount of proceeds of IPOs by Rosneft and Otkrytie Holding on the Moscow Exchange in 2016.
Source: own calculations based on data released by Rosstat; the Bank of Russia; the Moscow Exchange; Merger.ru.
In 2016, the proceeds raised by issuance of shares accounted for only 0.1 percent of total investments in fixed assets. This means that the bulk of new cash raised by Russian companies in the domestic market for shares and corporate bonds continued to be spent on refinancing projects, debt redemption, merger and takeover deals, and used for other purposes that had little to do with investing in fixed assets. From 2017, Rosstat has no longer disclosed this type of statistics, thus increasing uncertainty with regard to the information that is very important if we want to really understand the effects of IPO-SPO of shares.
Thus, the exchange market for equities has so far contributed rather moderately to real asset accumulation by companies and to economic growth. The domestic stock market's potential has not yet been fully relied upon in dealing with the key problems faced by the Russian economy.
3.3. The market for non-government bonds
In 2017, the Russian financial market displayed relatively favorable conditions for growth of the domestic corporate bonds segment. Thanks to the ruble's stability and low inflation, the returns of corporate bonds finally climbed back to their 2013 level, prior to the introduction of sectoral sanctions. Besides, in spite of the year-end reduction of the key rate to 7.75 percent, the record-low inflation rate of 2.5 percent ensured high returns, in real terms, of fixed rate instruments. The returns of corporate bonds launched by reliable issuers rose significantly above the interest rates on bank deposits, thus making them an attractive instrument to be invested in by private dealers and collective investment funds.
Moreover, from January 1, 2017, in accordance with Federal Law No 242-FZ dated July 3, 2016, the rate of tax on bond yield for legal entities was reduced from 20 to 15 percent. From January 1, 2018, individuals were made exempt from personal income tax on the coupon yield of ruble-denominated corporate bonds issued over the period 2017-2020, if the coupon rate it not higher than the refinancing rate of the Bank of Russia. Thus the income tax rate for corporate bond holders was brought to the same level as the tax rate for interest rate on individual deposits.
In 2017, the value of bonds loans in Russia continued to climb, amounting to RUB 19.4 trillion, which represents a 19.9 percent growth relative to 2016 (Fig. 20). Over that year, the value of corporate bonds, including non-marketable bond issues, increased from RUB 9.4 trillion to RUB 11.4trillion, or by 21.3 percent; that of regional bonds - from RUB 0.63 trillion to RUB 0.72 trillion, or by 14.3 percent; and that of federal bonds (OFZ, government saving bonds (GSO), etc.) - from RUB 6.1 trillion to RUB 7.2 trillion, or by 18.0 percent. In spite of the high demand for money resources necessary for covering budget expenditure, the RF Ministry of Finance in 2017 took a moderate stance in its policy and abstained from dramatically increasing government domestic debt, leaving some room for growth of the borrowings of Russian companies and regional administrations.
Fig. 20. The movement of the volume of ruble-denominated bonds in circulation from 1998 through 2017, billions of rubles.
Source: own calculations based on data released by the RF Ministry of Finance and Cbonds.ru.
The specific feature of bond offers in 2017 was that the value volume of corporate bond issues was increasing at a faster rate than that of federal and regional bonds. The value volume of corporate bond issues increased from RUB 2.4 trillion in 2016 to RUB 2.9 trillion in 2017, or by 21.6 percent. The main factor behind that growth was the placement of a bond issue by Rosneft, its relative share in the total value volume of new bond offers over that year being 36.8 percent (Fig. 21). Meanwhile, the value volume of federal bond issues increased from RUB 1.1 trillion in 2016 to RUB 1.8 trillion in 2017, or by 63.1 percent. Over the same period, the value volume of regional bond issues soared from RUB 159.1 billion to RUB 210.9 billion, or by 32.6 percent. The growth drivers for all categories of bonds were the increasing demand of businesses and the government alike for money resources that they needed to cover their expenditures and fund their projects in conditions of restricted access to foreign financial markets and limited income sources, and on demand side - growth of excess liquidity in the banking sector and the demand for ruble-denominated assets displayed by some categories of foreign portfolio investors. In 2017, the first OFZ, corporate and regional bond issues targeting retail investors were launched.
□ GKO-OFZ- GSO □ Regional bonds □ Corporate bonds
Fig. 21. The value volume of ruble-denominated bond issues placed in 1993-2017,
billions of rubles
Source: own calculations based on data released by the RF Ministry of Finance and the Moscow Exchange.
Although the Moscow Exchange now lists nearly 400 bond issuers, the primary market for corporate bonds is a highly concentrated one, being dominated by bond issues placed by state-owned enterprises (SOE). As follows from data presented in Table 7, over the period 20102017, 24 biggest issuers accounted for 58-88 percent of the total value volume of corporate bond offers; in 2017, this index amounted to 82 percent, thus getting near its record high of 2009.
Among big bond issuers, state-controlled companies prevailed; the top-24 alone, over the period 2009-2017, accounted for 37-75 percent of the total value volume of new corporate bond offers. In 2017, that index hit its record high of 75.0 percent. Thus, the corporate bond market
is currently functioning as a mechanism for redistributing financial resources in the market in favor of big players, represented in the main by SOEs.1
Table 7
The concentration rate of ruble-denominated corporate bond issues and the relative share of state-controlled issuers in 2009-2016
Top 5 issuers Top 10 issuers Top 24 issuers Market, total
Total | including SOEs Total | including SOEs Total | including SOEs
2009
Billions of rubles 440 390 610 441 803 513 917
Market share, percent 48.0 42.5 66.5 48.1 87.6 55.9 100.0
2010
Billions of rubles 177 147 304 200 513 317 855
Market share, percent 20.7 17.2 35.6 23.4 60.0 37.1 100.0
2011
Billions of rubles 241 191 389 309 642 405 1089
Market share, percent 22.1 17.5 35.7 28.4 59.0 37.2 100.0
2012
Billions of rubles 265 265 429 334 690 443 1199
Market share, percent 22.1 22.1 35.8 27.9 57.5 36.9 100.0
2013
Billions of rubles 550 550 705 640 1035 830 1741
Market share, percent 31.6 31.6 40.5 36.8 59.4 47.7 100.0
2014
Billions of rubles 875 827 1051 934 1334 1038 1739
Market share, percent 50.3 47.6 60.4 53.7 76.7 59.7 100.0
2015
Billions of rubles 683 683 861 788 1180 891 1919
Market share, percent 35.6 35.6 44.9 41.1 61.5 46.4 100.0
2016
Billions of rubles 972 882 1228 1038 1653 1176 2439
Market share, percent 39.9 36.2 50.3 42.6 67.8 48.2 100.0
2017
Billions of rubles 1518 1518 1890 1803 2329 2139 2852
Market share, percent 53.2 53.2 66.3 63.2 81.7 75.0 100.0
Source: own calculations based on data released by cBonds.ru, rusBonds.ru and the Moscow Exchange.
1 For more details on the role of state-owned companies in the market capitalization of securities issued by Russian companies, see Abramov A., Radygin A., Chernova M. State-owned enterprises in the Russian market: Ownership structure and their role in the economy. Voprosy ekonomiki (in Russian), No 12, 2016).
The low competition rate in the markets for underwriting and consulting services associated with offers of corporate and regional bonds is confirmed by the movement of the Herfindahl-Hirschman index (Fig. 22). From 2009 onwards, the market for investment and banking services rendered in the corporate bond market began to transform from a highly competitive into a moderately concentrated one, when the monthly HHI moved within the interval between 800 and 1,800. In 2017, the HHI in the segment of services for corporate bonds amounted to 1,009. From 2011, the market of services for issues of regional bonds has been balancing between moderately and highly concentrated zones. In 2017, when the HHI rose to 2,442, it shifted into the category of markets with a high concentration rate.
5 845
"■"Corporate bonds Regional bonds
Fig. 22. The Herfindahl-Hirschman index, based on data on trade organization services for ruble-denominated corporate and regional bonds in 2007-2015
Source: own calculations based on data for 2007-2016 released by cBonds.ru.
After the introduction of sectoral sanctions in July 2014, Russian companies began to actively re-enter the Eurobond market only from 2016 onwards. In 2016, Russian corporate Eurobond issuers raised a total of USD 15.7 billion; in 2017, that index amounted to USD 27.4 billion, which represents a 74.5 percent rise on the previous year. Over the first three months of 2018 alone, they placed Eurobonds to the total value of USD 9.6 billion.
In 2016, the value volume of ruble-denominated corporate bonds was estimated to be USD 141 billion, that of Eurobonds - USD 136 billion; a year earlier, these two indices amounted to USD 133 billion and USD 139 billion respectively (Fig. 23). On the whole, over the period since the emergence of new geopolitical risks in 2014, the value volume of Eurobonds issued by Russian companies shrank from USD 182 billion in 2013 to USD 136 billion in 2016, or by 25.3 percent. Over the same period, the value volume of domestic corporate bonds in US dollar terms tumbled from USD 165 billion to USD 141 billion, or by 14.6 percent.
400 350 300 250 200 150 100 50
182 166
4 13
2 3
0 1 2 3
0 0 0 0
20 20 20 20
Fig. 23. The volume of Russian corporate bonds (CB) in circulation, billions of USD
Source: own calculations based on data released by CBonds and the Moscow Exchange.
Over the period 2015-2016, the Eurobonds issued by Russian companies became an integral part of the domestic financial market, thus greatly contributing to the reinstatement of the return rates of this type of securities at a normal level after their downfall in December 2014 - January 2015. Similarly to the liquidity level of ruble-denominated bonds, that of Eurobonds was actively sustained by resorting to the FX repo mechanism. In 2016, the value volume indices for repos in Eurobonds recalculated in ruble terms were stably above the corresponding index for repos in ruble-denominated bonds (Fig. 24). In 2017, as the Bank of Russia discontinued FX repos for the period of one year and 28 days, the FX repo segment gradually dwindled to
zero.
12 000 ---------------------------------------------------------
10 000
\
I , / \
8 000 » \ / \
- » —Iv
6 000
/ \ ▼ /
4 000
.//^ —. / v
2 000
3
»aij > u e ■£>
2015
2016
• Corporate Eurobonds
2017
■ Ruble-denominated CBs
Fig. 24. The volume of repos in ruble-denominated corporate bonds and corporate Eurobonds
on the Moscow Exchange, billions of rubles
Source: own calculations based on data released by the Moscow Exchange.
0
In 2016, the primary market witnessed increased issuer and underwriter activity associated with the introduction of new forms of financial instruments. Among the most significant innovations we may point to the placement of perpetual subordinated bonds by Russian Agricultural Bank, the issuance of overnight bonds by VTB, and the asset-backed securities issued by the Agency for Housing Mortgage Lending in the framework of its Mortgage Factory project. In 2017, several big state banks - Sberbank of Russia, VTB Bank, and Russian Agricultural Bank began to actively sell their bonds to retail investors. In early 2018, Alfa Bank issued perpetual Eurobonds likewise oriented to retail investors.
The demand for new corporate bond issues and the volume of transactions on the secondary market was largely determined by the domestic money market's liquidity index. Since the early 2000s, we may note several periods, each of them differing by the specific factors that were responsible for market liquidity behavior, which in its turn influenced the market for corporate bonds (Fig. 25). This, over the period from January 2001 through July 2004, the liquidity index was moderate, the demand for corporate bonds being sustained by domestic banking sources and the monies in the type-C accounts of non-residents, which had been frozen after the default. Over the period from August 2004 through August 2008, after Russia was granted an investment grade rating by international rating agencies and until the onset of crisis in 2008, alongside the ruble's stabilization, carry trading strategies were employed,1 when both the liquidity index and the demand for bonds were sustained by cheap foreign loans. The period from September 2008 through August 2011 was that of crisis and post-crisis recovery, when the monetary authorities were keeping the banking system's liquidity at an acceptable level by relying on centralized funding sources, while at the same time imposing a constraint on it being used as corporate and consumer loans in the form of a high rate of refinancing. Over the period from September 2011 through January 2016, liquidity was sustained in the main by the Bank of Russia's repo transactions designed to refinance banks.
From January 2016 until the present day, the principal factor sustaining the banking system's liquidity has been the accumulation of funds in the bank accounts of budget funding recipients resulting from budget expenditures being covered by allocations from the Reserve Fund, i.e. budgetary sources. It is this particular factor that produced, from 2016 onwards, the excess liquidity phenomenon (money overhang) in the banking system, when ruble-denominated bonds and the Bank of Russia's deposit auctions became the main liquidity absorption mechanisms. In 2017, yet another mechanism was launched - general collateral certificates (GCC) issued by the National Clearing Center of the Moscow Exchange. The low returns of these instruments were secured by the direct access of biggest non-financial companies to the National Clearing Center's services.
In 2017 and in January-February 2018, the rapid money overhang growth in the banking system, its mean index for February 2018 amounting to RUB 4.9 trillion, was followed by a sharp plunge in the volume of trades in corporate bonds, from RUB 15.6 trillion in June 2017 to RUB 9.1 trillion in February 2018, or by 41.7 percent. That plunge was caused by the shrinking value volume of repos in corporate bonds resulting from the reorganization, by the Bank of Russia, of three major Russian banks and the switchover of borrower demand from
1 According to the Bank of Russia's definition, carry trade is a trading strategy that involves borrowing at a low interest rate and investing in a financial asset that provides a higher rate of return. It is employed by forex and stock market participants for deriving income in the form of the positive interest rate differential between two currencies or two different forward points. (Financial Overview: Monetary Policy. Information and Analytical Materials, Bank of Russia, No 4, Q4 2016, pp. 36-37).
repos in bonds to repos in GCCs caused by their desire to reduce the cost of short-term loans, and also some other factors.
20 000 000 18 000 000 16 000 000
^ 14 000 000 --
12 000 000 --
Secondary trades I Bond offer •Bank liquidi-ty
Refinancing by RF Ministry of Finance
Refinancing by Bank
of Russia *-
Crisis and recovery
Carry trading
Moderate liquidity &-►
8 000 000 --
6 000 000 --
4 000 000 --
2 000 000
5 200 ¿000 4 800 4 600 4 400 4 200 4 000 3 800 3 600 3 400 3 200 3 000 2 800 2 600 2 400 2 200 2 000 1 800 1 600 1 400 1 200 1 000 800 600 400 200
ty idi
ui iq
i
B
* Bank liquidity is understood as banks' residuals on correspondent accounts and deposits with the Bank of Russia.
Fig. 25. Operations with corporate bonds and bank liquidity over the period from January 2001 through February 2018
Source: own calculations based on data released by the Bank of Russia and the Moscow Exchange.
The speedy money overhang growth in the banking system, which over the period 20062017 jumped from RUB 0.7 trillion to RUB 4.1 trillion, or 5.7 times, can largely be explained by the increasing idle money kept as residuals on the accounts of non-financial companies with banks, meaning first of all biggest state-owned enterprises (SOE). This is confirmed by data in Fig. 26, describing the amount of cash residuals kept by 145 public companies with the highest capitalization indices, including 44 SOEs.1 The total amount of residuals kept by SOEs on their bank accounts increased from RUB 2.3 trillion in 2011 to RUB 6.0 trillion in 2016, or 2.6 times; over the same period, the amount of residuals kept by private companies increased from RUB 0.9 trillion to RUB 1.5 trillion. The residuals growth peak in the SOE sector occurred in 2014-2016.
In a sense, the emergence of money overhang demonstrated by the banking system and biggest public companies, and primarily by SOEs, is an irrational process, because it actually means a redistribution of resources from investment in and development of businesses in the real sector to short-term speculative deals like repos in the financial market. The factors preventing the overflow of these resources into the real sector have to do with the investment climate issues and the Bank of Russia's high key rate relative to the current inflation index. The
1 In this case, SOEs are understood as those companies where the aggregate stake held by the state, both directly and indirectly, is above 25 percent of voting shares.
■S 10 000 000
existence of money overhang in the economy and the banking system is one more factor that is fraught with inflation and national currency depreciation risks.
6 000
5 000
4 000
3 000
2 000
1 000
- 4 500 4 000 3 500
- 3 000 2 500 2 000
------- 1 500
1 000 500 0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Monies and their equivalents held by private companies ■ ■ Monies and their equivalents held by SOEs ^^^»Money overhang in banks*
* Banks' residuals on correspondent accounts and deposits with the Bank of Russia.
Fig. 26. Banks' money overhang and the cash residuals in the accounts of private and state-owned companies (SOEs), billions of rubles
Source: own calculations based on data released by the Bank of Russia and financial reports released by public companies.
In February 2018, the average yield of IFX-Cbonds portfolio amounted to 7.1 percent per annum, thus diving below its 2013 index,1 the latter being observed prior to the geopolitical shocks and the introduction of sectoral sanctions in 2014 (Fig. 27). This was achieved in the main by the moderately tough monetary policy, maintained sustainability of the budgetary system, and lowering inflation.
At the same time, in 2014, growth of the corporate bond market began to be secured by the increasing volume of non-marketable bond issues that had no market quotes on the exchange. In 2017, the relative share taken up by the marketable issues of ruble-denominated corporate bonds in their aggregate market capitalization index shrank to 47.3 percent vs. 50.1 percent in 2016. In 2017, the value growth rate of marketable corporate bond issues in circulation was 14.5 percent, while that of non-marketable issues amounted to 27.7 percent. The lower value growth rate of marketable corporate bond issues was strongly linked to the freeze of pension savings, the latter previously having been one of the major sources of new money inflow on the corporate debt market.
1 The yield to maturity of IFX-Cbonds portfolio in December 2013 was 8.4 percent per annum.
■o c
12 000
10 000
8 000
Sectoral sanctions
I Key rate increase
^ ' 'to 17 percent RF ratin | "" "^j ' downgraded
by S&R and Moody's
6 000 -----
4 000
2 000 ,
25 23 21 19
S
3
17 5
a r
e
15 & nt
13 ce r
e
CLi
11
9 7 5
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
□ Non-marketable CBs - left-hand side axis
Marketable CBs - left-hand side axis Yield to maturity of CBs* - right-hand side axis
* The yield to maturity of IFX-Cbonds portfolio.
Fig. 27. The value of Russian corporate bonds in circulation and the yield to maturity of IFX-Cbonds portfolio over the period from December 2003 through March 2018
Source: own calculations based on data released by cBonds.ru
As demonstrated in Fig. 28, over the period from July 2003 through March 2018, Russia's domestic corporate bond market experienced two shocks: in February 2009, when the yield index of IFX-Cbonds portfolio rose to 24.8 percent per annum with the subsequent plunge of its duration index to 0.8 years; and then in late December 2014, when its average yield increased to 17.0 percent per annum, and its duration index declined to 0.7 years. The shock of 2014 was caused in the main by the introduction of sectoral sanctions in July 2014 and the sharp tumble of oil prices from September 2014.
From H2 2015 onwards, thanks to the efforts of Russia's monetary authorities, the situation in the domestic debt market became more stable. By April 2, 2018, the yield index of IFX-Cbonds portfolio had dropped to 7.24 percent per annum, and its duration index increased to 2.82 years. These parameters are significantly better than those recorded as of December 30, 2013, when its yield index amounted to 8.39 percent per annum, and its duration index - to 1.99 years.
Among the corporate bonds issues, the highest volume of trades on the exchange market in 2017 was demonstrated by Issue 3 of Transneft bonds, several issues of Rosneft bonds, and one issue of VEB bonds.
Thus, the drivers of growth in the corporate bonds market differed over time, but were nevertheless represented in the main by short-term sources of funds and short-term strategies. The deficit on the market for long-term assets and investment climate instability are the factors that suppress growth in the market for non-government borrowing.
The dominating role of the money market in the overall structure of transactions in the secondary market for corporate bonds on the Moscow Exchange is illustrated by Fig. 29. In February 2018, the relative share of repos in the total value volume of trades in corporate bonds
0
amounted to 96.0 percent. At the same time, only 1.6 percent of these were market transactions, i.e., corporate bonds were traded in an anonymous auction market; and 2.4 percent, in terms of their value volume, were traded in the NTM segment. For reference: in 2005, the relative share of repos was 28.0 percent, and that of market transactions - 11.5 percent; the remaining 60.6 percent were negotiated trades.
25 23 21 19 17 15 13 11 9 7 5
I I I ftl
0,84
Liberalization of CB market
III-
0,74
I I I
,00
2,50
2,00
1,50
1,00 7,23
0,50
H 1-H 1S (N (N (N m m on on ^t 4T 4t </n vn un un 60 60 60 60r^ C^ CO CO
- Yield to maturity of IFX-Cbonds portfolio - left-hand side axis The duration of the IFX-Cbonds portfolio bonds is the right axis
Fig. 28. The yield to maturity and duration indices of IFX-Cbonds portfolio over the period
from July 1, 2003 to April 2, 2018
Source: own calculations based on data released by cBonds.ru
The low liquidity of market transactions in corporate bonds on the exchange makes market-based and fair pricing of these instruments difficult and gives rise to risks for the accounting policies of financial institutions.
As shown in Fig. 30, a surge in the volume of repo deals in the corporate bond market usually coincides with the 'government support wave' sweeping across the money market in response to shock-triggered situation. The first wave occurred after the 2008 crisis and continued until H2 2011. The next wave of the Bank of Russia's support for the market through the repo mechanism was launched in late 2011 in response to the Eurozone crisis and continued until December 2015. From January 2016 onwards, the major money market growth factors became the support provided by the RF Ministry of Finance and the increasing money overhang in banks, the latter being redistributed through the repo market by settlements with the National Clearing Center. In this connection, an important role in supporting the Eurobond market was played by FX repos, their volume increasing from 2015 until H2 2017( Fig. 24).
□ Auction (market) mode DRepo mode "Negotiated trades mode
Fig. 29. The structure of trades in corporate bonds, including Eurobonds, on the Moscow
Exchange, percent
Source: own calculations based on data released by the Moscow Exchange.
The total value volume of trades in corporate bonds on increased from RUB 126.8 trillion in 2016 to RUB 150.7 trillion in 2017, or by 18.9 percent. Meanwhile, over the same period, the volume of repo transactions was increasing at an accelerated rate relative to the other trading modes. Thus, the volume of repo deals jumped from RUB 122.6 trillion in 2016 to RUB 146.4 trillion in 2017, or by 19.4 percent; that of market transactions increased from RUB 1.3 trillion to RUB 1.4 trillion, or by 5.1 percent; and that of negotiated trades increased from RUN 2.9 trillion to RUB 3.0 trillion, or by 3.1 percent.
However, from H2 2017 onwards, the value volumes of trades in corporate bonds began to shrink at a significant rate, the deepest plunge being demonstrated by the money market segment. In February 2018, relative to August 2017, the monthly volumes of trades in corporate bonds declined as follows: in the repo segment - from RUB 14.2 trillion to RUB 8.7 trillion, or by 38.4 percent; in the segment of market transactions - from RUB 154 billion to RUB 143 billion, or by 7.3 percent; in the segment of negotiated trades - from RUB 321 billion to RUB 220 billion, or by 31.6 percent. If the plunging volume of market transactions can be explained by the fewer workdays in February than in August, the plunge of the repo market was caused by more serious factors, the three most important ones being as follows: The reorganization procedures in several major bank; the curtailing, by the Bank of Russia, of FX repo deals; and growth of the alternative liquidity market in the form of GCC. In H2 2017, the Bank of Russia appointed temporary administration teams and began to audit several big banks that had previously been active players in the repo market: in August - Otkrytie FC Bank; in September - B&N Bank and Rost Bank; in December - Promsvyazbank. Their reorganization and recovery, financed from the central source, saved them from the necessity to refinance by
resorting to the more expensive repo market instruments. In November 2017, the Bank of Russia announced that it would discontinue FX repos for the period of 28 days and one year, this being an important method of maintaining the liquidity of corporate Eurobonds. Besides, the fast growth of the market for repos with GCCs made it unnecessary, in many cases, to resort to the more expensive repos in bonds.
□ Auction (market) mode DRepo mode "Negotiated trades mode
Fig. 30. The value volume of trades in corporate bonds, including Eurobonds, on the Moscow Exchange, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
Thus, over the past 10-12 years, the corporate bonds market's behavior has been shaped in the main by changes in the money market segment. So far, the role of the segments of market transactions and negotiated trades has been relatively modest. As shown in Fig. 31, from 2011 onwards, market transactions and negotiated trades have not been demonstrating such strong growth trends as the repo segment that we discussed in the previous subsection. Among all the events that influenced the market transactions and NTM segments, the most noteworthy one is the decision concerning the pension savings freeze, introduced from January 1 2014, and still in effect.
As can be seen from Table 8, the average annual volume of market trades in corporate bonds over the three year preceding the pension savings freeze (2011-2013) was RUB 1.6 trillion vs. RUB 1.3 trillion over the three subsequent years (2014-2016), i.e., after the freeze the volume of market trades in corporate bonds shrank by 17.0 percent. It is also demonstrated that the freeze caused a shrinkage in the NTM segment by 24.1 percent. At the same time, over the same period, the average trading volume in the money market gained nearly 60 percent. With certain reservations, on the basis of these facts it can be assumed that the pension savings freeze from 2014 onwards produced a significant negative effect on the liquidity index of the corporate
bonds market on the stock exchange. This negative effect could not be offset by the effects of liberalization of depository services in the corporate bonds market for non-residents, introduced from February 2014.
800 000
700 000
600 000
500 000
400 000
300 000
200 000
100 000
Liberalization of CB market for non-residents
2017
□ Auction (market) mode ■ Negotiated trades mode
Fig. 31. The value volume of market transactions and negotiated trades in corporate bonds, including Eurobonds, on the Moscow Exchange, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
Table 8
Analysis of the effects of pension savings freeze on liquidity in the corporate bonds market on the Moscow Exchange
0
Trading modes Average annual trading volume on Moscow Exchange, billions of rubles Change, percent
2011-2013 2014-2015
Market transactions 1,604 1,332 -17.0
NTM 3,961 3,006 -24.1
Repo 55,977 89,468 59.8
Source: own calculations based on data released by the Moscow Exchange.
Fig. 32 analyses the relative shares of different groups of financial organizations (private and public companies, the Bank of Russia) in the aggregate volume of trades in bonds on the Moscow Exchange, including market transactions, negotiated trades and repos.1 The distribution of relative shares of various participants in trades in bonds in the total trading turnover on the exchange strongly depends on the banking system's refinancing methods.
1 Including corporate, regional and government bonds. From August 2015, the Moscow Exchange no longer discloses information on its monthly trades volume for each bond category.
During the period of the Bank of Russia's active refinancing of the banking system through repo operations from September 2011 through January 2016, the role of Bank of Russia and big state banks in exchange trades in bonds was very prominent. Thus, for example, in 2012 the Bank of Russia and SOEs accounted for 35.5 percent and 29.1 percent respectively of the total volume of exchange trades in bonds, or for 64.6 percent if taken together.
As direct repos with the Bank of Russia gave way to refinancing through repos with the central counterparty where bonds were used as collateral, the relative share of the Bank of Russia shrank significantly, while that of SOEs increased, reflecting their increasing importance as liquidity sources in the banking system.
In H2 2017, several big banks (Otkrytie FC Bank, B&N Bank, Rost Bank, and Promsvyazbank), which used to play a major role in exchange trades in bonds, especially in the repo segment, were taken over by the Bank of Russia, and so became state-controlled entities. This translated into a soaring relative share of SOEs and the Bank of Russia as their source of borrowing in the total volume of trades in bonds. Thus, for example, in August 2017, the relative shares of SOEs and the Bank of Russia amounted to 37.1 percent and 20.6 percent respectively. However, later on, after the reorganization of those banks and their switchover to other centralized funding sources instead of repo deals, the relative shares of the Bank of Russia and SOEs shrank back to their previous level. In February 2018, the Bank of Russia's relative share amounted to 1.8 percent, that of SOEs - to 27.2 percent. It may be assumed that alongside the reorganization of these banks, the volume of repos in bonds will decline further, because these deals will no longer be used as funding sources by the banks experiencing financial difficulties.
100 90 80 70 60 50 40 30 20 10 0
2017
IBank of Russia
] State-controlled entities other than Bank of Russia □ Other participants in trades
Fig. 32. The relative shares of private brokers and state-owned entities in trades in bonds on the Moscow Exchange, percent
Source: own calculations based on data released by the Moscow Exchange.
As shown in Fig. 33, the role of non-residents and domestic private investors in exchange trades in bonds (all bond categories) has been relatively modest. In February 2018, nonresidents accounted for only 7.4 percent of their total value volume, and individuals - for 0.8 percent. One exception is the category of federal bonds (OFZ), where non-resident take up more than a third of total investment.
In 2017, the OFZ-N issue was launched that targeted retail investors. Some regional administrations and corporations likewise began to encourage individuals to buy their bonds. However, the progress so far achieved in that sphere has been modest in qualitative terms. It could be said that some additional measures are needed in order to encourage households to get more actively involved in the domestic market for debt-based financial instruments.
100 90 80 70 60 50 40 30 20 10 0
Individuals ■ Non-residents ■ Other resident organizations
Fig. 33. The structure of investors participating in trades in bonds on the Moscow Exchange from January 2005 through February 2018, percent
Source: own calculations based on data released by the Moscow Exchange.
An important criterion of the corporate bond market's performance is its ability to attract investments in the assets of companies operating in the real sector as well as in the assets held by banking structures. The information on how the resources attracted by Russian companies through bond offers are used by them to ensure growth of their fixed assets is released by Rosstat on the basis of surveys of companies-issuers of securities. Rosstat's data demonstrate that, over the period 2000 to 2015, only a small fraction of resources generated by corporate bond issues was actually invested in fixed assets.
In 2015, out of the total annual value volume of bond offers, which amounted to USD 26 billion, only USD 2.6 billion, or 6.6 percent, was invested in fixed assets (Table 9). Available statistics most clearly indicate that the market for corporate bonds has no noticeable effect either on investment in fixed assets or on the rate of economic growth. As was mentioned earlier, corporate bonds issues are de-facto the sources of short-term finance, and so companies prefer to use the income generated by bond placement mostly for replenishing their current assets and refinancing their old debt.
Since 2016, Rosstat no longer releases information on the relative share of bond issues in the structure of source of investment in fixed assets, which may be interpreted as the recognition of the insignificance of the stock market for this type of investment. However, this fact does
a
a
a
a
a
a
2012
2013
2014
2015
2016
2017
not rule out the importance of the issue represented by the still insufficient use of corporate bonds as a source of targeted funding for investment in the real sector and fixed assets.
Table 9
The parameters of domestic market for ruble-denominated corporate bonds
(billions of USD)
Bonds in circulation Secondary market, including repo Bond offer Investment in fixed assets generated by bond offer
billions of USD the same, as percentage of capitalization the same, as percentage of placement volume
2000 2 0.2 1.1
2001 3 1 0.8
2002 3 2 2 0.1 3.0 6.7
2003 5 8 3 0.1 2.1 3.8
2004 9 15 5 0.1 1.1 2.0
2005 17 44 9 0.3 1.8 3.3
2006 33 135 17 0.1 0.3 0.6
2007 49 371 18 0.2 0.4 1.1
2008 67 457 16 0.2 0.3 1.2
2009 80 293 29 0.1 0.1 0.3
2010 99 757 28 0.03 0.03 0.1
2011 117 1,237 31 0.014 0.01 0.05
2012 134 1,866 39 0.14 0.1 0.4
2013 163 2,839 54 0.05 0.03 0.1
2014 174 2,032 46 0.2 0.1 0.4
2015 133 1,277 29 2.6 1.9 6.6
2016 141 1,895 35 no data no data no data
2017 196 2,732 49 no data no data no data
Source: own calculations based on data released by the Moscow Exchange; cBonds; the Bank of Russia; Rosstat.
3.4. The market for government bonds
Over the period 2016-2017, in contrast to the situation in 2014-2015, the volume of borrowings attracted by the RF Ministry of Finance though the issuance of government securities was higher than the volume of government debt redemption. Thus, these debt instruments became a true source of budget deficit financing, raising net borrowing, according to CBonds statistics, in the amount of RUB 547 billion and RUB 1,270 billion respectively.
The evolution of the OFZ structure (Fig. 34) was largely determined by the RF Ministry of Finance's debt policy priorities and the roles of various categories of investors. In the study by Lu and Yakovlev,1 three phases in the OFZ market's development are identified: prior to the 2008 crisis; from mid-2009 through mid-2011; from mid-2011 onwards.2
Prior to the onset of financial crisis in 2008, when the budget was always drawn up with a surplus, the government had little interest in increasing the OFZ market. Against this background, the key sources of demand for government bonds were pension savings and bank assets, which were often targeted by the carry trading strategies. The participation of nonresidents was still low-key, and they were represented in the main by speculative funds. Consequently, major roles in the structure of government bond issues were played by OFZ-AD (debt amortization federal loan bonds), because their parameters were convenient for pension funds, and by OFZ-PD (constant coupon income federal loan bonds) that were more oriented
1 Lu, Y., Yakovlev, D. Exploring the Role of Foreign Investors in Russia's Local Currency Government Bond (OFZ) Market. IMF Working Paper, No WP/17/28, February 2017.
2 It should be noted that this classification of phases in the OFZ market's development is very similar to the division of the corporate bond market's history periods suggested in our comments to Fig. 25.
to market investors because the coupon income was predetermined for the entire period until their maturity date. The less marketable issues of OFZ-FK (federal loan bonds with a fixed coupon yield), which had been used as a tool of renewing the government domestic debt after the default on GKO, were gradually leaving the market. In 2008, the relative shares of OFZ-AD, OFZ-PD and OFZ-FK in the structure of government securities amounted to 70.9 percent, 26.4 percent, and 2.7 percent respectively.
7 000 --------------------------------------------------------------------
6 000
СД <U
•g 5 000
<4H
О
Й 4 000
4 3 000 л
£ 2 000
f
•o 1 000
□ GKO
□ BOFZ
□ OFZ-PK
DOFZ-PD
0 OFZ-PK □ OFZ-AD
□ OFZ-IN
OFZ-N
Note. Hereinafter, the following abbreviations are used:
BOFZ - zero-coupon federal loan bonds;
GKO - short-term zero-coupon government bonds;
OFZ - federal loan bonds;
OFZ-AD - debt amortization federal loan bonds;
OFZ-IN - federal loan bonds with a face value tied to the Russian Federation's official inflation rate;
OFZ-PD - constant coupon income federal loan bonds;
OFZ-PK - federal loan bonds with a floating coupon tied to the RUONIA rate;
OFZ-N - federal loan bonds for retail investors ('people's bonds').
Fig. 34. The value volume of GKO-OFZ offering over the period from 1993 through March 2018
Source: own calculations based on data released by the RF Ministry of Finance.
From 2009 through mid-2011, the RF Ministry of Finance was interested in borrowing as a source for covering budget deficit. To achieve that goal, it relied on OFZ-PD issues oriented to banks with surplus liquidity. The new bond issues were offered at a premium of 5-10 basis points.1 Non-residents' demand for OFZ was low due to the uncertainty concerning the interest rate.
Since mid-2011 and until the present time, the OFZ market has experienced many important developments that significantly boosted the role of the market for government securities and caused some shifts in its structure. The key change was that from mid-2012 onwards, nonresidents became the main providers of liquidity in the OFZ.2 Their high demand for OFZ-PD, and from 2015 also for OFZ-PD, resulted in further shrinkage of the relative share of OFZ-AD.
0
1 Lu, Y., Yakovlev, D. Exploring the Role of Foreign Investors in Russia's Local Currency Government Bond (OFZ) Market. IMF Working Paper, No WP/17/28, February 2017, p.10.
2 Ibid, p.14.
Another factor that worked in the same direction was the freeze of pension savings in 20142018, which curtailed the demand of pension funds for OFZ-AD pension funds. It was in the interests of the RF Ministry of Finance that the relative share of OFZ-AD should be reduced: in 2016, the replacement, uninitiated by the Ministry, of OFZ-AD with a face value of RUB 63.7 billion by OFZ-PD with a face value of RUB 56.4 billion raised a significant amount of cash for the budget. At the same time, from 2015, federal loan bonds with a face value tied to the inflation rate (OFZ-IN) for institutional investors, and from April 26, 2017, similar bonds targeting retain investors (OFZ-N), were launched onto the market. As a result, the topmost positions in the structure of OFZ issues as of March 31, 2018 were occupied by constant coupon income federal loan bonds (OFZ-PD) and bonds with a floating coupon (OFZ-PK), their relative shares amounting to 65.0 percent and 24.9 percent respectively. The relative shares of debt amortization federal loan bonds (OFZ-AD), bonds with a face value tied to the inflation rate (OFZ-IN), and federal bonds for retail investors (OFZ-N) amounted to 7.0 percent, 2.5 percent, and 0.6 percent respectively.
In 2017, the highest trading indices among OFZ issues were OFZ-PK 29006 maturing in January 2025; OFZ-PD 26207 maturing in February 2027; OFZ-PD 26221 maturing in March 2033; and OFZ-PD (26218 and 26219) maturing in 2026-2031.
One of the key issues that must be dealt with in order to make an investment in OFZ an attractive option is to make the portfolio's yield to maturity move ahead of the inflation rate (Fig. 35). The positive phenomena observed since early 2016, including the notable decline in the rate of inflation and the stabilization of the ruble's exchange rate against foreign currencies, made it possible to once again, from March 2016 onwards, to offer positive yields of OFZ Cbonds-GBI portfolio in real terms.
The month-end results of March 2018 demonstrated that, while inflation in per annum terms amounted to 3.3%,1 the yield of the OFZ portfolio was 8.4%. At the same time, on the whole over the period under consideration (January 11, 2010 - March 31, 2018), the average yield of 8.3% per annum was still notably below the inflation rate, whose average index was 10.0%.
60,0 50,0 40,0 30,0 20,0 10,0 0,0
2010
2011
2012
2013
2014
2015
2016
2017
2018
Inflation, % per annum • Yield to maturity of OFZ Cbonds-GBI portfolio - right-hand side axis
Fig. 35. The movement of inflation and yield to maturity of OFZ Cbonds-GBI portfolio over the period from January 11, 2010 to March 31, 2018
Source: own calculations based on data released by Rosstat and cBonds.ru
1 When calculated as the inflation growth index for a current months relative to the previous month. According to Rosstat data, inflation in March 2018 amounted to 2.4 percent per annum relative to March 2017.
So, in spite of the complicated geopolitical and macroeconomic situation, the government securities market continued to develop smoothly and began to play an increasingly important role in budget deficit financing. Over the last three and a half years, the government and the Bank of Russia managed to stabilize the situation in the forex and financial markets. In terms of its yield indices in early 2017, the RF market for OFZ and Eurobonds was below its 2013 level, which was a time of relative geopolitical stability.
Similarly to the market for corporate bonds, the OFZ market displays more features of a money market than those of a stock market. The main stimulus for its domestic participants to acquire government bonds is the possibility to use then as collateral when borrowing money (Fig. 36). In February 2018, the share of repo transactions in the total value volume of trades in government bonds rose amounted to 90.5 percent. Only about 4.7 percent of all trades in government bonds were market transactions. In early 2017 - late 2018, the share of repo transactions in the total trades in government bonds gained 2-3 percentage points as a result of the shrinking repo market volume, for the same reasons as in the corporate bond market on the stock exchange (see comments to Fig. 30).
100 -| 90 -80 -70 -60 -50 -40 -30 -20 -10
0
Liberalization of CB market for non-residents
of year-long FX repo auctions
Termination by RF CB of FX repo auctions for 1 year and 28 days -
Sectoral sanctions
Oil price plunge
Launch of GCC by NCC and reorganization | of Otkrytie FC -N
RF downgraded below
investment rating
1,2
2012
2013
□ Auction (market) mode
2014 2015
□ Repo mode
2016
■ Negotiated trades mode
2017
Fig. 36. The structure of transactions in federal bonds, including Eurobonds, on the Moscow Exchange from February 2012 through February 2018, percent
Source: own calculations based on data released by the Moscow Exchange.
In 2017, the volume of repo transactions in government bonds increased relatively moderately, to RUB 117.2 trillion from RUB 113.6 trillion in 2016, or by only 3.2 percent (Fig. 37). A quite different situation was observed in the market transactions segment, where the volume of trades in government bonds soared from RUB 1.7 trillion in 2016 to RUB 2.9 trillion in 2017, or by 67.6 percent. The trading volume also increased in the negotiated trades sector -from RUB 3.3 trillion in 2016 to RUB 3.8 trillion in 2017, or by 12.7 percent. The growth rate slowdown in the government bonds sector of the money market occurred for the same reasons as in its corporate bonds segment: the reorganization of several formerly active participants in
the repo market, the termination of FX repos by the Bank of Russia, and a rise in the use of GCCs.
Fig. 37. The value volume of trades in federal bonds, including Eurobonds, on the Moscow Exchange from February 2012 through February 2018, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
The decline of trading volume in money market for government bonds since September 2017 was even deeper than that in the corporate bond segment. The probable reason is that, in 20162017, in contrast to the situation in the market for corporate bonds, the most prevalent type of repos in government bonds, in terms of their value volumes, were RF Eurobond refinancing deals (Fig. 38). Therefore the ban on FX repos imposed by the Bank of Russia translated into a deeper plunge of the value volume of repos in government bonds compared with that of repos in bonds issued by private borrowers.
2015 2016 2017
RF Eurobonds ----OFZ - Bank of Russia bonds (ruble-denominated)
Fig. 38. The value volume of repos in OFZ and RF Eurobonds on the Moscow Exchange,
billions of rubles
Source: own calculations based on data released by the Moscow Exchange.
In contrast to the situation with corporate bonds (see Fig. 31), over the period from early 2015 through February 2018, the segment of market transactions in government bonds was demonstrating a positive growth trend. The value volume of market transactions in government bonds amounted to RUB 1.4 trillion in 2015, RUB 1.7 trillion in 2016, and RUB 2.9 trillion in 2017 (Fig. 39). The growth of market transactions in federal bonds was caused by an active inflow of non-residents into that market segment and the increasing interest in OFZ displayed by private investors in view of the high return rates of government securities in real terms, when the return rates of OFZ overshot those of bank deposits.
900 000 800 000 700 000 600 000 500 000 400 000 300 000 200 000 100 000 -0
2013 2014
□ Auction (market) mode
2015 2016
■ Negotiated trades mode
Fig. 39. The value volumes of market transactions and negotiated trades in federal bonds, including Eurobonds, in the Moscow Exchange from February 2012 through February 2018, millions of rubles
Source: own calculations based on data released by the Moscow Exchange.
The opening, by Russia's central depository in February 2013, of nominal holder accounts for foreign clearing and settlement systems triggered an inflow of foreign investment into the domestic government debt market. The relative share of non-residents in the secondary market for OFZ increased from 6.5 percent in July 2012 to 28.1 percent in May 2013 (Fig. 40). After May 2013, it somewhat declined to 24.9 percent in December 2013 in response to the behavior of the global financial market caused by huge capital outflows from the developing markets after the US Federal reserve's announcement of its intention to raise its key rate. The period between January 2014 and January 2015 saw a succession of events that produced a very negative effect on Russia's financial market: the ever increasing geopolitical risks associated with the situation in the Crimea; the introduction of sectoral sanctions in July 2014; the downfall of prices in the oil market from September 2014; the ruble's depreciation; Russia's sovereign credit rating downgraded to junk by S&P as of 25 January 2015 and by Moody's as of 20 February 2015. As a result, in January 2015, the relative share of non-residents in the structure of trades in OFZ shrank to 18.7 percent. The measures introduced by Russia's
monetary authorities helped stabilize the situation in the financial and forex markets, thus creating incentives for non-residents to return to Russia's domestic market for OFZ, and so in January 2018 their relative share amounted to 33.9 percent.
40 -,
35
30
25
20
15 -
10 -
5
8000
- 7000
6000
5000
4000
3000
2000
1000
0
2012 2013 2014 2015 2016 2017
□ OFZ market volume (outstanding face value amount), billions of rubles (right-hand side axis) ■ Relative share of non-residents in OFZ market, percent (left-hand side axis)
Fig. 40. The participation of non-residents in the OFZ market1 from February 2012 through January 2018
Source: own calculations based on data released by the Bank of Russia and the Moscow Exchange.
Thus, due to the modest relative shares taken up in the domestic OFZ market by retail investors, pension savings and collective investments, and the concentration of banks predominantly in the money market for OFZ, non-residents were the most active group of investors trading in OFZ on the spot market (market and NTM transactions). In the future, the growth prospects of Russia's OFZ market will largely depend on whether or not it will manage to attract domestic institutional investors, and also, to a certain extent, retail investors, to the spot market for OFZ.
3.5. The derivatives market
The year 2017 saw a continuation of the trading activity decline in the market for derivatives with underlying securities, which had first became visible in March 2016 (Fig. 41).
The futures trading volume declined from RUB109.5 trillion in 2016 to RUB 77.6 trillion pin 2017, or by 29.1 percent; the number of contracts - from RUB 1.89 billion to RUB 1.50 billion, or by 20.6 percent; and the number of transactions - from RUB 341.2 million to
0
1 In this case, it is the relative share of transactions closed by non-residents in the total volume of market transactions and negotiated trades in OFZ on the Moscow Exchange.
RUB 254.1 million, or 25.5 percent. After having peaked in February 2016, the futures market turnover indices began to tumble rapidly.
The main factor behind the dwindling trading activity in the futures market for contracts with underlying securities from March 2016 onwards was the ruble's stabilization alongside the growth of Russian stock indexes in 2016 followed by their stagnation in 2017, which reduced the needs of market participants to hedge on the stock prices by trading in the derivatives market. The trading activity in the equity futures market was also kept in check by the raised stock exchange tariffs in that market segment and the replacement of flat fee by commission charged as a percentage of transaction value (introduced from October 2016), which made the derivatives market operations less attractive to high frequency traders.1
In contrast to the futures market, the equity options trading segment managed to avoid a contraction in trading activity, both in 2017 and in 2016. The volume of options trading increased from RUB 3.9 trillion in 2015 to RUB 5.8 trillion in 2016, and to RUB 6.9 trillion in 2017, or by 47.9 percent and 18.9 percent respectively; the number of contracts jumped from 53.7 million to 72.5 million, and then to 83.7 million, or by 35.0 percent and 15.4 percent respectively; and the number of transactions - from 4.9 million to 6.1 million, and then to 6.7 million, or by 22.9 percent and 10.2 percent respectively.
14 000 000 -,
13 000 000 -
12 000 000
11 000 000 s le bl
10 000 000 ru
9 000 000 f o
8 000 000 ns io
7 000 000 - " l
6 000 000 e, m
5 000 000 4 000 000 lu ol > g in
3 000 000 ad r
2 000 000 H
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Volume of futures trading - left-hand side axis I Volume of options trading - left-hand side axis -Number of transactions in futures - right-hand side
■Number of transactions in options - right-hand side axis
44 000 000 42 000 000 40 000 000 38 000 000 36 000 000 34 000 000 32 000 000 30 000 000 28 000 000 26 000 000 24 000 000 22 000 000 20 000 000 18 000 000 16 000 000 14 000 000 12 000 000 10 000 000 8 000 000 6 000 000 4 000 000 2 000 000
Fig. 41. The trading volume and number of transactions in the Moscow Exchange's futures market from September 1, 2001 through March 31, 2018
Source: own calculations based on data released by the Moscow Exchange.
In response to the stabilization of the national currency's exchange rate, rising return rates of the stock indexes, and volatile commodity prices, the futures market structure on the Moscow Exchange in 2016-2017 tipped towards commodity and index futures, as the relative share of forex futures was shrinking (Fig. 42). The highest growth was demonstrated by the relative share of commodity futures; it was caused by the increasing demand for futures contracts for Brent crude, copper, sugar, and precious metals.
1 M. Mesropyan. A lucrative October. Vedomosti, November 6, 2016.
In the futures market structure, the relative share of index futures jumped from 19.3 percent in 2015 to 28.6 percent in March 2018; that of equity futures - from 3.0 percent to 5.7 percent; and that of commodity futures - from 5.8 percent to 21.6 percent respectively. Meanwhile, the relative share of forex futures dived from 71.9 percent to 43.2 percent. As before, over the period 2016-2017 the demand for security futures remained low.
100,0 90,0 80,0 70,0 60,0 50,0 40,0 30,0 1 20,0 10,0 0,0
QForex instruments □ Interest-bearing instruments □ Equity instruments "Index instruments □ Commodity instruments
Fig. 42. The futures market structure on the Moscow Exchange over the period from January 2009 through March 2018, percent of value volume
Source: own calculations based on data released by the Moscow Exchange.
In 2016-2017, the aforesaid factors were also shaping the structure of option transactions on the exchange market (Fig. 43). Within their structure, the relative share of transactions with index options increased from 50.7 percent in 2015 to 71.6 percent in March 2018, and that of commodity options - from 0.6 percent to go 2.6 percent. Over the same period, the relative share of forex options, on the contrary, shrank from 46.0 percent to 25.4 percent; and that of equity options - from 2.7 percent to 0.5 percent.
100,0 90,0 80,0 70,0 60,0 50,0 40,0
30.0 20,0
10.01 0,0
7,7
Jan Man ceH. G « ^ ^ S ^ s 8 Jan Man ceH. Jan Man ceH. Jan Man ceH. Jan Man ceH. Jan Man ceH. Jan Man ceH. Jan Man ceH.
2009 2010 2011 2012 2013 2014 2015 2016 2017
□ Forex instruments □ Equity instruments "Index instruments □ Commodity instruments
Fig. 43. The options market structure on the Moscow Exchange over the period from January 2009 through March 2018, percent of value volume
Source: own calculations based on data released by the Moscow Exchange.
3.6. Financial intermediaries and exchange infrastructure
The slow progress in the development of Russia's domestic stock market coupled with the tougher regulation of the activities of financial intermediaries have inevitable resulted in a shrinkage of the number of professional securities market participants (Fig. 44). The number of brokerage license holders plunged from 449 in 2016 to 376 in March 2018, or by 16.3 percent. Although a decade has passed since 2007, the number of active brokerage licenses in 2016 amounted to only 26.0 percent relative to 2007 (the pre-crisis year).
The number of market participants licensed to act as equity trust managers shrank from 348 in 2016 to 341 in March 2017, or by 2.0 percent. In 2016, the number of active licenses in this category amounted to only 29.2 percent relative to 2007.
Overall, the number of professional securities market participants in Q3 2017 was 632 vs. 681 in 2016, which represents a decline by 7.2 percent. The number of professional securities market participants in Q3 2017 amounted to only 35.4 percent relative to 2007.
1600 i 1400
<2 1000
o &
£ 800
C/5
<u
!m
8 600 •o
J 400
O
J 200
S
3
£
* as of Q3 2017.
Fig. 44. The number of issued licenses covering brokerage activities, dealer activities, equity trust management and professional securities market (PSM) participants
Source: own calculations based on data released by the Bank of Russia and Rosstat.
In 2011, the two largest Moscow-based exchanges - MICEX and RTS - were merged. This merger had important positive consequences for the development of Russia's stock market. The transactions on the stock and futures markets became easier. All liquidity necessary for carrying on transactions in the markets for government and corporate securities, as well as the futures and forex markets, could now be concentrated in the accounts of participants in trading in the exchange's single clearing and settlement system. The diversification of the exchange in servicing the transactions with different types of monetary and investment assets improved its financial sustainability in face of the widespread decline in the trade volume indices displayed by world stock exchanges and the reluctance of investors to buy risky assets.
Alongside positive changes, the merger of the RTS and the MICEX also produced some controversial effects for the domestic financial market development. First of all, now there was
2000
1800
1600
1400
1200
1000
800
600
3
£
2007
2009
2011
2013
2015
29.03.2018
Number of PSM participants (right-hand side axis) » Equity trust management (left-hand side axis) • Brokerage activities (left-hand side axis) Dealer activities (left-hand side axis)
no competition between the two exchanges, while previously it had acted as a powerful tool that boosted stock exchange activity in the interests of domestic investors and financial intermediaries. Table 10 shows the cardinal changes that occurred in the ownership structure of Moscow Exchange PJSC. Initially after the merger in 2011, a 59.0 percent stake in its capital was held by the Bank of Russia and several other state-controlled entities, while the other 41.0 percent was held by Russian participants in exchange trading and other resident entities. In 2017, the stake held by state-controlled structures now amounting to 43.1 percent, the aggregate stake held by non-residents had increased to 56.5 percent. In this connection, the main issue associated with the ownership structure of the Moscow Exchange is the absence therein of Russian private financial intermediaries, while those intermediaries, as was shown earlier (see Fig. 17 and 32), account for the bulk of transactions in financial instruments effected on the exchange market.
Table 10
The stakeholder structure of the two Russian exchanges before and after their merger
Before reorganization, as of 2011 After merger, as of February 1, 2012 2013 2014 2015 2016 2017
RTS OJSC MICEX CJSC
State stake - total 0.0 64.0 59.0 64.5 51.0 53.4 44.3 43.1
including:
Bank of Russia 0.0 28.6 24.3 24.7 12.1 11.8 11.8 11.8
Sberbank of Russia 10* 7.5 10.4 9.8 10.0 10.0 10.0 10.0
Vnesheconombank 0.0 10.5 8.7 8.0 8.4 8.4 8.4 8.4
Non-residents 0.0 0.0 0.0 14.9 25.9 36.0 52.3 56.5
Residents - private entities 90.0 36.0 41.0 20.6 23.2 10.6 3.4 0.4
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
* Troika Dialog CJSC purchased by Sberbank of Russia.
Source: own calculations based on data released by public information sources. The stakes held by the Bank of Russia, Sberbank of Russia and Vnesheconombank (VEB) were calculated on the basis of the Moscow Exchange's reports for several years; the stakes held by the State and non-residents over the period 2013-2017 are calculated on the bases of data released by Bloomberg; the stakes held by RTS OJSC participants are estimated based on the reports released by the RTS.
One of the advantages of the Moscow Exchange over its rivals in the global market is the diversity of its market segments. However, this business model gives rise to some additional risks that have to do with the lower incentives to develop the less marginal segments of the exchange's activity. At present, this has become manifest in the lower significance of the equity market in the total volume of trading on the exchange. The high risks and low returns on investment in securities placed by Russian issuer, increased volatility of fore rates and financial assets, the persistently high refinancing rates in the banking system, the pension savings freeze and inadequacy of the other domestic saving sources have all translated into certain привели к shifts in the market structure of the Moscow Exchange. Over the course of seven years, the relative share of capital market in the total trading volume tumbled from 13.2 percent in 2010 to 4.0 percent in 2017 (Table 11).
The relative share taken up by the money and forex market (MFX), on the contrary, increased from 72.0 percent in 2010 to 86.5 percent in 2017. More particularly, over the period under consideration, the relative share of the fore market increased from 38.1 percent to 39.2 percent, and that of the money market - from 33.9 percent to 47.3 percent. Growth in the forex segment was boosted by the ruble's instability and the access to the forex market on the Moscow
Exchange granted to the private clients of brokers and banks. The money segment was expanding in response to money overhang in banks and the accelerated growth of repos with the central counterparty.
Over the period from January 2010 through February 2018, the relative share of transactions with derivatives in the total trading volume dropped from 14.8 to 9.5 percent. This movement pattern occurred due to the stabilization of the ruble's exchange rate and the inflation index, and rising return rates on the domestic market for shares, which reduced the need to use hedging tools for market participants. The raised tariffs on the futures market and the switchover to commission charged as a percentage of transaction value resulted in a lower trading activity of speculative investors. Meanwhile, the efforts to create on the exchange a liquid market for interest-rate derivatives have remained unsuccessful.
Table 11
The market structure on the Moscow Exchange, percent
2010 2011 2012 2013 2014 2015 2016 2017 Jan-Feb 2018
Stock market 13.2 10.3 6.5 5.2 3.6 3.0 2.8 4.0 5.4
including:
Shares, Russian depository receipts (RDR), investment fund units 8.0 6.6 3.1 1.9 1.8 1.4 1.1 1.0 1.3
Bonds 5.2 3.7 3.4 3.3 1.9 1.6 1.7 3.0 4.1
Secondary turnover 3.4 2.9 2.8 2.7 1.5 1.2 1.1 1.2 1.6
New offering 1.8 0.8 0.6 0.6 0.3 0.4 0.6 1.7 2.5
Money and forex market 72.0 70.6 80.0 84.3 85.6 83.3 83.6 86.5 84.0
including:
Money market 33.9 41.3 48.3 50.7 45.7 38.0 44.8 47.3 41.5
Repo transactions 31.5 38.3 45.8 47.9 42.0 33.2 40.4 43.1 33.5
Lending market 2.4 3.1 2.5 2.8 3.7 4.8 4.4 4.2 8.0
Forex market 38.1 29.3 31.6 33.7 39.9 45.4 38.8 39.2 42.5
Spot trades 18.0 15.8 16.6 12.4 13.6 15.1 12.6 8.8 9.5
Swap trades 20.1 13.4 15.0 21.3 26.3 30.3 26.2 30.3 33.0
Futures market 14.8 19.1 13.5 10.5 10.7 13.7 13.6 9.5 10.5
Derivatives 0.0 0.0 0.0 0.0003 0.0002 0.0006 0.002 0.012 0.053
Commodity market 0.001 0.003 0.006 0.005 0.003 0.02 0.02 0.01 0.01
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: own calculations based on data released by the Moscow Exchange.
After the merger, it now became possible to create, on the basis of the MICEX Settlement Chamber, the National Settlement Depository (NSD) and the Depository Clearing Company (DCC). In accordance with Order of the FFMS of No 12-2761/PZ-I dated November 6, 2012, this status was granted to the non-bank credit institution National Settlement Depository (Close-end Joint Stock Company, NSD CJSC). In 2017, the NSD's equity, in compliance with Basel III standards, amounted to RUB 8.9 billion vs. RUB 11.3 billion in 2015, thus having declined by 21.2 percent. The value of securities kept by the NSD rose from RUB 31 trillion in 2015 to RUB 39 trillion in 2017, or by 25.8 percent.
Another entity affiliated to the Moscow Exchange is the National Clearing Centre (NCC). From November 2011, the NCC had been functioning as a clearing organization in the stock market, and from December 2012 - also in the derivatives market. In October 2013, the Bank of Russia recognized the National Clearing Centre CJSC to be the only qualified central counterparty (Central Counterparty National Clearing Centre, or CCP NCC). The strategic objective of the CCP NCC is to provide members of various financial market segments with
integrated clearing services, implying the use of unified collateral and the management of single positions (limits) across all the markets of the Moscow Exchange Group. The CCP NCC's equity, in compliance with Basel III standards, was reduced from RUB 54.3 billion in 2015 to RUB 45.9 billion in 2016, or by 15.5 percent.
3.7. Investors in the domestic stock market
One of the main obstacles to smooth development of Russia's domestic stock market has been the relatively low development level of institutional investors (pension and investment funds, insurance organizations).
In Q3 2017, the total volume of pension savings held by non-governmental (private) pension funds (NPF) amounted to RUB 2.4 trillion; the amount of pension savings held in the accounts of the RF Pension Fund and managed by government and private asset managers rose to RUB 1.9 trillion (Fig. 45). Considering the effects of the pension savings freeze and the recovery growth of GDP, the size of pension savings as a share of GDP declined for the first time in many years - from 4.8 percent in 2016 to 4.7 percent in 2017.
5 000 ------------------------------------------------------------------------ 6,0
4 500 4 000 3 500 3 000 2 500 2 000 1 500 1 000 500 0
5,0
4,0
3,0
2,0
1,0
0,0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
........Pension savings value held by NPFs
ESSSJ Pension savings value held by NPFs ■ ■ Government securities portfolio
Advanced portfolio ^<^~Pension savings value, share of GDP (right-hand side axis)
Note. For 2017, the value of pension savings and pension reserves held by the NPFs reflects the index for the year's first 9 months.
Fig. 45. The structure of pension savings in 2004-2017, billions of rubles Source: own calculations based on data released by Rosstat, the Bank of Russia, and the RF Pension Fund.
As shown in Table 12, over the decade that has elapsed since 2007, pension savings have become an important financing source for corporate and regional bonds. Their relative share in the structure of sources of financing for corporate bonds increased from 0.8 percent in 2007 to 11.4 percent in 2016. The corresponding index for the regional bond market leaped from 2.0 percent to 10.1 percent respectively. By their relative share in the sources of financing for non-government bonds, the pension savings held by NPFs have already achieved the average level typical of the OECD member states. As for their involvement in money market
instruments, government securities and shares issued by Russian companies, the corresponding index is still below 1.0 percent.
Table 12
The relative shares of pension savings invested by NPF in different financial
asset classes in Russia, 2007-2016
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Monies and deposits with banks 0.01 0.14 0.54 0.71 1.67 4.25 5.27 4.24 3.94 2.74
Corporate bonds 0.82 0.92 1.12 2.56 5.11 5.43 7.66 6.72 10.12 11.42
Federal bonds 0.16 0.08 0.14 0.11 0.54 0.46 1.07 0.49 1.56 2.49
Regional bonds 2.03 1.62 2.24 3.07 5.61 10.67 12.60 12.07 12.63 10.11
Shares 0.02 0.04 0.03 0.04 0.12 0.12 0.21 0.39 0.94 0.87
Source: own calculations based on data released by the Bank of Russia, cBonds, and the Moscow Exchange.
From mid-2015, sustainable growth has been demonstrated by another form of collective investment - open-ended unit investment funds (UIF), as can be seen in Fig. 361. The total net value of assets held by open-ended UIFs increased from RUB 110.2 billion in 2015 to RUB 216.9 billion in 2017, or nearly twofold. The total net value of assets held by interval UIFs over the same period dwindled from RUB 23.1 billion to RUB 6.2 billion, or by 73.2 percent (Fig. 46).
Fig. 46. The size of open-ended and interval unit investment funds, in relative
and absolute terms
Source: own calculations based on data released by Rosstat, the National League of Management Companies (MLMC), and the Bank of Russia.
1 For more details on this subject, see Abramov A., Radygin A., Chernova M. Russian institutional investors and privatization policy. Russian Economic Developments, No 12, 2016.
However, it is still too early to talk of a revival of collective investment activities in Russia. The obstacles to growth in this market segment are the underdeveloped infrastructure, outdated selling and marketing practices, legislative constraints on investing pension savings in UIFs, and low levels of public confidence and financial literacy. So far, this country lacks an efficient system through which the units of open-ended and interval UIFs could be properly marketed and sold.
Fig. 47 shows data on the number of individual investment accounts (IIA) opened by brokers and the number of individual accounts in the registers of unitholders in UIFs. Over the period from December 2016 through February 2018, the total number of accounts opened for retail clients of brokers on the Moscow Exchange increased from 1.10 million to 1.34 million, or by 21.5 percent. Over the same period, the number of active accounts opened or the clients of brokers operating in the exchange market declined from 111,000 to 106,000, or by 4.5 percent. According to estimated released by RAEX, the number of market retail investors in UIFs declined from 316,000 in 2016 to 342,000 in 2017, or by 8.2 percent.
1 400,0 1 200,0 +-1 000,0 800,0 600,0 400,0 200,0 0,0
--i-3-1-0--L3-4-0
■ Unitholders in UIFs, number*
□ Brokers' clients, number
□ Active brokers' clients, number
-1-1-03"'
* No data are available for February 2018.
Fig. 47. The number of retail clients of trust managers and brokers
Source: own calculations based on data released by the Moscow Exchange, the MLMC, and RAEX.
The year 2017 saw a notable revival in the brokerage services market for private clients. The four biggest stock brokerage companies - BCS, Finam, Sberbank of Russia, and VTB - have been intensely competing for leadership in servicing private clients (Fig. 48). Thanks to its skillful cooperation with Tinkoff Bank in attracting new clients, BCS, after having ranked only fourth in the brokerage services market, managed to get ahead of all its rivals, including some big state bank. The total number of its clients soared from 181,700 in December 2016 to 282,100 in February 2018, or by 55.2 percent. This case is interesting, in that it demonstrated the existing huge growth potential of non-bank financial companies, even in conditions of slow stock market growth and the heavy administrative burden imposed by the regulator.
In 2014-2017, the most noteworthy event in the sphere of private savings was the introduction of some revolutionary amendments to legislation, whereby it was envisaged that, from January 1, 2013, significant exemptions from PIT should be applied to income generated
by securities, provided that the individual to be made exempt from tax had held those securities for no less than three years; and from January 1, 2015, exemptions from PIT are also established for the contributions made by individuals to their so-called individual investment accounts (IIA)1
300
2010 2011 2012 2013 2014 2015 2016 2017
---- VTB Sberbank of Russia —--BCS -Finam
Fig. 48. The number of registered retail clients of the four biggest broker companies Source: own calculations based on data released by the Moscow Exchange.
In accordance with Federal Law No 420-FZ, dated December 28, 2013, 'On the introduction of alterations into Article 27.5-3 of the Federal Law "On the securities market" and Parts One and Two of the Tax Code of the Russian Federation', the income derived in the form of return on investment in newly purchased securities is to be made exempt from tax if their individual owner has been holding them for three or more years. The cap on deduction from the tax base is set at RUB 3 million for each year of holding a security or a unit. The exemption from PIT is not applicable to income derived in the form of dividends paid on shares and coupons paid on bonds, except in cases when individuals hold securities indirectly through open-ended unit investment funds. For this reason, the exemption will be most beneficial for long-term unitholders of open-ended funds.
Besides, from January 1, 2015, in accordance with the Federal Law 'On the securities market' and the RF Tax Code, Russian citizens are entitled to deductions from PIT when they open an individual investment account with a broker or trust manager. The cap on the amount of money to be placed on such an account is RUB 400,000 per annum. 2
According to data released by the Moscow Exchange as of the end of February 2018, the number of IIAs was 317,300 compared to 25,900 as of the end of May 2015 (Fig. 49). Thus, in less than three years, the number of IIAs jumped 12.2 times.
1 In terms of their status, these accounts are similar to two investment mechanisms popularly applied in many countries: individual retirement accounts (IRAs) (in the USA, Poland, the Republic of Korea, Canada, etc.) and individual savings accounts (ISAs) (in the UK). Because they are used for short-term saving, IIAs have more in common with ISAs than with IRAs.
2 It is intended to amend existing legislation, so that the cap can be increased to RUB 1 million.
70,0
60,0
&
< 50,0
40,0
250 000
200 000
30,0
20,0
I 10,0
¡25 914 0,0
350 000 317348
300 000
150 000
100 000
50 000
2015
2016
2017
2018
Relative share of 4 biggest non-bank stock brokers* (left-hand side axis) Relative share of 4 biggest stock brokers - banks ** (left-hand side axis) ^^Number of IIAs - total (right-hand side axis)
Fig. 49. The number of individual investment accounts (IIA) on the market over the period from May 2015 through February 2018
Source: own calculations based on data released by the Moscow Exchange.
Thus, the statistics of retail investor participation in trading on the exchange and the movement of IIAs demonstrate that individuals are actually prepared to get more actively involved in the stock market. However, the insufficiently developed collective investment methods and the pension savings freeze have made it impossible to fully unravel the potential role of available domestic savings. As a result, the activity of individuals in the domestic stock market is focused mainly on short-term and speculative deals, which are fraught with significant risks for this investor category. In order to reorient private investors to more long-term investment strategies, it will be necessary to reform the business model followed by financial intermediaries, introduce new standards of their activity, and to boost competition in the financial services market.
In many developing markets, foreign portfolio investors frequently act in accordance with similar scenarios. Their decisions concerning investing in or withdrawing their investment from a given assets are made depending on the general cyclical trends and the weight of a given country in the global stock indexes, and not on the individual features of its national economy or the specificities of securities issuers based in different countries.1
Judging from analytical data on global investment flows released by EPFR, the year 2017 was not remarkably successful from the point of view of attracting foreign investment funds to the Russian stock market. While in 2016 the net inflow of investment funds specializing on
0
1 For more details concerning the investment strategies followed by these funds in Russia, see Abramov A. Differences in the behavior of domestic and foreign private investors on the Russian stock market. Russian Economic Developments, No 11, 2014.
Russian stocks amounted to USD 1.18 billion, the year-end result of 2017 demonstrated an outflow of this investor category from Russia to the value of USD 2.20 billion.
In 2017, the value of assets held by foreign investment funds specializing on Russia amounted to USD 12.8 billion (Fig. 50). The size of funds investing in Russia (Russia-EMEA-Equity) was notably smaller than that of funds investing in China, India, Brazil, and South Korea. Over the 1-year period from 2000 through 2017, the mean return on investment in Russian for foreign investment funds amounted to 12.5 percent per annum in terms of US dollars, while the geometric mean of return for the RTS Index over the same period was 13.1 percent per annum.
29 000 -------------------------------------------------------- 1000,0
900,0 800,0
24 000
19 000
14 000 -
9 000
4 000100,0
700,0 600,0 500,0 400,0 300,0 200,0 100,0
-1 000 -------------------------------------------------------- 0,0
.O
(Jh
«M
e >
3 o ^ £
NAV of funds, mln USD - left axis
Cumulative operating cash flow, millions of USD (from Jan 2000) - left-hand side axis Cumulative return on portfolio (Jan 2000 = 100%) - right-hand side axis
Fig. 50. Total size, cash flow and cumulative return of funds specializing on investment in Russia from January 2007 through December 2017
Source: own calculations based on data released by EPFR.
The attractiveness of Russia's financial market for foreign investors in many ways depends on the domestic investment climate. In accordance with the goals set by Executive Order of the President No 596 dated May 7, 2012 'On long-term government economic policy', Russia has managed to achieve remarkable progress in her ranking based on the World Economic Forum's Global Competitiveness Index, where she moved from 67th place in 2013 to 38th in 2017 (Fig. 51). Among the BRICS members, Russia came ahead of Brazil, the Republic of South Africa and India, and was second only to China.
In our previous reviews of the situation in Russia's financial market, we identified several investment climate criteria applicable to Russia, which in the mid-2000s were viewed by conservative US investors as factors that made it undesirable to invest in shares and bonds of
Russian issuers of securities.1 By way of example, we cited the data released by CalPERS (California Public Employees' Retirement System), a big US public pension fund, which until 2006 had published the list of criteria and indicators applied as a basis for its decision-making concerning investing in one or other developing market. The investment climate estimates are as follows: independence of the judicial system; compliance with international audit and reporting standards; the level of protection of minority investor rights; the domestic stock market as a financing source for the national economy; banks' reliability; the proficiency of the regulation of exchanges.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Russia -—•■—-China
B India Brazil
RSA • — Total, countries included in ranking
0
Fig. 51. BRICS members' rankings in the World Economic Forum's Global Competitiveness Index in 2007-2017
Source: own calculations based on data released by The Global Competitiveness Report, released by the World Economic Forum (WEF).
Table 13 analyzes the movement of these six investment climate estimates with regard to each member of the BRICS group over the 11-year period from 2007 through 2017 on the basis of data derived from the WEF annual Global Competitiveness Reports. Traditionally, Russia's economy was ranked by the criteria of her investment climate and availability of financial resources in the domestic market, and so we specifically focused on these factors.
If we take the year 2012 as baseline, it will become obvious that by all the six estimates, Russia managed to improve her investment climate quality and accessibility of financial resources (Table 13 and Fig. 52). Thus, for example, in terms of judicial system independence, Russia moved from 122nd place in 2012 to 90th place in 2017; by the use of international reporting and audit standards - from 123rd to 100th; protection of minority investor rights - from 140th to 111th; by the potential for raising financial resources in the domestic market - from 10th
1 Russian Economy in 2008. Trends and Outlooks. (Issue 30). Moscow, IET, 2009, pp. 513-516.
to 90th; and by reliability of banks - from 132nd to 121st. The least progress was achieved with regard to regulation of exchanges - since 2012, Russia moved only from 114th place to 112nd. At the same time, in spite of the significant improvement in these rankings, is can be assumed that over the past 5 years, no fundamental changes were noted in the domestic investment climate and availability of financial resources.
Table 13
The most problematic aspects of Russia's investment climate, according to the World Economic Forum's Global Competitiveness
Index ranking
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017
Independence of judicial system
Russia 106 109 116 115 123 122 119 109 108 95 90
China 82 69 62 62 63 66 57 60 67 56 46
India 26 43 37 41 51 45 40 50 64 54 53
Brazil 89 68 78 76 71 71 65 76 92 79 59
RSA 23 30 38 44 35 27 22 24 24 16 36
Audit and reporting standards
Russia 95 108 119 116 120 123 107 106 102 103 100
China 102 86 72 61 61 72 80 82 80 68 71
India 27 30 27 45 51 44 52 102 95 64 69
Brazil 63 60 70 64 49 42 31 41 70 72 58
RSA 6 4 2 1 1 1 1 1 1 1 30
Protection of minority investor rights
Russia 125 128 127 132 135 140 132 118 116 116 111
China 114 94 71 66 60 68 75 67 71 48 38
India 27 33 36 55 62 52 52 76 69 37 42
Brazil 46 42 59 64 49 37 26 35 78 94 62
RSA 13 13 9 6 3 2 1 2 3 1 30
Access to financing in local stock market
Russia 81 87 96 107 98 100 90 86 88 95 90
China 82 80 66 52 46 46 38 34 44 40 31
India 13 8 3 10 15 19 18 39 45 31 39
Brazil 61 56 44 45 33 40 48 55 75 83 72
RSA 4 4 4 7 4 3 2 3 1 1 25
Banks' reliability
Russia 108 107 123 129 129 132 124 118 115 121 121
China 128 108 66 60 64 71 72 63 78 79 82
India 46 51 25 25 32 38 49 101 100 75 78
Brazil 36 24 10 14 16 14 12 13 27 38 26
RSA 16 15 6 6 2 2 3 6 8 2 37
Regulation of exchanges
Russia 103 110 113 118 116 114 102 91 97 113 112
China 111 109 91 61 53 58 63 58 52 57 60
India 30 25 11 15 26 28 27 62 69 58 64
Brazil 41 28 10 5 9 8 7 17 36 54 44
RSA 5 5 2 1 1 1 1 1 2 3 46
Source: own calculations based on data for a number of years released in The World Economic Forum's Global
Competitiveness Report.
Besides, as shown in Fig. 52, in 2007-2017 Russia ranked far below Brazil, India, China and the RSA by all the six estimates.
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w
Judicial system independence
......123 122 i in
^ # # ^ ^ Q<S
» Russia ■ Brazil
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India
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Protection of the rights of minority shareholders
128 127 132 135 140 132
"c 100
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Ü ^ # ^ ^ ^ ^ *\b ^
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India
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150 ----108 119 116 120 123 107 106 102 103 100
100
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ü
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China RSA
India
Reliability of banks 150 107 123 129 129 132 124 118 115 121 121
^ # # ^ ^ 0\fa ^
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India
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150 87 96 107 98 100 90 86 88 95 90
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India
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150 ----110 113 ^H6 114 102 91 97 113 112
100 1
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China RSA
India
Fig. 52. BRICS members' rankings in the World Economic Forum's Global Competitiveness Index, by several criteria relevant for conservative portfolio investors' decision-making
Source: own calculations based on data for a number of years released in The World Economic Forum's Global Competitiveness Report.
0
3.8. Risk factors in the Russian financial market
By way of summing up, we are going to point out the most significant medium-term risks of the Russian stock market.
The greatest risks for domestic ruble-denominated savings have to do with the regular depreciation of the national currency. As a rule, the ruble's depreciation always follows one and the same scenario. The declining price of oil and capital outflow suddenly result in a sharp shrinkage in the value of the ruble, followed by a period, 7 or 8 years long, when the ruble level
remains stable, and the national currency even strengthens a little (Fig. 53). However, the main issue arising in this connection is that the abrupt depreciation undermined the value of ruble-denominated savings, and it never recovers its initial indices even during the periods of the ruble's stability.
The causes of depreciation are the structural disproportions inside the Russian economy; because of these disproportions, the ruble strongly depends on the situation on foreign markets and the behavior of foreign portfolio investors.
At present, the financial market is moving along an upward curve, when the ruble strengthened from RUB 83.59 per USD as of January 22, 2016, to RUB 57.11 per USD as of March 26, 2018. As the implementation structural changes in the economy even under a favorable development scenario will require a rather long period of time, the risks posed by a sudden worsening in the eternal economic situation will remain real in the medium-term perspective.
Fig. 53. The movement of the RTS Index and the USD-to-RUB exchange rate over the period from September 1, 1995 through March 26, 2018
Source: own calculations based on data released by the Bank of Russia and the Moscow Exchange.
The prices of shares issued by Russian companies strongly depend on the behavior of oil prices. The coefficient of determination (R2) between the absolute monthly values of the RTS Index and the price of Brent crude over the period from September 1995 through February 2017 (Fig. 54) is equal to 0.8, which points to a very close interdependence of these two indicators. Oil prices also strongly influence the national currency's exchange rate.
Over the next few years, it is unlikely that oil prices may display growth; both demand and supply on the oil market are volatile indices. So, in the medium-term perspective we may expect, with a high degree of probability, that prices in the oil market will follow a cyclical behavior patterns, thus becoming a significant factor of volatility in the Russian stock market.
2 500 -,
„ 2 000 -
e
"(5 &
jg
CZJ
H
Pi
1 000 -
500
0
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150
Brent crude, USD per barrel
Fig. 54. The dependence of the RTS Index on the price of Brent crude, from September 1995 through March 2018
Source: calculations based on data released by Finam and the Moscow Exchange.
At present, the situation in Russia is relatively beneficial for growth in carry trades. The contributing factors are the ruble's strengthening, the stably high interest rates on the operations with ruble-denominated assets, and absence of any serious currency regulation constraints.
The negative consequences of carry trading strategy may become visible in several areas -as a surge in volatility of the national currency's exchange rate and prices for financial assets, or as a liquidity crisis in the banking system. The risks associated with the negative effects of carry trade on banks are currently rather low because, being restricted by the existing normative documents and some other factors, Russian banks so far have abstained from actively participating in such deals. Despite the relatively prominent position of non-residents in the structure of holders of shares and bonds placed by Russian issuers, the potential for implementing active carry trade strategies in this segment is limited due to the liquidity of the domestic stock market.
At the same time, according to the Bank of Russia's experts, the risks of a negative effect of carry trade on the financial market are frequently overestimated, because high returns are by no means the only factor determining the potential attractiveness of such operations, while the Sharpe ratio of transactions involving ruble-denominated assets, due to the ruble's high volatility, is lower than the corresponding ratios of the forex markets of other countries.1
The high returns on the Russian market for shares against the backdrop of a strengthening ruble attracted an additional inflow of non-residents to that market segment in H2 2016. However, these developments did not produce any qualitative changes in the investment climate or economic policies. Oil prices have remained unstable. Besides, in 2018, the upward movement of interest rates in the USA became more intense. All these factors may translate into an onset of a new steady outflow of foreign portfolio investors from the Russian stock market.
1 Bank of Russia. What do the trends say. Macroeconomics and markets. Bulletin of the Research and Forecasting Department. No 2 (14), March 2017, p. 38.
Some significant risks for the financial market are also created by the economic sanctions, although their effects on the market participant behavior so far have been rather limited. The main ways in which the sanctions can influence the financial market are the restricted access to borrowing for Russian companies, rising costs of borrowed resources, and foreign investment outflow from the share market. The available estimates of the effects of sanctions on Russia's financial market vary dramatically, but they are expressed mainly as a percentage of the expected slowdown in the GDP growth rate. Few studies have directly analyzed the actual consequences of the imposed sanctions for the financial market. Thus, according to E. Gurvich and I. Prilepsky (2016), the additional cumulative net capital outflow triggered by the sanctions, was estimated to be at the level of USD 58 billion in 2014 and USD 160-170 billion in 20142017. 1 And the opinion of RF Minister of Finance Anton Siluanov, voiced in late 2014, was that Russia's loss from the sanctions was about USD 40 billion per annum.2
In the short-term perspective, the currently imposed economic sanctions, which have restricted the access to borrowing in the global markets for a number of companies, produced little effect on the domestic financial market. The interest rates on loans in the domestic market have remained at the same level as prior to the introduction of sanctions. Besides, many private companies are exempt from these sanctions, and so they can borrow in the eurobond market. The sanctions mostly affect the investment activities of companies, and their purchases of foreign equipment and technologies. Fearing the sanctions, many big companies have preferred to postpone their investments, accumulating their cash reserves in their bank accounts instead.
In this sense, the sanctions do restrain the investment activity of businesses and thus produce a negative impact on economic growth.
Nevertheless, the risks associated with the introduction of new tougher financial sanctions in response to a possible exacerbation of geopolitical situation cannot be completely ruled out. If that should be the case, sanctions may trigger financial shocks at the level of big companies, thus requiring some additional support measures for Russian businesses.
Thus, a typical feature of the year 2017 was stagnation in the movement of rates of return of shares issued by Russian companies alongside favorable conditions for investing in government and corporate bonds. The situation in the share market was negatively influenced by the outflow of foreign portfolio investors and the pension savings freeze. The growth drivers in the bond market were the low inflation rate and the interest rates on bank deposits in the presence of a significant money overhang in the economy and the emerging interest of retail investors in government and corporate bonds. The latter have at last 'got the taste' of individual accounts and certain collective investment instruments, mainly bonds and UIFs.
The yields of government and corporate bond issues stabilized at a level below that of the pre-crisis year 2013. This triggered an accelerated growth of new issues of corporate and government bonds. The OFZ market has become an important source of budget deficit financing.
At the same time, no changes for the better have occurred with regard to the domestic source of stock market growth. The money market continues to prevail over the stock market, which means that the demand for securities placed by Russian issuers is sustained in the main by short-term financing sources provided by banks and other financial intermediaries. Another strong restricting factor for stock market growth, as before, is the freeze of domestic pension savings
1 Gurvich E., Prilepskiy I. The impact of financial sanctions on the Russian economy. Voprosy Ekonomiki (in Russian), No 1, January 2016, p. 33.
2 Volkova O. Counter-sanctions against sanctions: which of these are worse. RBC Daily, March 21, 2016, p. 4.
and their uncertain destiny. No notable changes have occurred with regard to the investment climate, either, and this factor also restricts the demand of major foreign portfolio investors for Russian financial instruments.
In view of all these developments, a priority direction in the domestic market progress could become support of domestic institutional investors, introduction of unchangeable 'rules of game' in the treatment of pension savings, and improvement of the investment climate and competitive environment in the domestic stock market.
3.9. Municipal and sub-federal debt market 1
3.9.1. Market development dynamics
According to the 2017 year-end data, the regional consolidated budgets and local government off-budget funds' budgets ran a deficit of RUB 61.5 billion or 0.07 percent of GDP (TTable 14).
To compare, the regional consolidated budgets and local government off-budget funds' budgets amounted to RUB 303.5 million in 2016.
In 2017, the budgets of subjects of the Russian Federation ran a deficit of RUB 15.5 billion, urban districts' budgets ran a deficit of RUB 29.5 billion, federal-status cities' inner-city municipalities' budgets ran a surplus of RUB 0.5 billion, municipal areas' budgets ran a deficit of RUB 5.4 billion, urban and rural settlements' budgets ran a deficit of RUB 1.0 billion, local government off-budget funds' budgets ran a deficit of RUB 9.6 billion (Table 15).
As a comparison, in 2016, the budgets of subjects of the Russian Federation ran a deficit of RUB 2.4 billion, urban districts' budgets ran a deficit of RUB 16.3 billion, federal-status cities' inner-city municipalities' budgets ran a surplus of RUB 0.3 billion, municipal areas' budgets ran a surplus of RUB 11.4 billion, urban and rural settlements' budgets ran a deficit of RUB 5.4 billion, local government off-budget funds' budgets ran a surplus of RUB 12.3 billion.
Table 14
Ratio of regional consolidated budgets surplus (deficit) and of regional budgets to budget expenditure in 2007-2017, percent
Year Regional consolidated budgets Regional budgets
2017 -0.5 -0.2
2016 0.003
2015 -1.6 -1.3
2014 -4.6 -4.9
2013 -6.4 -8.1
2012 -3.0 -3.5
2011 -0.2 -0.3
2010 -1.4 -1.6
2009 -5.3 -5.3
2008 - 0.7 - 0.7
2007 0.8 0.6
* including state off-budget funds
Source: own calculations based on the data released by the Federal Treasury.
1 This section is written by Artem Shadrin, Ministry of Economic Development of the Russian Federation, the Gaidar Institute.
Table 15
Local budgets surplus (deficit) to budget expenditure ratio in 2007-2017, percent
Year Inner-city municipalities budgets in federal-status cities Urban districts' budgets Municipal areas' budgets Urban and rural settlements' budgets
2017 1.9 -1.6 -0.4 -0.3
2016 1.3 -0.9 0.8 -1.5
2015 6.7 -3.0 -0.7 -0.6
2014 6.0 -2.2 -1.4 0.7
2013 - 3.47 -2.61 -5.59 2.24
2012 2.26 -2.01 -0.08 1.34
2011 6.15 -2.10 1.13 0.64
2010 -1.12 -1.16 -0.11 1.72
2009 -0.63 -3.32 -1.88 2.63
2008 -1.47 1.09 -0.26 2.72
2007 5.34 1.23 -0.04 2.34
Source: own calculations based on the data released by the Federal Treasury.
As of January 1, 2018, the consolidated budget (including local government off-budget funds) of 59 subjects of the Russian Federation and the city of Baikonur ran a deficit (58 regions in 2016). The overall deficit amounted to RUB 194.8 billion, or 2.4 percent of the revenue side (RUB 198.0 billion in 2016, or 3.1 percent of the revenue side of budgets that ran a deficit).
The median budget deficit value stood at 3.5 percent relative to a given budget revenue. The highest ratio of budget deficit to budget revenue was recorded in the Republic of Mordovia -21.4 percent, Toms oblast - 7.8 percent, and Orel oblast - 7.7 percent. St. Petersburg accounted for more than 21.8 percent or over RUB 42.5 billion of the total consolidated budget deficit, the Khanty-Mansi Autonomous Okrug accounted for around 8.9 percent or more than RUB 17.3 billion (Table 16).
Table 16
Execution of consolidated budgets of subjects of the Russian Federation in 2017
Budget revenues, rubles in billions Budget deficit (surplus), rubles in billions Deficit (surplus) to revenue ratio, % borrowing to revenues ratio, Net borrowing to revenues Redemption costs to revenues ratio, % Net borrowings to deficit
% ratio, % (surplus), %
1 2 3 4 5 6 7 8
Central Federal Okrug
Belgorod Region 110.9 -1.1 -1.0 11.6 0.0 11.6 0.8
Bryansk Region 72.9 -2.0 -2.8 9.2 -1.8 10.9 62.5
Vladimir Region 78.0 -0.9 -1.1 4.5 0.0 4.5 -0.9
Voronezh Region 135.3 -5.7 -4.2 65.7 -1.6 67.2 36.9
Ivanovo Region 48.4 0.5 1.1 38.9 0.0 39.0 -3.7
Tver Region 80.2 -1.9 -2.4 21.6 -0.4 22.0 16.8
Kaluga Region 78.8 -0.7 -0.9 14.8 0.2 14.6 -20.0
Kostroma Region 35.0 2.7 7.8 118.4 4.3 114.1 55.0
Kursk Region 70.8 -0.9 -1.3 42.0 0.2 41.8 -15.0
Lipetsk Region 75.9 -1.6 -2.2 5.4 -1.1 6.5 51.7
Moscow Region 690.1 16.5 2.4 10.9 0.1 10.8 4.0
Orel Region 41.2 -3.2 -7.7 92.5 8.1 84.5 104.6
Ryazan Region 69.7 -4.2 -6.0 29.9 -2.8 32.6 46.2
Smolensk Region 54.2 -0.3 -0.5 75.1 -5.8 80.9 1 205.6
Tambov Region 58.4 2.5 4.3 62.4 3.7 58.7 84.8
Tula Region 96.7 4.7 4.9 20.3 4.1 16.2 83.1
Yaroslavl Region 82.4 2.8 3.5 81.4 1.5 80.0 42.0
City of Moscow 2 291.0 3.4 0.1 0.0 -1.2 1.2 -803.5
City of Baikonur 3.8 0.04 1.2 0.0 0.0 0.0 0.0
Total 4 173.8 17.0 0.4 12.8 -0.6 13.3 -139.9
Cont'd
1 | 2 | 3 | 4 | 5 | 6 | 7 | 8
North-West Federal Okrug
Republic of Karelia 50.7 2.5 4.9 57.0 4.9 52.1 100.1
Republic of Komi 97.3 -2.9 -2.9 91.3 -3.1 94.4 104.4
Arkhangelsk Region 101.3 1.5 1.5 111.5 0.0 111.5 0.6
Vologda Region 84.4 -6.9 -8.2 26.4 -6.1 32.6 74.7
Kaliningrad Region 119.8 2.9 2.4 22.4 1.2 21.2 51.0
Leningrad Region 149.5 8.7 5.8 0.2 -1.0 1.2 -16.9
Murmansk Region 86.2 0.6 0.7 68.1 -2.0 70.1 -286.7
Novgorod Region 40.8 0.03 0.1 37.0 1.5 35.4 1 829.1
Pskov Region 37.1 1.6 4.3 98.7 4.7 94.0 110.1
St. Petersburg 585.7 -42.5 -7.3 5.1 3.6 1.5 49.6
Nenets Autonomous Okrug 21.1 -0.7 -3.4 35.1 -1.3 36.4 38.2
Total 1 373.9 49.9 3.6 31.2 1.2 30.0 31.8
Southern Federal Okrug
Republic of Kalmykia 15.6 0.6 3.8 56.7 3.3 53.5 85.3
Krasnodar Territory 346.8 -17.5 -5.0 16.6 -3.4 20.0 67.5
Astrakhan Region 53.0 -1.8 -3.5 58.2 -3.4 61.6 96.9
Volgograd Region 130.7 1.5 1.1 77.5 0.0 77.5 -1.0
Rostov Region 229.7 -1.4 -0.6 9.4 -0.3 9.6 42.5
City of Sevastopol 34.6 2.5 7.4 0.0 0.0 0.0 0.0
Republic of Crimea 177.1 0.8 0.4 2.3 -0.5 2.8 -123.3
Republic of Adygea (Adygea) 23.0 0.7 3.0 8.0 3.4 4.6 112.6
Total 1 010.6 -14.6 -1.4 22.4 -1.4 23.7 94.8
North-Caucasus Federal Okrug
Republic of Dagestan 132.2 -3. 6 -2.7 16.3 -2.7 19.0 98.7
Kabardino-Balkar Republic 36.3 2. 6 7.2 118.4 5.3 113.1 73.6
Republic of Northern Ossetia-Alania 34.2 0.3 0.9 25.2 0.7 24.5 78.2
Republic of Ingushetia 26.9 -0.2 -0.7 20.9 -0.5 21.4 75.7
Stavropol Territory 139.2 -0.4 -0.3 67.4 -0.8 68.2 290.3
Karachay-Cherkess Republic 27.8 -0.08 -0.3 49.9 -0.2 50.2 78.0
Chechen Republic 89.9 -0.4 -0.4 1.2 -0.8 1.9 174.4
Total 486.6 -1. 7 -0.4 38.5 -0.7 39.2 198.4
Volga Federal Okrug
Republic of Bashkortostan 241.4 -11.7 -4.9 2.5 -1.8 4.4 38.0
Republic of Mariy-El 36.9 -0.1 -0.4 46.8 0.0 46.8 1.7
Republic of Mordovia 46.9 -10.1 -21.4 71.3 21.6 49.7 101.0
Republic of Tatarstan (Tatarstan) 321.7 -13.5 -4.2 5.8 0.0 5.8 0.3
Udmurt Republic 93.9 -0.2 -0.2 84.1 0.1 84.0 -45.6
Republic of Chuvashia - Chuvashia 63.4 0.5 0.8 20.1 -0.4 20.5 -51.7
Nizhniy Novgorod Region 205.2 3.8 1.9 98.9 -0.4 99.2 -19.5
Kirov Region 71.6 0.09 0.1 64.3 0.7 63.7 553.0
Samara Region 211.1 0.4 0.2 26.1 -0.4 26.5 -221.4
Orenburg Region 112.7 1.0 0.9 32.7 -0.3 33.1 -39.8
Penza Region 68.5 0.5 0.7 20.6 -0.8 21.4 -113.2
Cont'd
1 2 3 4 5 6 7 8
Perm Territory 171.9 -0.5 -0.3 25.1 -1.8 26.9 612.9
Saratov Region 122.3 -0.7 -0.6 42.7 0.0 42.7 -5.4
Ulyanovsk Region 69.8 2.8 4.1 53.2 2.7 50.6 65.6
Total 1 837.5 -7.6 -0.4 35.7 0.1 35.5 -30.3
Urals Federal Okrug
Kurgan Region 48.9 2.3 4.6 42.1 4.0 38.1 86.7
Sverdlovsk Region 307.0 1.5 0.5 38.6 1.1 37.5 221.9
Tyumen Region 173.8 0.8 0.5 0.0 0.0 0.0 0.0
Chelyabinsk Region 212.8 -7.1 -3.3 5.8 -1.9 7.7 57.7
Hanty-Mansiysky Autonomous Okrug -Yugra 257.4 17.3 6.7 3.6 0.7 2.8 10.6
Yamal-Nenets Autonomous Okrug 196.7 -14.9 -7.6 0.6 -2.9 3.4 38.0
Total 1 196.7 -0.1 0.0 13.5 -0.2 13.7 1 957.5
Siberia Federal Okrug
Republic of Buryatia 69.4 2.9 4.1 64.8 1.9 62.8 46.9
Republic of Tyva 30.4 -0.4 -1.3 32.0 -1.4 33.4 106.4
Altai Territory 126.6 -2.1 -1.7 0.9 -1.0 1.9 58.7
Krasnoyarsk Territory 285.9 5.8 2.0 29.2 1.5 27.8 71.6
Irkutsk Region 196.8 0.5 0.2 7.6 0.0 7.6 -1.8
Kemerovo Region 195.5 -20.7 -10.6 27.4 -3.1 30.5 29.7
Novosibirsk Region 184.5 0.008 0.0 72.8 0.6 72.1 13 722.5
Omsk Region 107.1 3.0 2.8 131.2 1.2 130.0 44.4
Tomsk Region 78.6 -6.1 -7.8 84.4 3.5 81.0 44.7
Republic of Altai 21.1 -0.4 -2.1 8.5 -0.5 8.9 21.9
Republic of Khakassia 36.2 2.1 5.7 83.4 5.6 77.9 98.2
Zabaikalsky Territory 72.5 2.1 2.9 54.4 2.8 51.6 97.0
Total 1 404.6 -1.2 -0.1 44.2 0.5 43.7 -573.1
Far East Federal Okrug
Republic of Sakha (Yakutia) 225.8 8.4 3.7 11.6 2.4 9.2 64.0
Primorsky Territory 147.3 -4.3 -2.9 5.3 -0.8 6.1 27.9
Khabarovsk Territory 130.1 6.3 4.8 33.5 4.0 29.5 82.3
Amur Region 69.3 -0.5 -0.7 17.2 -4.1 21.3 619.1
Kamchatka Territory 83.4 -0.8 -1.0 10.3 1.1 9.2 -112.4
Magadan Region 38.8 1.5 3.9 55.4 3.3 52.1 83.4
Sakhalin Region 140.0 7.1 5.1 0.0 0.0 0.0 0.0
Jewish Autonomous Region 13.0 0.8 6.0 52.0 2.8 49.2 46.4
Chukotka Autonomous Okrug 31.5 1.4 4.4 5.0 -2.5 7.5 -56.0
Total 879.4 20.0 2.3 14.6 0.9 13.6 41.6
Total Russian Federation 12 363. 2 61.5 0.5 23.8 -0.1 23.9 -16.9
Source: own calculations based on the data released by the Federal Treasury.
In 2017, the consolidated budgets of 36 subjects of the Russian Federation ran a surplus (compared to 27 regions in 2016). These regions ran an overall budget surplus of RUB 133.3 billion, or 1.9 percent of the revenue side (RUB 197.8 billion, or 3.7 percent of the revenue side, in 2016). The median budget surplus value stood at 1.8 percent relative to the revenue side.
The biggest ratio of surplus to consolidated budget revenues was recorded in Kemerovo region - around 10.8 percent, Vologda region - 8.2 percent. In 2017, Kemerovo region accounted for 15.5 percent of the overall surplus of regional budgets that ran a surplus, and Krasnodarsky Krai - 13.2 percent, and Yamal-Nenets AO - 11.2 percent.
3.9.2. Debt structure
According to the data released by The Russian Finance Ministry, the debt accumulated by the subjects of the Russian Federation in 2017 contracted by RUB 37.8 billion to RUB 2.315,4 billion as the debt accumulated by municipalities rose by RUB 3.6 billion to RUB 368.0 billion (TTable 17)
Table 17
Volume and structure of debt of the subjects of the Russian Federation and debt of municipalities as of January 1, 2017 and 2018
Type of debt instruments Debt volume of RF subject, RUB million Municipalities debt volume, RUB million
2018 2017 increase/decrease 2018 to 2017, % 2018 2017 increase/decrease 2018 to 2017, %
Government securities 548 519.6 457 490.4 19.9 21 068.9 15 477.8 36.1
Loans issued by credit institutions, foreign banks and international financial organizations 666 961.2 808 509.1 -17.5 241 222.1 226 809.6 6.4
Public budget loans from other budgets of the budgetary system of the Russian Federation 1 010 337.7 990 494.1 2.0 90 429.9 103 751.3 -12.8
Government guarantees 81 535.6 88 297.2 -7.7 15 253.2 18 255.9 -16.4
Other debt instruments 8 050.3 8 400.5 -4.2 6.1 36.3 -83.3
Всего 2 315 404.5 2 353 191.2 -1.6 367 980.1 364 331.0 1.0
Source: own calculations based on the data released by the Federal Treasury.
Regions and municipalities borrowed in 2017 a total of RUB 2,939.6 billion. The top-ranked borrowers were Nizhniy Novgorod Region - RUB 202.8 billion, Omsk Region - RUB 140.5 billion, Novosibirsk Region - RUB 134.3 billion, Sverdlovsk Region - RUB 118.4 billion, Arkhangelsk region - RUB 112.9 billion, Volgograd region - RUB 101.4 billion, and Stavropol Territory - RUB 93.8 billion.
Securities issues accounted for 7.3 percent of the total consolidated regional budgets, loans from higher-level budgets (budget loans) constituted 39.9 percent thereof, loans from commercial banks and international credit institutions amounted to 52.8 percent thereof.
Total net debt of the consolidated regional budget was negative and constituted - RUB 10.4 billion. The highest ratio of net debt to budget revenues was recorded in the Republic of Mordovia - RUB 21.1 billion, and Orel region - 8.1 percent.
Largest net borrowers were: St. Petersburg - RUB 21.1 billion, the Republic of Mordovia -RUB 10.2 billion, Republic of Sakha (Yakutia) - RUB 5.4 billion, and Khabarovsk Territory -RUB 5.2 billion.
Regions had their accumulated debt reduced to the maximum extent by repaying more for outstanding debt instruments compared to new fundraising, were: Moscow-by RUB 27.1 billion, Krasnodar Territory - by RUB 11.8 billion, Kemerovo region - by RUB 6.1 billion, and Vologda region - by 5.2 billion
Table 18
Regional and local budgets net borrowing, as percent of GDP
Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net borrowing by sub-federal and local governments Including: 0.17 0.29 0.74 0.51 0.21 0.33 0.61 0.53 0.33 0.10 -0.01
Repayable loans from budgets of different levels -0.01 0.03 0.33 0.37 0.15 0.01 0.06 0.24 0.21 0.21 0.02
Sub-federal (municipal) bonds 0.08 0.17 0.24 0.07 -0.11 0.06 0.12 -0.01 -0.01 0.04 0.11
Other borrowings 0.10 0.09 0.17 0.07 0.17 0.26 0.43 0.30 0.13 -0.15 -0.14
Source: own calculations based on the data released by the Federal Treasury.
3.9.3. Domestic bond issues
Thirty four subjects of the Russian Federation and 3 municipalities had their bond prospectus registered in 2017 (as compared with 25 regions and 3 municipalities which issued bonds in 2016). The following regions had their bond prospectus registered with Russia's Ministry of Finance in 2017:
St. Petersburg, Krasnoyarsk and Krasnodar Territories, Republic of Sakha (Yakutia), Republic of Komi, Republic of Karelia, Republic of Mariy El, Republic of Chuvashia, Republic of Karachaevo-Cherkassia, Orenburg Region, Samara Region, Novosibirsk Region, Belgorod region, Yaroslavl region, Tambov region, Nizhny-Novgorod region, Sverdlovsk region, Tomsk region, Kaliningrad region, Irkutsk region, Volgograd region, Kursk region, Kemerovo region, Magadan region, Saratov region, Moscow region, Ivanovo region, Orel region, Kostroma region, Omsk region, Ulyanovsk region, Yamal-Nenets Autonomous District, Nenets Autonomous District, Khanty-Mansi Autonomous District - Yugra, city of Nizhny Novgorod, city of Novosibirsk, and city of Tomsk.
In 2016, the amount of placed bonds was RUB 215.3 billion, which is an increase of more than 34 percent in nominal terms compared to the level seen in 2016. Thus, sub-federal and municipal bond issues saw a YoY increase from 0.19 percent to 0.23 percent of GDP (Table 19).
Table 19
Amount of issued sub-federal and municipal bonds, as percent of GDP
Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Issue 0.26 0.43 0.41 0.25 0.10 0.19 0.23 0.16 0.12 0.19 0.23
Redemption 0.18 0.26 0.16 0.18 0.21 0.13 0.12 0.17 0.13 0.15 0.13
Net financing 0.08 0.17 0.24 0.07 -0.11 0.06 0.12 -0.01 -0.01 0.04 0.11
Source: own calculations based on the data released by Russia's Ministry of Finance.
The top-ranked bond issuers were St. Petersburg - RUB 30.1 billion, or 14.0% of total domestic bond issue, Krasnoyarsk Territory - RUB 17.8 billion, or 8.3 percent, and Nizhny Novgorod region - RUB 17.0 billion, or 7.9 percent.
Hence the top-3 issuers accounted for 30.2 percent of the total regional and municipal bonds placed (Table 20).
Table 20
Sub-federal and municipal bond placement in 2017
Subject of the Russian Federation Amount issued, rubles in millions Issuer's percentage of total amount issued, percent Amount issued to domestic borrowing ratio, percent
Central Federal Okrug
Belgorod region 4 000,0 1,9 31,0
Kursk region 1 300,0 0,6 4,4
Moscow region 12 500,0 5,8 16,7
Orel region 5 000,0 2,3 13,1
Tambov region 6 500,0 3,0 17,8
Yaroslavl region 10 000,0 4,6 14,9
North-West Federal Okrug
Republic of Karelia 2 000,0 0,9 6,9
Republic of Komi 10 000,0 4,6 11,2
Kaliningrad region 1 706,8 0,8 6,4
St. Petersburg 30 100,0 14,0 100,0
Nenets Autonomous District 625,5 0,3 8,4
South Federal District
Krasnodar Territory 10 000,0 4,6 17,4
Volgograd region 10 000,0 4,6 9,9
North-Caucasus Federal Okrug
Republic of Karachaevo-Cherkassia 1 748,6 0,8 12,6
Volga Federal Okrug
Republic of Mariy-El 2 000,0 0,9 11,6
Nizhniy Novgorod region 17 000,0 7,9 8,4
Samara region 10 000,0 4,6 18,1
Orenburg region 4 000,0 1,9 10,8
Saratov region 5 000,0 2,3 9,6
Ulyanovsk region 5 000,0 2,3 13,5
Urals Federal Okrug
Sverdlovsk region 9 950,0 4,6 8,4
Khanty-Mansi Autonomous District 7 000,0 3,3 76,4
Yamal-Nenets Autonomous District 1 000,1 0,5 90,9
Siberia Federal Okrug
Krasnoyarsk Territory 17 800,0 8,3 21,3
Kemerovo region 9 000,0 4,2 16,8
Novosibirsk region 10 000,0 4,6 7,4
Tomsk region 6 098,2 2,8 9,2
Far East Federal Okrug
Republic of Sakha (Yakutia) 5 000,0 2,3 19,1
Magadan region 1 000,0 0,5 4,6
Russian Federation — Total: 215 329,3 100,0 7,3
Source: own calculations based on the data released by Russia's Federal Treasury.
The highest level of securitization (79.8%) was observed in St. Petersburg -1 00 percent, and Yamal-Nenets Autonomous District - 90.9 percent.
In 2017, the amount of bonds issued by subjects of the Russian Federation and municipalities exceeded by RUB 97.0 billion the amount of redeemed securities, while in 2016 - RUB 32.0 billion (Table 21).
Table 21
Net borrowing in the domestic market for sub-federal and municipal bonds, rubles billion
Consolidated regional budget Regional budgets Municipal budgets
2017
Net borrowings 97.0 91.4 5.6
Attracted funds 215.3 205.2 10.1
Principal repayment 118.3 113.8 4.5
2016
Net borrowings 32.0 26.7 5.3
Attracted funds 160.5 153.6 6.8
Principal repayment 128.5 126.9 1.6
2015
Net borrowings -5.8 -7.1 1.3
Attracted funds 98.4 94.2 4.2
Principal repayment 104.3 101.4 2.9
2014
Net borrowings -9.2 -7.4 -1.8
Attracted funds 111.5 110.1 1.4
Principal repayment 120.7 117.5 3.2
2013
Net borrowings 77.6 75.4 2.2
Attracted funds 154.6 149.6 5.0
Principal repayment 77.0 74.2 2.8
2012
Net borrowings 38.2 36.8 1.3
Attracted funds 119.8 115.9 3.9
Principal repayment 81.7 79.2 2.5
2011
Net borrowings -58.2 -57.1 -1.1
Attracted funds 55.0 53.4 1.7
Principal repayment 113.2 110.5 2 .8
2010
Net borrowings 29.8 28.6 1.2
Attracted funds 111.1 105.8 5.2
Principal repayment 81.3 77.2 -4.1
2009
Net borrowings 95.5 97.9 -2.5
Attracted funds 158.1 154.0 4.1
Principal repayment 62.6 56.1 6.6
2008
Net borrowings 68.9 73.0 -4.1
Attracted funds 178.6 177.3 1.2
Principal repayment 109.7 104.3 5.4
2007
Net borrowings 25.9 23.7 2.2
Attracted funds 84.2 79.9 4.3
Principal repayment 58.3 56.2 2.1
Source: own calculations based on the data released by Russia's Federal Treasury.
Most of the regions that issue bonds on a regular basis continued doing so in 2017 (Table 22).
Table 22
Sub-federal and municipal bonds prospectus registration in 2007-2017
Issuer 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
1 2 3 4 5 6 7 8 9 10 11 12
Subjects of the Federation
Krasnoyarsk Territory * * * * * * * * * * *
Nizhniy Novgorod Region * * * * * * * * * * *
St. Petersburg * * * * * * * * * *
Cont'd
1 2 3 4 5 6 7 8 9 10 11 12
Tomsk Region * * * * * * * * * *
Republic of Sakha (Yakutia) * * * * * * * * * *
Yaroslavl Region * * * * * * * * * *
Republic of Komi * * * * * * * *
Republic of Karelia * * * * * * * * * *
Novosibirsk Region * * * * *
Omsk Region * * * *
Sverdlovsk Region * * * * * *
Hanty-Mansiysky Autonomous Okrug * * * * *
Irkutsk Region * * * * * * *
Moscow Region * * * *
Yamal-Nenets Autonomous District * *
Tambov Region * *
Volgograd Region * * * * * * * * * *
Krasnodar Territory * * * * *
Republic of Chuvashia * * * * * * * *
Republic of Mariy-El * * * *
Magadan Region * * *
Kemerovo Region * *
Ivanovo Region * * *
Ulyanovsk Region * * *
Nenets Autonomous District *
Kursk region *
Kaliningrad region *
Saratov region *
Orel region *
Republic of Karachaevo-Cherkessia *
Udmurt Republic * * * * * * * * *
Republic of Mordovia * * * *
Republic of Khakassia * * * * * *
Stavropol Territory * * * * * *
Tyumen region *
Tver region * * * * * * * *
Lipetsk region * * * * *
Voronezh region * * * *
Smolensk region * *
Leningrad region * *
Republic of Bashkortostan * * * * * *
Tula region * * * *
Kostroma region * * *
Moscow * * * *
Kaluga region * * * *
Vologda region * *
Ryazan region * *
Republic of Buryatia *
Murmansk region *
Penza region * *
Kurgan region *
Republic of Kalmykia *
Khabarovsk Territory
Republic of Kabardino-Balkaria
Briansk region
Sakhalin region
Primorsky Territory
Municipalities
City of Novosibirsk * * * * * * * *
City of Tomsk * * * * * * * *
City of Nizhniy Novgorod *
City of Omsk * *
City Volzhsky, Volgograd region *
City of Krasnoyarsk * * * * * *
Cont'd
1 2 3 4 5 6 7 8 9 10 11 12
City of Kazan * * * *
City of Krasnodar * *
City of Ufa *
City of Elekrostal, Moscow region * *
City of Smolensk *
City of Lipetsk * *
City of Magadan * *
City of Bratsk *
City of Novorossiysk *
City of Ekaterinburg *
Klin district, Moscow region *
Noginsk district, Moscow region *
City of Blagoveshensk *
City of Cheboksary *
City of Balashikha, Moscow region *
Odintsovo district, Moscow region
City of Astrakhan
City of Briansk
City of Voronezh
City of Orekhovo-Zuevo, Moscow region
City of Yaroslavl
City of Voronezh
City of Yuzhno-Sakhalinsk
City of Novocheboksarsk
City of Angarsk
Vurnarsky distric, Republic of Chuvashia
City of Shumelia, Republic of Chuvashia
City of Barnaul
City of Perm
City of Kostroma
City of Arkhangelsk
City of Dzerzhinsky
Source: Ministry of Finance of the Russian Federation.
3.10. Russia's banking sector1
3.10.1. Banking sector's main development trends
In 2017, banking sector demonstrated moderate development trends across main indicators. Asset holdings went up by 6 percent during the year somewhat below nominal growth rate of Russia's GDP. The ratio of banks' asset holdings and annual GDP remained at 91-92 percent for the second year in a row (Fig. 55).
The number of lending institutions decreased by 56 from 623 to 567 during the year. The process whereby some of the credit institutions were forced out of the market on the grounds of failing to meet the regulator's requirements notably slowed down. Around fifty banking licenses were revoked in 2017 - half of what was seen in 2015 and 2016 when ninety banking licenses were revoked annually.
1 This section is written by Mikhail Khromov, the Gaidar Institute, IAES-RANEPA.
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
■ ■ Asset holdings relative to GDP ■ ■ Loans relative to GDP
Asset holdings growth rate (right-hand scale)
Fig. 55. Banks' asset holdings growth rate and banking sector size relative to Russian economy size, percent
Sources: Bank of Russia, Rosstat, own calculations.
3.10.2. Update of regulation procedure for bank resolution mechanism
The resolution of Bank Otkrytie FC will be the first case of applying a recently introduced new mechanism for the resolution of commercial banks. The mechanism enables the Bank of Russia to control more efficiently bank resolution costs and can tilt the balance between banking license revocation and solvency recovery in favour of the latter.
For the entire H2 2017, bank resolution mechanisms were applied to five banks, three of which were major Russian private banks, namely Bank Otkrytie FC, Promsviazbank, and Binbank.
Amendments to the federal law were adopted in spring 2017, which regulate procedures for bank resolution mechanisms.
New regulations securing an alternative mechanism for the resolution (solvency recovery) of banks are in force since June 2017. For this purpose the Bank of Russia has established an entity, the Fund for Banking Sector Consolidation (FBSC), and set up a FBSC management company fully controlled by the Bank of Russia. The updated mechanism has been proclaimed to be designed primarily for curtailing bank resolution costs and for increasing control over spending of appropriated resources.
Until recently bank resolutions have been performed basically at the cost of the Bank of Russia, involving Deposit Insurance Agency (DIA) and investing banks that are interested in bailing out a given bank so that it can develop its business. Quite often, however, investing banks used the money allotted for bank resolution for the purpose of their own business development. The new bank resolution mechanism prevents using the money prior to selling the rescued bank. Thus two elements - the DIA and the investing bank - have been removed
from the chain of financial aid for rescued banks and replaced with the management company controlled by the Bank of Russia
What are the DIA's provisional results concerning procedures for the recovery of Russian banks' solvency? As at 1 August 2017, the Deposit Insurance Agency was involved in recovering solvency of 26 banks using the old procedure. Bank resolution procedures had been completed by the same date for another 20 banks. As a result of such procedures, rescued banks generally affiliated with investing banks. As at 1 July 2017, the Deposit Insurance Agency allotted more than RUB 1.2 trillion in banks' solvency recovery procedures, most of which (RUB 1.14 trillion) were provided in the form of repayable loans from the Bank of Russia. Furthermore, actual maturity dates for such loans may be found to be long-term enough. DIA's repayments to the Bank of Russia within the bank resolution procedures in place have so far been less frequent than new loans. The DIA's debt in H1 2017 increased more than RUB 70 billion. Moreover, this happened under the circumstances when solvency recovery procedures had not yet started for new banks. There were only two such banks in 2016-H1 2017, one (Peresvet Bank) of which was already subject to a preliminary moratorium on the repayment of creditors' claims, that is, the insured event occurred from the perspective of the deposit insurance framework.
What should be kept in mind is that the financing of bank resolution procedures is just one of the channels available for crediting the DIA by the Bank of Russia. The DIA's core function - to provide insurance for retail bank deposits and to ensure that the depositors of shutdown banks are repaid on a continuous basis - is loss making. The Mandatory Deposit Insurance Fund ran out of its own money as early as summer 2015. Today, the deficit of the deposit insurance framework is covered by Bank of Russia's loans, with a credit limit being updated on a regular basis. At half-year (2017) end, the existing agreement between DIA and the Bank of Russia envisages to allocate RUB 820 billion, of which only RUB 657 billion were received. Over six months of 2017, the Ban k of Russian actually allocated around RUB 108 billion for assistance to the deposit insurance system.
The ratio of these two items of Bank of Russia's spending on the DIA - on bank resolution and on payments to depositors - can be a criterion for making a decision on banking license revocation or for making attempts to revive a bank. As long as the Mandatory Deposit Insurance Fund is able to cover payments to depositors, the decision-making on resolution of a given bank, particularly a big enough bank, could be a way to continue running a deficit-free deposit insurance framework. These considerations have not been applied since summer 2015 until now because both processes - deposit insurance and bank resolution - have been financed in a similar manner, that is, through the Bank of Russia's loan to the Deposit Insurance Agency. Within the new bank resolution mechanism framework the Bank of Russia is supposed to increase its control over spending on solvency recovery of troubled banks, and therefore it may be assumed that bank resolution would be a more preferable regulatory tool than banking license revocation when it comes to controversial cases
The Bank of Russia decided 29 August to implement policies aimed at increasing the financial sustainability of Bank Otkrytie FC. Otkrytie thus became the first bank in which the new bank resolution mechanism was applied just two weeks after the Bank of Russia's new regulations came into effect. Although no exact amount of the required aid has to date been announced, such an amount may be much bigger than what the Bank of Russia allocated in H1 2017 for bank resolution procedures. The Bank of Moscow project is still the largest ever
solvency recovery project worth almost RUB 300 billion in 2011. The Otkrytie rescue project has very good chances to hit a new all-time high.
It is safe to say, on the one hand, that as a result of this operation the Russian banking market would de facto miss a private player until the Otkrytie package is sold at a public auction. Until then the rescued bank will be managed by the regulator, with its development strategy being determined by regulator's actions. Indeed, this will have a strong effect on the market because Otkrytie has been a country's largest private bank over the past two years. However, an attempt to save a top private bank seems rather a step towards promoting competition in the banking market in the long term. Had the Otkrytie's banking license been revoked, top state-owned banks would have had a big share of retail deposits.
What in this case should be regarded as definitely negative signal is that this has secured the 'too big to fail' concept in the Russian banking market. Let us recall the liquidity crisis of 2004 at Alfa Bank, representing the then largest private bank in Russia, facing a drastic deposit outflow. No deposit insurance framework was in place at that time. To prevent panic among customers and to compensate the owners for liquidity loss, the bank owners had to use their own money to prop up the bank in short order. The owners of Otkrytie seemed to have neither money nor incentives to save the bank in 2017. The bank's customers however received a signal from the regulator suggesting that their money will be intact regardless of the quality of management and whether or not the owners want to keep the bank alive. This indeed was a positive fact for the Otkrytie's customers, whereas the same fact is quite negative in terms of management of risks that may affect the financial system in the long term.
3.10.3. Banking sector financial result
The deceleration in the banking profit was caused by large losses in banks that were placed under financial recovery. The biggest banks continue accumulating the major share of profits among operating banks. Moreover, the yield from regular banking operations remains rather volatile.
The Russian banking sector ran a book profit of RUB 790 billion as of the 217 year-end, which was 15 percent less than a year earlier. The annualized return on assets (ROA) down from 1.1 percent to 1.0 percent and return on equity (ROE) down from 13.2 percent to 10.4 percent.
As we noted a year earlier, the banking sector profitability remains lower than what it was during the pre-crisis period of 2011-2012 and especially with the period of 2005-2007 when Russia's banking sector boasted of the highest investment attractiveness.
The deceleration in the banking sector growth rates in 2017 was caused by losses in large banks that were placed under financial recovery in Q3 2017. As of the end of three quarters of 2017, there were top four loss-making banks, namely Bank Otkritie FC (-RUB 279.3 billion), Rost Bank (-RUB 82.8 billion), Trust Bank1 (-RUB 72.9 billion) and Binbank (-RUB 31.9 billion), making a total of -RUB 466 billion. These banks were loss making at year-end as a whole. However, starting with bank resolution Bank of Russia stopped opening their books. Moreover, in December resolution was opened regarding another large private bank -Promslyazbank. Its financial result as of 2017 year-end also turned out to be negative
1 Financial recovery procedure for Trust Bank commenced as early as 2014, with active involvement of Bank Otkritie FC. This affiliation enables us to include Trust Bank in the group of banks that were placed under resolution in Q3 2017
The losses emerged following the appointment of provisional administration to the banks -a compulsory procedure as part of the financial recovery (resolution) process - moving a great deal of assets to higher risk categories, which required immediate increase in provisions for losses on such assets. Therefore, the banks had to spend more on increasing their provisions, thus deteriorating their financial performance figures. The financial performance figures were satisfactory enough until financial recovery came into force
For instance, Bank Otkritie FC, which was placed under resolution on 29 August 2017, reported a profit of RUB 7.1 billion as of the end of July 2017, whereas RUB 31.8 billion in losses were recorded shortly after in August. The primary negative financial performance results of RUB 254.5 billion were posted in September.
Binbank and Rost Bank, which were placed under financial recovery on 20 September 2017, were officially considered as profit-makers (RUB 2.1 billion and RUB 1.3 billion, respectively) as early as late August 2017, whereas substantial losses were recorded in September.
Trust Bank has disclosed its financial reports on an irregular basis since its resolution in December 2014. Its financial performance figures were most likely negative throughout the entire period of financial recovery. For example, the bank posted RUB 9.6 billion in losses as of the end of the first three quarters of 2016.
The banking sector profitability was heavily affected by the performance figures of problem banks, showing considerable growth in costs on loan loss provisions that increased RUB 605 billion during the first three quarters of 2017, including an increase of RUB 370 billion in September alone. The banking sector posted an increase of RUB 361 billion in loan loss provisions as of the end of the first three quarters of 2016.
The banking sector profit related to the revaluation of foreign exchange accounts turned out to be zero over the first three quarters of 2017, whereas bank losses totalled RUB 42 billion as a result of exchange rate dynamics over the same period previous year (Fig. 56).
• ■ Profit before provisions formation ^Z^l Increase in provisions for possible losses After-tax profit
Fig. 56. Principal components of bank profit, billions of roubles Source: Bank of Russia, own calculations.
Thus profit from regular banking operations in January-September 2017 amounted to RUB 1,279 billion, up by 28 percent from RUB 996 billion a year earlier. The result could have been regarded as a positive signal if it were not for the fact that profit from regular banking operations remains volatile enough. The profit from regular banking operations in January-September 2015 was higher than what it was over the first three quarters of 2016. The profit varied during the first nine months of 2017, from RUB 207 billion in January 2017 to RUB 47 billion in September.
The sharp decline in the performance figures of banks under resolution gives evidence of long-brewing problems facing the banks. This leads to a conclusion that the financial statements of these banks released shortly before the commencement of financial recovery contradicted the reality. This brings some scepticism towards the performance figures of other banks. The Bank of Russia, as a banking market regulator, de facto has turned out to have limited control over financial status of most banks.
Therefore, there is close relationship between Russian banking sector's financial performance figures and its high concentration, when financial performance figures of some banks, including also smaller banks, can have a strong effect on the entire banking sector. Excluding the top four loss-making banks, the rest of the banks reached a profit of RUB 1,141 billion in January-September 2017, up 80 percent from the same period of 2016.
Another aspect of such a concentration is a persistently big number of state-run banks. For instance, the four biggest state-run banks (Sberbank, VTB, VTB24 and Gazprombank) ran a profit of RUB 675 billion during the first three quarters of 2017, which means that the entire banking sector profit was generated by state-run banks. A significant contribution of state-run banks to the banking sector profit reflects their leading position in the market. Therefore, by accumulating a great deal of financial resources for equity build-up, these banks have a bigger development potential than private banks. A kind of vicious circle is therefore developing. Low profitability of private banks discourage their owners to increase equity, thus securing their subordinate position to the public segment of the banking sector.
3.10.4. Interaction between banks and households
Recovery of consumer lending has facilitated growth in final consumption expenditures and brought about stability of households' savings amid the ongoing decline in real income. However, in the long-term prospect this situation will put at risk both the financial stability of households and the resource base of the banking sector.
In 2017, households' budgets were formed amid the ongoing stagnation of real incomes. During 2017, households' cash incomes rose in nominal terms by 2.5 percent, however, in real terms they turned out to be 1.1 percent lower than a year earlier. In the same period, households' real disposable cash income fell even further by 1.7%.
Despite weak cash income growth in nominal terms, final consumption expenditures increased both in nominal and real terms. The volume of consumption in nominal terms rose by 5.3 percent notably outstripping income growth rates. Final consumption expenditure growth rates came to 1.1 percent in 2017. The share of expenditures on final consumption in the total volume of households' cash incomes amounted to 72.3 percent, which is 2.0 percentage points higher against 2016.
In 2017, households' savings saw mixed dynamics as regards various components thereof. In 2017, households' bank deposits increased by RUB 1.9 trillion, down 18.2 percent compared to the previous year. In 2016 savings on individuals' bank accounts and deposits rose by
RUB 2.3 trillion. In addition, the share of households' incomes used for replenishment of bank accounts fell from 4.3 percent in 2016 to 3.4 percent 2017.
The fall in the households' cash inflow into banks affected both ruble deposits and, to a greater extent, accounts and deposits denominated in foreign currency. In 2017, the cash inflow to retail ruble accounts and deposits with Russian banks amounted to RUB 2.3 trillion unchanged compared to 2016. Dynamics of deposits denominated in foreign currency (with adjustment to the exchange rate revaluation) were already close to zero in 2016. In 2016, growth of foreign currency deposits constituted in ruble equivalent 52 trillion. In 2017, the decrease of bank deposits denominated in foreign currency constituted RUB 388 billion, constituting mora than 7 percent of the total households' accounts and deposits denominated in foreign currency in Russian banks.
Against the background of deceleration of personal cash inflow into banks, cash turnover has picked up both in rubles and in foreign currency. Monetary aggregate M0 (physical paper and coin) increased over 2017 by RUB 731 billion up 54 percent against 2016.
The volume of foreign currency in cash notably increased in 2017. Over the year, the volume of foreign currency in cash went up by USD 11.8 billion. A year earlier, purchases of foreign currency were less by 60 percent-around USD 7.5 billion. However, in our view it would be premature to speak about substantial growth in foreign currency predominance. A larger portion of growth in foreign cash can be explained by the abovementioned reduction of foreign currency deposits with banks. In 2017, the aggregate deposits denominated in foreign currency (both cash and non-cash) turned out to be lower than a year before.
A greater appeal of cash as compared to bank deposits can be explained by a sustained decrease in interest on bank deposits. Therefore, as regards annual ruble deposits the average interest rate fell from 7.1 percent per annum in 2016 to 6.0 percent per annum in 2017. As regards annual ruble deposits, the reduction was even more dramatic (from 8.6% to 7.0% per annum).
The interest on foreign currency deposits fell notably. If in 2016 USD deposits could yield 1.2-2.1 percent per annum, in 2017 they earned only 0.7-1.4 percent. The interest on annual euro deposits constituted solely 0.3 percent compared to 0.7 percent in 2016.
Against the background of low interest on bank deposits households do not see any difference between keeping cash or have a bank deposit. By choosing the cash mode of savings in foreign currency, the depositor avoids risks related to the Russian banking sector, primarily, the risk of a bank license being revoked and the need to purchase foreign currency again and loose on the exchange rate transaction. It is noteworthy that deposits are compensated in rubles only.
As regards ruble deposits, the effect of the interest rate decrease happened to be less significant, but even in this segment households in general were less motivated to keep money on bank accounts.
Nevertheless, total amount of households' bank deposits and cash at 2017 year-end moved up by 9.2 percent from RUB 34.4 to 37.7 trillion.
Recovery of bank lending has become the main factor both behind growth in households' consumption expenditure and maintaining behavior of savings in 2017.
Personal debt on bank loans over 2017 up RUB 1.4 trillion, nearly 8-fold more than a year earlier (RUB 177 billion). Outstanding debt growth vis-à-vis households' cash income up from 0.3 percent seen in 2016 to 2.5 percent in 2017.
Consumer landing was the main contributor to the expansion of the loan portfolio. In this money market segment, the sustained decline of the debt gave way to its growth in March 2017. As a result, over 2017, households' consumer lending debt to banks rose by RUB 0.68 trillion following a drop of RUB 0.34 trillion in 2016.
Mortgages also demonstrate positive dynamics. Over the year, households' mortgage debt up RUB 0.68 trillion against RUB 0.52 trillion seen in 2016.
It appears that in the near future the existing situation with households' finances and relations between banks and households will stay highly unstable.
Firstly, as was stated above, consumption growth and even stability of households' savings are underpinned by growth in borrowed funds, rather than higher incomes. This source of households' well-being can be regarded only as a temporary one. In the long-term, any loan reduces the nominal value of households' disposable income by the value of interest payments. It means that amid a lack of sustainable cash income growth active refinancing of loan debts is inevitable. Probably, such a process is already underway driven by falling loan interest rates. However, reduction of interest rates has its own limits and both for borrowers and lenders it is crucially important that by the time when interest rates cease to go down the Russian economy could embark on the trajectory of sustainable growth ensuring a substantial increase in households' real incomes.
Secondly, in 2017 households ceased to be net creditor of the banking sector: growth in accounts payable turned out to be higher than that in deposits growth. The situation is likely to change for the better in December when bank deposits demonstrate notable growth by virtue of seasonal factors. However, generally, for banks such a trend means a loss of one of the most stable sources of their liabilities. Amid reduction of external borrowing volumes, corporate lending which is less profitable as compared to the retail one will continue to stagnate.
3.10.5. Bank lending as the main source of financing Russian economy
Corporate lending in Russia exhibited sings of buoyancy in 2017. New corporate bank loans have reached higher nominal volumes than prior to the crisis. Most importantly, the ratio of lending to economic activity volumes has also increased, albeit not higher than pre-crisis values. The quality of credit portfolios owing to large banks resolution does not provide visible improvements.
During 2017, banks issued new corporate loans worth RUB 38.4 trillion, up 8.1 percent from the previous year. At the same time, 2017 so far has not become a record one in new corporate loans issued - 2014 results were a little bit higher in nominal terms - RUB 38.53 trillion.
The rise in the lending market in 2017 was generally triggered by the increase in both ruble and foreign currency loans. Over the year, banks issued ruble loans worth RUB 34.8 trillion, up 7.5 percent from the previous year. The increase in foreign currency loans was more impressive. During 2017, banks increased foreign currency corporate loans by 29.4 percent in ruble terms and 8.1 percent in dollar terms.
However, the share of foreign currency loans remains small. In 2017, banks issued loans to the tune of USD 62 billion or RUB 3.6 trillion in ruble equivalent that constituted less than 10 percent of total new loans.
The loan market recovery has been seen not only in nominal terms but, most importantly, also in the size of economic activity. Over 2017, the volume of corporate bank loans reached 25.1 percent of companies' turnover against 24.2 percent a year earlier. However, the today's
ratio of lending to economic activity in the lending market is far behind the ratios seen in previous periods. At 2013 year-end, the ratio reached 30.4 percent (Fig. 57).
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The upsurge in new loans has naturally led to a recovery in outstanding corporate bank loans. During 2017, total outstanding bank loans up 4.9 percent with adjustment to loans issued in foreign currency, meanwhile in 2016, outstanding debt shrank by 0.1 percent (Fig. 58).
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Fig. 58. Dynamics of corporate bank loans growth for 12 months
Sources: Bank of Russia, own calculations.
Current state of the corporate loan portfolio quality so far does not allow to speak about notable improvements. Over 2017, the share of outstanding loans in the total volume of
outstanding corporate bank loans contracted merely by 0.2 percentage point from 6.1 percent as of January 1, 2017 to 5.9 percent as of January 1, 2018.
Moreover, foreign-currency components of overdue loans exhibited mixed dynamics. The share of overdue ruble loans in total outstanding ruble loans dropped by 0.5 percentage point during 2017, whereas the share of overdue foreign currency loans shrank by merely 0.1 percentage point. This is due to the overall decline in outstanding foreign currency loans, in front of which the proportion of "bad" foreign currency loans becomes bigger.
A negative factor is the recovered growth in the ratio of loan loss provisions to total credit outstanding was due to large banks resolution, additionally quality of the credit portfolio deteriorates. Most likely, this issue can solely be resolved surgically - by keeping bad loans off the resolution banks' banker books, for example, through setting up of toxic debt funds and dumping bad assets of resolution banks onto the funds balance sheets.
Percentage of overdue corporate bank loans Corporate loan loss provisions
Fig. 59. Values of quality of bank corporate credit portfolio, percent Sources: Bank of Russia, own calculations.
