Financial and Investment Decision Making in Russia

1
Financial and Investment Decision Making in Russia

• Dr. Ivan Darushin
• The Department of Credit Theory and Financial
  Management
• St-Petersburg State University

2
Investments

• In finance, the purchase of a financial product
  or other item of value with an expectation of
  favorable future returns.
• In general terms, investment means the use money
  in the hope of making more money.
• In business, the purchase by a producer of a
  physical good, such as durable equipment or
  inventory, in the hope of improving future
  business.

3
Short-term investments

• An account in the current assets section of a
  company's balance sheet. This account contains
  any investments that a company has made that will
  expire within one year. For the most part, these
  accounts contain stocks and bonds that can be
  liquidated fairly quickly.
• Most companies in a strong cash position have
  a short-term investments account on the balance
  sheet. This means that a company can afford to
  invest excess cash in stocks and bonds to earn
  higher interest than what would be earned from a
  normal savings account.

4
Long-term investments

• An account on the asset side of a
  company's balance sheet that represents the
  investments that a company intends to hold for
  more than a year. They may include stocks, bonds,
  real estate and cash.
• The long-term investments account differs largely
  from the short-term investments account in that
  the short-term investments will most likely be
  sold, as the long-term investments may never be
  sold.

5
Investing ways
6
Main foreign economy features concerned with
investing abroad

• the securities market and it characters
• the accounting and taxation features
• banking characters
• limitations on direct investments.

7
Russian Securities and Derivatives Markets
8
General plan

• Definitions
• Foundation of the market (1991-1992)
• Privatization in Russia (1992-1994)
• Financial and stock crisis in 1998
• Current state of the Russian securities market
• legal regulation of market
• important market features
• disparities of stock relations
• Derivatives market

9
Definitions

• Security is a legal form document which secure
  the totality of interests and non-property
  rights. Realization and delivery of these rights
  are possible with the security presentation.
• (Civil Code, 1994)

10
Securities market

• Securities market is a part of capital market
  (the market of debts issued for one or more
  years)
• Some securities are circulate on the money market
  (market of debts with less maturity than one
  year)

11
Securities market

• Primary market (deals between the issuer and the
  first investor)
• Secondary market (deals between investors)
• Stock market (deals are arranged on the stock
  exchange)
• Over-the-counter (OTC) market (deals are arranged
  outside of stock exchange)

12
Securities market

• Cash market deal arranges and executes at the
  one period (delivery of securities can lag from
  arrangement up to 3 days)
• Derivatives market execution of the deal take
  place in some long period (from some weeks up to
  some years)

13
Securities

• Debts securities (bills, bonds, certificates,
  etc.)
• Equity securities (shares)
• Derivatives (forwards, futures, options, swaps)

14
Securities

• Government securities (government bills and
  bonds)
• Municipal securities
• Corporate securities (shares, bills, bonds)
• Bank securities (certificates)

15
Securities

• Short-term (bills, certificates) up to 1 year
• Medium-term up to 3-5 years
• Long-term up to 10-15 years
• Perpetual (shares) without the maturity

16
Participants of securities market

• Issuers
• Investors
• Regulators
• Institutional investors (funds, unit investment
  trusts, etc)
• Professionals of the market
• brokers
• dealers
• registrars
• clearing houses
• depositaries
• organizers of deals (stock exchanges)

17
Role of market

• Securities connect lenders of capital (investors)
  with borrowers of free capital (issuers).
• Professionals provide help in deal arrangement
  for investors and issuers.
• Regulator establishes rules for other participants

18
Its of importance

• Securities market works properly if
• regulator established the rules
• different types of securities exist
• professionals work properly
• market execute it main role (connection of
  investors and issuers)

19
The state of the Russian economy in the beginning
of 1990th years

• High Rate of inflation
• 800 - 1991
• 2600 - 1992
• High level of state budget deficit
• Overissue of money
• Deficit of funds
• High level demand for short-term credits
• Permanent growth of interest rates (1-2 per
  month)
• Lowering of gold and exchange currency reserves
• Repayment of state credits by issuing of new
  loans
• Summary crisis of the economy and the finance
  system

20
The first analogues of the Russian securities.

• Hyperinflation
• constant necessity of funds
• use of money substitutes
• bills of exchange
• banks payment obligations
• clearing house checks
• various coupons
• wage payment by production of enterprises
• Summary All of these are the first Russian
  securities.
• In fact its quasi-money.

21
Debt instruments and government papers in 1991

• 1987 certificates for natural persons
  (Sberbank)
• 1989 state Exchequer Stock to bearer
• 1990 state premium bonds for natural persons
• 1990 loan of Finance Ministry for legal persons
  (5, 8 and 10 years)
• 1991 Government internal loan (15, 30 years)
  for legal persons
• 1992 bonds of Russian internal lottery-loan
• Summary market is present but not large.
• Secondary market is absent.

22
Market of shares

• In the USSR shares market was absent.
• 1988 enterprises were aloud to issue shares of
  labor collectives for the workers and shares of
  enterprise for legal persons.
• Only conditionally shares (dividend is paying
  from development fund).
• Since 1990 market enlarges
• new joint-stock companies, banks and exchanges
• reorganization of public industries (its
  necessary to obtain a permit of Government).
• Totally legal vacuum

23
Shares of exchanges, enterprises and banks

• In the end of 1991 shares take 35.7 of stock
  market.
• 25.8 - shares of exchanges
• 5.4 - shares of banks
• 3.3. - shares of firms
• 2.1 - shares of investments companies
• 2 - industrial enterprises

24
Other stock instruments

• First bonds of private companies 1991
• - in the end of 1991 2.1 of stock market
• First certificates of deposit 1991
• (Sberbank, AvtoBank)
• First derivatives 1991
• (futures and options)
• Summary stock market with different types of
  papers appeared by the end of 1991.

25
Stock market in 1992

• Stagnation of shares market (only 59 enterprises
  were reorganized into joint-stock companies)
• Growth of the certificates of deposit market (28
  of stock market volume)
• Growth of the bills market (issued by banks)
• First emission of municipal bonds (Moscow region)
• Evenly securities dont play the role of an
  investment instrument. The volume of trade
  doesnt correspond with the economy proportions.
• Main opposition high rate of state sector of
  economy
• Solution privatization

26
Small privatization in 1992

• To privatize in the first place
• Trade firms
• Public catering establishments
• Transport companies
• Agricultural enterprises
• Large-scale enterprises can prepare for
  privatization.
• Primary intent increase of the budget income,
  financial stabilization ? highest possible
  valuation.
• Opposition a wide range of privileges for
  workers
• Results 3701 companies were privatized in 1992
  (more than a half were reorganized into
  joint-stock companies)

27
Stock market in 1991-1992 (totals)

• Laid foundations of the market legal regulation
• Appearance of the first professional participants
  (brokers, dealers, etc)
• Beginning of licensing of professional activities
• Appearance and testing of different types of
  securities (shares, bonds, bills, certificates,
  etc)
• Training of potential investors for work with
  securities (including psychological factors)

28
Program of wide privatization

• Government program of privatization, 1992
• Methods of privatization (by the program)
• Shares selling (joint-stock companies)
• Auction selling of enterprises
• Selling by commercial contest
• Investment auction
• Asset selling of companies to be liquidated
• Redemption of leasehold

29
Program of wide privatization (2)

• To privatize until the end of 1994
• 60 of enterprises in light industry,
  agricultural, transporting, retail trade and
  consumer services
• 50 of enterprises in food industry, building,
  wholesales trade and catering
• Total sum of assets 72 billion rubles

30
Program of wide privatization (3)

• Three groups of companies
• fewer than 200 workers and fewer than 1 million
  rubles capital value selling by auction or
  contest
• more than 1000 workers and more than 50 million
  rubles capital value reorganization to
  joint-stock companies and selling of shares
• other companies any method.

31
Program of wide privatization (4)Tree variants
of privatization
Category of share Type of share Quantity of shares (by variants), Quantity of shares (by variants), Quantity of shares (by variants),
Category of share Type of share 1 2 3
preference A B 25 30 - 19 - 30
ordinaries at a cut price normal price with option works fund State fund 10 - 5 10 20 - 51 - 10 20 20 - 20 10 20
32
Characteristics of gold share

• 3 years veto in the following cases
• Modifications of articles of the association
• Reorganization and liquidation of the company
• Interest in another business
• Pawning, renting and selling of privatized
  property.
• Gold share is a state property only.
• In cases of sell its transformed at the ordinary
  share.
• Repealed in 1997.

33
Voucher privatization

• First security for the mass voucher
  (privatization check).
• Characteristics
• Nominal 10 000 rub
• To bearer
• Secured by the state property.
• Utilization
• to pay for shares (in the process of
  privatization)
• to buy securities on the voucher auctions
• to sell (free circulation)

34
Russian voucher

• Different prices
• Market price (from 4000 rub in April 2003 to
  45000 rub in December 2003)
• Nominal price used only in the process of
  privatization (exchange at face-value)
• Auction price (quantity of shares exchanged for a
  voucher)
• by request without a quantity of shares
• by request with the minimum quantity of shares

35
The results of the voucher privatization

• Wide variety of shares (June 1994 104 000
  companies privatized, shares of 16000 joint-stock
  companies sold)
• Large quantity of shareholders (more than 40
  million)
• Accelerated formation of securities market
• Paltry incomes from privatization (about 1000
  billions of rubles by November 1994)
• Waste of the state property and control (500 of
  the biggest companies with evaluative
  capitalization of USD 200 billions were sold for
  USD 7.2 billions)

36
The part of the voucher privatization in the
stock market formation

• Increase of the market volumes
• Approved technology of securities trading
• Rapid growth of secondary shares market
• Growth of authorized capital stock (existent
  corporations issue excess shares)
• Creating of the market institutional participants
  structure (investment funds, financial companies,
  etc)
• Every citizen became a participant of the
  securities market
• Stratification of society

37
Legal control of the stock market

• Federal Law On the securities market, 1996
• Definition of securities
• Procedure of issue and registration
• Professionals of the market
• Federal authority of the market regulation
• Professional associations of market participants

38
Federal Committee of the Securities
Market(Federal Financial Markets
Service)www.ffms.ru

• Licensing of professional activity
• Standards of professional activity
• Registration of emission advertisement
• Registration of emission results
• Protection of placement owners rights
• Control of market functioning
• Rights and obligations of Professional
  associations of market participants

39
Professional associations of market participants
(self-regulated organizations)

• NAUFOR - National Association of Stock Market
  Participants www.naufor.ru (1996) market
  regulation, making out of the foundations of
  professional ethics, legislative control (about
  2000 participants).
• PARTAD - Professional Association of Registrars,
  Transfer Agents and Depositories www.partad.ru
  (1994) creating the infrastructure of stock
  market, elaboration of information efficiency and
  software support.

40
Creation of RTS

• RTS Russian Trading System, created by NAUFOR
  and NASDAQ in 1995. www.rts.ru
• Main features
• Full computerized trading system
• Steady trading
• Participants arrange the deals from remote
  stations
• Large quantity of securities
• Nowadays biggest stock exchange in Russia (more
  than 65 of stock deals in Russia)
• has an organized sector (listing, securities of
  biggest companies)
• and a secondary sector (shares of small
  companies, without listing procedure)
• and a derivative sector (futures and options on
  shares, index and currency) www.forts.ru

41
Privatization in 1997-1998

• Continuing selling of shares in state property
• however
• 12 000 companies in state property (in the end of
  1998)
• 2 500 control packets of shares
• 5 000 non-control share holdings
• and
• only 30 millions of dollars in the form of
  dividend
• (ineffective management)

42
Totals of 1992-1997 years

• Accelerated creation of the Russian shares market
  (by emission of shares of privatized companies)
• Rapid growth of the secondary market
• Legal regulation of the market
• Formed structure of market professionals and
  market infrastructure

43
Preconditions of the stock market crisis

• Asian financial crisis
• Growth of Russian market risks
• Stagnation of production in 1998 (decrease of GDP
  on 0.2)
• Extension of the budget deficit (collected taxes
  are 40 of budget plan in 1998)
• Decrease of the export volume
• Red ink of the payment balance
• High value of the public debt service (issuing of
  new debts to liquidate the previous debts)

44
GKO and state budget deficit

• Financing of budget deficit by issuing of State
  Short-term Obligations (GKO) since 1993
• Rapid growth of public debts volume (by GKO
  issuing)
• High interest of GKO (7-8 per month in currency)
• High value of the public debt service
• 10.1 of on-budget expenditures in 1996
• 35.2 - in 1998
• Debt money turned to liquidate previous debts
• (Financial pyramid of GKO)

45
Default of August 18th

• Termination of GKO trading
• Restructuring of GKO debts to the new securities
• Total sum of debts 45 billions of dollars
• 31 - foreign investors
• Cancellation of currency corridor (national
  system of currency regulation)
• devaluation of ruble (5 times in 2 months)
• crisis of the payment and banking systems
• crisis of the securities market

46
Crisis of the stock market in 1998

• Decrease of securities prices (RTS-index decline
  3 times in 2 months)
• Decrease of trading volumes

47
Positive points of 1998 crisis

• the rouble devaluation created preconditions for
  growth of the national production and,
  consequently, for development of the financial
  market
• bankruptcies of ineffective enterprises took
  place the number of the traders on the
  securities market decreased
• spare cash assets were moved from the state
  sector of economy to the corporate one (the high
  interests on GKOs had distimulated investments in
  the private sector)

48
Program of GKO debts restructuring

• Joint resolution of Ministry of Finance and
  Moscow Club of creditors.
• For banks
• 10 - by funds
• 20 - by shares
• 70 - long-term state bonds
• For other companies
• 30 - by funds
• 20 - by shares
• 50 - long-term state bonds
• To natural persons, pension funds, nonprofit
  organizations
• 100 repayment of money or 2nd method

49
The results of the crisis

• It can be considered that by the present time the
  Russian securities market has overcome the
  consequences of the 1998 crisis. The development
  of the securities market took place in favourable
  macroeconomic environment. Since 2000,
  stabilization and slow reduction of interest
  rates has being observed, the interest on the
  state securities being lower than the interest on
  similar instruments on other developing markets
  since 2002. The credit rating of the Russian
  Federation has been rising since 1999, but it is
  still lower than the average level of the rating
  of other countries with the markets being formed,
  although the difference gradually reduces.

50
Crisis overcoming. Market of shares
51
Crisis overcoming. Market of shares
52
Disproportions of market

• institutional problems
• problems of price formation and equality of
  investors
• supply problems
• demand problems.

53
Institutional problems of the market

• Overconcentration of broker-dealers in Moscow and
  lack of them in the peripheral regions.
• Overconcentration of other professional
  participants of the stock market in Moscow.
• High concentration of institutional investors in
  Moscow.
• Concentration of stock exchanges and off-exchange
  trade operators in 4 centres 4 in Moscow, 2 in
  Saint Petersburg, 2 in Yekaterinburg, 2 in
  Novosibirsk.
• Concentration of transactions and financial
  assets in Moscow.

54
Problems of price formation and equality of
investors

• The oligopolistic nature of the market
• Concentration of the market on several particular
  shares.
• The fragmental character of the share market
• Insularity of regional exchanges within their
  regions and their constant remoteness from the
  national market
• Manipulating with prices and insider trading

55
Problems of securities supply

• 1. Absence of certain segments of the market
• 2. The limited number of the issuers whose shares
  are transacted on the organized market.
• 3. Absence of mass supply of shares.
• 4. Insignificant amount of the free float of
  stock.
• 5. Poor legal regulation of ownership
  relations.
• 6. Conflicts of interests which make it difficult
  for enterprise to enter the market and decrease
  the investment attractiveness of shares.
• 7. Low level of corporate management.
• 8. Absence of a proper system of opening the
  information on the securities market.

56
Problems of demand for securities

• deficit of cash resources for investment
  purposesunderstated economy monetarization as an
  anti-inflation policy
• lack of trust of investors.
• crisis of trust in the state as the issuer of
  securities.
• absence of the class of institutional investors
  as a whole.
• strong dependence of the market on the actions of
  foreign investors
• excessive administrative barriers, ineffective
  and alternativeless regulation

57
Disproportions and unsolved problems of market
relations

• absence of state development strategy
• securities market doesnt work as a mechanism of
  savings transformation into investments (people
  save in currency and bank deposits)
• poor efficiency of the market
• shares market doesnt work as an instrument of
  capital formation
• absence of a dividend policy (most companies)

58
Disproportions and unsolved problems of market
relations

• underestimation of Russian companies shares
• small volume of state loans market (3.4 of GDP)
• high trading cost and low information efficiency
• down level of information clarity
• low liquidity of the secondary market
• absence of trust for securities from citizens
  (active participants - only 0,1 of population)

59
Crisis of 2008
60
Bonds

• Domestic bonds
• Eurobonds
• Securitized debts
• CDO (CLO, CBO, CMO)
• CLN
• LPN
• Information about bonds market www.cbonds.ru

61
Securitization scheme
Assets owner
SPV
Investors

• Assets owner creates the SPV and delivers assets
  to it
• SPV issuing secured bonds
• SPV passes the proceeds to assets owner as a
  payment for assets

62
CLN scheme
(1) Buying of CLN

(3) Periodical payments
Credit owner
Investor (CLN buyer)
(5) Discharge (default) on CLN
(2) Periodical payments (coupons and nominal)
(4) Default
Credit (bond)
63
CLN activated by issuer

Service the loan
Russian company
SPV founded by Russian company
Money
Money
CLN
Investors
64
CLN activated by creditor

Russian company debts owner
SPV founded by debts owner
Debts Money
Money
CLN
Money
Bonds ???
Investors
65
Innovations on the bonds market

• Stock bonds
• Amortized bonds
• Bonds with indexing
• Convertible bonds
• Bonds with options (call or put)
• Mortgage-backed bonds

66
Mortgage-backed bonds

• The Low on Mortgage-backed securities (2003)
• Pass-through certificates
• CMO (collateralized mortgage obligations)
• Agency of Housing Mortgage Loans (AHML)
• (founded by Government in 1997)

67
Derivative market

• Moscow Inter-bank Currency Exchange
  (www.micex.ru) - 10 futures (shares, stock index,
  USD, Euro, some goods)
• St-Petersburg Currency Exchange 6 futures
  (currencies, gold), 18 options (some goods,
  petroleum, LIBOR USD, LIBOR Euro)
• FORTS (Futures and Options of RTS, www.forts.ru)
  23 futures and options (15 shares, 3
  currencies, RTS index, 4 goods)
• Stock Exchange St-Petersburg futures on
  goods.
• Complete volume of derivative market 2 of
  stock exchanges general volume

68
4 types of external factors influencing the
development of the Russian market

• Influence of long-term cycles
• Influence of oil prices
• Influence of leading markets and interdependence
  of markets being formed
• Competition of national markets.

69
Influence of oil prices

• a high correlation (0.87) of the Russian stock
  market with the fluctuations of the world oil
  prices has been proved with 7 months outpacing
  lag of oil prices.

70
Influence of leading markets and interdependence
of markets being formed

• the decisive factor of the dynamics of the
  Russian securities market are the actions of
  major international investors
• (In 90 of observations (from 1995 to 2005) its
  dynamics was synchronous with the behaviors of
  the considered groups of markets)

71
Correlation with foreign markets

• 0,945 USA and Latin America markets
• 0,9 Brazil market
• 0,87 European developing markets (East Europe)
• 0,66 European developed markets.
• ! Correlation of crisis period was increased with
  developing markets and decreased with developed
  markets.