A version of this article first appeared in Global Investor magazine in early 2007
On June 16 1989, Norwich Union launched an advertising campaign based on the premise that investment in what was still then the Soviet Union would become the norm in years to come. The campaign focused on the ‘Mirov 11’, an imaginary sports turbo car of the future, representing the kind of investment opportunity people could one day share through a Norwich Union savings and investment plan. While some reservations remain today about the rule of law and the attitude of the ruling authorities to private ownership and profit, it seems that Russia’s day has now come. It puts the ‘R’ in the increasingly fashionable acronym BRIC, which stands for Brazil, Russia, India and China.
A new report from Grant Thornton underlines dramatically the investment opportunities that could lie in store for these four countries, of which Russia is the most interest for the purposes of this story. Based on 7,200 interviews in 32 economies, the report contains a number of compelling statistics, including the bold prediction that by 2050 the BRIC countries will account for 44% of global GDP (gross domestic product) compared with 27% in 2005, and just 13% in 1975. The report predicts that by 2050, the average income in both India and Russia will be around the current US level of $41,300.
This helps explain why, despite some remaining reservations in the international investment community about the rule of law and the attitude of the country’s ruling authorities to private ownership and profit, Russia’s day has now apparently come. Even at a time of a significant rise in investor risk aversion in early March, which saw over the past week has seen a sharp increase in financial market volatility and a general flight to quality and away from riskier assets, the outlook for Russia is more favourable than at the time of its last major economic setback in 2000. Against this backdrop of increased financial market volatility and a flight to safe-haven assets, it appears timely to assess the prospects for the Russian equity market over the remainder of 2007.
A research note from VTB Bank Europe on the prospects for Russian equities in 2007 further illustrates the new mood. Its central scenario (which it says has a 45% probability rating) assumes growth in the Russian equity market of around +10% over 2007, which would bring the RTS equity index to around the 2,000 level towards the end of the year. This would include the potential for a number of short, but strong downward corrections along the way.
In its bear market scenario (with an estimated probability of just 20%) VTB projects a -20% correction in 2007. A decline of this magnitude would bring the RTS down to around the 1,450 level. This scenario could materialise for a number of reasons. In particular, a sharp correction in RTS could be triggered by such factors as a sharp decline in global growth expectations, a substantial fall in oil prices, or a significant sustained increase in global investor risk aversion. “On the whole, we assess that external factors present the most likely catalyst for a sharp downward correction in the Russian equity market, although the significant run-up in equity prices seen over recent years suggests some opportunity for a domestic-led RTS correction.” says VTB.
In the bullish scenario (estimated 35% probability) VTB projects +30% growth in the Russian equity market by the end of 2007, which would raise the RTS index to around the 2,350 mark. Compared to the performance of the RTS index over the past four years, this upside scenario appears relatively cautious. However, it is this backdrop of an outstanding performance of the Russian equity market which leads us to present a relatively cautious upside scenario.”
In such a context, the early bird will be best positioned to catch the investment worm. And although Russia dominates the thoughts and portfolios of increasing numbers of international investors, the story is similar throughout the rest of central and eastern Europe. ING Bank, which has built up its network in the region over the past 10-15 years, tells the story of a record year for Poland in its first market news bulletin of the year. “The year 2006 turned out to be the best year in the history of the Warsaw Stock Exchange and the Polish capital market as a whole, with record values and volumes traded both on cash and derivatives markets, rising indices and very good IPO performance,” it reports. WSE market capitalisation increased by 40% during 2006, driven by growth in the number of companies listed (38 new listings, including six foreign companies) and positive market trends, it says. At the end of the year, companies from nine countries were listed on the WSE: Poland, Czech Republic, Slovakia, Hungary, Netherlands, Israel, Ukraine, Germany and the USA. ING expects the impetus to be sustained in 2007.
Where investors go, of course, so will custodians and providers of other financial services follow, and there are currently four main providers of custody and related securities services plying their trade in the region: Citigroup, UniCredit Markets & Investment bank, ING Bank and RZB. Deutsche Bank is up and coming as a custody provider in the region, competitors note.
UniCredit is currently undergoing an extensive rebranding operation but for the moment operates under a series of local provider names across the region. It has a presence in every country in the region, other than Belarus and Albania, says David Penstone, head of business sales and development, and reports assets under custody in the region of around $120bn. “The more advanced countries in the region have enjoyed stellar performance over the past two to three years, and we now have around $120bn of assets under custody in the region,” he says. “But there is still a long way to go. The Slovak market remains a debt-oriented market, and market practices in many of the countries are often very loosely defined or nonexistent, with the focus on local investors rather than incoming foreigners. UniCredit Markets & Investment Banking – Custody CEE and its offices through-out Central and Eastern Europe (including Bank BPH & Pekao (Poland), International Moscow Bank and HVB brands) continue to be recognised as the leader in custody in the region, successfully competing with global giants such as Citibank. Being the only provider in the CEE to cover all the markets of the region, the group is also recognised for its leadership in local market development, an important role at this stage in the process.”
“Starting in Vienna where the group clears some 28% of the total turnover on the Vienna Stock Exchange for remote members a product that was driven by BA-CA, the group is focused on steering market authorities in the direction that our clients wish to travel – recently the group was instrumental in directing the introduction of Real Time Gross Settlement, a central counterpart and a second settlement batch for on-exchange trades.”
“In Hungary, our head of custody, Attila Szalay-Berzeviczy, is also the Chairman of the Budapest Stock Exchange and a board member of Federation of European Stock Exchanges – thus influencing not only the Hungarian Capital Market but that of the Europe as a whole. Our Hungarian office was instrumental in ensuring that withholding tax on dividends was abolished and the nominee concept was introduced. In Poland, the merged group – Bank BPH and Pekao – will become one of the top two in terms of assets under custody. More importantly, our head of custody in Bank BPH in Poland -- Radoslaw Ignatowicz – Bank BPH - is also the chairman of the Custodial Banks Counsel for 4 consecutive terms. The bank has used its influence to guide the market towards international standards. The group was the clearing agent for the first remote trades on the exchange – a product which was developed based upon our leadership in Vienna.”
“Having pioneered custody in the CEE after the fall of the Iron Curtain - starting with Hungary in 1992 - the group has the most experience across the region. Our people actively lobby for and against market regulations and practices in the best interest of our clients. The group often act as a quasi consultant with respect to market infrastructure having most recently assisted the Czech Market authorities with the introduction of nominee concept and the authorities in Bosnia to recognise the role of the a custodian. We have nine full-time professionals located in Vienna who are solely responsible for Sales, Best Practises and Relationship Management for the entire group in the region. This team coordinates sales and product activities to the benefit of the individual location and customer. Being a member of EUROFI, the team is helping guide new EU Directives whilst recognising the local favour of each market.”
ING Bank, which has offices in eight countries (Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia, Russia and Ukraine), claims record volumes of assets under custody in them. In Russia, Natalia Sidorova, head of securities services in the bank’s Moscow office, says that the figure of $123bn at the end of March was approximately double that of a year earlier, while the 10,000-12,000 monthly average transaction volume the bank handles if around 50% higher than 12 months previously.
“There are a number of driving forces at work,” says Lilla Juranyi, head of global custody for ING Wholesale Securities. “Foreign interest in investment is growing as economies stabilise and liberalise, market infrastructure improves and changes take place in the legal and regulatory environment. Russia, Ukraine, Bulgaria and Romania look very much today like Hungary, Poland and the Czech Republic did around 8-10 years ago, but the development process has accelerated as we have moved along the learning curve. Bulgaria and Romania are in a clear state of transition having joined the European Union at the start of this year. The implementation of harmonisation policies cannot take place overnight, but this is an exciting time for those countries, and we see interest in them increasing.”
Elsewhere, she says, interest has abated in the four CEE countries which acceded to the EU in 2004 (Poland, Czech Republic, Slovenia and Hungary) and which are now starting to show signs of a new maturity. “We have competition on a level playing field, fees are shrinking, and interest is developing in securities lending as a product in Poland and Hungary. Moreover, the local media have reported interest in buying the Bulgarian Stock Exchange from OMX, Deutsche Borse, Wiener Borse, Borsa Italiana, the Warsaw Stock Exchange and the Athens Stock Exchange,” she notes.
Citi, which has a direct custody and clearing presence in six CEE countries (Czech Republic, Hungary, Poland, Romania, Russia and Slovakia, where it opened as recently as 2005) reports significant increases both in the volumes of assets under custody and transaction volumes in the period 2004-06. For assets under custody, the figure in the Czech Republic is up 150%, Hungary 9.9%, Poland 87.47%, Romania 300% and Russia 343.4%. For transaction volumes, the respective figures are up 171.65% (Czech), 15.5% (Hungary), 16.6% (Poland), 148.57% (Romania) and 763.8% (Russia).
“All the markets are at different stages of development and are maturing at different rates,” observes Clive Triance, Europe, Middle East and Africa (EMEA) Head of Direct Custody and Clearing and Chief Operating Officer for Securities and Fund Services EMEA at Citi. “We have grown dynamically over the past few years, and are now the largest foreign provider of custody and clearing services in Poland. Assets under custody with us there account for around 70% of local pension fund assets. Romania is small but growing quickly, while international investor appetite for Russia - with its emergence from communism, its gradual acceptance of capitalism, and its need for foreign investment to exploit its energy reserves and other natural resources - has been growing enormously. We offer a full settlement solution in Russia, and customers who are keen to get into the market quickly can use our network to trade rather than build their own back office. Demand is there from the inflow side (broker-dealers) and from the outflow (broker-dealers, pension funds and other investors looking for a global provider to trade assets in other markets). We looked at operational risk, built a technical solution for ourselves, and customers are now benefitting from that investment.”
Not everything, though, is for the best in this best of all possible worlds, and despite all the apparent liberalisation, Russia’s past continues to cast a long shadow over the present and into the future. “The rouble is now theoretically fully convertible,” says Lilla Juranyi. “But it remains problematic, albeit for bureaucratic reasons rather than economic reasons. Opening a rouble account can be a difficult, demanding and inconvenient process. You have to apply for a local tax registration number, and that takes several weeks and requires heavy documentation, which needs to be translated into Cyrillic for the local market.”
Something, of course, which a custodian with a local presence and local expertise can help greatly, but unlike some people in the industry she is far too polite to take the opportunity to advertise or evangelise…
Key Market Developments
Foreign stock exchanges eye Bulgarian Stock Exchange
National bank joins European System of Central Banks and becomes a shareholder in European Central Bank
BSE abolishes its ‘C’ listing category
WSE boasts record year in 2006, and expects same again in 2007
WSE plans new alternative market
Treasury casts light on WSE privatisation plans
Nominee concept wins regulatory support
Electronic trade confirmation initiative takes step forward
Romania pledges to adopt euro by 2014
National Bank inflation target achieved for first time
Foreign investor stock and equity purchases top €1bn in 2006
Foreign investors view Romania as a ‘tiger’ economy
6% economic growth forecast for 2007
40% increase in stock exchange transactions forecast for 2007
Moody’s dubs banking system stable
Foreign purchase of Russian bank shares facilitated
Restrictions eased on purchases of newly issued Russian bank shares
Russian Depository Receipts launched
CSD saga continues; rambling and inconsistent draft bill under discussion
European transparency directive to become effective May 1 2007
MiFID to become effective November 1 2007
Nominee rules to become effective November 1 2007
CSD says securities transfers doubled in 2006
CSD and Bratislava Stock Exchange introduce new clearing and settlement system
Securities trading: new rules approved
Securities depository merger discussions planned
Another CSD saga continues; most optimistic launch date for CSD capable of handling both cash and securities now May 2008
Zagreb Stock Exchange unanimously approved merger with Varazdin