BCS sees groundwork for future returns in Russian financial reforms
The ongoing reforms of financial regulations and adoption of more international standards bode well for investors in Russia, according to Tim Bevan and Joseph Dayan at BCS Financial Group.
Bevan – managing director Prime Brokerage (pictured) – and Dayan – head Of Markets – point to a number of key changes that are making the Russian market more palatable to international investors.
This is important for BCS, because while it has gained a significant domestic market share in financial services, it needs to look to foreign business to keep it on a path to growth.
The Group runs brokerage, banking, asset management and custody business, and has been running a proper London office for about six months. One reason for the expansion is found in the structure of its client base and type of business in Russia.
Despite having a strong position, with some 10%-15% equity market share of the Micex exchange by turnover, and a top three derivatives and FX trading position in Russia, it is dominated by retail business. This is because of the relatively under-developed institutional market in Russia.
This necessitates going where the growth is located, Bevan and Dayan say, and for Russian businesses this is still London – the ‘financial capital’ of Russia (see below), and itself a key driver of policy designed to entice Russian savings and investments back home.
The emerging opportunities are likely to be in areas such as equities and fixed income, derivatives, FX and so on in Russia.
No discussion of the investor opportunities in Russia can exclude the effects of politics. But it is felt that the changes being implemented today will bear fruit, despite examples of abuse of investors that still occur ad hoc.
A number of key structural reforms to the investment market have taken place. New post-trade rules are one area affected. Together with other changes they are allowing clear transfer of title ownership of assets, whereas previously there were examples of investors losing their money because of lack of transparency on this point.
Equity trading rules have changed. From a T+0 and no concept of clearing to the Western model of T+2 and the ability to trade without having to transfer the entire asset.
From January 2014 reporting rules will be in line with Western standards, with IFRS also coming in for big companies.
And with sovereign debt now Euroclearable it has become part of the global asset pool.
The current consensus of Russia offering deep value may be slightly misleading, says Dayan, because of certain assumptions being used, for example, around the cyclical nature of certain stocks.
The market capitalisation weightings also play a part: Gazprom is cheap, but it is also a big part of the index on this basis.
What BCS feels, however, is that if there is a tightening of discounts coupled with positive benefits from the improvements in governance, then returns to investors should be improved further in future. The unanswerable question at this point is how quickly such benefits may occur.
There is also the issue of Russia being seen as long in what China is short, which is a macro trade bet.
However, both Bevan and Dayan believe domestic stories will become more interesting as the structural changes take effect. For example, pension funds have been required by law previously to only make positive returns. That is changing, and will make it easier for such investors to consider other types of investments and assets.
Another area of the market becoming more institutional in its approach is family offices. Typically set up to serve the oligarchs, these are now adjusting their approach.
And there are opportunities in Russia that do not exist in Western markets. Corporate loans are growing at 15% annually and personal loans by about 25% annually, Bevan and Dayan say.
One intriguing part of developments in Russia is its view of London. The country does not want London to remain effectively the ‘financial capital’ of Russia, says Dayan.
Instead, it prefers to see a model of itself as a major financial centre on the eastern edge of Europe. The city is also looking at the example of the Dubai International Financial Centre, as a way to encourage the local industry to grow.
Another reason to encourage the return of more business currently being done abroad back to Moscow is because of concerns over liquidity shocks in times of crisis.
Moscow has another tool it wants to use to encourage local business: the IPO pipeline. Some $80bn in privatisations are currently being touted. This may be slightly unrealistic, but even a smaller part of that would be significant in terms of the local stock market. The challenge in the immediate term is poorer demand for cyclical emerging market stocks, although the ongoing restructuring on top of a turn in demand for that type of asset could bring stronger demand.