Member Update

Fund managers brace themselves for Russian fall-out

Despite the glaring warning signs and litany of pessimistic Western intelligence reports, the Russian invasion of Ukraine caught a number of institutional investors by surprise. According to data from the Moscow Exchange (MOEX), foreign investors are currently sitting on circa $86 billion of Russian equities, $20 billion of Russia’s USD debt and  $41 billion of Rouble denominated sovereign bonds. [1] 

A number of institutional investors – including pension schemes and sovereign wealth funds across the US, UK, Canada, Norway and Australia – are coming under massive political and regulatory pressure to divest their Russian holdings. Several Russian-focused funds have already suspended investor redemptions. Given the extent of the sanctions being imposed on Russia –  offloading these problem assets will be incredibly tough. Capital losses are also expected to be substantial owing to the precipitous fall in market prices, doubling of Russian interest rates and collapse of the Rouble’s value.

So what is exactly happening? The exclusion of certain Russian banks from the SWIFT financial messaging network at the end of February had already made it extremely complicated for foreign institutions to exit their Russian investments. In short, this measure effectively rendered it almost impossible for firms to remit any sales proceeds from Russia. Not only are foreign investors at enormous risk of breaching sanctions rules if they do sell their Russian assets, but few – if any counterparties – will want to buy or sell Russian securities because of the political environment, market risk and potential scope for incurring harsh penalties should they violate sanctions.

Compounding matters further is that foreign institutions are banned by the Russian government from selling locally listed securities on MOEX while trading of Russian companies abroad has been suspended. According to the FT-  Nasdaq, Deutsche Borse and the London Stock Exchange (LSE) are among some of the major stock exchanges to have introduced share trading bans on listed Russian securities.[2] In addition, the LSE has ceased trading of global depository receipts of several Russian-based companies including Rosneft, Sberbank, Gazprom, En+ and LuKoil.  Elsewhere, MSCI and FTSE Russell have both excluded Russian securities from their respective EM (emerging markets) indices – a decision that will further heap pressure on the country’s embattled equity market.

At a financial market infrastructure level, CSDs (central securities depositories) have also made it significantly harder for foreign institutions to trade in the Russian market. Euroclear confirmed it would suspend its link with the Russian Bank, VTB, which until now has acted as the main outlet for trades in Russian securities for both Euroclear and Clearstream. Clearstream also stated that the Rouble was no longer an eligible settlement currency inside or outside of Russia, while Euroclear stopped settling Rouble denominated trades transacted outside of Russia on March 3. [3] Asset servicing has also been impacted with income distributions accrued from Russian securities now suspended until further notice. It is unclear what would happen if a Russian security undertook a corporate event but it should be assumed overseas investors impacted by the embargo would have to allow it to lapse.

With there being no end in sight to this crisis, it is highly probable that foreign institutions’ holdings of Russian assets are likely to be trapped for the foreseeable future. Local providers in Russia – such as custodians – can certainly provide information to clients, –  but other services will likely be restricted.

[1] Financial Times (March 1, 2022) Investors struggle to trade Russian assets as sanctions hit market plumbing

[2] Financial Times (March 1, 2022) Investors struggle to trade Russian assets as sanctions hit market plumbing

[3] Reuters (February 28, 2022) Europe carves out Russian securities from financial markets