Investments and Finance in Russia

1. Investments and Finance 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. Investing ways

4. Finance • is the management of money in which an individual or a business decides how the money will be used to generate more revenue or profit. 3 sub categories: • Public finance; • Corporate finance; • Personal finance.

5. Main foreign economy features related to financial system and investing abroad • securities market and it characteristics; • accounting and taxation features; • banking characteristics; • limitations on direct investments.

6. Russian Securities and Derivatives Markets

7. 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

8. 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)

9. 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)

10. 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)

11. 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)

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

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

14. 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

15. 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)

16. 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

17. It’s 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)

18. 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

19. 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 it’s quasi-money.

20. 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.

21. 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 (it’s necessary to obtain a permit of Government). Totally: legal vacuum

22. 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

23. 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.

24. 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 don’t play the role of an investment instrument. The volume of trade doesn’t correspond with the economy proportions. Main opposition: high rate of state sector of economy Solution: privatization

25. “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)

26. 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)

27. Program of “wide” privatization “Government program of privatization”, 1992 Methods of privatization (by the program): • Shares selling (joint-stock companies); • Auction selling of enterprises; • Investment auction; • Asset selling of companies to be liquidated; • Redemption of leasehold property

28. 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

29. Program of “wide” privatization (3) Three groups of companies: • fewer than 200 workers and fewer than 1 million rubles capital value – selling by auction; • 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.

30. Program of “wide” privatization (4)Tree variants of privatization

31. 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 it’s transformed at the ordinary share. Repealed in 1997.

32. 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)

33. Russian voucher Different prices: • Market price (from 4000 rub in April 1993 to 45000 rub in December 1994) • 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

34. 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 billion of rubles by November 1994) • Waste of the state property and control (500 of the biggest companies with evaluative capitalization of USD 200 billion were sold for USD 7.2 billion)

35. 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

36. 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

37. 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

38. 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.

39. Creation of RTS RTS – Russian Trading System, created by NAUFOR and NASDAQ in 1995. (micex.rts.ru) Main features: • Full computerized trading system • Steady trading • Participants arrange the deals from remote stations • Large quantity of securities 2011 – merged with MICEX (Moscow Interbank Currency Exchange) • Nowadays – biggest stock exchange in Russia (more than 90% of stock deals in Russia): • has an organized sector (listing, securities of biggest companies) • secondary sector (shares of small companies, without listing procedure) • derivative sector (futures and options on shares, index and currency) www.forts.ru

40. 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)

41. 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

42. Preconditions of the stock market crisis in 1998 • 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)

43. GKO-OFZ and state budget deficit Financing of budget deficit by issuing of GKO (State Short-term zero-coupon Treasure Bills) and OFZ (coupon-bearing Federal Loan Bonds) 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)

44. 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

45. Crisis of the stock market in 1998 • Decrease of securities prices (RTS-index decline 3 times in 2 months) • Decrease of trading volumes

46. Positive pointsof 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)

47. 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

48. 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.

49. Crisis overcoming. Market of shares

50. Crisis overcoming. Market of shares