Financial and Investment Decision Making in Russia Dr. Ivan Darushin The Department of Credit Theory and Financial Management St-Petersburg State University 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. 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. 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. Investing ways Capital owners (investors) Securities Direct interaction Banks market Capital lenders (objects of investments) 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. Russian Securities and Derivatives Markets 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 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) 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) 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) 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) Securities • Debts securities (bills, bonds, certificates, etc.) • Equity securities (shares) • Derivatives (forwards, futures, options, swaps) Securities • Government securities (government bills and bonds) • Municipal securities • Corporate securities (shares, bills, bonds) • Bank securities (certificates) 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 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) 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 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) 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 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. 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. 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 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 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. 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 “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) 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) 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 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 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. Program of “wide” privatization (4) Tree variants of privatization Category of Type of Quantity of shares (by variants), % share share 1 2 3 A 25 - - preference B 30 19 30 at a cut price 10 - 20 normal price - 51 - ordinaries with option 5 - 20 works fund 10 10 10 State fund 20 20 20 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. 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) 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 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) 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 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 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 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. 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 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) 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 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) 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) 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 Crisis of the stock market in 1998 • Decrease of securities prices (RTS-index decline 3 times in 2 months) • Decrease of trading volumes 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) 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 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. Crisis overcoming. Market of shares Crisis overcoming. Market of shares Disproportions of market • institutional problems; • problems of price formation and equality of investors; • supply problems; • demand problems. 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. 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 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. Problems of demand for securities • deficit of cash resources for investment purposes– understated 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 Disproportions and unsolved problems of market relations: • absence of state development strategy; • securities market doesn’t work as a mechanism of savings transformation into investments (people save in currency and bank deposits); • poor efficiency of the market; • shares market doesn’t work as an instrument of capital formation; • absence of a dividend policy (most companies) 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) Crisis of 2008 Bonds • Domestic bonds • Eurobonds Securitized debts: • CDO (CLO, CBO, CMO) • CLN • LPN Information about bonds market www.cbonds.ru 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 CLN scheme (1) Buying of CLN (3) Periodical payments Credit owner Investor (CLN buyer) (5) Discharge («default») on CLN (coupons and (2) Periodical payments (4) Default nominal) Credit (bond) CLN activated by issuer Service the loan SPV founded by Russian company Russian company Money Money CLN Investors CLN activated by creditor Russian company Debts SPV founded by debts owner Money debts owner Money Money CLN Bonds ААА Investors Innovations on the bonds market • Stock bonds • Amortized bonds • Bonds with indexing • Convertible bonds • Bonds with options (call or put) • Mortgage-backed bonds 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) 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 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. 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. 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) 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.
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