Capital market of russia

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  1. What is Capital Market?

  2. Capital Market in Russia

  3. Developments affecting financial market transactions in Russia


  1. What is Capital Market?

Capital Market, is used to mean the market for long term investments, that have explicit or implicit claims to capital. Long term investments refers to those investments whose lock-in period is greater than one year. In the capital market, both equity and debt instruments, such as equity shares, preference shares, debentures, zero-coupon bonds, secured premium notes and the like are bought and sold, as well as it covers all forms of lending and borrowing.

Capital Market is composed of those institutions and mechanisms with the help of which medium and long term funds are combined and made available to individuals, businesses and government. Both private placement sources and organized market like securities exchange are included in it.

Functions of Capital Market

  • Mobilization of savings to finance long term investments.

  • Facilitates trading of securities.

  • Minimization of transaction and information cost.

  • Encourage wide range of ownership of productive assets.

  • Quick valuation of financial instruments like shares and debentures.

  • Facilitates transaction settlement, as per the definite time schedules.

  • Offering insurance against market or price risk, through derivative trading.

  • Improvement in the effectiveness of capital allocation, with the help of competitive price mechanism.

Capital market is a measure of inherent strength of the economy. It is one of the best source of finance, for the companies, and offers a spectrum of investment avenues to the investors, which in turn encourages capital creation in the economy.

Types of Capital Market: The capital market is bifurcated in two segments, primary market and secondary market:

  1. Primary Market: Otherwise called as New Issues Market, it is the market for the trading of new securities, for the first time. It embraces both initial public offering and further public offering. In the primary market, the mobilisation of funds takes place through prospectus, right issue and private placement of securities.

  2. Secondary Market: Secondary Market can be described as the market for old securities, in the sense that securities which are previously issued in the primary market are traded here. The trading takes place between investors, that follows the original issue in the primary market. It covers both stock exchange and over-the-counter market.

Capital market improves the quality of information available to the investor regarding the investment. Add to that, it plays a crucial role in encouraging the adoption of rules of corporate governance, which backs the trading environment. It includes all the processes that help in the transfer of already existing securities.

  1. Capital Market in Russia

While Russian capital markets regulation has come of age after more than two decades of rapid, and at times erratic, development, it still has some way to go before it reaches maturity. The process of Russian capital markets regulation started with the dismantling of the centrally planned Soviet economic model during the last decade of the 20th century, and a search for the most suitable market-oriented substitute for a defunct legal and regulatory regime. Apart from some scant financial market concepts and terminology antecedent to the Bolshevik revolution of 1917, Russian law provided little (if any) of the frame of reference needed to jump-start market reforms. The legislative reforms of the 1990s were heavily influenced by the US model of securities regulation, which at the time was given credit for governing the most liquid and efficient capital markets in the world. Russian financial regulation has since been decoupled from the US model proper, while largely following international trends. Significant strides have been taken in recent years, with the aim of expanding the product line of financial instruments and enhancing discipline in financial markets. Some other initiatives and commitments, including those taken within the G20 process, are still work in progress.

The centrepiece of Russia’s capital markets regulatory framework is the Federal Law on the Securities Market (Securities Market Act). The first version was enacted in 1996, which has since been amended more than 40 times, including most recently in 2016 (as discussed in more detail below).

The Securities Market Act:

  1. defines the scope and types of regulated market activities;

  2. establishes broad principles applicable to the various categories of regulated market participants;

  3. defines the various types of securities as well as the procedure for their issue and distribution;

  4. sets out the general rules applicable to secondary market trading activities;

  5. sets out the standards for continuous disclosure;

  6. regulates exchange trading;

  7. prohibits insider trading;

  8. defines repo transactions and derivative instruments;

  9. sets out the main principles of government regulation of the securities market; and

  10. bestows regulatory and supervisory authority on the Bank of Russia.

There also exists an interwoven web of other laws and regulations that influence the behaviour of market participants, including:

  1. the Civil Code;

  2. the Law on Joint Stock Companies;

  3. the Law on Organised Markets;

  4. the Law on Commodity Exchanges and Exchange Trading;

  5. the Law on Central Depository;

  6. the Law on Clearing and Clearing Activities;

  7. the Law on Protection of Legal Rights and Interests of Investors in the Securities Markets;

  8. the Law on the Crackdown Upon Unlawful Use of Inside Information and Market Manipulation;

  9. the Law on Mortgage-Backed Securities;

  10. the Law on Investment Funds; and

  11. the Law on Private Pension Funds.

In addition to these, a myriad of regulations are being passed, amended, repealed and superseded by new regulations on a continual basis.

Regulation of international capital market transactions

Russian legislators and financial regulators have long been concerned with finding an equilibrium between ensuring access to international capital markets for Russian issuers and preventing a liquidity drain to foreign markets. Measures to find this balance include, most notably, a requirement for a Bank of Russia approval of an offshore issue or trading on an organised market of equity securities by a Russian issuer. This approval for equity securities is conditional upon:

  1. the registration of the new issue of securities in Russia;

  2. the securities being listed on a Russian exchange

  3. the number of shares (or securities convertible into such shares) traded outside Russia not exceeding a prescribed threshold (varying between 5 and 25 per cent, depending on a number of factors, including local free float, Russia’s strategic interests, inter-regulator agreements); and

  4. in relation to depositary receipts, a restriction on the exercise of voting powers by any persons other than the security holders (i.e., foreign custodians or nominees may not vote such securities without express instruction from the holders).

Notably, however, the quantitative restrictions on the number of shares available for an offshore offering by the most liquid Russian issuers do not apply, provided that the offering meets certain additional requirements. A Bank of Russia approval is not required for an offshore issue of securities that are not shares or securities convertible into shares.

Foreign issuers are also restricted in their ability to tap into Russian capital markets, although in a different manner. Foreign issuers may issue sponsored Russian depository receipts and place them in the Russian market in accordance with Article 27.5-3 of the Securities Market Act. Alternatively, securities issued by foreign issuers may be directly eligible for trading in Russia if certain requirements, as set out in Article 51.1 of the Securities Market Act, are met.

First, securities issued by foreign issuers must be assigned a CUSIP2 number and a CFI3 code and recognised as securities for Russian law purposes following a specified procedure.

Second, they must be issued by a qualifying issuer, which is defined to include:

    1. a qualifying foreign sovereign issuer or its administrative subdivision or a foreign central bank;

    2. a qualifying multinational organisation;

    3. an entity incorporated in an OECD, Financial Action Task Force or MONEYVAL4 Member State, or in a jurisdiction whose financial regulator has signed a cooperation agreement with the Bank of Russia; or

    4. an entity that has listed its securities on an exchange approved by the Bank of Russia.

Placement (i.e., offering in the primary market) of securities issued by foreign issuers requires registration of a prospectus by the Bank of Russia. In most cases, the prospectus must be co-signed by a local broker that also assumes liability for the contents of the prospectus. In contrast, admission of foreign securities for trading in the secondary market may be effected without the registration of a Russian prospectus if the securities are listed on an eligible foreign exchange (FX) and are given a dual listing by a Russian exchange. Any other offering of or trading in foreign securities requires specific permission from the Bank of Russia, which should generally be granted if certain criteria are met. The Securities Market Act allows admission to exchange trading of unsponsored foreign securities without the issuer’s consent, provided that the securities are admitted to on-exchange trading outside the exchange’s principal listing, but that the securities have been included in the primary listing of an eligible foreign stock exchange (this latter requirement may be disapplied for debt securities) and that the securities are not restricted from public offering in Russia under their governing law. To date, however, the number of foreign securities distributed or admitted to trading in Russia (including in the form of Russian depository receipts) remains insignificant.

Foreign securities that have not been admitted for distribution or public trading may be offered without a registered prospectus to qualified investors through a bilaterally negotiated secondary market transaction or through an offering on a Russian exchange restricted to qualified investors. Similarly, ‘foreign financial instruments that are not recognised as securities’ (for Russian law purposes) may only be offered to persons who are ipso jure qualified investors (various types of regulated financial institutions) or have been categorised as qualified investors by a Russian broker. This awkwardly-phrased provision, which amounts to a suitability-like selling restriction, has resulted in a caution-driven choice by most international dealers to have their cross-border derivative transactions with unregulated Russian corporate clients intermediated by a local broker. Local brokers alone may classify a client as a qualified investor. Because the term foreign financial instrument is undefined and the regulator has to date declined to provide any interpretative guidance on its definition, these burdensome structures (which increase transaction costs and may limit the throughput capacity of a local broker) tend to be used for all underlying assets involving foreign currency, securities or other benchmarks. The choice to use a local broker also often stems from a lingering uncertainty over the enforceability of cross-border cash-settled derivative transactions with Russian unregulated entities under the gaming provisions of the Russian Civil Code.

The measures designed to lower the entry barriers for foreign securities into the domestic market were mirrored by changes to liberalise the outbound flow of securities trading flows. Most importantly, recognition of the status of foreign nominee holders of securities (even if by way of a phase-in approach sequentially encompassing government and corporate debt securities and equities) and the creation of a central depository are designed to streamline the infrastructure for a seamless cross-border flow of interests in securities and facilitate offshore trading in Russian securities.

Much like the four preceding years, 2019 has been a year in which the Russian capital markets have been affected by opposite forces. On the one hand, the statutory and regulatory reforms referred to in Section I have laid the foundations for a quantum leap of market activities and a new level of complexity of financial techniques and instruments available to market participants. These developments, however, have largely been eclipsed by sanctions in the international sector affecting, inter alia, the ability of some of the largest players in the Russian financial and energy sectors to issue new debt and equity securities or otherwise raise capital in international financial markets. Complying with the existing sanctions, and apprehensive of more sanctions to come as a result of an escalation of geopolitical tensions regarding the situations in Ukraine and Syria, and allegations of intervention in the electoral process in other countries and of Russia’s involvement in the poisoning of a former Russian military intelligence officer in the United Kingdom, most international financial institutions have sharply curtailed their dealings with Russian counterparties, thus bringing the cross-border capital market flows for new issues to a virtual halt. Predictably, this has had a knock-on effect on local market flows and liquidity, particularly in non-rouble currencies. There has been no indication so far in 2019 that the sanctions are likely to be softened or lifted in the short term. On the contrary, we have seen new sanctions introduced and a real risk of a tightening of the sanctions regime. As a result, despite some positives in the legislative and regulatory agenda, 2019 has largely been a period of doldrums in the Russian financial markets. The mid to long-term effects of the international sanctions on Russian capital markets both local and cross-border cannot be easily or accurately assessed at the time of writing, as much will depend on how the international geopolitical situation evolves and whether the sanctions are tightened or relaxed as a result.

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