Vibrant Market Now Russian Bear

Surrounded by vacant seats and unattended stock-trading terminals, Sylvie Armand-Delille tried to assess the unlovely degree to which her business has crashed.

“Even four months ago, this room would have been filled with people screaming at each other, passing orders, everyone holding two phones to their ears,” said Armand-Delille, the director of Moscow operations for London brokerage Fleming UCB.

“I would never have had the time to do an interview like this during the trading day or even meet someone for lunch.”

Now a daytime visitor is a welcome break in the tedium. The Moscow stock market, which in 1997 was the best-performing emerging market in the world, today has all the verve of a backwoods goat barter.

It is hardly surprising that the Moscow stock market has closely tracked the vaulting ambition and painful descent of the outside world’s expectations for Russia’s economy. When hope was rising, as in 1996 and 1997, the market here more than doubled in value each year. When expectations crashed--thanks in part to the fiscal crisis that climaxed with the government’s Aug. 17 devaluation of the ruble and default on its domestic debt--so did the market.

But the workings of this system also illuminate many aspects of the Russian economy indirectly--such as its corruption, favoritism and self-delusion.

“The rise was absolutely real,” said Armand-Delille, who came to Russia from France as an investment broker in 1992, on the heels of the fall of communism. “But with the benefit of hindsight, the rise in Russian investments turned out to be a huge bubble. It’s very disappointing because we really believed in it. I committed my time and energy. And since August I’ve spent a lot of time trying to figure out where we made our mistake.”

This was a stock market like few others, a bourse in which rules and regulations were little more than a facade erected to cloak some unsavory goings-on and profound economic weaknesses.

For a few years that facade was a truly glittering one. After 1994, when President Boris N. Yeltsin won reelection, investors bet on his continued success at taming inflation and on his reform-friendly economic policies. Trading volume on the Moscow market peaked at slightly more than $200 million a day in November 1997, when there were signs that 1998 would mark Russia’s first year of real economic growth since the Soviet Union’s 1991 collapse. It was only this year that the enthusiasm started to drain away.

Yet from the very beginning, the Moscow stock market was a uniquely treacherous thing. With trading based not at a specific location, as it is at the New York Stock Exchange, but among loose conglomerations of independent traders and market-makers, similar to Nasdaq in the U.S., the market lacked such rudimentary mechanisms as clearinghouses, which normally ensure that money and shares safely change hands.

A bare handful of listed companies on the Russian Trading System, or RTS, offered the kind of detailed and reliable financial information Western investors expect; to this day only one Russian company, Moscow cellular phone service provider Vimpelcom, has floated an initial public offering on the Big Board.

In 1996, the U.S. Agency for International Development attempted to cure some of the system’s structural defects by paying to create a government regulatory agency, a clearing company and an electronic trading system. AID hoped they would give the country’s fledgling capitalists and investors the confidence that would turn the system into a genuine capital-raising tool.

That never happened. For one thing, there were almost no domestic investors. Unlike in the United States, where the average salaried 35-year-old is inundated with exhortations to invest in stocks and advice on how to do so, even educated and well-paid Russians own scant savings. Nor are there institutional investors flush with cash. The total assets of Russian pension funds are estimated at a paltry $200 million, compared with more than $2 trillion in the U.S.

“The Russian economy is in the first stages of developing a capital market,” said Viktor B. Sakharov, president of the Moscow Stock Exchange, one of three competing organizations engaged in Moscow-based stock trading. “The foundation of any investment is the savings of the people. Without that there’s no possibility of raising capital.”

What Russians did have was an abiding mistrust of banks, brokerages, investment pools and other financial institutions that typically handle investment capital. This proved well-placed, given the recent history of pyramid investment schemes and failed banks.

“That’s why the people aren’t rioting” over the collapse, said Boris Jordan, an American of Russian descent who was building a domestic finance conglomerate when the August crisis wiped out much of his capital. “It’s because their money was not in the system.”

Instead, while ordinary Russians kept their savings in dollars stashed in mattresses and under floorboards--an estimated $50 billion has been squirreled away like this--the Moscow market became mainly a vehicle for foreign investors to speculate on dozens of huge former government-owned companies, especially in the sectors of oil, gas and other natural resources.

By most estimates, about 95% of the capital in the market was of foreign origin; trades were typically executed by brokerages registered in Cyprus or other offshore locations and were settled in U.S. dollars.

Yet almost from the start, the system labored under peculiarly Russian burdens. One was a tendency for majority owners to behave as autocratically as 19th century czars. While Russian law forbade the sale of controlling stakes in domestic companies to foreigners, Russian managers were accustomed to treating minority shareholders like vermin.

“There’s no respect for the minority stake here,” said Garry K. Kasparov, the Russian chess grandmaster who helps manage the Russia Growth Fund, a Virgin Islands-based mutual fund that invests in Russian equities. “It’s a big problem that unless you have control of a Russian company, you can’t be comfortable,” Kasparov said in a telephone interview from his Moscow home.

Cases are legion of majority owners stripping a company of significant assets for their own benefit or unilaterally diluting the holdings of minority shareholders. In one celebrated 1997 case, a group of politically connected managers apparently managed to cancel Jordan’s visa while he was waging a takeover battle for their company. (Jordan eventually got back into the country, only to face a similar problem a year later.)

An even more irksome problem is the country’s byzantine network of so-called corporate registrars.

Under government rules, every publicly owned company is required to designate a registrar to maintain a roster of shareholders and certify ownership transfers. In practice, said Michael I. Leliavsky, president of Depository Clearing Co., the clearinghouse established with AID’s help, “the issuer controls the registrar completely.”

Many corporate owners became instant billionaires during the privatization drive by vacuuming up many of the 150 million vouchers--putative shares in privatized state companies--that had been distributed mostly to unsophisticated citizens and redeeming them for lucrative shares in the biggest natural-resource enterprises. Not surprisingly, the freshly minted tycoons were loath to see their ownership diluted by stock sales on the open market.

To this day, many registrars have remained less than fully accessible. Often they are located in the company’s hometown and safeguarded by overseers with all the pliancy of Soviet-era border guards.

The system adds enormous cost and complexity to what should be the routine matter of exchanging shares. Traders say it is not unusual for a broker’s agent to be forced to travel for days to record the transfer of a single block of stock in a company’s register, delaying the settlement of a trade for weeks.

For instance, every trade in Surgutneftegas, a gas and oil company that is one of the former Soviet Union’s largest privatized enterprises, must include about $1,000 for the price of a trip to its registry in Surgut, deep in Siberia about 1,500 miles east of Moscow.

Leliavsky cited one other company whose register is maintained in a town unserved by public transportation.

“So you hire a private car to go the last 70 kilometers to where the registrar works one or two hours a day,” he said. “You get there and he demands new documents.”

The outlandish transaction costs become absorbed into the price of the shares, making the true value of Russian equities that much harder to assess.

Nor are the registrars above brazenly manipulating the records under their control; the horror stories include numerous cases of share owners discovering belatedly that their names have been mysteriously crossed off a company’s register (sometimes in the course of acrimonious takeover battles). As a result, brokerages and trading firms customarily hire agents to visit every registrar every month.

Traders say the registrars’ power has gradually ebbed--in part because of pressure from traders complaining that they hampered the market’s overall growth--but they remain a costly and depressing influence. Trade settlements, which in most developed countries take three to five days, require two to three weeks in Russia.

“This is a modern system,” remarked Armand-Delille, gesturing toward banks of computer screens flickering with real-time trade data, “but as soon as a trade is made, you sort of go into the Middle Ages.”

None of this weighed very heavily on market participants as long as trading remained brisk.

“You sit and wonder how so many intelligent people could get caught up in this,” observed Armand-Delille. “The main reason is that change happened so fast on the political front that it led many people to believe it could also happen on the economic front. It was a bit of a crowd phenomenon. People who saw opportunity in Russia were like a little club. But you could go on visits [to listed companies] and see that things were seriously wrong. You’d come back to the office and say it’s better to not let investors see the companies, because they’d be completely terrified.”

While many investors harbored images of Russian managers diligently steeping themselves in Western business precepts, that was not the reality. “I could name you all the 20 Russian companies that are functionally competitive businesses,” Jordan remarked recently.

That message may finally have sunk in, as trading firms lick their wounds, cut their staffs and contemplate losses running into the hundreds of millions of dollars amid a global reassessment of the risks of investing in emerging markets like Russia.

As Leliavsky said, “We won’t see investors coming back to this capital market for a long time.”

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Vodka, Please

It was once the best-performing emerging market in the world, but trading on Moscow’s stock market is practically at a standstill. The market took a nose dive in summer after the government devalued the ruble and defaulted on its domestic debt. Weekly closes of the Russian Trading System since June 1:

Friday: 58.7

* Source: Bridge