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Analysis & Opinion
30.09.10 Trust But Verify
By Tai Adelaja

Russian state officials have been busy drafting legislation that could pose critical challenges to realizing President Dmitry Medvedev's vision of creating robust institutions that will attract foreign investors to Russia, a Russian newspaper reported on Thursday. But regulators insist the move is motivated by concern for the economy rather than a fear of outsiders.

A proposal made in July by the European Bank for Reconstruction and Development (EBRD) to buy a ten percent stake in the RTS, Russia’s major stock exchange, sowed so much panic within the government’s economic team that officials prepared a new law that would oblige foreigners to seek approval for purchase of more than five percent of financial infrastructure services, the Vedomosti business daily reported. President Medvedev has been pushing for reforms that will transform Moscow into a global financial center, along the lines of London, Singapore or New York, through liberalized financial laws and the creation of a special economic regime for foreign investors. However, some officials have expressed concern that no-holds-barred foreign involvement in the economy could be counterproductive, arguing that more spade work needs to be done to enable the country to reap the fruits of such modernization efforts.

In July, the EBRD announced plans to team up with an unnamed Russian bank to buy about ten percent of the Russian Trading System Stock Exchange (RTS) from bank KIT Finance. Though details were scanty, industry executives said EBRD could receive as much as a nine percent stake in the RTS if the deal were concluded, while its domestic partner would get just one percent. The transaction is valued at about $80 million, or about 35 percent more than its actual market value in June. EBRD representative Richard Wallis said the EBRD’s board of directors has approved the deal, although the deal has not been closed yet since it requires regulatory approval in Russia. In addition, the deal will also need the approval of the Russian government, which controls more than a four percent stake in EBRD through the Economic Development Ministry.

In a swift reaction to the announcement, Vladimir Milovidov, the head of the Federal Service for Financial Markets (FSFM), described the proposed transaction an “act of corporate selfishness,” saying that it lacks a clear strategy for the development of the Russian Stock Exchange, RIA Novosti reported. "We need to understand how this deal will continue to be linked with the development strategy of the exchange. It is unclear how the RTS is developing,” the agency quoted Milovidov as saying. “It is also unclear how the RTS would be developed. There are many [unresolved] issues before the management and shareholders of the RTS. Under these circumstances any talk or speculation about the purchase of stakes in the Exchange will harm the development of a common development strategy of the exchange.”

Vedomosti wrote on Thursday that Vladimir Milovidov and FSB Director Alexander Bortnikov have written to Prime Minister Vladimir Putin, complaining that an increase in the share of nonresidents in the capital of the RTS would prevent its merger with the MICEX, Russia’s other exchange, and derail efforts to create an International Financial Center in Russia. Acting on instructions from the prime minister, Finance Minister Alexei Kudrin instructed Milovidov to draft regulation that will effectively limit the participation of foreigners to no more than five percent in the ownership of stock market infrastructure, according to a source close to the board of directors of Russian Railways – a key shareholder in KIT Finance – cited by the paper. Putin's spokesman Dmitry Peskov said the decision by EBRD to buy a stake in the RTS requires a political solution and that no decision has yet been made on the issue.

A possible takeover of the RTS by the MICEX Group was first announced in April by Sergei Shvetsov, the head of the Central Bank's department for financial markets, who said that MICEX might turn the rival stock exchange into a full subsidiary. Analysts and traders have hailed the move, saying that it will make trading much easier by making more liquid securities available on the RTS. Merging the two stock exchanges is also seen as a key step toward making Moscow into an international financial center, since it would help to attract more foreign investors to Russia's financial market.

The FSFM chief said he was not particularly concerned about whether or not there is foreign participation in the RTS, but that a premature move on the part of the stakeholder could damage the very idea of creating an International Financial Center. "I can neither approve nor disapprove of the participation of non-residents," Milovidov said. “[However] without a clear strategy for the exchange and solutions to the problems that exist in it, it is very difficult for a regulator to positively predict the consequences of such moves.” He added that a decision on the purchase of stakes should be responsible and consistent with the future strategy of the RTS. “It must fit into the logic of creating a financial center and also fit into the solution to those problems that the RTS is now facing," he said.

The eagerness of KIT Finance to sell its stakes has been fuelled by the desire to obtain more than the current market prices, Milovidov said. However, he said, chasing profits on a financial derivatives market was one of the causes of the collapse of trading at the Exchanges in September 2008, when regulators were forced to suspend trading. “We now see the same financial institution making deals that can only be described as corporate self-interest,” he said. Milovidov confirmed that the FSFM is indeed working on a draft law that would enable the state to control the acquisition of more than five-percent stakes by foreigners in financial institutions, adding that the move was triggered by concerns over EBRD’s planned acquisition of a ten percent stake in the RTS.

The regulator said it would take part in a special meeting on October 12 that will discuss, among other things, KIT Finance and the sale of noncore assets, including shares in the RTS, Vedomosti reported on Thursday, citing two sources close to the Russian Railways Board of Directors. KIT Finance sent a proposal to sell up to a ten percent stake it owned in the RTS to eight state-owned institutions, including Sberbank, Agricultural Bank, VTB, Gazprombank, VneshEconomBank, Globex, Svyaz-Bank and MICEX, but none has been willing to buy, the paper wrote. In addition to two other prospective domestic buyers, KIT Finance could still sell its stakes to EBRD on the condition that the bank signs an undertaking to support the merger of the RTS and MICEX, as well as the creation of the International Financial Center on the bases of the merger, according to the company’s documents. EBRD appears ready to accept such conditions. EBRD chief Thomas Mirow has reportedly written to Prime Minister Vladimir Putin and Finance Minister Alexei Kudrin in September, stating that EBRD is ready to immediately start working with the RTS, MICEX and with the authorities to jointly agree on an approach to the consolidation of stock exchanges and their infrastructures and on the signing of a memorandum of understanding.

“EBRD would have brought influence and prestige to the planned International Financial Center, but it announced its plans to acquire a sizable chunk of the RTS at an inauspicious time,” Igor Belyakov, a financial market expert at the Economic Expert Group, said. “If the government officials had allowed the transaction to go through, EBRD would have had authority to exercise initiative and make key decisions affecting the creation of a financial center in Russia. A country needs more than simple trust in a foreign partner to allow such a degree of participation.”
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