Russia’s financial ecosystem is imploding. The impact is felt both in Moscow, where stock exchange trading is halted, as well as in the rest of the world. Institutional investors and multinationals are turning their backs on Russia as the economic fallout from its war on Ukraine make it almost impossible to do business there. Russia ETFs or funds are dropping out of the market in droves. Some are still open, as market makers manage to keep them barely alive. But for how much longer?
Worldwide there are nearly 900 equity funds and ETFs with a stake in Russia of five percent or more, InvestmentOfficer has learned from Morningstar. Managers of those funds, such as UBS, BlackRock, East Capital, Carnegie Fonder, Danske Invest, Pictet and Liontrust have now shut down their Russia- or Eastern Europe-focused funds. “In light of current developments, it is not possible to calculate the net asset value of a fund,” a spokesman for UBS Asset Management said on Tuesday. The Swiss provider has therefore closed the UBS (Lux) ES Russia fund to trading. It’s one of many.
‘This leads to more uncertainty’
History shows that a crisis is not necessarily the death knell of a stock or bond market. During the debt crisis in 2010, the Greek stock market was down for a long time. This was also the case during the revolution in Egypt in 2011. Nevertheless, trade continued, thanks to market makers who estimate the price and then try to match supply and demand. The underlying shares of an ETF, for example, can simply be exchanged or settled in cash.
Sometimes the underlying shares can no longer be traded. This has been the case in Russia for a few days now. Moreover, the Moscow stock exchange has been closed since Monday. That leads to more uncertainty, wider spreads and more volatility, said an insider who wishes to remain anonymous.
Some Russia ETFs are still listed in New York. If investors then want to get out - given the developments in Russia - they look first to the market maker who provides the liquidity in the market. He then determines how much risk he is willing to take to keep the underlying securities on the book before he can sell them on. He will demand a substantial discount from the seller under the guise of “at this level I dare to do it”.
How long will the market maker last?
The risks in the case of Russia are considerable for the market makers. For how long will this crisis last and how extensive will it be? Against the background of this uncertainty, it may take between one and five years before the shares bought at a discount are profitable again.
But if the crisis lasts a long time and the outflow is large, there will come a time when the liquidity providers no longer want to carry the risks on their books and no longer accept sell orders. In that case, ETF providers can do nothing but close the fund or suspend trading, said one person with knowledge of market making. The suspension notices issued by fund and ETF providers in recent days give an indication of how quickly the market for Russian equities is drying up.
ETF providers cannot liquidate
For ETF providers, this creates a new problem. They cannot liquidate their products because they cannot buy or sell the underlying shares on the Moscow exchange due to the trading ban on foreign parties - apart from the fact that there are probably hardly any buyers in the market under the current circumstances.
“You can’t liquidate, because you can’t determine the value. And you can’t calculate a fee on it either. The only option is to wait until the Russian market opens up again. Only then can you see what the value of the underlying pieces is. I personally have never experienced this and therefore do not know how it works, for example, in the event of a major, protracted war,” said an experienced former market maker.
“One thing is certain: you are in no way worse off as an investor with an ETF than if you had invested in stocks directly in Russia,” he said.
Russian assets become ‘morally reprehensible’
The providers of ETFs and investment funds are very reluctant to elaborate on the liquidity problems and other challenges they are facing. But it is becoming increasingly clear that Russia has become a contaminated country in the eyes of the world. Evidence of this is provided by the world’s largest energy corporations, a “shocked’ Shell and BP, who both have decided to divest all their oil and gas interests in Russia with immediate effect.
BP, which has held a 20 per cent stake in Russian oil group Rosneft since 2013. “’We have been operating in Russia for 30 years. But this military action is a fundamental change,” BP executive Helge Lund said on Monday. “After a careful process, the BP board has concluded that our involvement in Rosneft, a state-owned company, simply cannot continue.
BP is writing off some 25 billion euros on its Rosneft investment.
That write-off is indicative of the broad sentiment. Having economic or financial interests in Russia now is seen as “morally highly objectionable”. Norway’s sovereign wealth fund and Storebrand also have already decided to divest.
For Russia funds and ETFs, there is therefore a significant chance that these products will lose value across a broad front and that massive suspension of trading or even closure and liquidation of these funds and ETFs will just be a matter of time.
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