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The President of Vnesheconombank, V. Dmitriev, made the relevant statement during the Vesti news broadcast on December 21, 2009.

Vnesheconombank, Vneshtorgbank, VTB Capital, VTB 24, Gazprombank, Sberbank, KIT Finance, Sviazbank and Bank of Moscow.

Section Monetary and Budgetary Spheres Similarly, the recovery in the MICEX index starting from February 2009 is more likely to have been due to the growth in private trading volumes than to government entity trading. It is possible that government support to the stock market using financial interventions has smoothed the market drop, but it is unlikely to have had any influence on the trend per se.

Market recovery was mostly due to private investors.

Source: proprietary calculations using MICEX data.

Fig. 19. Index trends in trading volumes for public and private MICEX market participants from May 2008 to January 2010.

If the stock market is viewed as a zero sum game in terms of average yields for market participants whereby the profit made by certain investors signifies losses for other investors, it follows that the high yields from the equity investments made by Vnesheconombank using a fixed interest rate subordinated loan (where the bank estimates its profits from the transaction at 60% according to the analysis it published in late 2009), amount to a deduction from the profits of other investors that sold their stocks to it at the bottom of the market. In this case it is more appropriate to speak about a profitable margin transaction by government-owned bank using a loan granted on highly favourable terms (maturity and interest rate) than to claim effective government support to the stock market and to investors.

Government support measures for the ruble-denominated bond market Fig. 20 shows monthly data on the issuance and secondary market trading volumes for ruble-denominated corporate boards at MICEX from 2001 to January 2010. The Fig. also shows data for bank liquidity measured by correspondent bank account and deposit balances for commercial bank deposits at the Bank of Russia. It can be seen from the Fig. but that the start of the financial crisis in August 2008 led to a significant decrease in bank liquidity, in stock RUSSIAN ECONOMY IN trends and outlooks exchange trading volumes, and in corporate bond placement volumes. The stock market crisis that started in May 2008 and was exacerbated by investor panic and the global markets following the Lehman Brothers investment bank bankruptcy announcement in September then threatened to spread to the ruble-denominated bond market. In September 2008 MICEX experienced a temporary crisis due to the lack of a risk management system for repo transactions that led to a default on such transactions by several key market participants. However, the timely intervention by the Bank of Russia, an improvement of settlement procedures, and the restructuring of insolvent banks have resulted in the avoidance of a systemic crisis in the bond market.

The decrease in trading volumes in the Russian corporate bond market continued until February 2009. The market experienced massive defaults on offers, coupon payments, and principal repayments by second tier issuers. However, starting from February 2009, secondary market trading volumes started an unexpectedly rapid recovery, and starting from June, high-volume corporate bond issues resumed. As a result, for 2009 as a whole, the volume of corporate bond placements in the domestic Russian market totalled 917 billion rubles compared to 398 billion rubles in 2008 and 457 billion rubles and 2007. Secondary market trading volumes for bonds in 2009 amounted to 9282 billion rubles, which is somewhat below the respective figures of 11349 billion rubles in 2008 and 9489 billion rubles in 2007.

Source: Bank of Russia, MICEX stock exchange.

Fig. 20. Corporate bond trading and bank liquidity in 2001- January The recovery in the corporate bond market in 2009 even in the absence of carry trading strategies that had been continuously used since 2004 was made possible due to the use of Central Bank resources and liquid funds within the state budget to maintain liquidity in the banking system. Fig. 21 shows that starting from February-March 2009, banks became the principal buyers of ruble denominated bond placements. Prior to the start of the financial criSection Monetary and Budgetary Spheres sis there was no clear link between the growth in bank portfolios of corporate bonds and the placements of such bonds, with an R2 regression ratio of zero. However, in March December 2009, the ratio increased to 0.4, pointing to correlation between the two sets of data1.

Source: Bank of Russia, MICEX stock exchange.

Fig. 21. Correlation between corporate bond placement volumes and bank investment in such placements (millions of rubles) The reason for bank preference for purchasing corporate bonds rather than increasing loan portfolios given sufficient banking sector liquidity in 2009 is that unlike lending, corporate bonds are liquid instruments. Their liquidity was supported by the government both directly, with the Bank of Russia using direct repo transactions with government bonds to lend to the banking system and indirectly, by shoring up the liquidity of state banks that traditionally acted as creditors in the market of interbank borrowings collateralised by such bonds. By repeatedly using the bonds as collateral for repo transactions, banks are able to use 1:1 or 1:leverage, i.e. raise 1-2 rubles of funding in the form of loans collateralized by bonds for each ruble invested in underlying bonds.

Fig. 22 shows the percentage share of various trading participant groups (private financial companies, government entities2, and the Bank of Russia) in the MICEX market trading volumes for corporate bonds for all types of transactions, including open market transactions, over the counter transactions, and repo transactions. The share of government entities in corporate bond trading significantly grew starting from March 2009, while the Bank of Russia From March to November this ratio equaled 0.7. It was only in November and December 2009 that other players, most likely pension system funds managed by Vnesheconombank, increased their participation in corporate bond placement activities.

Government entities are listed in the footnote to Fig 18.

RUSSIAN ECONOMY IN trends and outlooks joined the market in April as a major and liquidity provider by means of repo transactions and other transactions.1 From April 2009 until January 2000, the share of the Bank of Russia in corporate bond trading volumes at MICEX ranged from 0.7% to 17.3%.

Source: MICEX stock exchange.

Fig. 22. The share of private and public entities in MICEX corporate bond trading volumes (%) Fig. 23 shows an analysis of placement volumes not only for corporate bonds but also for ruble-denominated bonds issued by regional and federal governments. The placement volumes for federal and regional bonds in 2009 were considerably lower than corporate bond issues; however, these volumes set a record for the 2000s. Issues of Federal Borrowing Bonds (OFZ) and State Savings Bonds (GSO) increased from RUR 294 billion in 2007 and RUR 271 billion in 2008 to RUR 519 billion in 2009. The reasons for the increase in federal bond issues that was concentrated in the second half of 2009 are linked to the active policy measures by the Ministry of Finance aimed at mopping up excess liquidity in the banking sector that had increased due to the stalled growth of loan portfolios, including doing so by offering higher yields for such bonds compared to previous years. Regional bond placements grew from RUR 42 billion in 2007 and RUR 97 billion in 2008 to RUR 112 billion in 2009. The increased attractiveness of regional bonds for investors in 2009 was due to government support measures, similarly to corporate bonds.

The data on trading activity by the Bank of Russia shown in Fig. 22, exclude over-the-counter direct repo transactions by the Bank of Russia with corporate bonds.

Section Monetary and Budgetary Spheres Source: RTS trading system, IMF.

Fig. 23. Ruble-denominated bond placement volumes Fig. 24 shows the share of government entities and the Bank of Russia in market trading volumes for regional bonds. Although the market share of government entities from the Bank of Russia was relatively unchanged from August 2008 to January 2010, it is obvious that a preservation of the share at level approximately 40% of the total volume of regional bond transactions was an important factor in supporting this bond market segment.

Source: MICEX stock exchange.

Fig. 24. The share of private and public entities in MICEX regional bond trading volumes, % RUSSIAN ECONOMY IN trends and outlooks An effective mechanism of supporting the ruble-denominated corporate and regional bond market in 2009 was provided by the adoption of legislative amendments concerning the pension system that allowed to invest a proportion of pension system savings in non-government bonds. The Federal Law No 182-, On Amendments to the Federal Law on Nongovernment Pension Funds and the Federal Law On Investing the Funds for Financing the Savings Portion of Labour Pensions in Russia both came into effect on July 18, 2009. According to the provisions of these laws, the state management company, whose duties are carried out by Vnesheconombank, is now able to invest the public pension savings into a broader investment portfolio that includes corporate bonds by Russian issuers, government guaranteed bank deposits denominated in rubles or foreign currency, mortgage securities, and bonds issued by international financial institutions. As of October 2009, data about the structure of the Vnesheconombank investment portfolio published at the Russian pension fund web site, showed that the portfolio did not contain corporate bonds. However, it is likely that the presence of the savings portion of the pension system in the non-government bond market increased in late 2009 early 20101.

On the supply side, the growth in the ruble-denominated corporate bond market was driven by major state-owned companies. This was largely due to changes in the securities market legislation that facilitated the issue of traded bonds by using a simplified procedure for registering securities issues at stock exchanges instead of the Russian Federal Financial Markets Service. To promote greater stability in the corporate bond market, the allowed maturity for traded bonds was extended from one to three years. Bond issues were permitted not only for open joint stock companies but also for other business entities and state corporations.

Table 4 shows corporate bond placement data by issuer. Widespread defaults resulted in the bond market being effectively closed to second tier issuers. Principal corporate bond issuers in 2009 included natural monopolies (Russian Railways, Transneft, Gazprom), state corporations, Vnesheconombank, Atomenergoprom, and major private and state owned companies (LUKoil, AFK Sistema, VTB, Gazpromneft, MTS, the Novolipetsk Steel Mill, Severstal, MMK, etc). For many of these, the domestic bond market became a temporary substitute of foreign borrowings made difficult by the crisis of confidence in this market segment.

The crisis mitigation measures planned by the Russian government for 2009 envisaged the development of a mechanism of government guarantees for so-called infrastructure bonds to support the implementation of large scale development projects. However, the mechanism of such guarantees was not developed and consequently, no such bond guarantees were granted by the Ministry of Finance. It is most likely that the major companies and corporations sought to meet their domestic funding needs by way of issuing corporate bonds by reaching working agreements with state owned banks at top management level.

According to media reports, the initial placement of corporate bonds in 2010, i.e. the 23rd tranche of the Russian Railways bonds with a total value of RUR 15 billion and maturing in 15 years, the largest purchaser that bought RUR 1 billion worth of bonds was believed by trading participants to be Vnesheconombank using pension savings funds. A. Mazunin, Bonds significantly in debt// Kommersant, February 5, 2010, page 10.

Section Monetary and Budgetary Spheres Table Key ruble-denominated corporate bond issuers in Placement volume, millions Issuer Market share, % of rubles 1 Russian Railways (RZhD) 145 15,2 Transneft 135 14,3 Vnesheconombank 60 6,4 LUKoil 50 5,5 Atomenergoprom 50 5,6 Bashneft 50 5,7 AFK Sistema 39 4,8 MTS 30 3,9 Housing Mortgage Lending Agency 28 3,10 VTB (VTB 24) 23 2,11 Sibmetinvest 20 2,12 Gazpromneft 18 2,13 VTB Leasing Finance 15 1,14 Mechel 15 1,15 15 1,16 Gazprom 15 1,17 Novolipetsk Steel Mill 15 1,18 Severstal 15 1,19 NIA VTB 001 14 1,20 Petrokommerz Bank 11 1,21 MBRR 10 1,22 Rosbank 10 1,23 Rosselhozbank 10 1,24 Vimpelkom Invest 10 1,25 Other issuers 113 12, Total 916 Source: www.cBonds.ru, MICEX stock exchange.

Crisis mitigation measures taken by the Russian Federal Financial Markets Service to minimise stock markets risks The current financial crisis gave rise to a number of innovations in the area of government stock market regulation. Due to the increased market volatility, the Federal Financial Markets Service imposed a ban on brokers for entering into unsecured (short sale) transactions on September 18, 2008. The ban was lifted on September 26, 2008 but was then reinstated on September 30 and remained in force until June 15, 2009.

Starting from September 25, 2008 the Federal Financial Markets Service limited the use of debt leverage for margin transactions1 by brokerage clients. Prior to this restriction, brokers Margin transactions are securities purchase transactions by brokerage clients using borrowed funds. Unlike short sale transactions that are used to derive short term profits in a falling market, margin trading strategies are generally used in a growing stock market to derive incremental profits from using debt leverage.

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