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The growing attractiveness of the market for government bonds is driven by measures the MinFin undertakes to enhance the level of transparency and ensure a greater predictability for investors operating on this particular market, simplify and beef up the clearing systems reliability, unify the procedures of trading in, and depository servicing of, government, corporate and regional bonds. The above concerns the transition to a regular publication of quarterly schedules of OFZ placement and yields to maturity of new bond issues, cancelation of requirements about a preliminary depositing of cash on the day the auction is held, and transition to placement of benchmark issues of OFZ. Since 13 February 2012 all transactions involving OFZ have been transferred to the main trading regime at MICEX-RTS, which, according to the exchanges estimates, will allow increase of the number of participants in trading in this particular instrument from 304 6401. That also allowed a substantial simplification of, and bringing depository operations on the organized security market in consistency with, the rules on the market for equities and corporate bonds. More specifically, the head depository for GKO-OFZ is no longer bound to maintain duplicated data on custody accounts of owners of papers run at dealers sub-depositories together with the head depository in the frame of the so called Dealer Sub-Depository Technical Provision Center. Uniformity of procedures of running depository operations across all the segments of the securities market facilitates solving the task of attraction of non-residents to the domestic market for GKOOFZ. To this end, the major attraction for investors will be the possibility to open an account of a nominal holder of international clearing organization with the Russian central depository.

The successful placement of government papers in 2011 was also fueled by a favorable situation in the national economy, with inflation rates going down notably and having hit their all- time lows (6.1%) by the end of the year. For the first time in a multi-year history of OFZ placement, their yields at an auction and on the secondary securities market were substantially above the inflation rate (Fig. 26) since August-September 2011. Meanwhile, it can be assumed that despite the declining inflation rates, the MinFin did not opt for lowering the borrowing rates in H2 2011, thus creating a competition pressure on free cash resources on the financial market.

Let us note that the continuous expansion of government papers on the domestic financial market entails ambiguous consequences. A positive effect of the process is the rise of a liquid market for robust financial instruments which for the first time over a long-lasting period began playing the role of an indicator of risk-free rate of borrowing. In addition to tackling fiscal challenges, this is important as an impulse to growth in long-term domestic savings and expansion of the financial services sector. Meanwhile, given a narrow array of domestic institutional investors and sources of bank liquidity, an increase in public borrowings under market terms forms a substantial hurdle to corporate and regional borrowers. More than this, we believe that the rise in public borrowing on the domestic market in H2 2011 was one of the factors behind the temporary crisis of bank liquidity which did not let banks compensate for the closure of the credit window on the global markets by bolstering borrowing on the domestic debt market.

Mazunin A. Investors came for a long Ruble. Kommersant, 9 February 2012.

RUSSIAN ECONOMY IN trends and outlooks 35,30,25,20,15,10,5,0,2007 2008 2009 2010 2011 Long-term rate Medium-term rate Yeilds by the weighted-average auction price, as % annulized* Inflation (by months, as % annualized) * averaged over the month average-weighted rate by results of auctions weighted with account of placed bonds.

Source: by data of the Bank of Russia and Rosstat.

Fig. 26. The Average Monthly Rates on the OFZ Market and Inflation 3.4.2. The State of the Corporate Bond Market Fig. 27 displays monthly data on volumes of issues of Rb-denominated corporate bonds and the turnover of the respective secondary market at MICEX between 2001 and January 2012. In addition, Fig. 27 exhibits data on bank liquidity which is presented as average monthly cash balances on banks correspondent accounts and deposits with the Bank of Russia. In 2011, the volumes of the secondary market for corporate bonds soared up to Rb 36.3 trillion vs. Rb 23.0 trillion in 2010 and 9.3 trillion in 2009. For many years, despite frequent roller-coaster effects on the global market, the secondary exchange market displayed a phenomenal starch and was expanding steadily. In the pre-crisis years, when liquidity was on the upsurge, the rise of corporate bonds was secured largely by the carry trading strategy. In 2010, the growth factor became a rapid inflow of short-term liquidity as a consequence of an accelerated increase in monetization of the economy. The shrinkage of bank liquidity in was once again accompanied by an increase in the number of transactions on the secondary exchanging market for bonds, as it was repo transactions using which banks borrowed shortterm capital in the form of interbank loans and from the Bank of Russia.

Another peculiarity of the corporate bond market has become the fact that significance of the secondary market has been constantly on the rise vis--vis the role played by the bond placement process. In 2010, with volumes of issues of corporate bonds plunging 6.8%, the turnover of the papers in question on the secondary market was up 147.0%. In 2011, the value of the respective transactions soared by 8.1% and 58.0%, respectively. On the one hand, an outstripping growth rate in liquidity of the secondary market for corporate bonds has a positive effect on the term and rates of borrowing, while funding long-term loans with short-term resources bears greater risks for the market, including the risk of issuers lower possibilities to refinance their loans in the future.

% annualized jul jul jul jul jul oct jan oct jan oct jan oct jan jan oct jan feb feb feb feb feb apr jun apr jun apr jun apr jun apr jun sep sep sep sep sep dec dec dec dec dec aug aug aug aug aug nov nov nov nov nov mar mar mar mar mar may may may may may Section Financial Markets and Financial Institutions Current stage Liquidity on the Crisis and recovery 4 000 000 rise and the carry 1 trading heyday 3 600 000 period 1 3 200 1 2 800 1 2 400 1 2 000 Moderate liquidity 1 600 zone 1 200 800 400 - Secondary trading Placement Bank Liquidity Source: by data of the Bank of Russia and MICEX-RTS.

Fig. 27. Transactions with Corporate Bonds and Bank Liquidity between 2001 and January The markets for public and corporate bonds face the most pressing and yet unresolved challenge of attraction of domestic and external investors long money. It was banks that thus far have prevailed on this market as a source of capital: their share in the structure of sources of financing of corporate bonds first rose from 31.9% in 2008 to 42.7% in 2010 and then plummeted to 37.7% in 2011. An effective measure to support the market for Rb-denominated corporate and regional bonds became the passing of amendments to the law on pension system. The amendments resulted in the possibility to invest a fraction of money from the savings system in non-governmental bonds. In compliance with Federal Act of 18 July No. 182-FZ On introducing amendments to the Federal Act On investing of funds for financing the savings part of the labor pension in Russian Federation, the state-owned managing company whose functions are exercised by VEB was granted the right to invest residents pension savings in an extended investment portfolio, which is formed by Russian issuers corporate bonds, guaranteed by the state Rb- and forex-denominated deposits with credit organizations, mortgage-backed papers, and international financial institutions bonds, among others. The proportion of VEB and private managing companies investments formed by pension savings in 2009 accounted for 0.5% of the aggregate value of corporate bonds in circulation. In 2010 and by results of the 9 months of 2011, it surged up to 3.5% and 3.9%, respectively. The share of mutual investment funds and the money market in financing corporate bonds has been negligible and accounted for 0.3% of the value of capitalization of corporate borrowers bonds in 2009, 0.5% - in 2010 and 0.6% - in 2011.

Transactions with bonds, Rb mn Bank liquidity, Rb bn Jul-Jul-Jul-Jul-Jul-Jul-Jul-Jul-Jul-Jul-Jul-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Jan-Oct-Oct-Oct-Oct-Oct-Oct-Oct-Oct-Oct-Oct-Oct-Apr-Apr-Apr-Apr-Apr-Apr-Apr-Apr-Apr-Apr-Apr-RUSSIAN ECONOMY IN trends and outlooks That the corporate bond market has increasingly turned into an instrument of servicing interbank lending deals vs. the long-term nature of corporate bonds per se is demonstrated by the structure of transactions with corporate bonds at MICEX-RTS (Fig. 28). At the peak of the problem with bank liquidity, in November 2011, the proportion of repo deals in the aggregate value of exchanging deals with corporate bonds hit its all-time highs and accounted for 92%. That the corporate bond market has increasingly turned into an instrument of servicing interbank lending deals vs. the long-term nature of corporate bonds per se is demonstrated by the structure of transactions with corporate bonds at MICEX-RTS (Fig. 28). At the peak of the problem with bank liquidity, in November 2011, the proportion of repo deals in the aggregate value of exchanging deals with corporate bonds hit its all-time highs and accounted for 92%. Today, only less than 5% of transactions with corporate bonds are market ones, i.e. are used indeed for the sake of portfolio formation and restructuring. The risk of the current situation with corporate bonds is that should market participants switch to government bonds as a naturally simpler and more efficient mutual lending instrument on the repo market, they would trigger a systemic crisis on the market for corporate borrowings.

76 2005 2006 2007 2008 2009 2010 2011 Auction (market) regime Negotiated deal regime Repo transaction regime Source: by data of MICEX-RTS.

Fig. 28. Structure of Transactions with Corporate Bonds at MICEX, as % In contrast with the corporate bond market, the structure of exchanging deals with regional bonds (Fig. 29) displays positive changes. In early 2011, the share of repo deals on this particular market accounted for some 92%; however, it slid to 51% in H2 of the year, with the proportion of market deals hitting 22% in 2011. This evidences that regional bonds proved to a lesser degree be engaged in interbank lending and, per haps, investors more vigorously use them to shape up and restructure their portfolios jul jul jul jul jul jul jul jan oct jan oct jan oct jan oct jan oct jan oct jan oct jan feb feb feb feb feb feb feb apr jun apr jun apr jun apr jun apr jun apr jun apr jun sep sep sep sep sep sep sep dec dec dec dec dec dec dec aug aug aug aug aug aug aug nov nov nov nov nov nov nov mar mar mar mar mar mar mar may may may may may may may Section Financial Markets and Financial Institutions 2005 2006 2007 2008 2009 2010 2011 Auction (market) regime Negotiated transaction regime Repo transactio Source: by data of MICEX-RTS.

Fig. 29. Structure of Transactions with Corporate Bonds at MICEX, as % 3.4.3. Competition on the Market for Corporate and Regional Bonds Fig. 30 displays findings of an analysis of proportions of different groups of participants in trading (private and state-owned corporations1, and the Bank of Russia) in volumes of exchanging trading in corporate bonds at MICEX-RTS in all the regime, including market, negotiated deals, and repo transactions. The share of public structures in the volume of transactions with corporate bonds underwent practically no change throughout 2011; that said, between August and December, it was Bank of Russia which held the lions share of volumes of transactions with the said instrument, for in the period of exacerbation of the situation with liquidity, the Bank of Russia has been crediting banks by means of repo deals with corporate bonds. In so doing, the magnitude of the said operations proved to be greater than during the acute phase of the 2008 crisis.

2005 2006 2007 2008 2009 2010 2011 Public structures, less CBR The Bank of Russia Other participants in trading Source: by data of MICEX-RTS.

Fig. 30. Proportion of Private and Public Brokers in Volumes of Trading in Corporate Bonds at MICEX-RTS, as % VEB, VTB, VTB Capital, VTB24, Gazprombank, Sberbank, KIT-Finance, Sviaz-Bank, Bank of Moscow, Transcredit, and from 2011 IC Troika Dialogue.

jul jul jul jul jul jul jul jan oct jan oct jan oct jan oct jan oct jan oct jan oct jan feb feb feb feb feb feb feb apr apr apr apr apr apr apr jun jun jun jun jun jun jun sep sep sep sep sep sep sep dec dec dec dec dec dec dec aug aug aug aug aug aug aug nov nov nov nov nov nov nov mar mar mar mar mar mar mar may may may may may may may jul jul jul jul jul jul jan jan jan jan jan jan jan oct oct oct oct oct oct oct jun jun jun jun jun jun feb feb feb feb feb feb apr apr apr apr apr apr sep sep sep sep sep sep sep dec dec dec dec aug dec dec dec aug aug aug aug aug aug nov nov nov nov nov nov nov mar mar mar mar mar mar may may may may may may RUSSIAN ECONOMY IN trends and outlooks Fig. 31 shows the proportion of public structures and the Bank of Russia in volumes of exchanging trading in regional bonds. During the last four months 2011, the Bank of Russia has been vigorously participating in transactions with regional bonds, and during some periods would hold up to one-third of volumes of deals with regional bonds.

2005 2006 2007 2008 2009 2010 2011 Public structures, less CBR The Bank of Russia Other participants in trading Source: by data of MICEX-RTS.

Fig. 31. Proportion of Private and Public Brokers in Volumes of Trading in Corporate Bonds at MICEX-RTS, as % The market for corporate bonds appears substantially different from the one for regional bonds in terms of level of concentration measured by Herfindahl-Hirscmann Index (Fig.13).

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