Bogachev. In the process of reforming energy generating industry Gazprom has become the owner of major packages of generating companies’ stocks (RAO EES [United Energy Systems of Russia], Mosenergo [Moscow Energy Generating Com pany], OGK 1, OGK 2, OGK 4, OGK 6 and others). In early 2007 Gazprom bought controlling interest of SUEC (Siberian Coal Energy Company) producing one third of all Russian power generating coals. In 2006 it was announced that the rights to develop new off shore fields shall be granted exclusively to state owned compa nies. Private corporation TNK BP was challenged with numerous claims on behalf of tax, law enforcing and environmental authorities in 2006; at the same time vari ous media published information that Gazprom and Rosneft had offered to buy out the share of Russian shareholders in this integrated company112, and Gazprom ex pressed its interest in acquiring 75% interest in Kovykta gas condensate field (cur rently owned by TNK BP). At the same time analysts noticed oil and gas produc tion decrease in 2005–2006 versus 2000–2004 as a consequence of respective assets being shifted to state owned corporations113, as well as gas shortage in do mestic consumption in 2007.
GEF press release of September 26, 2006.
B. Grozovsky, Chief Owner in the Country. – “Vedomosti”, February 13, 2007.
“Vedomosti”, November 22, 2006.
V. Milov, The Echo of Property Redistribution. Forbes – February, 2007. – p 30.
Section Institutional Problems Another state owned corporation (Rosboronexport) acquired control over Av toVAZ (Automotive Plant, manufacturer of “Ladas”) and over VSMPO Avisma cor poration, the world’s largest titanium producer. The same corporation started ac quiring metallurgic plants (JSC Metallurgic Plant “Krasny Oktyabr”, Chelyabinsk metallurgic plant) with the purpose of creating metallurgic holding for special steel manufacturing.
According to The Heritage Foundation and Dow Jones & Company, Inc. Eco nomic freedom rating114, in 2006 Russia got only 120th position out of 157 having scored 54.01 out of maximum 100, which is below the score of 2005. Taking BRIC countries, China took 119th position (scored 54.02 балла), Brazil and India – 70th position (60.89 scores) and 104th position (55.60 scores) accordingly. The evalua tors believe that such a low score in the area of “financial freedom” is associated with inefficiency of the banking system, gaps in banking supervision and transpar ency, as well as limitations for non residents to enter banking and insurance busi nesses. Low rating in the area of property rights protection means that property protection is very weak in Russia, “judicial system is biased and corrupt”, and in such environment it is very difficult to assure contractual obligations are fully met.
In 2006 government was not able to propose clear rules in attracting foreign investors into strategic sites in the territory of the Russian Federation. Despite the fact of Russia chairing G 8 in 2006 and active dialogue in energy security, Russia and Western countries were not able to develop a common approach to resolve this problem. Russia rejected proposals to assure incentives to attract investment into oil and gas exploration, production and refining based on free market principles and fair competition between private companies; instead Russia accentuated the monopoly of state owned companies and their expansion both at domestic and foreign markets115. Lack of mutual understanding between countries exporting en ergy and countries consuming those resources is a serious threat to both econom ics and politics of all these countries including Russia.
The year of 2006 did not bring any significant changes in the area of informa tion openness of Russian economy. Media did not gain more freedom. On the con trary, during this year a number of central media changed their owners and were acquired by loyal to government business groups.
A number of positive changes were noticed in the area of listing. The required minimal liquidity standards for financial instruments and minimal capitalization The Heritage Foundation and Dow Jones Co. develop the economic freedom index (www. heri tage. org/index) based on evaluating the level of freedom in 10 areas: economy, trade, taxation, fi nance, monetary policy, investment, labor relations, independence from the government, protection of property rights and independency from corruption. Based on the final evaluation all counties are divided into 5 groups: free countries (80–100 scores), mostly free countries (70–79.9 scores), par tially free countries (60–69.9 scores), mostly non free countries (50–59.9 scores), non free coun tries (0–49.9 scores).
On February 14, 2007, the 6 month FRS Report to the USA Congress stated, that one of the key reasons for global oil prices to stay at the high level was “limited investment in energy sector on be half of international oil companies in some countries including Russia and Venezuela due to in creased level of government control over the energy sector” (www. оnline. wsj. com).
RUSSIAN ECONOMY IN trends and outlooks standards for securities were strengthened, as well as minimum standards for the issuers with regards to the term of being in business operations to be qualified for listings, as well as standards of strengthening the role of exchanges in controlling corporate governance compliance on behalf of issuers. However, low level of Free Float of Russian issuers (the portion of freely circulating stocks) still constitutes a serious problem when Russian companies are listed at Russian stock exchanges.
According to effective securities regulations and exchanges rules, the issuers in cluded into quotation lists A1 and A2 need to have at least 25% Free Float, as for level В list, this requirement has been reduced down to 10%. Shares with low Free Float are to a greater extent exposed to price manipulations and are more volatile, which creates additional risks for investors. The problem is that out of 306 issues of stocks allowed for circulation at MICEX (Moscow Inter Bank Currency Exchange) as of the end of 2006, only 16 were included into quotation list А1, and only 11 – into list A2. Thus, according to exchange listing requirements only every tenth of the companies offering their stocks should follow the minimum Free Float stan dards.
In 2006 Russia did not demonstrate sufficient progress in application of Inter national Financial Reporting Standards (IFRS). Evaluation by CalPERS is based on the opinion of eStandardsforum and takes into account the fact that in July the respective authorized government body – the RF Ministry of Finance – stated that within the Accounting and Reporting Mid Term Development Concept for the period 2004–2010 Russian companies shall be switching to IFRS on a mass scale.
According to the above mentioned Concept, application of IFRS during preparation of consolidated financial reports by “business entities of public value” shall become mandatory in 2004–2007 (under “business entities of public value” joint stock companies with publicly offered or floating shares are understood). Thus, the Min istry meant practically all companies with shares floating at stock exchanges. How ever, lack of law enforcement mechanisms does not allow for successful achieve ment of the set target.
Unfortunately, there are no recognized statistical data about the number of Russian JSCs using IFRS. According to our evaluation, the number of companies using IFRS is still significantly below the target level, and does not match the needs of not only foreign, but also of Russian domestic institutional investors. Thus, ac cording to our estimates, the round of issues by Russian companies with interest of Russian mutual investment funds (MIFs) constitutes about 450–500 issues. And only on 200–250 issues the issuers provide reporting according to IFRS (less than in 50% of the cases). This is an evidence of the fact that in many instances invest ment into Russian companies’ shares is often done at random (blindly), without sufficient level of investment strategy formalization. It is impossible to adequately evaluate the shares (from the point of view of their growth) issued by the compa nies which do not follow IFRS. Financial indices to classify companies’ shares and investment funds portfolios may be calculated only on the basis of IFRS (e. g., ac cording to the investment styles table – growth stock, value, combined). This may be of great significance for investors to gain awareness about profitability versus Section Institutional Problems risk with regards to different assets. Eventually even Russian domestic institutional and retail investors are forced to “fly without navigation equipment” (if we are to use aviation terminology), without adequately positioning themselves with regards to subjects of investment. It’s not difficult to imagine what may be the result of such flights.
The stock exchanges capabilities are not fully employed in the process of promoting IFRS among Russian companies. According to the existing listing rules such reporting is required only for the companies of A1 and A2 categories. It actu ally means that only every tenth company entering the market is obliged to apply IFRS.
Thus, in 2006 institutional problems underpinning Russian capital market maintained and even redoubled. What does it mean for foreign and Russian inves tors The key point is that the foundation for quantitative growth of financial market, its scale, debt instruments and liquidity level becomes more and more unsteady.
Capitalization growth of major state owned corporations is taking place at the ex pense of acquiring new assets on exclusive terms, but it is not accompanied by im proving the efficiency of utilized assets/resources. Major corporations become the elements of government policy; their decisions can be less and less forecasted.
Practically, there is no system of independent control on behalf of investors and civil society over the efficiency of managerial decisions in economics and finance.
All this increases the systemic crises exposure for capital markets and creates the pre requisites for violation of investors’ rights.
5.4.3. Institutional and Structural Disparities and Growth Factors The problems of investment climate in Russia in 2006 were surprisingly com bined with high yield of Russian companies’ shares, heavy growth of capitalization and liquidity of stock exchange market. It’s been the second year in a row, which is a very rare event that Russian stock markets remain global leaders with regards to their growth rates (see Figure 1).
In 2006 RTS index increased by 70.83% vs. the end of 2005, the incremental growth of MICEX and MSCI Russia indices was 67.5% and 52.9% respectively.
Only Peru, Venezuela, Cyprus and China performed better as for stock indices.
The profitability index of RTS was 2.5 times above the index of MSCI emerging economies. Growth of stock yield in Russia was accompanied by significant strengthening of Ruble: by 8.5% vs. USD. This became another “plus’ of Russian capital market for American and global investors.
RUSSIAN ECONOMY IN trends and outlooks Source: WFE (World Federation of Exchanges) data; WSJ publication data.
Figure. 1. Incremental growth of stock indices (%, December 2006 vs.
December 2005) The growth of stock market liquidity caused noticeable growth of Russian com panies capitalization and of stock prices volatility dynamics, as is shown in Figure 2.
Source: data by RosBusinessConsulting and Russian exchanges.
Figure 2. Capitalization, Liquidity and Volatility of Russian Stock Market Section Institutional Problems In 2006 capitalization of Russian companies grew from $472 bln up to $bln, i.e., 1.9 times; the stock trading volume at MICEX, RTS and St. Petersburg in creased from $180.2 bln up to $597.0 bln, i.e., 3.3 times. The mean square devia tion of RTS index per day, which reflects the volatility of “blue chips” prices, grew in 2006 and made 0.02 vs. 0.013 in 2005 meaning the risks of investment into stock increased by 1.5 times.
As per capitalization size Russian stock exchanges improved their position from 19 up to 15, leaving behind the markets of Korea Republic, India, Brazil and Taiwan (see Figure 3).
Source: WFE (World Federation of Exchanges) data; WSJ publication data.
Figure 3. Capitalization of 2006, USD bln Russian companies’ capitalization in 2006 made circa $908 bln, which reflects Russia’s position as one of the biggest emerging markets. Only China was ahead of Russia as per this index.
The exchange market liquidity indicators growth rate exceeded that of capi talization in 2006. The global position of Russian capital market as per this criterion is presented in Figure 4.
RUSSIAN ECONOMY IN trends and outlooks Comment. * Russian data include indices of RTS and MICEX.
Source: WFE (World Federation of Exchanges) data; MICEX and RTS data.
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