After my meetings in Moscow last week, I’m wondering whether there is a Russian model of investing that could work with our Anglo-Saxon world of trading and meeting one of the key guys at MICEX, the Moscow International Currency Exchange (nothing to do with one’s gender), gave me a different view of Russia’s position.
As mentioned last week, real-time settlement is key to Russia’s markets, because no-one trusts each other. This then inhibits leverage because of the need to deposit enough collateral to cover your position.
On MICEX, the Central Bank obviously has an ability to leverage as much as they want because they are guaranteed to pay back. The large banks, such as Sberbank, are allowed a reasonable level of leverage based upon a deposit of a percentage of their trading position, although I had the impression that this is a sizeable percentage. But everyone else has to deposit enough collateral to near enough cover their total trading. This inhibits trading and leverage, but at least it guarantees settlement which some might say is no bad thing.
But there is a bad thing.
As mentioned on Friday, the RTS Index has been bouncing around faster than a Bolshoi Ballet Ballerina this year. This is because no-one invests in Russian stocks or stock markets for the long-term. It’s all short-termism.
A casual trader will play with Russian stocks for six months and then pull out. An e-trader maybe for just a month. When asked “what is long-term in Russia”, my friend at MICEX calmly replied: “less than a year”.
You see you can get your fingers burnt real fast. We talk about short-sellers in Europe and America, but in Russia these guys are not just selling short, they’re selling Bashful, Grumpy, Sleepy, Sneezy, Happy, Doc and Dopey.
These are the ultimate of short sellers, and hence you can buy into Russian stocks in the morning and be a millionaire or a pauper by end of day.
That is why real time settlement is critical, and why positions, margin calls and trading structures are so key.
With MICEX, they claim to be trading around RUB 700 billion (GBP £17 billion / USD $25 billion) per day. Of that, over half is currency trading and the rest is everything from derivatives to equities, corporate bonds to treasury bills.
MICEX’s history is also interesting. The Exchange started just after Gorbachov’s reforms in 1990, as a division of the Central Bank of Russia.
Launched in 1992, it enabled currency trading which, before MICEX, did not exist in Russia.
MICEX were also at the heart of the bubble that led to the 1998 financial crisis in Russia, as GKOs were their stock in trade. GKO’s – Gosudarstvennoe Kratkosrochnoe Obyazatelstvo’s – are short term state bonds issued by the state of Russia and traded on MICEX. Because people did not understand or know how to deal financial instruments in Russia back then, it meant that debt was generated without any sense of the obligation to pay back.
As a result, GKOs were originally traded for the short term in days and weeks but, as people saw these as state-backed securities, they gradually moved into being traded in months and years. In other words longer term, rather than short term.
The result of over issuing GKOs and trading them long instead of short meant that, by the end of the 1990s, GKOs were worthless and the market imploded, creating a financial crisis with effects still felt today.
MICEX survived because they had diversified beyond trading currencies and GKOs to trading equities. Today, they trade a few hundred of Russia’s most liquid stocks such as Gazprom.
But the issue remains that, having had fingers burnt by trading long, no-one trades long today. Everyone trades short.
So there’s the rub.
By being short sellers, Russia’s markets are highly volatile and very liquid and, by being risk avoiders, Russia’s markets are totally geared towards zero risk. There is no risk in Russian trading as everything is geared towards real-time settlement. The only risk is technical risk if the systems fail.
A market with risk eradicated is not a market that can trade effectively.
Now I’m back in London and thinking that European and American markets are geared towards high risk arbitrage strategies based upon low latency leverage. We have market risk, credit risk, and operational risk.
But our market encourages risks, and this is also a market that cannot trade effectively, as recognised post the Lehmans collapse.
We are trying to baton down the shutters on liquidity risk and we talk about ‘likelihood of settlement’ as a part of the puzzle, although price and cost are just as important.
In Russia, there is no ‘likelihood of settlement’. Settlement is guaranteed.
But equally, in Russia, there is no long-term investment market.
So there may be a middle ground here, between highly leveraged risk strategies and guaranteed settlement; a middle ground between long-term investing and making a buck through a short selling bet.
Right now, the Anglo-Saxon model is broken, whilst the Russian model is yet to start working effectively to build commerce.
So, will the financial instruments of the Anglo-Saxon model play a part in building leverage and commercial growth in the Russian markets? The Russians certainly think so but if, and only if, the trading model can incorporate the risk management principles of the Russian model.