Internet Dominates Russia's Nascent Market

By Maria Trombly | Securities Industry News | April/May 2002

Newly formed stock markets have the luxury of avoiding burdensome traditions and impenetrable legacy systems. Russia is a prime example. The Russian equities market, fueled by advancements both large and small, has grown rapidly and is now dominated by Internet trading.

By the standards of many industrialized economies, the Russian equities market is small. But Russia's economy is growing faster than many of those of industrialized countries. By some measurements, the Russian stock market lags only China's nascent marketplace as the best performing. Further, internal changes, including a new commitment to corporate governance, have reduced the country's longstanding problem of capital flight, leading many experts to believe that this surge in Russian stocks is based on strong fundamentals and a relatively healthy economy.

"The Russian Trading System (RTS) Index was up 80 percent last year," said Kim Iskyan, an analyst at Moscow's Renaissance Capital, a leading Russian investment bank. The RTS index measures activity on one of the country's two largest stock exchanges.

The largest exchange in Russia and Eastern Europe, the Moscow Interbank Currency Exchange (Micex), which no longer deals in just currency but in government and corporate securities, just celebrated its 10th anniversary with record volume.

In 2001, Micex saw about $107 billion in trades. Of that, about $24 billion was in stocks, accounting for more than 80 percent of all equities trading in Russia. The exchange hit close to $73 billion in currency trading, with the rest of the trading in government and corporate bonds and currency futures.

Micex, like the other Russian exchanges, is a combination exchange; there's both a physical trading floor and an electronic trading system. The system processes around 150,000 trades a day-a tiny amount compared to Western exchanges, but it's growing. The system also allows external electronic brokerage systems to gain secure access to trades via the Internet.

"Information technologies are the foundation of the world financial market," said Micex CEO Alexander Zakharov in a recent report. "Today, trade through the Internet is the most democratic access to the financial market for individual investors."

By the end of 2001, almost 160 brokerages were connected to the Micex trading system and, as a result, about 70 percent of securities trading is now conducted over the Internet.

By comparison, the RTS, also based in Moscow, saw only $4.4 billion in trading last year, down from $5.8 billion in 2000. The RTS, founded in 1995, is a fully-electronic trading floor that focuses on the OTC market. It was the first to introduce electronic trading to Russia.

Micex is becoming the dominant exchange for blue-chip stocks, said Sam Barden, a sales trader at Renaissance Capital. "It's faster and more efficient," he said. "It's anonymous, as well, so it's a more efficient form of exchange than the RTS, which indicates bids and offers."

In resource-rich Russia, not surprisingly, one of the major drivers of the stock market-and the economy as a whole-is the oil sector. Profits from those companies are now being reinvested back into the companies as oil chiefs no longer feel they are under the threat of having their assets re-nationalized.

"The main risk," said Iskyan, "is if the Russian authorities relax their newly tightened grip on the business elite in Russia and allow them to flout tax and legal rules again. But we think that this is increasingly unlikely."

In an interview with Securities Industry News last summer, Russian Federal Securities Commission Chairman Igor Kostikov explained the steps the country was taking to ensure the enforcement of accounting standards to protect shareholders' rights and, in the process, attract domestic and foreign capital. That included the right of shareholders-and the commission itself-to go to court to ensure compliance.

"I can tell you from my experience in the West when I worked in London in 1990s and when we had the political scandals-the BCCI scandal, the Maxwell scandal-that it's all tied up in corporate governance," he said. "The U.K. securities market and the U.S. securities market each have been in development for centuries. The Russian securities market was started 10 years ago. And I think that now is the time that we have to clean it up." (Securities Industry News, June 25, 2001)

The results can already be seen in the oil sector, Iskyan said, with the most progressive and transparent companies now surpassing former industry favorites that have yet to demonstrate that they regard the maximization of shareholder equity as a high priority.

And though it doesn't exist today, there are indications that a high-tech sector may be starting to grow. "The high-tech sector is not yet developed," said Yuri Mintsev, head of customer relations at BrokerCreditService Ltd. (BCS). "We don't have the equivalent of a Nasdaq."

But BCS, for example, which has the most customers of any Russian brokerage, plans to go public later this year. Like its American equivalents, e-brokerages E-Trade and Charles Schwab, BCS did not originate in the nation's financial capital, Moscow, but rather in the west Siberian town of Novosibirsk, where the company is still headquartered. It was formed just over six years ago and for the first three years of its existence, it was a traditional telephone-based brokerage.

"In 1995, there was a huge shortage of brokerages," Mintsev said. The company was based in Novosibirsk because that's where the company founders were living at the time.

About one-third of its customers are institutional investors; the rest are retail customers. Like other Russian e-brokers, said Mintsev, BCS offers direct access to the exchanges. Today, 99 percent of its customers use the Internet to place their trades, Mintsev said. Of course, there are only 4,000 customers, but that's the largest number of customers of any brokerage in the country.

"Russia doesn't have an investing culture yet," said Mintsev.

Nor does Russia have countrywide access to the Internet. But connections are fairly good in towns with populations over 100,000, Mintsev said.

He sees tremendous value in Internet-based trading, because it allows access to the stock market by a larger percentage of the population and increases the country's economic literacy. "It also increases liquidity and volumes and lets new companies attract capital through the stock market," he said. "That helps the general economy."

Unlike e-trading in the United States, customers in Russia pay a commission that is a fixed percent of the trade, not a flat fee. In the case of BCS, that's a maximum of .06 percent of the trade. The low commissions make BCS very popular, but the firm also offers a number of other services, including asset management, consulting and stock market analysis.

Added Mintsev: "Our Internet trading system is the fastest in Russia."

BCS' customers, he also said, are not limited to Russia itself. The company currently employs about 120 people, with around 15 traders scattered through Russia's major exchanges. In addition to 10 traders at Micex, BCS also has traders at RTS, the St. Petersburg Currency Exchange and the Moscow and Novosibirsk stock exchanges. In addition to handling the 1 percent of orders that still come by telephone and taking over on the rare occasions when the electronic trading system goes down-about once a quarter, according to Mintsev-the traders also provide risk management and other services for clients.

Plans for later this year include improving the level of service and expanding the number of services available. "We want to offer our customers all kinds of services that exist in the financial markets," Mintsev said.

He added that the company expects its client base to climb by 50 percent to 6,000, with a corresponding increase in trade volume. New customers are expected to come both from the retail as well as the institutional side, he said. To accomplish this goal, BCS will increase its marketing budget by 70 percent. The company advertises on regional television, in magazines and newspapers and on banner ads on the Internet.

As is the case in all markets, the new Internet traders are not without their critics. Traditional brokers say these online firms are undercutting them with unrealistically low commissions. For example, among two leading Internet brokers, Emi Trast charges .01 percent, while URVB-Finansy recently reduced its commission levels to .0008 percent.

But there's a price to pay for luring customers with lower costs, often in profits. Russia's traditional brokerages out-earn their Internet competitors dramatically. In the first quarter of 2001, BCS earned around 800,000 rubles ($26,100), while traditional brokerage Russ Invest made 131 million rubles ($4.27 million).

According to the weekly news magazine, Russia Journal, there are more than 70 Internet brokers currently operating in the Commonwealth of Independent States (the former Soviet republics) and only about 5,000 Internet trading customers. That could lead to an imminent winnowing of the industry, as companies cut prices to levels below where they can sustain operations.

However, according to Renaissance Capital, Russia may see a sharp upsurge in investors in the next few years as a recent set of reforms has allowed the creation of the institutional investment environment for investment funds.

"We estimate that the reform of Russia's pension system is set to bring around $4 billion into the equity market by mid-2004," said Roland Nash, head of Renaissance Capital's research department, in a recent report. "Insurance funds are similarly gearing up to begin investing." Meanwhile, emerging market funds are expected to continue to invest in the Russian market, Nash added. (photos of Sam Barden and Igor Kostikov, respectively)