Western sanctions on Russia were designed to isolate the country from the international financial system but the economic offensive has also left international traders who hold shares in Russian companies cut off from their assets.
As Russian forces pushed into Ukraine, the US and the EU unleashed waves of measures against companies and individuals they alleged had close ties to Vladimir Putin’s regime.
Among the first moves were measures to stop Russian companies from raising money on overseas markets, like London or New York.
These prompted an equally forceful response from Putin: capital controls that banned Russia-based institutions from transferring foreign currency abroad. This, in effect, froze their assets inside Russia.
With the opposing nations at what amounts to economic war, foreign investors with investments in Russia seem “caught between the proverbial rock and a hard place”, says Steven Hill, a partner at law firm K&L Gates.
At the end of 2021, foreign investors held Russian equities worth $86bn, according to data from the Moscow Exchange. But the introduction of sanctions left them with an uneasy choice: divest from the Russian market, as some of the measures required; or — where permitted — hold on to their assets but face uncertainty over whether they could take control of them again.
Investors are already counting the cost to their portfolios. Russia’s biggest corporate names, such as Gazprom, VTB, and TCS Group, have been left holding assets worth a fraction of what they were in early February.
Moreover, the war in Ukraine is a huge blow to the integration in recent years of Russian companies with western stock exchanges — mostly the London Stock Exchange, but also the New York Stock Exchange and Nasdaq.
Shares in the companies are often traded on overseas markets as depositary receipts, a type of bank certificate that securitises the ownership of shares.
During the past two decades, London has been the predominant market for Russian companies to raise money outside Moscow. Thirty-nine Russian companies have listed in London and raised $44bn since 2005, according to financial data researcher FactSet.
This trend slowed in 2014, after the peak of the commodities boom and the imposition of initial sanctions against Russia in response to its annexation of Crimea that year. Now, though, the war in Ukraine has dealt an all but terminal blow to the relationship.
When Ukraine was invaded. shares in Russian companies became immediately toxic and western sanctions give international shareholders little time to divest. Meanwhile, banks were not only wary of breaking sanctions, but also worried that counterparts would not be able to settle their deals, or would be badly hit by volatile foreign exchange rates.
Faced with uncertainty and regulatory requirements to maintain an orderly market, many exchanges suspended the shares of Russian-incorporated companies.
London, home to the biggest cluster of Russian companies, suspended 28 companies. Index compilers like FTSE Russell, S&P Dow Jones, and MSCI, whose benchmarks are widely followed by fund managers, removed affected stocks from their indices at a price of zero.
At the same time, the Moscow Exchange shut for nearly a month when the war began.
When it reopened, investors found a very different market. Foreign investors’ access was restricted. Activity had greatly declined, making it harder to sell large blocks of shares. On the day the exchange restarted operations, private investors accounted for nearly 60 per cent of the total volume of trades, according to an exchange statement reported by Russian news agency Interfax.
The few other windows open to western investors have continued to close.
For example, depositary receipts had been able to represent shares listed in Russia as their receipt issuers held the underlying shares in the local market. As banks worked through the implications of the sanctions, some, including BNY Mellon, then allowed holders of Russian receipts to convert them into local shares in nearly 20 Russian firms. That would at least allow fund managers to hold the shares locally, even if they were difficult to trade.
However, Russia moved swiftly to clamp down on the practice, passing laws to formally delist and terminate most overseas depositary receipts. To prevent a rush, the central bank of Russia then limited the number of shares that depositary banks could convert, defending its move as in the interests of financial stability.
Or as the central bank put it: “Such practice may result in a disproportionate increase in the supply of local stocks in the market, which may have a significant impact on price and provoke a drop in stock prices.”
Russian companies could apply to the central bank for permission to keep their depositary receipt programmes but only a few have been successful. Gazprom, once among the most actively traded shares on the LSE, is terminating its London and Singapore receipts in May after its application was rejected.
The restrictions may not be permanent. At the end of April, Russia’s deputy central bank governor, Alexey Zabotkin, indicated in a news conference that Russia will slowly ease capital controls when the market stabilises.
And the shares, and the associated cash, have not disappeared.
Euroclear, the Belgium-based central securities depository, has said its balance sheet increased by 80 per cent in the first quarter, year-on-year, to nearly €23bn. This, it says, is because it has been accumulating coupons, dividends and redemptions from Russian companies but has been unable to pass them on to sanctioned parties.
Even so, few are taking many chances with what’s left.
K&L Gates, for example, advises clients to take urgent steps to preserve information about their investments, in case sanctions result in a devalued, or even lost investment — and the matter goes to arbitration.
“Protecting foreign investment in Russia is likely to be a challenging exercise for the foreseeable future,” it warns.