Next to India, Russia received high marks for one of the most difficult countries to provide global custody services to institutional investors. Most custodians view Russia as highly inexperienced in the securities markets. From the lack of security associated with the registration of equities to potential delays from repatriating currency from interest payments on Ministry of Finance Bonds, the Russian securities market lags in sophistication behind most other markets.
Russia's securities market is fraught with a high degree of registration and safekeeping risk, an additional concern expressed by several custodians. For example, share ownership is designated by the holder's name written on the ledger of a registrar which may be located in remote regions. The subcustodian and the counterparty physically attend the registrars' offices to effect transfer of ownership. Since only a handful of registrars are based in Moscow, long journeys are often required to other regions such as Siberia. Related out-of- pocket expenses are reported to be high. This process presents numerous opportunities for processing errors and outright fraud.
The only proof of ownership is the extract in the shareholders register. Settlement date on the contract is only an indication, as settlement may range from five to forty-five days after placement of an order.
To address these risks, one custodian established contracts with various local registrars to ensure proper registration of shares. The agreements require a monthly reconciliation of positions and guarantee access to inspect the registrar's books at any time. In addition, the custodian arranged with a local agent to physically inspect the registrar's books upon settlement of trades and on a quarterly basis. While it is impossible to dictate the actions of company registrars, due in part to the lack of valid securities laws, one custodian works closely with individual companies to establish agreements for an "expected" service level from local registrars.
Income payments are sometimes delayed by thirty days due to the inefficiency of the Russian postal service. Certain dividends may be paid-in-kind, i.e. if the company does not have the necessary funds, payment follows in the produce of the company. An occurrence of this event was not reported to-date. Upon receipt of interest payments, one custodian implemented standing procedures to immediately convert currency to US dollars, even before approval from the tax authorities is granted to repatriate funds. The policy is designed to protect clients from extreme currency fluctuations. Also, agendas of shareholder meetings are somewhat fluid -- often amended at the actual meetings.
"Customers are obliged to sign sale and purchase agreements with brokers before each and every transaction," says a custodian. There is little the custodian can do to make matters safer and simpler. A custodian suggested one way to avoid broker risk, "...investors buying stock should negotiate with their brokers to ensure re-registration into their name is effected before payment is executed." The custodian quickly adds that the responsibility for this action rests squarely with the investor.
"The market is developing within a volatile infrastructure, ridden with fraud, resulting in an extremely high degree of operational risk," says another custodian. Concern was expressed about the absence of service standards and fidelity funds which protect investors in the event of counter-party bankruptcy. Also, restrictive exchange controls combined with wide-ranging currency fluctuations make cash management processes very difficult to monitor.
One custodian summarizes the Russian securities market as having "...no recognized market practices." Thus, forming the basis of a recommendation to foreign investors to "... make use of limited ADR programs and country funds that are available to eliminate the currency and settlement risk."
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