On June 29, 2011, Russia’s two main stock exchanges, Micex and RTS, confirmed what months of rumours had anticipated with the announcement they were to merge. The deal was heralded as representing the start of creating a globally recognised exchange infrastructure in Russia able to compete with some of the most established financial centres in the world by 2020. But not all market participants are convinced this will happen.

Terms of the deal

Under the terms of the deal, Micex will buy RTS shares from its stakeholders – 35% in the form of cash and 65% will be given as shares in the newly merged exchange. The share swap rate was set at 1:3 and based on Micex shares being valued at 103.5 billion rubles ($3.7bn) and RTS shares, including preferred shares, being valued at 34.5 billion rubles.

Corporate procedures related to the merger are expected to be completed at the beginning of 2012 and an initial public offering of the new entity, which could raise as much as $300m, is planned for 2013. RTS currently trades in dollars and Micex in roubles. It is understood the new combined exchange will trade in roubles though settlement could be made in a variety of currencies.

The government’s holdings in Micex and the RTS mean the new exchange will still be state controlled – four state banks will account for just over 50% of the shares in the group. These are the Central Bank, Sberbank, VTB and Gazprom bank.

Ruben Aganbegyan, the Micex President, will become the chief executive of the joint exchange with responsibility for its development strategy and global presence. Roman Goryunov, the chief executive of RTS, will become deputy chief executive of the joint exchange with responsibility for developing its markets. The terms of the deal pay great attention to the integration process and a website dedicated to that has been formed to keep the market up to date with its progress.

Aganbegyan said in a statement that his main goal is establishing a global reputation and presence. “The main goal of the integration is creating a trading venue which is competitive on the global stage and which provides advantages to market participants and its shareholders as well as modernising the Russian financial markets,” he said.

“The most positive consequence of the integration will be increasing liquidity levels on the Russian market, improving opportunities for expanding businesses and implementing state-of-the-art technologies for brokers and clients with new IT platforms in Russia. The integration of trading venues will also represent a key step towards creating a globally important international financial centre.”

His deputy Goryunov added: “We have been presented with the serious task of making the Russian exchange infrastructure attractive, convenient and, above all, necessary for Russian and foreign market participants, investors and issuers. This is a great challenge for all of us. The crucial task is to maintain the dynamics of the Russian market for business development.”

A welcome reception

Most market participants have welcomed the move and broadly agree with the benefits cited by the executives driving the deal. But several stress the dangers of over exaggerating the benefits to the Russian financial markets. Others go further still and believe the merger is ill-conceived and could actually have negative consequences.

Evgeny Zelensky, capital markets partner at law firm Herbert Smith, says he expects there to be little effect on the derivatives market in the short term. But he does see wider benefits that will crystallise over time for the financial markets as a whole. These could eventually also strengthen the derivatives offering of the new exchange.

“This is more of a significant move for the securities and foreign exchange markets which could lead to increased liquidity in these sectors,” Zelensky says. “I very much hope the merger will eventually boost the derivatives market in Russia but that will take longer. At the moment, most derivatives are traded over the counter. While I believe there will be long term positives for the derivatives market, there is a long way to go.”

The biggest potential benefit cited by both the bourses and investors is a much-needed simplification of what remain relatively murky regulations and procedures in the Russian financial markets. Micex and RTS have different listing rules, procedures and guidelines meaning that those using both markets must duplicate their processes if they want to operate on both. “This merger should make compliance cheaper and reduce costs,” Zelensky says.

A series of regulatory changes have been made in recent years to make the system more transparent but the market lags behind other regulatory regimes. Insider trading, for example, was only declared illegal in August last year and many expect adherence to the new laws to be patchy at best. New regulations were also passed last year to simplify securities and derivatives laws in the country. While much remains to be done, some believe the creation of a unified exchange will aid this process.

“This is just the latest move in that direction,” says Zelensky. “A number of legislative changes in the financial regulations area were introduced over the past several years. There is still much to be done but the dynamic people see is a positive one.”

Aleksei Suturin, analyst at Sucden Financial, agrees that the merger represents a move in the right direction when it comes to consistency on trading laws. “It should create better transparency and clarity within the Russian market but to what extent remains to be seen. It will represent a more comprehensive platform and be more investor friendly as a result.”

Complementary businesses

A core positive cited by supporters of the deal is the fact that the two exchanges have complementary product offerings: Micex is stronger on the equities side while RTS has a bigger commodities and derivatives business. In fact, RTS was the tenth-largest derivatives exchange by the number of futures and options contracts traded last year, according to data from the Futures Industry Association.

“There were fulfilling different roles and they specialise in different products. So there should be synergies from that perspective,” says Suturin. “The exchanges weren’t really competing before and I believe that having a single major exchange like the UK does with the London Stock Exchange will make things more transparent and attractive to foreign investors.

“Although we will see little immediate change, over time we will see improvements in things like better technology, for example. The combined expertise and technology of both exchanges should bring advantages.”

Voices of discontent

The deal is subject for approval by the Federal Antimonopoly Service and extraordinary general meetings of shareholders of Micex and RTS scheduled for early August. But despite the many positives cited, there have been objections to the deal and some market participants remain concerned.

One of the biggest opponents of the deal has been Evrofinance Capital, which owns a 6.2% stake in Micex. Oleg Prexin, Evrofinance Capital’s chief executive, has reportedly written to the central bank and other state-controlled Micex shareholders to block the deal. He believes it undervalues Micex and only benefits RTS shareholders. He disputes the methodology used to value the exchanges.

He claims his firm previously set out two alternative scenarios for development to the Micex board of directors: to hold an IPO in 2012 or form an alliance with another leading global exchange.

Evrofinance’s objections will not now halt the deal’s progress. But there are others who also raise concerns. Some believe a clash of cultures could make integration difficult while the most common objection revolves around the lack of competition in the Russian market the deal creates – the combined entity will have what amounts to a monopoly position.

“The cultures of the two exchanges are different and with everything under one roof integration may not prove an easy process,” says Zelensky. “Some market players have expressed concerns that combining the two largest Russian exchanges may create anticompetitive pressures but I do not believe this will happen because they need to compete against the global exchanges.”

Vladimir Kuznetsov, an equity analyst at UniCredit Securities, is very concerned about the consequences of a monopoly. He believes pressure was put on the two exchanges to merge by the government’s regulatory authorities. He thinks they mistakenly believe the merger will strengthen Russia’s position as a financial centre – a stated aim of the government in recent years.

Last year, the Russian government announced that it planned to raise as much as $60bn via privatisations and the sale of equity stakes in businesses. The Russian market has performed well recently, partly thanks to this programme. It has enjoyed rising commodity prices, a bullish stream of large IPOs and a sizable privatisation programme.

Some believe the merger will help continue this growth and progress towards establishing a global financial market. But Kuznetsov believes this optimism is misplaced.

“These exchanges have looked at merging before and it was not seen as a natural way of things developing – there were a lot of differences. That is why I think they were talked into it. The authorities thought this would be an important step towards creating a vibrant financial centre in Russia and talked them into it,” he says. “But the reality is that there will be less competition as the deal creates a monopoly,”

“When you look at other industries where that has happened in Russia, that situation does not always work. If they wanted to create a global financial centre there are many other things they could have done first which would have had a much greater impact. I would have preferred to see the creation of a single unified depository, for example.

“In doing this, they have actually set artificial limits on competition. I think that if you want to see a product base grow, the creation of a competitive environment is a better way of encouraging this rather than relying on a single entity. There may well be synergies and, who knows, maybe one plus one will really equal more than two. But I am sceptical. If the authorities truly want to create a better business environment I do not believe this will work.”

Not all agree. “There are some negatives but they shared so little common ground that the argument about issue of a lack of competition doesn’t really stack up. I have never heard of anyone complaining about the fees. There are no other negatives from my perspective,” says Suturin.

Towards a global powerhouse?

The crucial question, however, is how the merger will be perceived by investors globally and whether it is perceived as moving Russia towards creating a financial centre on a par with those in similar sized economies elsewhere.

Oleg Jelezko, the vice chairman of RTS, and managing partner at Russian private equity firm Da Vinci Capital, has stated that the newly-formed exchange is planning to build a strong presence in markets including the Ukraine and Kazahkstan, as well as further afield. He also said the exchange would be interested in alliances with the five biggest global exchange groups.

He said detailed discussions with these have already taken place and a strategic alliance could be in place as soon as the end of the year. He has also compared the potential of the merged Russian exchange with the size of the Brazilian exchange. He has stated a goal of growing the value of the market by three times to around $16bn over a five year period.

Whether such ambitious goals can be realised is debatable. While most investors acknowledge the greater global clout the exchange will have, they are also keen to remain realistic.

“The jury is out but the combined exchange should be more powerful and command more respect globally,” says Zelensky. “I do think it will be perceived globally as a simpler and better system by the global markets. There has been a huge push in recent years to try to create a sizable exchange in Moscow and this is a move towards that goal. It has taken years to realise but that reality is closer now.”

Suturin at Sucden Financial agrees. “From a foreign investor’s point of view, two exchanges look complex. One looks far more attractive. Whether it can become a global financial centre, only time will tell. But it definitely helps. It certainly gives the new exchange more power and it should be very positive for foreign investors.”

Echoing Jelezko’s point, Suturin also notes that the deal will give the combined entity, especially if it succeeds in clarifying trading laws, better leverage when negotiating with other exchanges globally. “They have a great interest in seeking strategic partnerships or even further consolidation with other exchanges.”

There is also great interest in how the newly formed exchange might grow its product offering post-merger. Micex and RTS have focused more on the benefits of integration than growth at present but there have been some indications of where growth might be.

Micex might have been the weaker of the two on the derivatives side but has made no secret of the fact that it sees great potential in this market. In a strategic document entitled ‘Dashing for the top tier’ two of its stated aims were: to gain a leading position in derivatives markets for Russian/CIS financial instruments through acquisition of RTS; and to develop new products and services including stock options, interest rate derivatives and other products.

In fact, Micex launched two new derivatives instruments just days after the merger announcement: a futures product on one-month average RUONIA interest rate and futures on a three-month OIS fixing on the basis of RUONIA interest rate. Both contracts are designed on the basis of RUONIA interest rate, calculated by the National Foreign Exchange Association.

The exchange again acknowledged the importance of developing this area of its business in a statement. “Futures on interest rates are a key instrument in well-developed on-exchange derivatives markets, both in terms of trading volumes and open interest,” it said. “Active participants in trading in interest rate futures are almost all categories of market participants: commercial and investment banks, finance companies, manufacturing companies and even individuals.”

Analysts acknowledge the potential. “Micex has not really pushed into derivatives until now but this certainly puts it in a great position to strengthen its position in this market. There are a lot of positives there,” says Suturin.

Russia’s derivative market has long fallen short of its enormous potential. The merging of the exchanges is a bold statement of intent to form a global powerhouse. But the consolidation of the market must come with other changes, such as clarifying the regulatory environment. There is a long way to go before Russia can compete with the top tier global exchanges but should the benefits of this merger be realised, it will be a giant leap in the right direction.

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