von: stratfor.com

"Russia: Increasing the Risk of Investing in Russian Companies


Summary

Russia's Duma may pass legislation redefining the influence Western
banks have over the market of Russian companies' stock on the New
York Stock Exchange. Western banks have nominal ownership over
issued foreign stocks, allowing them to influence Russian business
practices to a certain degree. The new legislation would curb that
influence, which could present a risk to foreign shareholders.

Analysis

Russia's Federal Commission for the Securities Markets is pressing
the Duma to amend legislation that governs issues of American
Depository Receipts (ADRs) to Western banks. These amendments would
limit the power depository banks have over the ADR market, but
could increase the risks for foreign shareholders trading Russian
stocks.

Foreign companies cannot offer stock directly on the NYSE, so they
place a portion of their shares into a Western bank's holding. The
Western bank, now the depository bank, holds these shares on behalf
of each company and issues certificates, or receipts, on these
shares as ADRs.

Under current Russian legislation, the depository bank is the
nominal holder and owner of the originally issued block of shares.
This nominal ownership clouds an otherwise transparent foreign
market in which Russian companies could know who the actual
registered shareholders of the reissued ADRs actually are.

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For more on the Russia & the CIS, see:
<http://www.stratfor.com/CIS/default.htm>
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The new legislation would annul the terms of nominal ownership,
enabling Russian companies to account for their registered
shareholders. This, however, would limit the power depository banks
have over the market. With no controlling body to interfere in
company actions, Russian businesses have the tendency to engage in
corrupt practices. The new legislation, therefore, would increase
the risk for American investors trading Russian ADRs.

The Bank of New York (BoNY) has threatened to abandon Russia's
market if the legislation passes, according to an Oct. 20 Banking
and Stock Exchange report. As a depository bank, The Bank of New
York has considerable power and influence over the ADR market. It
controls over an estimated $1.5 billion in ADRs with a daily
turnover of $20 million to $50 million, reported the Banking and
Stock Exchange. BoNY also holds a monopoly over Russian ADRs,
though the bank will not confirm this quantitatively. But, in these
facts alone, it largely controls the reissue of ADRs to American
shareholders, which gives the bank power to influence the daily
turnover of Russian stock.

Apart from the power of reissue, depository banks control the
market through nominal ownership of ADRs. These banks can
discourage shareholders from trading ADRs, refuse to reissue the
stock, or arrest trading of Russia's ADRs altogether. Because
Russian legislation does not provide for registered shareholder
accountability, the Russian companies cannot appeal to shareholders
to resume trading, but must appeal directly to depository banks.
Therefore, the bank somewhat controls the market and influences the
companies that originally issued the stock.
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For more on Russia, see:
<http://www.stratfor.com/CIS/countries/Russia/default.htm>
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In addition, nominal ownership allows the banks to influence
Russian companies internally. Under Russian law, foreign ADR
holders do not hold any voting rights. Shareholders can circumvent
this law by turning over their voting rights to companies' boards
of directors who then vote on behalf of shareholders. BoNY, as a
nominal owner of blocks of issued stock, has the power to turn over
the collective voting rights on behalf of the bank, though not
necessarily on behalf of shareholders.

Given depository banks' control, Russian companies have to be
somewhat transparent if they expect active and fair trading of ADRs
on the NYSE. If the bank determines a company is corrupt or shady,
it can use the levers it has over the company to hinder ADR trade.
Diminished ADR trade will limit the amount of foreign revenue a
company earns through foreign stock exchange, which typically is
more lucrative than domestic exchange.

If the depository banks lose nominal ownership of ADR issues, then
they lose many of the levers they hold over the market and the
Russian companies. The technical duties would remain the same; they
would still act as depository banks and still reissue stock to
shareholders. However, the Russian companies would know the details
of their registered shareholders and would be accountable to them,
not to the banks. The depository bank would lose the power to act
as if it were a shareholder in control of trading a large block of
Russian stock.

Market influence provided by depository banks provides Russian
companies with an incentive to be somewhat honest. Russia's
oligarchs, known for corrupt business practices and money
laundering, run many of the companies that issue ADRs. The Bank of
New York, through its levers, has the power to intercept or prevent
some of these shady practices, thus ensuring profits and protecting
individual shareholders.

If the bank loses power as a nominal shareholder, the registered
shareholders would have considerably less market and company
control acting as individuals, rather than as a collective.
Everyone would have to decide to suspend trading, and everyone
would have to hand over their ADR rights in complete agreement for
the shareholders to exert the same influence the bank, as an owner,
could exert. Given this improbability, the oligarchs would lose the
incentive to avoid shady business practices.

Russian companies have already begun to register new shareholders,
but the banks' market influence remains, somewhat protecting
shareholders. If the banks' role changes, then foreign investors
would run an increased risk of investing in a Russian business -
and the risk of corruption would likely increase."


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