The credit default swap market, which many view as a source of true equity valuation, may be an ominous marker for Russian stocks.
In fact, Russian equities may be worth nothing at all, according to research posted by MSCI Research last week.
“We find that trading in Russian corporate CDS has surged since the Russia-Ukraine war began. Increased trading activity may indicate that the CDS market contains information not present in the equity market. Thus, our research incorporates the CDS market’s implied default probabilities to model Russian equity prices,” the post said.
An accompanying graph shows that trading in Russian corporate CDS spiked upward in early 2022 and has only fallen off recently, though it remains elevated from what it had been.
The blog further notes that while the Moscow Exchange saw domestic equity prices fall 40% in the wake of the invasion, the Russian CDS market has essentially gone to zero, with a graph showing that the probability of default for four key Russian equities has also spiked upward and remains at levels around 90%. It also points out that most foreign investors can’t trade Russia’s domestic equities, while the CDS market mostly represents institutional investors.
While Russian companies may continue to operate in a fairly normal way, and their equities may continue to trade on the domestic exchange, the blog says, CDS investors are essentially valuing Russian companies at zero.
Russia ETFs Face Uncertainty
“This lack of value may be emblematic of a combination of technical-default fear, failure of the CDS auction mechanism, restrictions on trading CDS linked to the securities of sanctioned companies, and a lower perceived value of Russian equity for CDS investors,” the post’s authors say, noting that the pricing divide could be alleviated if the Russia is able to rejoin the global economy and the international sanctions are lifted. However, that doesn’t seem like a likely outcome any time soon.
What this means for the ETFs tracking Russia’s market is up in the air. The $30 million VanEck Russia ETF (RSX), the sub-$1 million VanEck Russia Small-Cap ETF (RSXJ) and the $1 million iShares MSCI Russia ETF (ERUS) all halted trading in early March in the days following Russia’s invasion of Ukraine.
Reuters also reported a week ago that BlackRock’s iShares arm is closing its Russia and Eastern Europe ETFs that track MSCI indices and trade on the London Stock Exchange. The funds had combined assets of roughly $126 million at the time of the announcement and will delist on or around June 22.
Given that the U.K. operations of BlackRock’s iShares have deemed Russia uninvestable, the question of what this means for U.S.-listed ERUS, which also tracks MSCI’s Russia index, remains. At the end of January, ERUS had more than $500 million in assets, while its rival RSX had $1.3 billion. RSXJ had a little more than $25 million. Trading for those funds halted in early March.
MSCI announced it was freezing Russian securities in its indexes on Feb. 24, the day the Russian invasion of Ukraine began. After a consultation period, during which it polled investors, it concluded Russian markets were uninvestable and removed Russian securities from its emerging markets indexes. The index provider currently calculates a standalone index for Russia apart from its standard index offering.
Contact Heather Bell at [email protected]