30th April 2014
The Ukraine crisis could throw up a dilemma for global index providers over Russian firms hit by US sanctions.
Jan Dehn, head of research at Ashmore, notes that more Russian companies are at risk of being targeted by the US Office of Foreign Assets Control sanctions, following the inclusion of Bank Rossiya and Chernomornaftogaz on the sanctions list.
He says that OFAC sanctions could bar some investors from holding the Russian names in question, forcing them to sell positions at low levels and thus crystalizing mark to market losses.
He adds: “Others could be afflicted if the names are removed from fixed income benchmark indices. In equities, questions of country and company inclusion in benchmarks tend to be determined by users.
“In fixed income, index inclusion tends to be more rules- based. For example, ‘Index replicability’ is the main principle used by JP Morgan as the basis for including names in their indices.
“Whether index providers believe that the ‘loss’ of investors subject to foreign imposed sanctions constitutes enough of a challenge to ‘index replicability’ to justify dropping the names from the market’s benchmark indices remains to be seen; after all there are many investors and market makers in Russian assets outside of the US that would not be subject to, say, OFAC sanctions. This poses an interesting question to index providers in the event of new sanctions on index names: Can the index providers continue to be neutral or are they likely to be swayed in the interests of one particular stakeholder group, such as the US government or non-US clients?”
However Ashmore argues that whether or not a name appears in an index does not, in itself, impact that name’s ability or willingness to pay.
“In general, we think investors should be prepared to expose themselves to off-benchmark securities in Emerging Markets, not least because 89% of all fixed income securities are off-benchmark anyway.
“While the Ukraine situation is likely to inflict economic pain on Russia – which will ultimately hurt President Putin – it is also clear that Russia’s credit fundamentals are extremely strong. Net of official fiscal reserves, Russia’s total public debt to GDP ratio at the end of 2013 was just 1.5%.
“As of 18 April, Russia’s foreign exchange and gold reserves amounted to USD 482bn, surpassed only by China, Japan, Saudi Arabia, and Switzerland (Source: Ashmore/Bloomberg). Moreover, a change in macroeconomic policy adopted after 2008/2009 away from fixed towards a more flexible exchange, means that a weaker Ruble actually improves the public finances, thus improving the government’s ability to pay.
“Besides, Putin is popular. In other words, Russia can stomach a lot of pain, both economically and politically. We think investors should bear these factors in mind and not base their decisions on the headlines emanating from the heated public spat between the US and Russia, or questions of index eligibility. Investors should focus on value.
“Tensions may escalate further in the near-term, but this crisis looks likely to be resolved diplomatically. Given Russia’s ability and willingness to pay, we think the right strategy is to add at weak levels, not to sell at or near the bottom.”