Down Debt

Russian stocks could be ‘essentially worthless’, says MSCI study

Russian stocks may have “no value” compared to prices listed on the Moscow Stock Exchange, according to a new study by MSCI.

Moscow ceased trading after stocks capitulated following Russia’s invasion of Ukraine, and reopened a month later after the longest stock market shutdown since the fall of the Soviet Union. The Moscow Stock Exchange has also had its recognized status revoked by many international powers.

The MOEX Russia index is down more than 36% since the start of the year on Friday afternoon, and international investors in Russian securities have faced restrictions in managing and valuing their positions since the start of the war.

Based on a model that links stock and bond markets, MSCI said on Friday that the credit default swap market suggests Russian stocks “could be essentially worthless” in contrast to quoted prices.

Credit default swaps are derivative products that allow investors to exchange their credit risk on a company, country or other entity with that of other investors. Lenders acquire CDS from investors under the agreement that the investor pays the lender if the borrower defaults.

“The incongruity between the CDS market and the quoted prices of Russian stocks may be due to a combination of fear of technical default, failure of the CDS auction mechanism, restrictions on CDS trading linked to sanctioned companies and a lower perceived value of Russian stocks for CDS investors,” Zoltan Sass, senior partner at MSCI, added in Friday’s report.

The model works on the assumption that if a company’s stock price falls to zero, it will choose to default on its debt. In this framework, explained MSCI, the default risk of a company is determined by its value in relation to its level of indebtedness.

Models rooted in this concept have been used to calculate probabilities of default from stock prices, but they can also infer stock prices from probabilities of default, which MSCI analysts did in the note. Friday research.

“We find that the trading of CDS of Russian companies has increased since the start of the Russian-Ukrainian war. The increase in trading activity may indicate that the CDS market contains information that is not present on the market. Thus, our research incorporates implied CDS market default probabilities to model Russian stock prices,” Sass said.

While Russian stocks are down 36% since the invasion, prices when aligned with the CDS market were virtually zero, according to MSCI data.

“A fundamental explanation for the disconnect is that investors trading on one market are not trading on the other. Most foreigners are unable to trade Russian stocks and CDS are only available to institutional investors,” Sass added.

Market distortions

The research also noted that the model results could also be the result of the distortion of the CDS market itself by the Russian-Ukrainian war. If a default results in a payment on a CDS, the underlying bonds should be auctioned.

“Difficulty transferring these bonds due to sanctions or other market frictions can inflate the premium required for default protection and thus the implied default probability of CDS,” Sass said.

“Furthermore, obstacles to paying bonds due to sanctions could trigger a technical default, where the company is not actually bankrupt but is unable to pay coupons or principal for other reasons.”

Given that the Russian market is tightly constrained, all areas of the market have seen some level of distortion, Sass pointed out, but MSCI believes the disconnect between equity and CDS markets is “striking” and may reflect valuations. differ due to several factors.

“Russian companies can continue to operate, generate income and pay dividends, which means they can have value for the small fraction of investors who can invest in them. In contrast, Russian stocks seem without value from the perspective of CDS investors,” Sass said. said.

“This lack of value may be emblematic of a combination of fear of technical default, failure of the CDS auction mechanism, restrictions on CDS trading tied to securities of sanctioned companies, and lower perceived value. Russian stocks for CDS investors.”

He suggested that greater consistency in prices could be achieved through the reopening and reintegration of Russian markets and the economy, and the lifting of sanctions, but said that in the meantime investors might seek a deeper picture of stock price drivers by looking beyond a single asset class.