Russian stocks may have “no value” compared to prices quoted on the Moscow Stock Exchange, new research from MSCI suggests.
Moscow halted trading after stocks capitulated after Russia’s invasion of Ukraine, and reopened a month later after the stock exchange’s longest shutdown since the fall of the Soviet Union. The Moscow Stock Exchange has also been stripped of its recognized status by many international powers.
The MOEX Russia index is down more than 36% year-to-date as of Friday afternoon, and international investors in Russian securities have endured restrictions on managing and valuing their positions since the start of the war.
Based on a model that blends equity and bond markets, MSCI said on Friday that the credit default swap market suggests that Russian stocks “could be essentially worthless” compared to quoted prices on the stock exchange.
Credit default swaps are derivatives that allow investors to swap their credit exposure to a company, country or other entity with that of other investors. Lenders purchase CDS from investors under the agreement that the investor will pay the lender if the borrower defaults on their obligations.
“The mismatch between the CDS market and quoted prices of Russian stocks may be due to a combination of fears of a technical outage, a failure of the CDS auction mechanism, restrictions on trading CDS linked to securities of sanctioned companies, and a lower perceived value of be Russian equities for CDS investors,” added MSCI Senior Associate Zoltan Sass in Friday’s report.
The model assumes that when the stock price falls to zero, a company chooses not to pay its debt. Within this framework, MSCI explained, a company’s default risk is determined by its value relative to its debt.
Models based on this concept have been used to calculate default probabilities from stock prices, but they can also infer stock prices from default probabilities, as analysts at MSCI did in Friday’s research note.
“We note that trading in Russian corporate CDS has skyrocketed since the beginning of the war between Russia and Ukraine. Increased trading activity could indicate that the CDS market contains information that is not present in the stock market. Therefore, our research incorporates the implied default probabilities of the CDS market into the model,” said Sass.
While Russian stocks are down 36% since the invasion, prices have been essentially zero when aligning with the CDS market, MSCI data showed.
“A basic explanation for the split is that investors trading in one market are not trading in the other. Most foreigners cannot trade Russian stocks and CDS are only available to institutional investors,” Sass added.
market distortions
The research also noted that the model’s results could also be the result of the distortion of the CDS market itself by the Russia-Ukraine war. If a default results in a payout on a CDS, the underlying bonds would have to be auctioned.
“Difficulties in transferring these bonds due to sanctions or other market frictions can increase the premium required for protection against default and thus the implied default probability of the CDS,” said Sass.
“In addition, impediments to paying bonds due to sanctions could trigger a technical failure where the company is not actually bankrupt but is otherwise unable to pay coupons or principal.”
Because the Russian market is severely constrained, all areas of the market have experienced some level of distortion, Sass pointed out, but MSCI believes the disconnect between equity and CDS markets is “striking” and could reflect different valuations based on multiple 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 appear worthless from the perspective of CDS investors,” Sass said.
“This fall in value may be emblematic of a combination of fears of a technical failure, failure of the CDS auction mechanism, restrictions on trading CDS linked to securities of sanctioned companies, and a lower perceived value of Russian equities for CDS investors.”
He suggested greater consistency in pricing could be achieved with the reopening and reintegration of Russia’s markets and economy and the lifting of sanctions, but said that in the meantime investors may be seeking a deeper picture of stock price drivers, by looking beyond a single asset class.
