Putin’s broken market link puts trades worth billions in limbo

Russia’s central bank is keeping a close watch on a key piece of market infrastructure targeted by European Union sanctions.

Asked after Friday’s interest-rate decision whether the Bank of Russia would join potential lawsuits to fight a freeze on the National Settlement Depository, Governor Elvira Nabiullina said officials are “working on the best strategy and tactics.”

Few institutions better represent Russia’s sudden financial isolation since the invasion of Ukraine than the NSD. After the attack, more than a hundred billion dollars’ worth of stocks and bonds were left blocked after the world’s biggest settlement systems froze its accounts, according to estimates by the ITI Capital brokerage in Moscow.

And since the European Union blacklisted the NSD directly at the start of June, there’s little chance transactions with those assets will be freed up anytime soon.

Here’s a closer look at Russia’s crumbling market bridge:

Foreign ties

Housed in modern offices opposite Moscow’s 19th century Yelokhovsky Cathedral, the NSD established links over the years with foreign clearing houses, custodian banks and international securities regulators.

That gave overseas investors easy access to Russian assets, helping curb trading overheads and pushing down the cost of capital for local corporations and the government.

But the wave of international sanctions and local capital controls that followed President Vladimir Putin’s invasion of Ukraine have cut Russia off from financial markets, pushing the government toward its first foreign default in a century.

The NSD’s accounts at the world’s biggest settlement systems — Euroclear Bank SA and Clearstream Banking AG — are the source of most pain.

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Impact of war

In the wake of the February 24 attack, Euroclear froze transactions with the NSD as it vetted the depository to make sure it wasn’t in breach of sanctions, according to people familiar with the situation, who spoke on condition of anonymity because the details aren’t public.

The processing of trades slowed almost to a standstill, and then at the start of this month, the European Union blacklisted the NSD outright.

The depository was deemed to be “directly and indirectly enabling” the Russian government, because of the “high degree” of state control over its owner — the Moscow Exchange — the EU said in its official journal.

Euroclear implemented an asset freeze on the NSD in response, halting the due diligence it had been conducting. For its part, the NSD promptly suspended transactions in euros, announcing an “emergency” situation.

Scope of the damage

The limits on the NSD’s accounts froze securities worth tens of billions of dollars.

Non-residents had exposure equivalent to about $48 billion of Russian equity and $38 billion of fixed income — mostly government ruble bonds known as OFZs — via the NSD, according to Iskander Lutsko, chief investment strategist at ITI, one of Russia’s top ten brokerages. Euroclear has also blocked about $27 billion of foreign assets, principally shares, held by Russians, Lutsko said.

Despite the sanctions, Russian companies and the state have so far managed to pay investors about $6.5 billion in coupons and maturities since early March, according to data compiled by Bloomberg News. Locals relying on their NSD account at Euroclear to access those payments have missed out.

The conversion of depository receipts of Russian companies listed abroad into local shares has also stopped due to the block on the NSD.

Bottleneck

Before the most recent restrictions, transactions involving assets denominated in currencies other than the ruble were eligible for settlement provided the securities or the counter-parties involved weren’t the subject of EU penalties, according to Euroclear’s website.

For each deal with a Russian counter-party, Euroclear required a so-called MT 599 attestation to prove no penalties were breached and due diligence had been performed.

While this allowed unsanctioned Russian banks and market participants with their own Euroclear accounts to keep settling their trades, those going via the NSD’s accounts at Euroclear were blocked.

OFZ optimism

Russia’s isolation contrasts with the optimism of a decade ago, when the Russian Finance Ministry was pushing ahead with a direct link to international clearing houses for its local OFZ bonds.

Eventually, Euroclear started direct settlement of Russian ruble-denominated government debt in February 2013, opening the market to foreign investors, who no longer needed to trade via local brokers.

Access to municipal and corporate debt markets followed in the months after, while it took several years more for global custodian banks to be able to open direct accounts at the NSD.

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