It's been five years since the disastrous crash of 1998, and the Russian stock market-once dominated by a small circle of investors-has taken off. "Macroeconomic fundamentals have improved, reforms have progressed and the energy sector is poised for robust growth in the future," said Diana Choyleva, senior economist for Russia and emerging markets at London-based Lombard Street Research. "And foreign investors have more of an appetite for risk, since the U.S. and European markets aren't offering such growth prospects."

Today, the Russian stock market is liquid and poised for growth, Choyleva said, due in larger part to a radically revamped regulatory structure and the emergence of electronic markets like the RTS Stock Exchange and the Moscow Stock Exchange.

Oversight and Regulation
The Russian Federal Securities Commission (RFSC) has begun to step up to the plate when it comes to actively regulating the fledging industry, said Nikolai Krylov, a partner at Winston & Strawn.

Krylov, whose experience with the Russian securities industry goes all the way back to the late 1980s, said Russia is going through some very significant regulatory changes. He compares the country today to the United States in 1933, when the U.S. Securities and Exchange Commission was first created in the wake of the Great Depression.

One recent change, which may make it easier for more Russian investors to get into the stock market, was to require Russian firms to list on Russian stock exchanges before listing overseas. Today, many Russian firms list directly in the United States or Europe-meaning that foreign investors get better disclosure than Russians.

"There was such a lack of transparency in this area," Krylov said. "The government wanted to have a better understanding of the financials of the companies."

Even though this regulation will mean additional legal costs for Russian companies, Krylov points out that the benefits will assuredly outweigh the costs.

"It's hard to argue why they didn't disclose something to the public in Russia, and did disclose it overseas," he said. "This will clearly lead to more complete disclosure for companies in Russia."

Another regulatory change, also implemented earlier this year, was to require financial information for the previous five years to be provided on a consolidated basis.

Many Russian companies have grown so quickly that it can be hard for their executives-not to mention investors-to keep track of all the subsidiaries. This situation could also lead to abuses, Krylov said.

"The Russian giants have so many subsidiaries, so many affiliates, that it's easy to shift money between them," he said.
Krylov said he hopes that better regulation, as well as more access to the market itself, will help the Russian market mature. He would also like to see more companies go public.

"The level of penetration into the market is very insignificant," he said. "I hope that in the next several years, more and more firms would have access to the market. That would create more transparency, bigger volume, and bigger interest in the market, which would facilitate more active involvement of the government in regulating the stock market."
RTS currently tracks quotes for around 600 stocks, of which 300 are traded on the system. Another 100 or so are traded on Micex (the Moscow Interbank Currency Exchange).

Krylov said he expects to see some resistance to regulation at first, since the RFSC has been pretty much inactive in past years. "Now that it has started to play a role, some of their efforts are not particularly welcome," he said. "But this is a natural process."

Another area that requires regulatory improvement is commodities trading. Russia does not currently have a commodities exchange. "The idea has been in the air for a long time, and it's time to implement it," Krylov said. "But I'm not sure there's legal basis for it, and that's a concern for me."

According to Jacques Der Megreditchian, managing director and head of capital markets at Troika Dialog, Russia's oldest and largest brokerage, the country's big industrial companies find it easier to use offshore structures to hedge commodities risk.

"Probably it will come, sooner or later," he said of a commodities market. "I think there is some need today, but I don't think it will have strong development for a year or two."

RTS Stock Exchange
The trading system used by the RTS Stock Exchange (formerly known as the Russian Trading System) was world-class from the start. In fact, the technology was based on the Nasdaq platform, according to RTS VP Alexey Sukhorukov.
Called the Portal system back in the mid-1990s, the system ran on a computer from Maynard, Mass.-based Stratus Technologies. However, by 1998, the difficulties of trying to modify the system to meet the specific needs of the Russian stock market proved daunting, in part because of different accounting systems and different trading rules in Russia vs. the U.S.

In addition, in order to keep up with growing trading volumes, RTS would have had to buy new hardware if it decided to stay with Portal. RTS decided it was cheaper to build a system from scratch rather than modify Portal, so in 1998 the exchange developed RTS Plaza. With the new system, RTS was able to continue using the same computer it bought in 1997, without buying additional equipment.

"The first version of Plaza had the same functionality as the Portal system and used the same trading principles," Sukhorukov said. "Then we added order-driven trading." With order-driving trading, it's possible to match bids and orders automatically, he said.

In addition, Plaza was also expanded to handle initial public offerings and bond trades. Another major upgrade scheduled for 2004 will combine the cash market-for stocks, bonds and exchange-traded funds-and the derivatives market.

The derivatives market is called Forts (Futures and Options in RTS) and launched in September 2001. Forts was based on a system from the St. Petersburg Stock Market, in which RTS owns a stake.

The St. Petersburg Stock Market was an attractive investment for RTS in large part due to one specific stock. St. Petersburg held the right to trade a very specialized instrument: Gazprom stocks. Gazprom is Russia's natural gas monopoly and not only dominates the order-driven market, but also makes up 20 percent of Russia's total stock market capitalization.

"We bought shares in the St. Petersburg Stock Market in order to be able to trade Gazprom shares," Sukhorukov said. And, though technologically the actual trades occur at RTS, legally they take place in St. Petersburg.

As at the Moscow Stock Exchange, traders at RTS have to deposit money into accounts ahead of time in order to guarantee their order-driven trades. For quote-driven trades, there's no such guarantee of settlement and RTS has a T+3 settlement cycle.

"Well, T+3 is the usual rule, but in practice it's not absolute," Sukhorukov said. "If the two sides have agreed to settle the trade in T+7, then that can happen as well."

Sukhorukov is currently working on getting everyone to a T+3 standard-T+2 or T+1 isn't even on the agenda, he said.

Moscow Stock Exchange
The Moscow Stock Exchange built its trading system in-house, starting in 1997. Originally, it allowed for initial public offerings and follow-up trading of stocks and bonds. It has been modified over the years to meet the evolving needs of the exchange, said Alexei Ryzhikov, VP of trading at the exchange.

The trading platform is also used by regional exchanges, including ones in Siberia and Lipitsk, in central Russia. Ryzhikov said he's currently working on licensing the system to exchanges elsewhere in Russia, as well as in Belorussia, Ukraine and Kazakhstan.

Moscow Stock Exchange CTO Alexander Branevski said the exchange runs on several servers, the biggest of which is a four-processor server from Hewlett-Packard running the Windows 2000 operating system. In the next year, he said, he hopes to expand on this by adding a Linux-based server as well.

Branevski started out at KPMG Consulting developing the Vladivostok International Stock Exchange, and also worked at the country's Depository and Settlement Union before coming to the Moscow Stock Exchange. That experience, combined with those of his colleagues at stock exchanges in New York, Tokyo and Denmark, gave the exchange the skills needed to build a new trading system for the Moscow Stock Exchange, he said.

In order to buy a stock on the Moscow Stock Exchange, a trader has to have enough funds on account at the SberBank of the Russian Federation to cover the cost. If a trader wants to sell stock, it must be held at the Depository and Settlement Union. The trades are settled on a nighttime batch basis.

Ryzhikov said he hopes to be able to move the market to a T+5 settlement cycle with the next year.

While questions remain on the regulatory front, the development of a commodities exchange is a major project at the Moscow Stock Exchange.

The system will be ready to go in September, he said, with futures and options trading available a few months after that.

The first products traded? Wheat, rye, sunflower seeds, sugar and other agricultural products.

"Milk and meat also, possibly, but it will be more difficult because of government regulation," said Ryzhikov. "Oil is also more difficult because it's monopolized. But we're hoping that, in a year or two, the markets will reach that sector as well."

Ryzhikov said the MSE learned how to run a commodities exchange from joint efforts with the Chicago Board of Trade. He added that there used to be a commodities exchange in Russia after the fall of the Soviet Union, but it was badly damaged in the 1994 currency crisis, and completely finished off in the crash of 1998.