Would you feel safe if corrupt Ukrainian government bureaucrats had an inside view of every stock, bond or other security you as an individual or company purchased? If you answered no to this question, perhaps it is time to reconsider your position on Ukrainian equity and debt.
The very fabric of the nation’s financial system – its independence and trust in the eyes of investors – is being challenged by legislative changes that would give Ukraine’s government a majority stake, and likely inside view, at an agency responsible for clearing and documenting all securities transactions.
Adopted by President Viktor Yanukovych’s ruling majority in parliament this summer, the relevant legislation was passed on to the president on Sept. 7, who now has 15 days to sign it. If he does, analysts say the “depository system law” would do lasting damage to Ukraine’s already embattled investment climate, and struggling securities market.
While traders, brokers and investors rarely give a moment’s thought to the infrastructure supporting the millions of daily transactions, a depository is, in fact, crucial to the functioning of a financial system. It is a nervous system of a market. Flowing through it is a treasure propriety information that can be used by the wrong hands for abuse.
“The depository assures that securities move between buyers and sellers as intended, once the transaction payments are processed and ownership of securities is never in doubt,” explained Marius Vismantas, an expert on financial legislation at the World Bank, which for years assisted the Ukrainian government in setting up the country’s financial infrastructure.
“Only when the depository says ‘ok’ is your money transferred to the seller. The importance of this cannot be underestimated,” Vismantas emphasized.
The controversial legislation proposes to merge a largely defunct state depository, the National Depository of Ukraine, with the independent one, the All-Ukrainian Securities Depository. The latter was set up with the financial assistance of the U.S. government more than a decade ago. It is a self-regulating organization owned by market participants, much like the systems in the West.
Plans envision that the state will, through the merger, have no less than a 50 percent stake in the new depository, giving bureaucrats and government insiders an inside view on the registration of all transactions, securities ownership and approval. A parallel process is taking place in regard to the clearing system, another technical function crucial to the stock market’s operations.
Proponents of the changes argue the current proposals are necessary to centralize the stock market infrastructure in order to lower costs. Such consolidation is in line with international trends, they add. The Independent Association of the Banks of Ukraine, set up in November 2011, said it would restore order in the stock market.
“A single securities depository demonstrates the high development of the stock market,” an IABU spokesperson told the Kyiv Post. The spokesperson added that the introduction of strict control by Ukraine’s central bank, headed by Yanukovych loyalist Serhiy Arbuzov, over the central depository and clearinghouse is expected in about 18 months. A decision about transfer of control, through privatization or other, would come later.
“On the one hand, there is a legitimate desire to arrange a central depository,” said Dmytro Tarabakin, managing partner of leading Kyiv-based investment bank Dragon Capital. “The problem is in how things are done. Unfortunately in Ukraine, the good intentions have been used for bad deeds.”
The current system is closer to international standards. The AUSD, which accounts for over 85 percent of transactions, is majority owned by market participants with the state accounting for just a 30 percent. Meanwhile, the NDU is majority owned by the state, directly or indirectly through state-owned banks for instance.
“The AUSD, by all objective criteria appears to be stronger technically, institutionally and even financially. Despite the fact the NDU is owned by the government. The way we saw the story of NDU was: inefficient use of government funding, government equity; nontransparent management, nontransparent ownership, and quite a bit of private capture of a state institution,” said Vismantas.
“There is no apparent need, from a policy perspective, for the state to continue investing public, taxpayer money into new state-owned financial institutions. The state should continue strengthening its policy making and regulatory capacity, and rely on market-based institutions, which have critical amount of trust from market participants,” he added.
Meanwhile, the banking association argued the NBU’s share in the NDU was larger than in the AUSD, so creating the new entity on the former’s base was simply more convenient.
A document sent to news agency Interfax-Ukraine by the USAID Financial Sector Development Project, which also provided expertise to the government, pointed to several additional sources of concern: the lack of a proper international audit and assessment of the assets of both depositories; no fair and transparent mechanism for the merger; proper protection of the interests of present private shareholders.
The latter is of particular worry to the market participants, who have staked their money in the institution, and could lose the sizable revenues to the newly created institutions.
“People are blatantly re-writing the law in a way to deprive the private depository, in which private businesses and the U.S. government have invested, to deprive them of commission revenues and transfer unilaterally all the business to a state depository,” Tarabakin said.
Market participants who spoke to the Kyiv Post on condition of anonymity for fear of reprisals expressed concerns the new structure could lead to abuse. Should propriety information get into the wrong hands, it could be used by government or corrupt officials and their associates against businesses. So-called raiders, notorious in Ukraine for abusing weak legislation and corrupt courts to take over assets and companies, could exploit it.
The IABU told Kyiv Post that “market participants believe abuses are widespread at the moment. But the appearance of a single controller in the person of the central bank, though it could limit the rights of traders, would strengthen control and civilize the chaotic and not always clear Ukrainian stock market.”
The NBU did not respond to repeated attempts by the Kyiv Post to obtain a comment.
Commenting on the value of the depository information, Vismantus said: “This information only has value to those who have ill intentions. Unfortunately, Ukraine is not immune from those kind of intentions and from people who would be able to use that information for ill purposes if they got it. Raider attacks give unfortunate examples that problems still exist.”
If signed into law by Yanukovych, the changes are likely to bode bad for Ukraine’s already battered stock market. Dismal liquidity, low quality issuers and a lack of investor confidence have set the UX index of the country’s biggest exchange tumbling 64 percent since its high 18 months ago. At the end of August it was the world’s second worst performer, behind Cyprus, with 28 percent in the red.
It has shown a level of volatility unheard of in Europe. Already down close to 60 percent on the year, the UX stock index lost a staggering 40 percent from the beginning of May to June 7. It bounced back, notably with a ridiculous 18 percent jump on July 2-3, to be followed by a 7 percent loss on a single day.
Few investors are ready for such risk, particularly if they do not trust the clearing and depository systems.
“Investors who don’t have much trust to the state authorities might consider it as increased Ukrainian risk,” said Artem Lazaruk, head of sale and trading at Kyiv-based investment bank Phoenix Capital.
“[The UX is not having] the best times at the moment and the new law could just finish off the wounded animal,” he added.
Kyiv Post editor Jakub Parusinski can be reached at [email protected].
