This article was written by TKB Investment Partners.
The US recently added several Russian entities and individuals to its sanctions list, causing a sell-off on the Russian stock market (see Exhibit 1).
Among the blacklisted companies are three public ones: Rusal, the alumina producer, En+, the holding company, and carmaker GAS – all companies controlled by Oleg Deripaska. The US Treasury imposed a ban on the ownership of any equity and debt instruments issued by these companies.
Investors fear that additional measures might be taken against other public Russian companies.
Exhibit 1: Changes in Russian asset prices 01/04/18 – 19/04/18
Source: FactSet, BNP Paribas Asset Management, as of 19/04/2018
In fact, we do not expect similar restrictions to be imposed on the broad Russian equity market and we consider the current market drop an overreaction:
- The Deripaska case is particular as he was suspected by US law enforcement and government agencies to have been involved in US elections meddling on the behalf of the Russian government.
- The imposition of market-wide restrictions would be even more harmful for US asset management businesses than sanctions involving Russian sovereign debt. Previously, broad sanctions were not imposed after the US authorities decided that such action could materially backfire on US investors.
- We consider the Ukrainian and Crimea crisis a more likely reason to impose sanctions than US elections meddling, which continues to be very contentious.
US sanctions: what happened?
On 6 April 2018, the US Department of the Treasury extended sanctions against a number of Russian entities and individuals (Specially Designated Nationals). Russian politicians, state-owned company executives and businessmen were put on the sanctions list. Of the 14 Russian entities that were added, 12 are companies controlled by newly included individuals and 2 are defence companies.
The Treasury said the actions followed the January 2018 CAATSA Section 241 report that had been prepared as part of the investigation into Russian interference in the 2016 US presidential elections campaign.
The new sanctions include the following:
- All US entities and individuals must cease all business relations with the 12 companies controlled by newly added SDNs before 5 June 2018. This includes prohibition of all transactions and activities with listed companies, including an immediate ban on exports from the US and a ban on imports to the US starting 5 June 2018. All US individuals must cease their cooperation with the listed companies, including employment and membership of the board of directors.
- A freeze on all property and accounts in the US of the SDNs and the listed companies.
- Prohibition of ownership of any equity and debt instruments issued by Rusal, En+ and GAS, including those issued before 6 April 2018. This assumes the mandatory sale of all such financial instruments by US entities and individuals by 7 May 2018.
Out of the 12 Russian entities, eight are controlled by Oleg Deripaska, three of which, namely Rusal, En+ and GAS, are publicly listed companies. According to the US Treasury, Deripaska acted or was purported to act for or on behalf of, directly or indirectly, a senior official of the government of the Russian Federation, which may relate to the investigation into US presidential campaign meddling.
The new list does not include companies in which sanctioned individuals or entities hold less than 50%. For example, Norilsk Nickel, in which Deripaska holds about 28% through Rusal, is not on the sanctions list.
How did the market react to the latest sanctions?
Shares in the three Deripaska-controlled companies as well as the broad stock market reacted with a massive sell-off (the MSCI Russia index declined 9.6% on the day and the Russian ruble fell 3.6% against the US dollar).
The reason for the drop in the value of shares in Deripaska’s companies is obvious: investors are anticipating the ownership ban to come into force in a month’s time and are seeking to liquidate their positions as fast as possible and at any price. In addition, according to Rusal’s statement, the new sanctions may have a strongly negative impact on its business – Rusal generates about 10% of its revenue in the US – and it may lead to a technical default.
In our view, the main reason for the sell-off in the broad market is the retrospective imposition of financial sanctions. The US has imposed financial sanctions on public Russian companies before, for example on Sberbank, VTB and Rosneft in 2014.
Those restrictions, however, concerned only financial instruments issued after the announcement of the sanctions, so the restrictions did not prohibit ownership of these equities since the entities had already been public.
In the latest instance, the US imposed a ban on ownership of all financial instruments issued by designated entities, regardless of the time of issuance. Thus, investors may now fear similar sanctions on other Russian companies.
What is the outlook?
Indeed, we cannot exclude the possibility that similar sanctions will be implemented on other Russian companies in the future. Given the US Treasury statement and previous sanctions, it looks like a company needs to meet the following criteria to be included in similar restrictions:
- Its shareholders or the company itself must be considered by the US to pose a threat to the US economy, its foreign policy, national security or sovereignty
- The entity or individual, meeting the above-mentioned criteria, must own at least 50% in the company.
It is hard to assess which Russian individuals or entities might be considered by the US to pose such a threat. The Deripaska case stands out since he was suspected of being involved in US elections meddling on the behalf of the Russian government.
We nonetheless do not expect similar restrictions to be imposed on the broad Russian equity market. Thus, we consider the recent decline in the index to be an overreaction. In early February, the US Treasury issued a report on the potential consequences of the imposition of sanctions on Russian sovereign bonds.
The report said the Treasury did not support such restrictions because of the potential harm to US asset managers’ interests. Non- residents hold more than a third of the total Russian sovereign bonds outstanding. The situation is similar for equities. According to our estimates, Sberbank CIB and Bloomberg data, foreign investors hold 60%-70% of the Russian market’s free-float, while US-domiciled funds hold 30%-35%.
Thus, the imposition of market-wide restrictions would be even more harmful for US asset managers than sanctions on Russian sovereign debt, which were not imposed.
In addition, we consider the Ukrainian and Crimea crisis a more serious reason to impose sanctions than US elections meddling, which remains quite contentious. The key difference this time is the allegation by US authorities of Deripaska’s personal involvement in the US-Russia political tensions. Thus we believe the latest sanctions are a one-off event as opposed to a step towards broader restrictions on investment in Russian assets.
 En+ and GAS are controlled by Deripaska, while his indirect stake in Rusal is slightly below 50%. Viktor Vekselberg, who was also added to the US sanction list, holds another major stake in Rusal, so the total stake of sanctioned individuals is above 50%.