Post-Communist Economies

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The rise of collateral-based finance under state capitalism in Russia

Ilja Viktorov & Alexander Abramov

To cite this article: Ilja Viktorov & Alexander Abramov (2021): The rise of collateral- based finance under state capitalism in Russia, Post-Communist Economies, DOI: 10.1080/14631377.2020.1867426 To link to this article: https://doi.org/10.1080/14631377.2020.1867426

© 2021 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.

Published online: 20 Mar 2021.

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Full Terms & Conditions of access and use can be found at https://www.tandfonline.com/action/journalInformation?journalCode=cpce20 POST-COMMUNIST ECONOMIES https://doi.org/10.1080/14631377.2020.1867426

The rise of collateral-based finance under state capitalism in Russia Ilja Viktorov a,b and Alexander Abramov c aCentre for Baltic and East European Studies, Södertörn University, Huddinge, Sweden; bDepartment of Economic History and International Relations, Stockholm University, Stockholm, Sweden; cInstitute of Applied Economic Research, Russian Presidential Academy of National Economy and Public Administration, Moscow, Russia

ABSTRACT ARTICLE HISTORY The article examines emerging financial capitalism in Russia and its Received 21 July 2018 recent developments, the rise of collateralised finance and trading Accepted 12 November 2020 in repo markets. The main conclusion is that a combination of KEYWORDS sophisticated speculative practices with a strong state presence in Russia; state capitalism; financial markets is a distinctive feature of Russia after 2008. The collateral; repo; money decoupling of the financialsystem from the credit supply to the real markets; central sector is still continuing after the collapse of Communism. The role counterparty; liquidity of the capital markets is restricted to short-term liquidity manage­ ment in money markets, which rose after 2011 due to an increased provision of state liquidity. The existence of a large monetary over­ hang accumulated within the Russian banking system and its inter­ connectedness with collateralised markets are discussed. The development stages of the repo markets and the main collateral types are considered in relation to the expansion of the state liquidity supply. This study provides an additional perspective within the ongoing debate on contemporary state capitalism in emerging markets.

1. Introduction What happens if the fragilities of speculative finance overlap with a strong state presence in the economy? The Russian case considered in this article provides a perspective on outcomes produced by the interaction of such seemingly contradictory tendencies. After 1991, Russia underwent a large-scale process of privatisation, deregulation and liberalisation as a part of its transition to a market economy. Key institutional solutions and practices of global finance produced by an ongoing process of financialisation in Anglo-Saxon countries were introduced in Russia. However, starting from the early 2000s, the Russian state made a comeback in the economy as an active player. The process embraced an increase in state ownership, the coordination of economic activity and the control over main liquidity flows. These developments have been well-documented in previous research on the Russian corporate sector in general (Abramov et al., 2016; Chernykh, 2011; Vanteeva & Hickson, 2015), extractive industries in particular (Gustafson, 2012; Hanson, 2009), commercial banking (Vernikov, 2012) and the non-

CONTACT Ilja Viktorov [email protected] © 2021 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group. This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives License (http://creativecommons.org/licenses/by-nc-nd/4.0/), which permits non-commercial re-use, distribution, and reproduction in any med­ ium, provided the original work is properly cited, and is not altered, transformed, or built upon in any way. 2 I. VIKTOROV AND A. ABRAMOV bank financial sector (Viktorov & Abramov, 2016). The re-emergence of the Russian state in the economy had political origins, not least connected to clashes between elite power networks and the rise of Vladimir Putin’s siloviki (Sakwa, 2014),1 but it also reflected the objective complexity of the Russian transition to capitalism (Adachi, 2015). The 2008 crisis became a turning point that made state expansion in financeat the expense of the private sector irreversible. In the 2000s, inflows of foreign speculative capital at the time of the oil price boom created a fragile regime of financial capitalism; its systemic failures could not prevent outflows of global liquidity in 2008 (Abramov, 2008; Nesvetailova, 2016). The tendency towards the state’s presence in the economy was reinforced with the introduc­ tion of Western sectoral sanctions as a part of the Ukrainian geopolitical crisis in 2014 (Connolly, 2018), and after a new currency crisis unfolded in Russia in 2014–15 (Johnson & Woodruff, 2017; Viktorov & Abramov, 2020). There has been little research on the financial architecture of post-2008 Russian capitalism, not least on how liquidity flows are organised and redistributed between state-controlled actors. Very little has been written about how this process is interrelated with a broad international tendency towards the formation of collateralised finance and the expansion of repo (repurchase agreement) markets. The repo instrument is used as a form of lending involving the sale and repurchase of marketable collateral assets at a given time period and price level specified by a contract. Repos underpin the circulation of liquidity between central banks and financial intermediaries, while government and corporate bonds, stocks and a broad array of securitised assets are used as collateral. Starting in the 1990s, repo operations have been playing an ever-increasing role in the financial markets of core capitalist economies (CCEs) and have become a systemic ele­ ment of monetary policy and central banks’ refinancing operations. Repos have enabled the rise of highly liquid speculative markets, thus transforming the nature of contempor­ ary finance and banking. The main task of monetary authorities has therefore been to mitigate the risks of a systemic crisis, which are immanently present due to the instability of collateralised finance (Gabor, 2016; Gabor & Ban, 2016; Nyborg, 2017; Sissoko, 2019).2 Collateral-based finance has been reproduced ever since in emerging market and developing countries (EMDs), including China (Gabor, 2018b; Kendall & Lees, 2017), India (Dua, 2020) and Brazil (Kaltenbrunner & Painceira, 2018). Russia has followed this global trend but has developed a number of distinctive features that make it a special case for studies of the political economy of collateralised finance. Most recently, the creation and subsequent expansion of the highly centralised trading of general collateral certificates (GCCs) in the state-controlled monopoly Moscow Exchange (MOEX) has resulted in the securitisation of repo markets in Russia, making it the first country to introduce this instrument. Remarkably, a master’s thesis remains the only work that provides a relatively compre­ hensive account of how repo markets had been evolving in Russia until the early 2010s (Bagrei, 2014). It presents an affirmativenarrative of repos as a progressive innovation that helps Russia to embrace the ‘best practices’ already introduced in ‘developed’ financial markets. This view reflects a prevailing approach adopted by Russian market participants and regulative authorities towards collateral-based finance. A critical account of how the Russian state has promoted repo markets is non-existent so far. This article explores the inner-mechanisms of collateralised finance in Russia and the contribution of repo markets to the functioning of Russia’s state-led financial capitalism. POST-COMMUNIST ECONOMIES 3

We demonstrate that, like in CCEs, the Russian state has been at the heart of the expansion of collateralised finance, but its role in this transformation has been essentially different. Rather than defining the rules of the game and issuing principal government collateral to promote the rise of repo markets, the state agencies and state-controlled financial intermediaries actively engaged in repo trading. Therefore, this study intends to make an empirical contribution to current debates on state capitalism in EMDs (Carney, 2015; Kutlay, 2020; McNally, 2012; Nölke et al., 2015, 2019; Petry, 2020), although its theoretical conceptualisation is beyond the scope of this article.3 For practical purposes, we understand state capitalism as an economic system where the state owns key assets and controls the main financial flows while state-owned business entities act like quasi- independent market players with the primary purpose of profit maximisation. With its emphasis on state ownership, which appears rather as an instrument used by powerful elite networks to control economic resources (Nölke et al., 2015), state capitalism differs from the post-war East Asian developmental state (Tsai & Naughton, 2015). The latter assumes governmental capacity to mobilise the resources of both privately and state- owned business entities to create economic growth (Evans, 1995). The rest of the article consists of six sections. Section 2 presents a theoretical discussion on market-based banking (MBB) and collateralised markets, relating those within the Russian context. Section 3 highlights the expansion of Russia’s repo markets in light of how liquidity flows changed after 2000 and identifies the main distinctive features of collateralised finance in Russia. Section 4 discusses the evolution of collateral types, and Section 5 identifies a monetary overhang in the Russian banking system and discusses how its accumulation has been related to the liquidity management of state money. Section 6 looks at the securitisation of the state-run repo markets and the introduction of GCCs and discusses central counterparty (CCP) risks for the Russian financial system. The last section summarises the findings of the study.

2. Market-based banking and collateralised finance: a theoretical perspective and its relevance to Russia Zysman (1983) defines three models of the national financial system, basing his classifica­ tion on the interconnection between industrial policy and the financial sector as a capital supplier. The first one is a capital market–based system typical of Anglo-Saxon countries. It allocates long-term industrial funds through security issues of stocks and bonds with prices set in competitive markets. This model is characterised by the non-relational interaction between investors and industry, with a great diversity of available market segments, instruments and specialised institutions. Financial intermediaries do not strive to establish long-term relationships with company management, concentrating instead on increasing the market value of diversified portfolio investments. The second model is a state-led credit-based system with a government that pursues an active industrial policy and influences the distribution of investments according to its policy agenda. The French state’s industrial policy and East Asian developmental states during the post-war period fit well within this model. A bank-led credit-based system is the third model suggested by Zysman, with post-war West Germany as its typical illustration. In such a system, a few large financial institutions coordinate industrial policy and credit supply to companies, thus remaining strongly autonomous from the state. The government does not interfere 4 I. VIKTOROV AND A. ABRAMOV in the markets by conducting administrative price-setting or providing financialassistance to banks. The banks collect deposits from household savers and distribute liquidity as credits to enterprises based on the cultivation of long-term mutual relationships between lenders (banks) and borrowers (non-financial companies [NFCs]). This reduces the impact of market and price fluctuations on the credit supply to the non-financial sector, thus creating what Zysman describes as the financial power of banks. Starting in the late 1970s, the financial markets underwent an unprecedented liberal­ isation that triggered the process of financialisation or the rise of finance as the main source of profiting at the expense of the productive sectors of the economy (Epstein, 2005; Krippner, 2011; Lapavitsas, 2013). Within the financial sector, the focus shifted to risky short-term market operations and away from supplying long-term ‘patient’ capital to NFCs, leading to increased volatility in the financial markets (Hardie, 2012; Sissoko, 2019). This fundamental transformation of global finance required a further revision of Zysman’s classification. Hardie et al. (2013) claim that a new model of financial capitalism has emerged in CCEs, one they define as MBB, which combines the weakest features char­ acteristic of both credit- and capital market–based models in terms of the accumulation of systemic risks and fragilities. MBB is still concentrated on credit activity, but the nature of this intermediation has been very different. Traditional relational banking as a part of the capital supply and exchange of information between financial institutions and NFCs has been abandoned, thus reducing the financial power characteristic of ‘old-school’ com­ mercial banks. Customer deposits do not necessarily constitute the main source of banks’ liabilities, as a consequence of which undermining a stable base for the provision of long- term capital to enterprises. Instead, banks rely on borrowing from the market, mainly from other intermediaries, and on lending to the market, increasingly to other financial institu­ tions. Therefore, banks have been relying on the creation and utilisation of assets and liabilities whose value depends on market sentiments rather than on the ability of financial institutions to withstand market instability (Berndt & Gupta, 2010; Spears, 2019). In general, the difference between commercial banks and non-bank financial intermediaries, such as investment banks, money market funds and hedge funds, has blurred (Guttmann, 2018; Hardie & Maxfield, 2013, pp. 58–62). Under MBB, banks and other intermediaries have benefited from dramatically increased profits generated by speculative finance at the cost of financial stability and long-term engagement with NFCs. Essentially, fundamental uncertainty, pro-cyclicality and the fragility of finance are char­ acteristic of MBB, as evident during the 2008 global crisis (Adrian & Shin, 2010b; Mehrling, 2012). Notwithstanding the analytical value of the concept suggested by Hardie and his co- authors, it would be an exaggeration to present MBB as a principally new type of financial capitalism. Rather, it could be viewed as a next phase of the sophistication of the old capital market–based system. The rise of market-based finance has taken place due to the disintermediation of traditional banking (Sissoko, 2019). The multifaceted nature of MBB embraces a broad variety of practices, including securitisation, derivative trading, shadow and parallel banking and repo markets. The last-mentioned are critical for MBB since trading collateral makes possible the extensive exchange of assets and large-scale liquid­ ity flows. In collateral-based finance, intermediaries rely on repo markets for the purpose of short-term liquidity management and leveraged trading involving risky speculative strategies for profit maximisation (Adrian & Shin, 2010a; Gorton & Metrick, 2012; Poszar, POST-COMMUNIST ECONOMIES 5

2014). The multiple reuse of collateral creates collateral chains that interconnect financial institutions depending on repo markets as a source of funding and profit-making (Gabor, 2018a; Singh, 2011). Two aspects of collateralised financeare central to undermining financialstability. First, banks, other intermediaries and, increasingly, central banks rely on the mark-to-market (MTM) practice of the daily pricing of collateral used for repo transactions to its constantly changing market value. The practice of repo haircuts is applied for this purpose.4 During periods of market stress, margin call practices are enacted each time the market value of collateral falls below the borrower’s capacity to repay the loan obtained through a repo transaction. The decreased value of pledged securities does not correspond to the amount of borrowed money, and the borrower needs to either provide additional collateral to the lender or be exposed to an enforced sell-off of collateral. Therefore, unlike with traditional banking, MBB protects primarily the interests of the lender at the expense of the borrower’s and at the cost of stability. In the worst case, the chain of margin calls can lead to a liquidity spiral (Brunnermeier & Pedersen, 2009), a combination of falling asset prices and a liquidity squeeze, triggering deleveraging and cross defaults between financial intermediaries. Second, collateralised finance puts a special responsi­ bility on the state since the sustainability of the markets depends on the ability of the monetary authorities to issue ‘safe’ principal collateral as government bonds (Boy, 2014; Gabor & Ban, 2016). The monetary policy’s primary objective becomes managing liquidity through the provision of ‘safe’ collateral and maintaining the price stability of those assets. This transforms the fundamental role played by the central bank in the financial system, from being the lender of last resort to the dealer of last resort (BIS, 2015; Mehrling, 2011). After the fall of Communism and the initial phase of ‘shock therapy’ with the privatisa­ tion and liberalisation of prices and foreign trade, EMDs in Central and Eastern Europe (CEE) were exposed to similar tendencies towards the establishment of MBB and the embracing of practices of financialisation. In the 1990s, these included the privatisation of banks and the dismantlement of relational banking, the liberalisation of interest rates, the introduction of central bank independence with financial stabilisation as the policy priority (Johnson, 2000; Ruziev & Dow, 2015). International financial organisations (IFIs), Western central banks, government agencies and other financial institutions became the main drivers of this transformation. Ideology and practices of financialisation were trans­ mitted through the exercise of soft power by IFIs and central banks in CCEs, including educational programmes targeted at the officials and employees of the financial regula­ tors in EMDs (Johnson, 2017). Gabor (2015) demonstrates the actual transition priorities envisioned by IFI-affiliated economists at the beginning of the transition in the early 1990s. High-status Western transitologists advocated the destruction of the planned economy’s financial system and its institutions, including the relational nexus between state-owned banks and NFCs. The planned economy should be replaced by a new system of profit-maximising firms put under the strict market discipline of new commercial banking and its rigorous assessment of borrowers’ creditworthiness. At that time, non- existent capital markets would provide a new source of investments enabling NFCs to raise capital through the issuance of bonds and equity. By the early 1990s, a monobank system of the planned economy, the elimination of which the transitologists had proposed, no longer existed in Russia. As a part of the initial 6 I. VIKTOROV AND A. ABRAMOV phase of nomenklatura privatisation that started in the late 1980s, the former branches of Gosbank (the Soviet State Bank) were transformed into a number of quasi-market state- owned banks taken over by political insiders. What was destroyed in the 1990s was the relational banking that embraced the refinancing and lending practices between Gosbank’s former branches and mass-producing enterprises. By the mid-1990s, Russian banks had reduced dramatically the provision of credits to NFCs (Johnson, 2000, pp. 98–106), leaving Russian enterprises with no choice but to rely on retained profits as the main source of business conduct. Squeezing lending to NFCs resulted in non-monetary debt-clearance schemes that secured for years the survival of enterprises and substituted limited access to refinancing and credits (Ivanenko, 2004; Woodruff, 1999). Capital mar­ kets established on the advice of consultants from the United States Agency for International Development (USAID), associated with power networks in the US financial industry, did not deliver a promised alternative for raising funds for NFCs (Kuznetsova et al., 2011; Viktorov, 2015). By the end of the 1990s, the implementation of the policy agenda advocated by IFIs had contributed to a deep economic decline and systemic failure to create a new sustainable model of capitalism in Russia (Nagy, 2000; Florio, 2002; Popov, 2011). From the 2000s, financialisationin CEEs was supported by capital account liberalisation and increased dependency on global liquidity inflows.The majority of CEE economies saw the takeover of domestic banking by the subsidiaries of foreign banks, the establishment of shadow (parallel) banking and the rise of collateralised finance (Gabor, 2013; Kaurova, 2018; Nesvetailova, 2016).5 The ties between financial intermediaries and NFCs remain severed. What has changed since then in CEEs is the introduction of more-complex instruments and practices of global finance that underpin domestic liquidity manage­ ment. In the 2000s, Russia started to diverge from the general trends in CEEs and saw the state return to the financial sector. Unlike in most of the region’s economies, influential Russian political and business insiders, including the powerful banking lobby, continued to successfully prevent a massive takeover of the banking sector by foreign players (Sutela, 2013, p. 174; Vernikov, 2012). Relational banking between large state-controlled banks and NFCs was restored in part, which contributed to a better economic perfor­ mance by such enterprises in the 2000s (Vanteeva & Hickson, 2015; Vernikov, 2014). However, it would be too early to conclude that financein Russia has been transformed into a state-led credit-based system, as envisioned by Zysman; industrial policy in Russia has not been nationally implemented but restricted to a limited number of NFCs and projects (Fortescue, 2018; Simachev & Kuzyk, 2016). The state-owned banks became providers of financialisation, relying on either borrowing from the global wholesale money markets or receiving inflows of liquidity from hydrocarbon exports, a comparative advantage that the rest of the post-Communist CEE economies were unable to use (Viktorov & Abramov, 2020). Thirty years have passed since the transition debates, yet neither the banking sector nor the capital market instruments, such as equity and corporate bonds, have been the main source of investment in fixed capital for companies (Karlova et al., 2020). Figure 1 reveals that bank credits made a limited contribution to companies’ investments, fluctuating around 89% of total investments in fixed capital in the 2010s. This fact testifies to the disintermediation of banks in terms of the capital supply outside the financialsector. The retained profitsof enterprises (57.1% in 2019) and public funds (15.8% in 2019) have been the principal sources of capital POST-COMMUNIST ECONOMIES 7

Figure 1. Investment structure of fixed capital for Russian companies by origin (%). Sources: based on the Rosstat and MOEX data, accessed at www.gks.ru and www.moex.ru. *For 2016, only equity issues data is available. Data for 2017 is not available. The MOEX had no initial public offerings (IPOs) in 2018. provision to NFCs. Throughout the observed period, the contribution of capital market instruments to fixed capital investments has been negligible. In 2015, its share was only 2%, one of the highest between 1998 and 2015.6 Instead, capital market instruments have been used increasingly in speculative activities and in recent years as collateral for the liquidity management of state-originated liquidity flows. To summarise, the emerging financial capitalism in Russia can be described as a combination of statism and financialisation, the latter adopted from the West and gradually transformed into an integral part of Russia’s economic environment. A rapid spread of collateral-based finance and associated repo trading has been the main novelty during the 2000s and 2010s, which will be the primary focus of the next two sections.

3. Russia’s repo markets: development stages and main peculiarities The main phases of the repo market expansion from 2005 until 2019 in relation to how liquidity flows changed in the domestic capital market are presented in Figure 2. Because trading in repo markets in Russia is mainly exchange-based, this data is representative of the general developments of collateralised finance in this country. The Central Bank of the Russian Federation (CBR) has been a driving force behind the rise of collateral-based finance in Russia. In 1996, the CBR introduced repo in the govern­ ment short-term bond GKO market for the first time as a refinancing policy instrument. 8 I. VIKTOROV AND A. ABRAMOV

Figure 2. Volume of repo trading in domestic securities on the MOEX by collateral type, including equity, bonds and GCCs, 2005–2019 (in RUB tn). Source: based on MOEX data, accessed at www.moex. ru, as published in April 2020. *For repo with the CCP and GCCs, see Section 6. **Reflects liquidity supplied by the monetary authorities to repo trading on the MOEX.

However, this initial prelude became short-lived due to the GKO market default in 1998 (Bagrei, 2014, pp. 38–40). Remarkably, repos appeared in Russia each time the monetary authorities, notably the CBR, were put under the control of elite networks that promoted a deeper integration of the Russian financial system into the global markets. During these periods, the CBR’s leadership was more inclined towards adopting practices and instru­ ments of international finance. Neither before 1996 nor between 1998 and 2002, when the CBR was governed by competing elite networks that advocated continental-style relational banking, were repos widely used. Until 2002, Russian monetary policy was conducted using traditional policy tools, such as direct lending to banks, deposit auctions or bank reserve requirements (Johnson, 2017, pp. 189–196). This period of moderate liquidity in the Russian capital markets did not prevent Russia from experiencing high economic growth rates in the productive sector (Gavrilenkov, 2004). The first phase of the repo markets’ expansion took place between 2005 and 2008. In 2003, the CBR reintroduced repos as a key element of its refinancing policy. Between August 2004 and August 2008, in particular after the liberalisation of the capital account in 2006, Russian capital markets experienced large liquidity inflows from international markets as a part of carry-trade practices of global finance. This took place in parallel with inflows of high hydrocarbon export revenues. Not only non-residents but also domestic intermediaries, including banks and investment banks, accessed international wholesale money markets (Lu & Yakovlev, 2017, pp. 8–9). As in other EMDs exposed to carry trade, financial intermediaries exchanged foreign liquidity to undertake short-term positions in POST-COMMUNIST ECONOMIES 9 rouble-denominated assets, such as stocks and corporate bonds. Russian securities were also pledged as collateral in repo transactions in the interdealer repo market in pursuit of complex speculative trading strategies involving leveraging, pyramiding and derivative products. Large profits could only be extracted when the rouble was strong. Therefore, the pre-2008-crisis architecture of the Russian financial markets was unsustainable due to the fragility of funding, short-term speculative strategies and the systemic weaknesses of its regulative and institutional framework. This time, an attempt to create a functional collateral-based financial system in Russia was interrupted by the global crisis. Corporate bonds and stocks turned out to be poor replacements for an absent ‘safe’ government bond collateral. As soon as global flows were reversed, carry trade stopped, the prospects of hydrocarbon export income decreased, and liquidity drainage, in combination with a drop in the collateral value under repo, led to a non-payments crisis. A local run on repo paralysed the Russian financial system in September 2008 (Abramov, 2008; Zamaraev et al., 2009, pp. 66–73). The second phase of the repo markets’ growth took place in a different macroeco­ nomic reality. After the global crisis, the Russian market underwent a systemic transfor­ mation. Privately owned commercial banks, negatively affected by active engagement in leveraged trading, were rescued by the state or nationalised. Privately owned investment banks were ruined, bankrupted or taken over by state-controlled banks and corporations (Viktorov & Abramov, 2016). From 2008, the developments of Russian collateralised finance started to diverge from the global pattern because it was transforming into a key element of the money market based on the circulation of state-originated liquidity between the main market players. At the same time, large Russian corporations and banks, predominantly state-owned, witnessed a sharp decrease in access to international wholesale money markets. While the accumulated external corporate sector debt remained high until 2014, its further increase stagnated (Viktorov & Abramov, 2020, p. 496). After 2008, the main factor behind the resumed expansion of the repo markets was connected to the increased inflows of CBR liquidity into the banking sector, which accelerated from 2011. Repo markets in Russia have been primarily based on extremely short-term liquidity management, with an overnight segment dominating repo trading. In February 2014, the CBR established a one-week repo auction as its key policy rate for liquidity provision to the banking sector, replacing a very short-term repo overnight auction as a key policy instrument (Central Bank of Russia [CBR], 2013, pp. 15–17). This signalled the CBR’s policy priority to extend maturities in lending through repos and, indirectly, in credit supply to NFCs. The 2014–15 financialcrisis led to a change in monetary policy conduct in Russia. It also brought about the introduction of Western financial sanctions against Russia, which had to repay its external corporate sector debt. Instead of the CBR, the Ministry of Finance (MOF) became the main provider of liquidity for large corporations and the banking sector. The third period of the rapid expansion of repo markets characterised by increased trading through the newly established CCP followed, as shown in Figure 2 and will be addressed in detail in Section 6. By the early 2010s, the repo markets in Russia had developed three distinctive features. The first one is directly connected to the GKO market default in 1998, when the Russian government refused to serve its debt. Unlike in other countries where repos are traded primarily over the counter (OTC), trading in the Russian repo markets is exchange-based, 10 I. VIKTOROV AND A. ABRAMOV

Figure 3. Collateral base used for the interdealer repo market as a percentage of total trading volume, 2013–2017. Source: based on data from the National Finance Association (NFA, 2015a, 2015b, 2017). with a central clearing. After 1998, the counterparty risk was high because of the lack of trust between market participants. In the early 2000s, the MICEX (Moscow Interbank Currency Exchange) clearing and depository infrastructure was considered a sort of guarantor for repo transactions being executed (Annenskaya, 2009). Founded in 1992, the MICEX, a direct predecessor of the MOEX, has been controlled by the CBR. In the 2000s and 2010s, this rendered the MICEX-MOEX trading platform a suitable mechanism for the distribution of CBR liquidity through direct repos with commercial banks. The share of the domestic OTC repo market in the total volume of repo trading has been low.7 Exchange- based repo markets have been highly centralised due to the MOEX’s monopoly status. The merger between the CBR-controlled MICEX and the Russian Trading System, a privately owned stock exchange, into the MOEX in 2011 was largely conditioned by the CBR’s policy priority to concentrate clearing and depository services in one institution (Viktorov & Abramov, 2016). Second, as an EMD economy, Russia has lacked a ‘safe’ principal collateral that would fully underpin sophisticated repo markets. After the GKO default in 1998, the idea of such an anchor represented by state bonds was discredited for a long time to come. The subsequent expansion of the midterm government bond OFZ (Obligatsii Federal’nogo Zaima, or Federal Loan Bonds) markets lagged behind the increased demand for high- quality collateral. Financial market participants had to rely on alternative collateral types in repo operations. This applied to CBR operations (Bagrei, 2014, p. 50) and the interdealer POST-COMMUNIST ECONOMIES 11

Figure 4. Collateral base used for the interdealer repo market as a percentage of the total outstanding amount of open positions, 2013–2017. Source: based on data from the National Finance Association (NFA) (2015a, 2015b, 2017). repo market in the 2010s (Figures 3 and 4). This factor contributed to the market participants’ reliance on poor-quality securities for high-risk leveraged trading before the 2008 crisis. The lack of ‘safe’ collateral, including both government and corporate bonds, has also restricted the CBR’s ability to pursue a refinancing policy. This was especially important when the CBR injected large liquidity into the banking sector between 2011 and 2015. In part, the CBR had to refinancebanks by accepting illiquid non- marketable collateral. Much of the emergency state liquidity, worth several trillion rou­ bles, was provided to banks based on the relational exchange of assets and cash between the CBR and large state-controlled banks, which negatively affected financial stability during the 2014–15 crisis. A considerable share of the provided state liquidity was channelled into the currency market, thus contributing to the increased volatility of the Russian national currency (Gavrilenkov, 2016; Viktorov & Abramov, 2020). The third distinctive feature concerns a separation between exchange-based and OTC repo markets, which perform different functions in Russia’s financial system. From the early 2010s, exchange-based repo markets have been the main channel of liquidity redistribution supplied by the government, the CBR and other market participants. They have been a key element of short-term money market operations and liquidity manage­ ment, considerably surpassing the interbank lending market in terms of size and the number and type of participants. On the other hand, the OTC repo market has been an 12 I. VIKTOROV AND A. ABRAMOV

Figure 5. Maturities of repo transactions in domestic exchange-based versus OTC repo markets in Russia as a percentage of total trading volume. Source: NFA (2019, pp. 7–8).

opaque relational market involving a limited number of participants, mainly the largest state-owned banks and corporations. Large pools of liquidity are exchanged between entrusted counterparties, which means that OTC repo transactions perform, inter alia, a function of long-term credit provision from the largest banks to their clients, the major NFCs. The latter use their securities portfolios to access liquidity through repos instead of applying for credits from banks.8 Maturities in the OTC repo market are generally much longer in comparison with exchange-based repo trading (Figure 5). The latter is still dominated by overnight transactions, which accounted for 62% of the total trading volume in 2019 (NFA, 2019, pp. 7–8). While the size of the OTC repo market in terms of trading volumes through repos is relatively limited, its share of the outstanding amount of open positions is commensurable to exchange-based repo markets (Figure 6). Therefore, the rise of the OTC repo market in Russia can be interpreted, in part, as a substitute for relational banking between the key market players, the largest banks and NFCs. This outcome is well aligned with the growth of state capitalism in Russia with its focus on the concentration of financial flows. However, the OTC repo market cannot be equally accessible for private small and medium-sized companies as a source of liquidity, and even less so as a source of long-term capital due to higher counterparty risk and the exclusionary character of this segment of repo markets.

4. Main collateral types: evolution under the state expansion in finance The rise of repo markets in Russia, as depicted in Figure 2 in Section 2, has altered the role played by securities in Russian financial markets. It has been noted that the issuance of securities in Russia does not contribute in any significant way to NFCs’ investments in POST-COMMUNIST ECONOMIES 13

Figure 6. Exchange-based versus OTC repo markets in Russia, total outstanding amount of open positions (in RUB tn). Source: based on data from the NFA (2019, p. 5). fixed capital. At the same time, securities do not perform their function in terms of tradability of risk in the same way they used to before the 2008 crisis. Figure 2 demon­ strates that equity and a variety of bonds represented the main types of collateral for repo transactions, even after the introduction of GCCs in 2016. After the 2008–09 crisis, trading in equity and, in particular, in corporate bonds could hardly be described as competitive markets consisting of independent market participants. In the state-controlled monopoly MOEX, an order-driven auction trading mode and a more specificnegotiated trades mode have been, by and large, replaced by repo transactions. In recent years, the latter constituted about 80% of all MOEX transactions in the stock market section (Figure 7) and almost totally dominated trading in corporate bonds (Figure 8). With competitive arm’s-length trading in Russian securities no longer the main factor for price formation, it raises the question about mechanisms that define the price formation of Russian secu­ rities. In terms of financial stability, this is a fundamental question since both equity and bonds underpin the circulation of liquidity as collateral in repo transactions, which is directly related to the CBR’s monetary policy conduct. Data from Figure 2 (Section 3) attests to the decreased use of equity as collateral in repo markets. In 2008, equity was used in 65.8% of all repo transactions. In 2018, this share dropped to 14.8%, in part due to the CBR’s policy priority to decrease systemic risks in repo markets since stocks as collateral demonstrate higher price volatility compared to debt securities (Mironov, 2011). The main reason, however, is a general stagnation of the Russian equity market after 2011. Only stocks of a limited number of issuers, predomi­ nantly the largest state-owned NFCs in the extractive sectors, such as Gazprom and 14 I. VIKTOROV AND A. ABRAMOV

Figure 7. Trading modes of the MOEX’s Main Equity Market sector as a percentage of total trading volume. Sources: based on the MOEX data, as published in April 2020.

Rosneft, or banks, such as Sberbank and VTB, have highly capitalised and liquid trading. The share of companies with state participation (CSPs) among issuers in Russia’s domestic market capitalisation has been traditionally very high (Figure 9).9 After 2013, the number of IPOs and SPOs (Secondary Public Offerings) in the MOEX has been minimal. From 2013, there has been a long-term tendency to delist public companies whose shares had been previously traded on the MOEX.2001). This stagnation is due to several factors. After 2008, and, in particular, from 2014, Russian markets have been undergoing a process of decoupling from global financial flows, which limits inflows of foreign liquidity that previously supported the price of Russian stocks (Viktorov & Abramov, 2020). The institutional deficiencies of the post- Communist macroeconomic regime in Russia (Kluge, 2017; Ledeneva, 2013), including illegal corporate raiding (Gans-Morse, 2017), also constrain the rise of privately owned Russian NFCs, which impedes a further development of the equity market. Companies that would potentially be able to issue equity prefer to forgo IPOs due to their owners’ fear of losing control over their businesses after going public.10 Put in other words, this outcome reflects the failure of the promise to create a capital market–based financial system envisioned by foreign economists and USAID consultants who, at the beginning of the 1990s, promoted the ideology of transition in Russia (Wedel, 2001) In contrast, Figure 2 demonstrates that the use of fixed-income instruments as collat­ eral in repo trading has been continuously accelerating after 2000. The MOEX does not POST-COMMUNIST ECONOMIES 15

Figure 8. Trading modes of the MOEX’s Corporate Bonds sector as a percentage of total trading volume. Sources: based on the MOEX data, as published in April 2020. disclose disaggregated data on types of bonds used as collateral for trading in Russian repo markets. Therefore, it is necessary to look closely at the evolution of primary and secondary markets for fixed-income instruments. Figure 10 shows the expansion of the main domestic rouble-denominated segments of the Russian debt markets. Domestic corporate bonds demonstrated a steady growth that outpaced the expansion of the government OFZ market. To understand why the Russian corporate bond market con­ tinued to grow after 2008 notwithstanding the state takeover of private financial institu­ tions and the progress of the OFZ market, we need to return to the issue of how demand for domestic debt securities is interconnected with liquidity flows in domestic money markets. Figure 11 illustrates these long-term developments. Depending on factors that conditioned the origins of liquidity, we define five periods, starting from January 2001. The periodisation of the main stages of liquidity flows is the same as it was for the discussion on the rise of repo markets in Section 3 (Figure 2). The first period, from January 2001 to July 2004, was characterised by moderate liquidity when demand for domestic corporate bonds was limited. The second period started in August 2004, when large inflows of cheap foreign liquidity through the carry- trade mechanism supported demand for corporate bonds used as collateral for leveraged trading. The period between September 2008 and August 2011 included the 2008–09 crisis and a subsequent post-crisis recovery. The Russian monetary authorities substituted foreign capital inflows with the targeted provision of direct funds supporting the banking 16 I. VIKTOROV AND A. ABRAMOV

Figure 9. Share of companies with state participation (%) in total domestic equity market capitalisa­ tion, 2005–2019. Sources: based on the MOEX data, as published in April 2020.

sector’s refinancing. The use of this state liquidity for lending to companies and con­ sumers was limited due to the CBR’s high key policy rates, but this increased a cumulative demand for domestic debt securities. Between September 2011 and January 2016, bank liquidity was supported by massive CBR liquidity provision. These inflows of state money created additional demand for corporate debt securities, thus stimulating new issues and increased trading in the secondary market. From 2016, massive inflows of state-originated liquidity provided to banks by the MOF directly through deposits, or indirectly through liquidity deposited by state-controlled NFCs, gave a new impetus to a demand for domestic securities. Alongside the CBR deposit auctions, domestic bonds became sterilisation instruments of the state- originated liquidity, as shown in Figure 11 with the dramatically increased trading volumes in the secondary corporate bond market.11 A substantial increase in the issuance of OBRs (Obligatsii Banka Rossii, or CBR bonds) from 2017, as shown in Figure 10, is also conditioned by excessive liquidity in the Russian banking system. Used as sterilisation instruments by the CBR and exclusively circulated among Russian banks, OBRs emerge as one of the key collaterals used in repo transactions. The transformation of the domestic corporate bond market into an integral part of liquidity flows created by, and exchanged between, the Russian monetary authorities and state-controlled market participants led to a regrouping of the main players in this market. Most notably, the independent private market participants’ share of new issuances and secondary market trading decreased substantially after the 2008 global crisis. Figure 12 illustrates this tendency regarding the primary market. In January 2003, at the beginning of the corporate bond market’s expansion, the share of CSPs was only 22.2%. By POST-COMMUNIST ECONOMIES 17

Figure 10. Outstanding value of domestic rouble-denominated segments of the Russian debt markets, 1998–2019 (in RUB bn). Sources: based on data from the Russian MOF, accessed at www.minfin.ru, and Cbonds Group, accessed at www.cbonds.ru.

December 2019, this share had reached its historic maximum of 71.8%. Thus, the rouble- denominated corporate bond market works as a mechanism for the redistribution of financial flows in favour of the largest CSPs. The 2014 currency crisis, geopolitical tensions, Western financial sanctions and the subsequent shock increase in the CBR policy rate strengthened the tendency to segregate different segments of corporate debt securities. The market has been less transparent, and many of the issued bonds have been transformed into a closed system of relational lending between a limited number of large systemic players. Figure 13 demonstrates how the share of non-market issuances, i.e. bonds with no stock exchange listings, increased after 2013. Between December 2013, when the Ukrainian crisis started to escalate, and March 2020, the market segment of bond issuance grew by only 54.5%, compared with an increase of 1,198.1% for non-market issuance. During the 2014–15 crisis, the growth of non-market issues coincided with a sharp increase in the price of borrowing through the issuance of corporate bonds, which is reflected by an upward move of the yield-to- maturity (YTM) curve depicted in Figure 13.12 The increase in non-market issues, com­ pared with the lack of such a reaction during the 2008 crisis, testifies to the development of new compensatory mechanisms within Russia’s state capitalism. Its institutions are able to substitute and, wherever possible, to complement financialproducts and practices that find it difficultto expand by relying on market-based mechanisms. Quasi-market practices appear instead. The use of Russian forex-denominated corporate Eurobonds as an important col­ lateral type in domestic repo markets is a relatively recent phenomenon. Before 2014, Russian Eurobonds constituted an offshore OTC market. Most transactions were non- transparent and made outside Russia, serving as a suitable channel for leading Russian 18 I. VIKTOROV AND A. ABRAMOV

Figure 11. Primary and secondary corporate bond markets and bank liquidity in Russia, January 2001– January 2019. Sources: based on data from the CBR, accessed at www.cbr.ru, and the MOEX, accessed at www.moex.ru. Bank liquidity is defined as correspondent account balances and deposits of credit institutions with the CBR. banks and NFCs to access global liquidity. The introduction in 2014 of Western sectoral sanctions against a number of state-owned banks and corporations led to a massive sell-off of Russian corporate Eurobonds by foreign investors while the number of new issues dropped dramatically. In the absence of reliable statistics, the market consensus is that most Russian Eurobonds have been purchased by cash-rich Russian banks and corporations when their value had recorded the steepest drop.13 Moreover, in 2014, the MOEX provided an emergency solution, thus making it possible for listing and on- exchange secondary market trading in Russian corporate Eurobonds. In 2015, about 30% of repo trading on the MOEX switched to Eurobonds, making these securities one of the key collaterals in Russian markets (Marich, 2015). Therefore, in 2014–15, Russian corporate Eurobonds underwent an unprecedented transformation, from being an offshore OTC market to a domestic exchange-based market. It is highly plausible that the current tendency to replace forex-denominated corporate Eurobonds with rouble-denominated corporate bonds, which can be seen in Figure 14, will continue. This means the decoupling of Russian corporate debt markets from global financial flows. Finally, strong reasons have prevented the main government bond market OFZ from being a key collateral for Russian repo markets. After the default on the short-term government bond GKO market in August 1998, the OFZ market’s expansion remained for a long time very slow. Due to high inflows of hydrocarbon income, the MOF had limited incentives to issue debt using OFZs as an instrument to sterilise liquidity. POST-COMMUNIST ECONOMIES 19

Figure 12. Share of companies with state participation (%) in the outstanding value of domestic rouble-denominated corporate bonds, 2005–2020. Sources: based on data from Cbonds Group, accessed at www.cbonds.ru.

Therefore, contrary to international practice, OFZ bonds did not provide an anchor for the main domestic yield curve (World Bank, 2006, pp. 51–60). In the 2000s, there was conse­ quently no principal collateral while collateral-based finance was increasing. The limited tradability of Russian government bonds meant that OFZs could not be used widely as ‘safe haven’ collateral in the local market in times of financialdistress, as happened during the 2008 crisis. Recent developments in the OFZ market diverged from those in the Eurobond market. Notwithstanding Russia’s strained relations with the West after 2014, this segment has been increasingly integrated into global financial flows. After the 2008 crisis, the MOF increased borrowing through new OFZ issuances for budget-balancing purposes. In paral­ lel, the Russian regulatory authorities prioritised attracting foreign money into the OFZ market. Between 2010 and 2013, they reformed the infrastructure for the acquisition and deposition of domestic securities by foreign investors, thus making the cross-border move­ ments of international capital easier. In fact, a continuous dialogue between the MOF and international investors, mainly global money market funds and hedge funds, conditioned the institutional and infrastructural evolution of the liberalised OFZ market after 2011 (Lu & Yakovlev, 2017, pp. 4–5, 14). Inflows of foreign liquidity and the subsequent growth of the non-residents’ share of the total volume of the primary OFZ market were the outcomes of this liberalisation (Figure 15). The actual impact of foreign investors on the OFZ market has been stronger because they dominate trading in the secondary OFZ market. The presence of foreign capital in the OFZ market has decoupled it from other segments of the Russian fixed-income market. Despite the increased issuance and use 20 I. VIKTOROV AND A. ABRAMOV

Figure 13. Outstanding value of rouble-denominated corporate bonds and the YTM curve of the IFX- Cbonds corporate bond portfolio, December 2003–March 2020. Sources: based on data from Cbonds Group, accessed at www.cbonds.ru. of OFZs in repo operations, government bonds have not performed the role of a benchmark for the price valuation of other fixed market instruments (Lu & Yakovlev, 2017, p. 26). In other words, OFZs cannot be viewed as principal collateral in Russia.

5. Distribution of state liquidity after 2016: monetary overhang January 2016 ushered in a new period of state-led liquidity management. During 2015, the CBR gradually abandoned its policy of liquidity provision to the banking sector through direct repos and credits against non-market collateral. Figure 16 demonstrates a gradual decrease in the CBR-led bank refinancing (‘CBR net operations to provide and absorb liquidity’) from its peak level in January 2015. Instead, the MOF became the main provider of liquidity that has been accumulated in the bank accounts of budget-financed companies. The Russian financial system had never experienced such a large-scale supply of state liquidity as between 2016 and 2020. In Figure 16, this is reflected by the indicator ‘Change in general government accounts with the CBR’. The sell-out of assets previously accumulated in the Reserve Fund has been the principal source of the MOF’s budgetary spending.14 This factor has defined the accumulation of excessive liquidity in the banking sector (indicator ‘Correspondent account balances of credit institutions with the CBR’), which required its absorption. POST-COMMUNIST ECONOMIES 21

Figure 14. Outstanding value of rouble-denominated bonds and Russian corporate Eurobonds (in USD bn). Sources: based on data from the CBR, accessed at www.cbr.ru, and the MOEX, accessed at www. moex.ru.

The Federal Treasury, the MOF’s subsidiary tasked with managing and supervising the execution of the federal and general government budgets, has been an important player in Russian financial markets. This has been possible due to the accumulation of temporarily unused budget funds that the Federal Treasury deposits in banks, provides as public budget loans and lends to the market through repo. At their peak level in 2019, these funds totalled more than three billion roubles (Figure 17). Although a broad array of market participants are able to access this short-term state liquidity through the repo mechanism in the MOEX, the three largest state-owned banks, the ‘Big Three’ of Sberbank, VTB and Gazprombank, receive the largest stake. In 2019, the share of all the money the MOF deposited in ‘the Big Three’ came to 72%. This money does little to promote economic growth and investments in the real sector because the Federal Treasury lends to banks and the market on a short- term basis. A special condition, namely maintaining a balance between the raising and depositing of budget money, applies every day, thus making it difficult for banks to trans­ form this liquidity into long-term credits. Instead, they use it for short-term lending to other banks. This means that the liquidity accumulated by the MOF is withdrawn from the economy and used primarily as a source of profiting for the Federal Treasury. Therefore, in recent years, with its complicated framework of interbudgetary transfers, account types and complex control mechanisms, by which the allocation and circulation of trillions of roubles’ worth of budget money are executed, the MOF and the Federal Treasury have been able to create a parallel financial system beyond the traditional banking one supervised by the CBR. As a result, the MOF’s impact on monetary policy conduct may be comparable with the role played by the CBR (Obukhova, 2020). Between 2016 and 2020, excess liquidity grew in both the banking and corporate sectors. This outcome can mainly be explained by an increase in liquidity accumulated 22 I. VIKTOROV AND A. ABRAMOV

Figure 15. Non-residents’ share of the OFZ market, February 2012–March 2020. Sources: based on data from the CBR, accessed at www.cbr.ru, and the MOEX, accessed at www.moex.ru.

primarily by the largest state-controlled companies. There are no available statistics to provide a full assessment of how excess liquidity in the corporate sector is distributed between state- and privately owned companies. However, it is possible to assess this ratio based on a data sample of the largest 222 publicly listed companies, including both CSPs and privately owned entities. Between 2011 and 2019, available funds in the bank accounts of privately owned companies and CSPs increased at the same pace by 2.75 and 2.8 times respectively. However, during the entire observed period, the total amount of funds accumulated by CSPs dwarfed the resources of private companies (Figure 18). We suggest defining this excess liquidity as a monetary overhang. Historically, the concept has been applied to a variety of monetary phenomena that had in common the accumulation of large pools of liquid assets retained by the banking system or the money holdings of the non-bank public instead of using these assets for credits or spending. Methodologically, it is usually difficult to provide an exact quantitative estimation of such excess liquidity. Monetary overhangs have been observed in developing economies, notably in Africa, that failed to channel accumulated liquidity into lending to NFCs. In CCEs, such overhangs appeared during recessions that followed periods of financial turmoil or wars, thus leading to banks’ distrust of potential borrowers and their cred­ itworthiness (Caprio & Honohan, 1991; Dornbusch & Wolf, 2001). In the Russian context, this concept was first introduced as a part of the Sovietology and transitology theoretical debates of the 1980s and early 1990s. In particular, the disequilibrium school stressed the existence of a monetary overhang as a result of the constrained spending of Soviet consumers due to a mismatch between the money supply and the supply of available POST-COMMUNIST ECONOMIES 23

Figure 16. Monetary overhang in the banking sector and liquidity management by the CBR and MOF, January 2011–January 2020. Sources: based on data from the CBR, accessed at www.cbr.ru. goods in the shortage economy (Kim, 1999). This debate was quickly over as hyperinfla­ tion caused by price liberalisation depreciated the deposits of the Russian public in 1992 (Gabor, 2015). In the 2010s, an accumulation of a monetary overhang in the banking sector and in the accounts of state-controlled companies signalled that the current system of liquidity management in Russia was deficient. Financial institutions are not fully capable of channelling this liquidity into lending to enterprises and the general public. Instead, it circulates among (mainly state-owned) financial market participants that rely on diverse short-term instruments to extract quick profits from this exchange. Repo has been an ideal instrument that satisfies this purpose.

6. Securitisation of Russian repo markets under state control: trading in general collateral certificates Most recently, the evolution of collateral-based finance in Russia resulted in the formation of the general collateral repo market. The transition from liquidity shortage in the banking sector to its surplus was preceded by a systemic transformation of the money market infrastructure. To begin with, in 2013, the MOEX introduced a new repo trading mode with a CCP represented by the MOEX-controlled National Clearing Centre (NCC). The new CCP infrastructure was jointly developed by the MOEX and the CBR. The latter monitored the systemic risks in the interdealer repo market, where the 2008 crisis in Russia started, 24 I. VIKTOROV AND A. ABRAMOV

Figure 17. Budget funds in deposits, interbudgetary loans and repos, January 2015–July 2020 (in RUB bn). Sources: based on data from the MOF, accessed at https://minfin.gov.ru/ru/statistics/fedbud/.

and intended to minimise those by creating a new CCP system. By 2012, this market segment remained the main mechanism for redistributing liquidity in the financial system and was of greater systemic importance than the interbank money market. The CBR’s policy of managing fragilities in repo markets was carried out on the initiative and advice of the International Monetary Fund (Mironov, 2011; CBR, 2014, pp. 31–34).15 The MOEX official in charge of money market management admitted that the practices of the European repo markets and collateral management constituted a direct source of inspira­ tion for institutional solutions in Russia (Marich, 2009). Indeed, after the 2008 global crisis, IFIs and state regulators in CCEs started to view CCP as a key element of financial stability in collateralised OTC markets so as to cope with a counterparty risk and chain reactions similar to those that resulted from the Lehman Brothers’ default (Bank of International Settlements, International Organization of Securities Commissions [BIS-IOSCO], 2012). The market participants’ defaults and the non-payment crisis in Russia in autumn 2008 had similar origins as in CCEs. Therefore, it seemed rational to follow the global trend towards a concentration of risks inherent in collateralised finance within CCPs, with a subsequent revision of risk management practices in these institutions. After the introduction of the Russian CCP in 2013, repo with the CCP faced a rapid growth in trading volumes. In 2019, its share achieved 81.9% of the total MOEX repo trading, including trading in GCCs (Figure 19). This increase was well aligned with the publicly declared purpose of the reform. It was assumed that the state monetary POST-COMMUNIST ECONOMIES 25

Figure 18. Monetary overhang in the largest 222 publicly listed companies, including CSPs and private companies (in RUB bn). Sources: based on data from the CBR, accessed at www.cbr.ru, and the financial records of publicly traded companies. The data was computed by Maria Chernova. Due to the year-to-year change of ownership structure, the same companies could appear as privately owned or CSPs in different years. *Only preliminary estimations are available for 2019.

authorities could not allow the CCP, which became the only counterparty for participants in the CCP-cleared repo markets, to fail. Of special importance for the MOEX was that trading with the CCP would substantially decrease the transaction costs in repo markets, thus making it easier for market participants to access liquidity through pledged collat­ eral. The MOEX believed that increased stability and the provision of better service would attract additional liquidity to MOEX-based repo markets (Marich, 2014). According to MOEX officials, the increased tradability of collateral would also extend otherwise very short overnight repo maturities. For that purpose, in 2013, the MOEX complemented the establishment of the CCP with the parallel introduction of a collateral management system (sistema upravleniya obespecheniem). The main rationale behind this solution is a principle of collateral substitution, when a market participant may create a repo basket consisting of differentsecurities. Collateral can be replaced by other security in the repo basket each time a market participant needs to withdraw a pledged security from the basket or to use it for other repo transactions. The commensurability of collateral depends on the MTM revaluation conducted by the CCP. This innovation is also based on European collateral management practices.16 In reality, the systemic risks did not disappear with the introduction of CCP repo trading. The reliance on the daily MTM practices of collateral revaluation means that the ultimate dependence continues to rest on fundamental market insecurity, which is 26 I. VIKTOROV AND A. ABRAMOV

Figure 19. Trading modes of repo transactions with securities (%) on the MOEX, by transaction counterparty. Sources: based on the MOEX data, accessed at www.moex.ru, as published in April 2020. *Reflects the liquidity supplied by the monetary authorities to the MOEX repo trading. characteristic of MBB. Instead, the risks are concentrated within the CCP, thus putting high demands on a central clearing organisation to evaluate and manage market risks con­ cerning the quality of collateral, the size of haircuts, the price movements on particular securities and the availability of sufficient funds that guarantee transactions. To summar­ ise, repo market stability and the entire market infrastructure depend on one key actor, with an unpredictable outcome in times of market stress (Blundell-Wignall et al., 2014; Cox & Steigerwald, 2017). Although there is no guarantee that such a systemic risk will not be realised in the future, the Russian financial market infrastructure demonstrated a stronger resilience during the 2014–15 crisis. Unlike in 2008 and due to the presence of the CCP and a centralised clearing, there was no systemic collapse of the securities market in 2014–15, when the value of underlying collateral sharply decreased and the rouble exchange rate was highly volatile. Nor did this happen in March 2020, when the market stress due to the COVID-19 crisis was at its most intense. Repo trading with GCCs introduced by the MOEX in 2016 was the culmination of institutional reforms to create collateral-based finance in Russia. This innovation was also developed in close cooperation between the MOEX and the CBR.17 The former had a rather instrumental business-oriented approach. Its logic was to develop a new product much sought after by market participants, thus enabling the MOEX to expand its profit- maximising activities.18 Those participants who pursue profits in money markets are not restricted only to privately owned companies or non-residents. First and foremost, they POST-COMMUNIST ECONOMIES 27 are represented by actors with generous access to state liquidity, such as state-controlled banks, the primary participants of repo trading with the CCP; large state-owned NFCs; and the monetary authorities, represented by the Federal Treasury and the CBR. The creation of GCCs resulted in the securitisation of collateral in Russia, which makes trading in repo markets highly liquid and enables the full, mutual substitution of accepted collateral. The value of pledged securities is transformed into standardised GCCs, which appear as a universal means of payment in repo markets, a kind of quasi-money. CCP trading’s and the collateral management system’s earlier mechanisms, such as the repo basket, are used in creating the GCC system. GCCs are a new type of security issued by the NCC, a central clearing organisation, in exchange for assets deposited by market participants into a collateral pool. Market participants retain full legal ownership rights to deposited securities, such as shareholder voting and dividend income, which, in part, explains the popularity of GCCs as a financial instrument. At the same time, the GCCs received enable market participants to easily access liquidity in the money markets or to use them for other securities operations, such as trading in the interdealer repo market. Being able to substitute assets deposited in the pool has been one of the main benefits of the GCC system since it facilitates higher tradability of collateral. Daily MTM revaluations of the collateral pool as well as haircut practices as a part of collateral acceptance into the pool have also been an integral component of the GCC system. A (very simplified) principle behind the workings of GCC trading with repos is shown in Figure 20. The participation of NFCs in securitised collateral markets was another ambition behind the GCC project. NFCs, mainly exporters of raw materials, such as state- controlled oil companies, are not allowed to directly trade securities, which is reserved exclusively for professional market participants and banks. Instead, NFCs’ access to the GCC market has been provided indirectly through a mechanism of deposits with the CCP that is also used by the state monetary authorities. NFCs provide liquidity without getting GCCs in exchange and receive instead income at attractive repo rates. This is the main

Figure 20. Creation of GCCs and GCC trading. Source: Moscow Exchange (MOEX) (2016, p. 4). 28 I. VIKTOROV AND A. ABRAMOV rationale for the presence of NFCs in the repo markets with GCCs.19 However, the MOEX officials’ expectations of attracting large pools of liquidity provided by cash-rich NFCs into collateralised money markets have not been fulfilled to the extent they had anticipated. So far, the MOEX has been more successful in attracting short-term liquidity provided by commercial banks, the Federal Treasury and the CBR (CBR, 2020). The introduction of GCC trading, which still today remains a unique innovation in global finance, has revolutionised Russia’s collateral markets. A further expansion of repo trading volumes and an increased share of repos with the CCP between 2016 and 2019 are statistically visible in Figures 2 and 19. MOEX officials legitimised the introduction of GCCs, referring to ‘the best practices’ previously developed in collateralised markets in the Eurozone and making claims, such as ‘we did not invent this wonderful wheel, it has been invented before us and rolls successfully in Europe’ (Marich, 2016). The securitisation of repo markets is presented for the Russian public in a very favourable light, as a financial innovation that gives economic actors better access to capital. However, the MOEX and the Russian monetary authorities took a further step towards increasing the tradability of collateral compared to the general collateral markets in the Eurozone. In the case of Russian GCCs, securities are no longer used directly as collateral in repo markets. Instead, GCCs as a securitised product, backed by the current market value of underlying securities of different investment quality, are used as a universal store of value and a means of payment in repo market trading. To summarise, the MOEX and the Russian monetary authorities attempted to create GCCs as a safe and liquid asset commensurable with the quality of the OFZs (Poltev, 2016). The main question that arises in this context is whether GCCs represent, in reality, a safe asset that would survive the next crisis. As happened in 1998, 2008 and 2014–15, a new crisis would inevitably entail a sharp decline in the value of certain underlying securities kept as collateral in asset pools used for creating GCCs. A new wave of corporate defaults cannot be excluded. The sustainability of the GCC system will depend on the credibility of risk management practices applied by the NCC, in particular which securities it will accept as collateral to create asset pools for GCC issuances. So far, the NCC, the Russian CCP, has pursued a conservative risk management policy, including a differentiated approach to collateral acceptance and defining the size of the haircuts, which are generally less pro-cyclical than existing market sentiments that define the value of collateral at a particular moment.20 A critical reading of the European sovereign debt market’s formation demonstrates, however, that the ‘wonderful wheel’ of collateralised finance did not roll as successfully as central bank officials and market infrastructure representatives had promised. The 2012–14 Eurozone crisis provides an illustration that pooling assets of differentinvestment quality into the same basket in an attempt to create identical collateral for trading in repo markets might undermine financial stability (Gabor & Vestergaard, 2018). Domestic corporate bonds illustrate the fragility of collateral accepted to asset pools that underlie the issuance of GCCs. In the case of repo with the CCP and GCCs, these securities still constitute one of the key collateral types. Starting in 2015, the number and outstanding amounts of defaults on domestic corporate bonds increased substantially, even though it was below the critical level observed during the 2008–09 crisis (Figure 21). The recent wave of corporate defaults could have been even higher had it not been for the CBR’s bailout programmes for insolvent banks, which prevented a new systemic crisis POST-COMMUNIST ECONOMIES 29

Figure 21. Debt service defaults (including technical defaults) of Russian corporate bond issuers, 2008–2019. Sources: National Association of Securities Market Participants (NAUFOR) (2018, p. 25) and data from Cbonds Group, accessed at www.cbonds.ru. in the Russian corporate debt market from unfolding. For example, the fall of Otkritie Bank in 2017 resulted from opaque cross-collateral practices between Otkritie Bank and its connected insiders. The latter used low-quality bonds issued by affiliated companies as collateral against borrowed cash received from Otkritie Bank (Krivorotova et al., 2018). Russia has a history of scheming, concealing information and outright fraud practised by financial market participants, corporate issuers and state regulators (Mamonov, 2018; Tulin, 2009; Viktorov, 2015). Thus, it does not exclude the possibility that much collateral, regarded by state regulators as ‘safe’ today, will lose its market value in times of crisis. This factor does not completely rule out the emergence of systemic risks that can potentially undermine newly created CCP and GCC-based repo markets, which are increasingly being transformed into core elements of Russia’s money market.

7. Conclusions The paper intends to increase our understanding of state-led financial capitalism in Russia, with its unusual alliance between speculative finance and state control over capital allocation. We have found a self-supporting system of capital markets where an array of domestic securities circulate through a repo mechanism underpinning liquidity flows between government agencies, the CBR, state-controlled banks and corporations and the remaining private economic agents. Repo markets make this exchange quick 30 I. VIKTOROV AND A. ABRAMOV and ‘effective’ by increasing tradability and creating additional opportunities for profit­ ing. The state-controlled MOEX is positioned at the centre of this complicated system of liquidity flows as the only organiser of exchange-based repo trading. With its infrastructural organisations, the NCC and the National Settlement Depository, the MOEX is the main guarantor of the sustainability of the entire system. Russia represents today a specific example of MBB. An expansion of trading with GCCs epitomises a merger of practices borrowed from global speculative finance, on the one hand, with post-Soviet Russia’s domestic evolution towards state capitalism, on the other hand. The accumulation of excessive liquidity within the financial sector, as discussed in Section 5, which we prefer to define as a monetary overhang, testifies to a systemic failure of the Russian economy. Since 2012, it has been stagnating (Akindinova et al., 2020; World Bank, 2018), the reasons for which remain unexplained. A poor investment climate and imperfect institutions cannot be viewed as the main causes of the current stagnation. Russia has since 1998 been experiencing periods of high and moderate growth, reces­ sions, crises and recovery. All these fluctuations took place in the same, admittedly poor, investment climate. Economic agents have always been aware of the institutional cronies of Russia’s state capitalism and have learned to navigate this environment (Kennedy, 2017; Vasileva, 2018). The reasons behind the stagnation should be looked for elsewhere, including the conduct of macroeconomic and monetary policy. This study demonstrates that the monetary transmission mechanism of capital into investments is broken; banks prefer to channel state-originated liquidity into financial transactions in collateralised markets instead of transforming it into credits. Securities are used as collateral, which is a primary rationale behind the demand that supports new issues of debt instruments and increases volumes in secondary market trading. Short-sightedness remains at the very heart of Russian finance, as a result of which it limits the role played by financial intermediaries to the redistribution of liquidity in the money markets. It is reasonable to ask whether a future transformation of the Russian version of MBB into a different system is feasible. Financial capitalism does not exist in a vacuum. A particular composition of capital and liquidity flows reflects the preferences of elite groups that control bureaucratic institutions, state-owned banks and the largest NFCs. Examples of existing nexuses between financeand elites with diverse political preferences are numerous, both in the CEE region (Drahokoupil, 2008; Schoenman, 2012; Szanyi, 2019) and beyond (Cobbett, 2018; Dörry, 2016; Fichtner, 2014; Shih, 2008). Russian state-led financial capitalism with its speculative capital markets is a hybrid, a compromise between, on the one hand, elite networks that advocate a deeper integration of Russia into global financial architecture and, on the other hand, various elite groups that promote institutional solutions associated with state capitalism. If the constellation of interests shared by these elite groups changes, so might the preconditions for a future transformation of Russia’s financial capitalism.

Notes

1. The Russian word siloviki is translated as ‘people of power’, that is to say, people with a security service or military background inside the Russian state apparatus and business entities. POST-COMMUNIST ECONOMIES 31

2. Collateral-based finance is not only confined by repo markets. With its deep historical, legal and philosophical context, collateral embraces a broad set of instruments and practices that are not exclusively restricted to contemporary capitalism (Boy & Gabor, 2019). However, the expansion of repo markets has increased dramatically the marketability and tradability of collateral affecting financial stability. The repo markets’ centrality in contemporary financial capitalism makes them the primary focus of our analysis of collateralised finance in Russia. 3. An elaborated theoretical approach to state capitalism in Russia would require a comprehensive analysis of its economy rather than confining it to financial issues. For a broad review of the literature on the theorising of state capitalism, see Alami and Dixon (2020). 4. A haircut is the difference (margin) between the market price of the security pledged as collateral and its agreed value against the cash that the borrower, who initially owns the collateral, receives from the lender as a part of the repo transaction. If the haircut size is 2%, the borrower receives $98 against the pledged security with a market value of $100. The haircut works as a guarantee provided for the lender against any decline in the collateral’s market value. The size of the haircut depends on the quality, or ‘safeness’, of collateral, with government bonds considered the most secure collateral. Changing market sentiments towards a certain security can lead to an increase or decrease in the haircut size (see Adrian & Shin, 2010b, p. 608). 5. We do not use the definition of shadow banking for Russia. Unlike in CCEs, shadow banking would be primarily associated with the underground criminal economy and the prevalence of informal finance practices. Illegal encashment is a typical example of such widespread activities going back to the 1990s ‘transition’ and even earlier to the informal sector in the Soviet planned economy. 6. From 2016, the Federal State Statistics Service (Rosstat) stopped publishing data on the contribution of corporate bonds and equity to fixed capital investments, simply reflecting the insignificance of the Russian capital markets for economic growth. The latest available data from 2015 demonstrated that only 6.6% of total domestic corporate bond issuance was channelled into investments in fixed capital. 7. According to the NFA repo market surveys between 2014 and 2019, this share, which includes all repo transactions, excluding exchange-based repo trading and the offshore OTC repo market, varied between 3.5% at its lowest for the second quarter of 2014 and 8.7% at its highest for the third quarter of 2015 (NFA, 2015a, p. 6; 2015b, p. 6; 2017, p. 7). For the first three quarters of 2019, it was 6.7%. The share of the offshoreOTC repo market has declined in recent years and was 1.8% for the first three quarters of 2019 (NFA, 2019, p. 3). 8. Director of the Money Market Department at the Moscow Exchange, interviewed on 18 February 2020 in Moscow. 9. We define CSPs as companies with a total sum of direct and indirect state ownership that provides more than 10% of the voting stock. For a discussion on which Russian companies can be regarded as state-owned, see Abramov et al. (2016). 10. Investment banker, interviewed on 29 January 2013 in Moscow. 11. This trend was reversed between September 2017 and May 2018, when increased liquidity injections into the banking system were accompanied by decreased trading volumes in the secondary corporate bond market. This reversal was closely linked to the CBR’s bailout of three large commercial banks, including Otkritie Bank. 12. The YTM curve of the Interfax-Cbonds Russian corporate bond portfolio is the main domestic indicator for following how the market evaluates the risk connected to investment in rouble- denominated Russian corporate debt. 13. Fixed-income trader at a Russian investment bank, interviewed on 18 January 2018 in Moscow; fixed-income trader at a global investment bank, interviewed on 24 April 2018 in London. 14. The Reserve Fund was one of Russia’s two sovereign wealth funds accumulated during the oil boom years of the 2000s. Almost depleted by January 2018, it was merged with the Russian National Wealth Fund, the other sovereign wealth fund. 32 I. VIKTOROV AND A. ABRAMOV

15. Until 2011–13, the CBR did not even have access to comprehensive statistics on exchange- based repo trading. The CBR’s takeover of the former non-bank financial sector regulator, the Federal Financial Market Service, in 2013 improved considerably its capacity to monitor systemic risks in repo markets. The creation in 2013 of a repository as a part of the future CCP infrastructure enabled the CBR to collect statistics also on the OTC repo market. 16. Regarding the formation of the collateral management system in Russia, see the special issue of the journal Depozitarium (National Settlement Depository [NSD], 2017), ‘Collateral Management: Service of the Interdealer Repo Transactions’, issued by the National Settlement Depository (NSD, Russian acronym NRD). Like the NCC, the NSD is owned and controlled by the MOEX, putting these institutions under the ultimate control of the CBR and its officials. 17. Director of the Money Market Department at the Moscow Exchange, 18 February 2020. 18. This logic is not articulated explicitly, but its presence is implicit in almost all interviews, public speeches and texts by MOEX officials for public consumption. 19. Director of the Money Market Department at the Moscow Exchange, 18 February 2020. 20. Ibid.

Acknowledgments

The authors wish to thank Andrei Vernikov and two anonymous referees for their comments on previous versions of the paper. Special thanks go to Maria Chernova, who computed data for Figure 18. We are also grateful to Johannes Petry for the stimulating discussions on finance in state capitalist societies at the Critical Macro-Finance Workshop at Goldsmiths, University of London, which he co-organised in September 2019.

Disclosure statement

No potential conflict of interest was reported by the authors.

Funding

This work was supported by the Jan Wallander and Tom Hedelius Foundation, Tore Browalds Foundation, Sweden [P19-0241]; The Foundation for Baltic and East European Studies, Sweden; Åke Wiberg Foundation, Sweden [H15-0156]; Helge Ax:son Johnson Foundation, Sweden.

ORCID

Ilja Viktorov http://orcid.org/0000-0002-3557-1298 Alexander Abramov http://orcid.org/0000-0003-4285-9115

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