Investors and the ukrainian stock market

Even people not involved in the investment business are now saying that we need to deal ASAP with the problem of foreign and domestic investments that “escaped” Ukraine. So far “the process is at a standstill.” The world is feverishly watching the ups and downs of global stock market indices and trying to forecasting when, where and how much to invest as the crisis passes.

Everything is much simpler in Ukraine. Many people are already observing with interest the stock index curve of basically the only stock market that functions under market conditions – the PFTS. But when it contracted fivefold in 2008, this didn’t trigger an analysis of the cause and effect relationships: the global crisis – problems with financial resources – global economic recession – investors leaving Ukraine – Ukrainian stock market slump – economic recession in Ukraine. Everyone is used to our stock market being “free” - thereby not related to anything, in general, a totally “independent” market, that is in its early stages – they they’d didn’t even bother with analysis and conclusions.

The first responses to appear and catch the media’s attention were about “speculators having left” the Ukrainian stock market. This is indeed the case because in crisis situations portfolio investors are among the first to leave dangerous markets and look for more reliable environments to put their money.

However, it’s become the norm in Ukraine to associate the word “speculators” with the word “swindlers” that this information was treated very disparagingly. So they left – we don’t need speculators. Not understanding of the essence of stock markets, it’s easy to brush aside the fact that Ukraine lost this important component.

Naturally, those professionally tied to the stock market performed deeper analysis. But their voices weren’t heard. In Ukraine the stock market is viewed as something exotic that appeared and existed, even had its own state regulatory body, simply because that’s what a market economy is supposed to have. Our leaders don’t quite understand the connection between this market and the country’s economy. But what understanding of the role of stock markets can there be given the rapid changes in the “supreme commander of the economy” and constant changes in political priorities.

A stock market requires knowledge and an ability to analyze its impact on the economy…Right now this knowledge is imperative. All the claims concerning the need to improve the investment climate without an understanding of the role of the stock market, moreover in a post-crisis period that we should already be thinking about, remind me of the saying “fine words butter no parsnips.”

So what does Ukraine have today? There are no investors, the stock market has sunk deeply, and it’s not known what will attract investors to Ukraine and when. Let’s take for example the most convenient investments – so-called direct investments. An investor has available resources and is looking to invest them for a period of time to then recoup his investment plus profit. For companies this type of investment is in fact convenient - they’re not burdened with debt obligations and can use the resources received for development.

From the outside this all looks like investments unrelated to the stock market. For “direct” investors, the main task prior to making an investment decision is to calculate the return on investment, taking into account the sectoral, regional and political risks. But before making a decision to move towards Ukraine, this investor will first look at the stock market, even despite its rudimentary state.

Shares in companies, even leading ones, have fallen; corporate bonds have fallen sharply in terms of emission and sale; state securities aren’t being bought; IPOs in terms of numbers and volumes have dramatically declined, and planned IPOs have been cancelled. And somehow this is all on the background of mass departure by portfolio investors, who are called speculators, but who are the first to signal the state of affairs in our economy - worn out from the rapid change in programless governments.

But, let’s say that clear economic programs appeared and the global crisis loosened it powerful grip. Our “direct investor” not only successfully bought the company that dropped in price during the crisis, but is convinced that it hasn’t completely gone under, that it can be built up, and likely with additional corporate resources from that very stock market. As they say “the same old sixpence…”

Everyone will change while the country seeks a way out of the financial and economic crisis. In the banking system the strong will survive, companies will either grow some muscle or leave the market…but the stock market, based on the first year of the crisis, will likely remain as is.

What does an investor want to see from our stock market? What will draw his attention to Ukraine? What will help him become convinced that his property here won’t be lost in battles with competitors or due to excessive corporate interest by those very structures that register this property? What will allow him, if necessary, to invest money into the company he bought at a market rather than manipulated price? Will he be able to buy only a portion of the company, as ends up happening now? But disrespect for any non-controlling share in a joint stock company has long since scared off those investors who could provide a company with money, having, let’s say, a 20 percent share in its ownership.

The stock market’s problems can and should be viewed from various angles, while understanding and interpreting the systematic relations. Ukrainian stock market analysts are closely following the ongoing processes. Their statistics and analysis rather correctly link the circulation of securities with processes in the financial sector and real economy. Unfortunately, it seems that this subject is of interest for a rather small circle of experts.

This analysis is not seriously reflected in any of the anti-crisis programs. Interestingly enough, we have yet to see or hear any stock market experts on the numerous talk shows. There have been many discussions and accusations about the formula for calculating the gas price, about the economic grounds for various tariffs, and about the rate of the hryvnia…as they say – the people will eat it up. But talk shows aren’t to blame for these same people not understanding the impact the stock market has on their pockets.

Ukrainians, to great extent, learn about market economy from talk shows. When they suddenly lose or find money in their wallets, the media and talk shows are the first to respond. They all try to figure out where the money went or came from. They mention the stock market only when there are loud scandals over the loss of money through stocks. The broad reasons for the stock market’s problems aren’t exposed or named. But the names of the “swindlers” and their companies flash on tv screens and in newspaper columns.

There is nobody to discuss the reasons for the drop in these stocks because the usual talk show personalities and media aren’t knowledgeable in these issues…and I have yet to see any stock market experts on the screen. But let’s emphasize once again that these mass shows and publications aren’t at fault – they simply reflect the sad reality. Our leaders and their teams don’t understand the role of the stock market in hyping up the crisis and therefore don’t speak about this.

And what about investors? Those who are more knowledgeable will review the experts’ statistics and analysis. By the time those who aren’t learn the “scandalous facts” - the PFTS has fallen again. Careful, something’s amiss in Ukraine!

They waited it out - the real economy is getting back on its feet, the credit system has lowered its interest rates to reasonable levels, the exchange rate has become more or less forecastable and adequate. Our direct investor (let’s continue with this example because they’re impatiently waiting for his investments) believes that the company he likes based on price and opportunity for growth, will bring him the expected returns on his direct investment. We sympathize with the naпve. However, when it comes to Ukraine, there probably aren’t such naпve investors any longer. They got burned and are awaiting positive changes in the stock market.

Let’s say an investor plans to buy 85% of shares, take on a leading corporate management role proportional to the size of his shareholdings, within time attract additional resources through public (open) emission, thereby lowering his shareholdings to 75%; then, having strengthened the company, find a strategic investor and sell all his shares “into good hands” and leave a good impression about himself on the investment market. He didn’t ruin the company but strengthened it, and even during the sale selected a strategist that will ensure the company’s further growth, which will leave our investor with the normal reputation and not “buy low - sell high.” Ukraine’s dream is to find such investors!

But the harsh realities of the stock market await our investor. While we crawl our way out of the crisis (with complete lack of government attention to this market and to development its legal and normative base) our investor will think thrice before entering Ukraine. And even the ratification of the long-awaited law on joint-stock companies and persistent attempts by the regulator – the State Commission on Securities and the Stock Market – to bring the normative base in line with the realities of the global stock market experience, aren’t easing our investor’s worries.

But perhaps many already understand the truism that the joint-stock form of capital is convenient given its ability to attract investments. The stock market isn’t among the state’s development priorities. Nobody is convinced that by the time we emerge from the crisis the stock market will be able to secure the financial inflows that the economy needs. And we won’t be pressed to wait for investments in Ukraine even with all the measures to “improve the investment climate.”   

Let’s trace the obstacles that our direct investor will encounter in implementing his abovementioned plans. We’re not even considering ill-fated corruption, corporate raidership and bureaucratism. We’ll simply look at the state of the legislative and normative base and the registration of the ownership rights to the purchased 85% shareholdings. The current Law “On the National Depositary System and Peculiarities of Electronic Circulation of Securities in Ukraine,” adopted in 1998 (and much needed back then), should have been reviewed a long time ago taking into account the realities of the development of depositary systems around the world. Meanwhile, legislators will never get around to ratifying a new version, let alone a needed new law.

The prepared draft Law of Ukraine “On the Depository System of Circulation of Securities” raises more questions than answers due to the general practice of preparing and approving laws. Mechanisms for enacting laws aren’t adequately worked out. Usually this only involves the legislative coordination – and rather scant at that - between the new law and existing laws. Nobody is bothering with issues related to the systematic coordination of procedures in Ukraine, which opens the way for mistakes, corruption and corporate raidership. The regulator clearly does not have enough functions to ensure enforcement of laws.

Rather, the function is outlined in article 7, paragraph 23 of the Law “On State Regulation of the Securities Market” (define procedures for effective securities legislation enforcement). But the principles, goals and methods of state regulation of the securities market is a separate and extensive topic, especially when there are lively discussions going on about the degree and role of government influence on the market during a global crisis. In acquiring 85% of shares, our investor enters the minefield that is corporate management. It’s expected that he’ll be able to circumvent some mines starting on April 29, 2009, when the new Law of Ukraine “On Joint Stock Companies” goes into effect.

There are also more questions than answers regarding the procedure for executing this law. For certain companies, the old law on business entities will still apply for another two years. It won’t be easy for our investor to sort through these cobwebs. We should also remember that according to the new law, which protects the interests of minority shareholders, minority shareholders have the right to demand that our investor buy their shares. But at what price? Try to make sense of article 8 of the law and its concept of market value. Stock market experts are still holding lively discussions, while investors are thinking of ways to circumvent this norm.

Our investor is getting ready to sell his package of shares and so far has decided to lower it to 75%. He makes a public issue, which allows him to give the company a financial injection for its development. Having learned from his own bitter experience or that of his fellow investors, he won’t lower his shareholdings below 60%. Battles between investors for a place in corporate management in Ukraine have made news around the world. Having carefully read the norm in the new law on quorum for general shareholders’ meetings at 60%, he won’t get burnt a second time.

Therefore, he opts for emission. The 2006 Law of Ukraine “On Securities and the Stock Market” and a host of normative documents issued by the State Commission on Securities and the Stock Market have made the procedure for emissions more or less clear. Unfortunately, these procedures don’t outline the regulator’s concrete and strict responsibilities.

Article 15 of the 1996 Law “On State Regulation of the Securities Market” on the responsibilities of the Commission and its officials “as established by Ukrainian legislation” includes nothing about the responsibility for efficient handling of the issuer’s documents. If they find a mistake in the submitted documents, they make the issuer correct it. Later they find one more mistake and the process repeats itself. As a result, instead of the set normative timeframe, the process is dragged out for a month, while the company and Ukrainian economy wait for money…

It’s often the case that this can be explained by the ineptness of the issuer and his specialists. But Ukraine needs investments, so there should be a procedure that minimizes the time for receiving finances. And there needs to be control over executive discipline. Then there won’t be hallway conversations about bribes to get through normal procedures envisaged by the regulations.       

Now our investor is ready to exit the investment. If he didn’t think about this process from the very beginning, then he’s in for endless mess due to discrepancies between tax norms, currency norms, the foreign investor’s status in Ukraine.

The terms in our example were very simplified. We didn’t look at involving professional institutional investors (ICI) in the joint stock company. We didn’t look at problems of stock market operations when shares in our companies are in free circulation and the investor expects an objective assessment of the company’s capitalization, which will help give him a certain reputation and return on the sale of the investment.

And so we wait for the crisis to end, investment climate to improve and investments to increase. As for the stock market – “the same old sixpence.” Per instructions from the Cabinet of Ministers, a new draft “Concept on the Strategic Development of the Financial Sector in Ukraine through 2015” is being prepared. But without a program for getting the stock market through the crisis with concrete decisions and timeframes, without programs for other strategic sectors in Ukraine, we’ll never see these needed investments.

We need to start with a systematic analysis of the stock market’s legislative and normative base and clarifying all the cause and effect relationships. Who can and should do this? The State Commission on Securities and the Stock Market can’t hack it alone. And after all, this research doesn’t fall within its competence. Moreover, there are quite a few regulators in Ukraine who control the circulation of securities. An added plus is that each has its own infrastructure. Ukraine has wonderful experts who should be working on this together with the regulators.

The eternal question remains – where to get the money? After all, the cheap always end up paying double. If we want investments, we have to spend. We’re not talking about pumping tens or hundreds of millions like we’re doing to rescue strategic industries. We’re talking about financing the development of programs. But regulators shouldn’t be developing them alone. Let’s not forget one of the principles of the stock market – the division between making rules and applying rules. Business needs such a program and will find a way to involve its experts in its development.

We could, of course, continue our grand meetings about improving the investment climate in Ukraine, attracting investors, especially western ones. Out of nothing we’ll get nothing. Without decisive and real actions to develop the Ukrainian stock market, our investment climate won’t get through the challenges it faces. During this forced pause and economic recession, our legislators and government institutions are simply duty-bound to use all necessary measures and make a decision regarding the stock market.

NOTE: Article translated into English for the U.S.-Ukraine Business Council (USUBC), Washington, D.C., SigmaBleyzer is a member of the USUBC.