The rapid shut-off of Russia from western financial markets saw equities and bonds get marked down to zero or become virtually illiquid, derivatives evaporating and ETFs either terminating or entering a zombie state. Eight months on, we investigate whether investors will be able to recoup any assets from their Russia ETFs.

Within days of Ukraine being invaded, the Moscow Exchange had shut, MSCI branded Russia “uninvestable”, emerging market indices deleted their Russia exposure and primary markets for Russia ETFs vanished as issuers suspended creations and redemptions.

By the middle of March, European exchanges halted trading of Russia ETFs, killing off the secondary market and leaving the products untradeable everywhere but over-the-counter (OTC) in what Bloomberg Intelligence senior ETF analyst Eric Balchunas described as an “unprecedented” moment.

With around $6bn of total Russia-exposed assets frozen by May, according to Morningstar, issuers faced the unenviable decision of either shutting the lights out on their Russia ETFs and losing all their clients’ money or keeping fee-waived products on ice at a cost to themselves, with no clear end in sight.

The first asset manager to throw in the towel and lock in a value of zero was Invesco, which closed its swaps-based Invesco RDX UCITS ETF (RDXS) ETF on 21 June.

RDXS’s benchmark provider, Wiener Boerse, priced its Russia exposures to near zero as EU and US sanctions took effect, only to delete its DX index entirely on 17 May as Russian federal law 114-FX forced companies to cancel the global depository receipts (GDR) the index was based on.

This prompted Invesco’s counterparties to cancel the swaps on the index and the RDXS ETF was terminated, meaning the fund “lost all that was invested” as “the value of the ETF shares also went to zero”, an Invesco spokesperson told ETF Stream.

While swaps allow counterparties to avoid the slippages, costs and other frictions involved in trading physical exposures, RDXS’s synthetic methodology meant, unlike those holding GDRs, it had no claim on the underlying shares. Effectively capturing derivatives on another derivative priced at zero, swap deletions meant investors recouped none of their money.

Invesco said in a statement: “There are no GDRs to point to or whose value to debate. When that index went to zero, the value of the swap contract went to zero, and with it, the value of the fund. Once the index stopped existing, there was nothing to do but wind down the swap and with that, the fund, which has no ownership claim on any Russian security anywhere.”

For less technical reasons, investors in ETFs from Russia-focused ITI Funds are also unlikely to recover any assets as the issuer pleads with shareholders to close its Irish fund platform.

ITI Funds ceased creations and redemptions on its ITI Funds RTS Equity UCITS ETF (RUSE) and ITI Funds Russia-focused USD Eurobond UCITS ETF (RUSB) on 1 March, only to propose terminating the strategies on 22 August. On the same day, it suggested liquidating its UCITS ETF SICAV but the meeting was not attended by enough shareholders for the motion to pass.

No quota was required for the motion to pass in a later meeting on 16 September, yet it was once again unsuccessful here and at another meeting on 6 October. ITI renewed its appeal to close its platform on 20 October.

Russia ETFs biding their time

Other issuers are willing to be patient and set aside the Russian components of their ETFs in hopes they will be able to sell the assets at an unknown point in the future. BlackRock, for instance, shut its iShares MSCI Russia ADR/GDR UCITS ETF and iShares MSCI Eastern Europe Capped UCITS ETF (IEER) a day before Invesco’s RDXS but did not lock in a value of zero on its Russian securities.

After selling off IEER’s non-Russian components, the two ETFs were left with GDRs on Russian stocks which were set to be deleted. BlackRock initially said it would not exercise its right to convert GDRs purchased before 27 April into underlying shares as this would not be in keeping with the ETFs’ investment objectives, however, it has since decided to begin the process of converting the depository receipts and will keep shares of the ETFs on its fund register.

Investors will likely see some value from their Russian securities returned when they become tradable some way down the line, but this will be subject to liquidity, spreads, international investor access, volume, volatility and may not represent assets’ determined fair value given “the nature of those investments”, BlackRock said.

The process of converting GDRs can also be expensive as seen in the US, where VanEck called on investors in July to contact banks issuing depository receipts, as it estimated converting the underlying on its $37m Russia ETF would cost $7.2m.

Elsewhere, DWS offers the Xtrackers MSCI Russia Capped Swap UCITS ETF (XMRD), which like Invesco’s RDXS relies on synthetic exposure, however, it by-and-large directly replicates Russian stocks rather than GDRs, meaning unlike RDXS its reference index has not vanished.

Even though public prices are not currently available, its underlying swaps will track its benchmark when some value eventually returns.

“As a result, the ETF can stay open for the time being while continuing to be suspended,” a company spokesperson said previously.

On the fixed income side, PIMCO in August introduced the option of ‘side pockets’ on its PIMCO Emerging Markets Advantage Local Bond Index UCITS ETF (EMLB) and two other ETFs holding Russian sovereigns.

This mechanism would essentially put Russian bonds in ‘time-out’, setting these illiquid assets aside in a new unit class and allowing the rest of the ETFs’ baskets to trade as usual. Though primarily a tool for seamless trading, the side pockets could allow PIMCO to put its Russia exposures on ice until they are able to be redeemed for a value above zero.

This means unlike ETFs tracking other emerging market bond indices, which offloaded their Russia exposures at a value of zero, investors in EMLB may still realise some value on its 5.6% Russian debt allocation.

Still in limbo

Meanwhile, other ETF issuers are yet to pull the trigger on whether they will shut their Russia ETFs or hold out until they become tradable again, come what may.

Amundi operates the GDR-based Lyxor PEA Russia MSCI Russia IMIM Select GDR UCIST ETF (PRUS) and Lyxor MSCI Russia UCIST ETF (RUS) but unlike BlackRock, has not committed to exercising its right to convert the receipts into underlying shares.

A spokesperson told ETF Stream: “We continue to closely monitor the situation and to examine all the possible options in the best interests of the fund’s shareholders while adhering to relevant regulations.”

HSBC Asset Management declined to comment on any updates regarding the HSBC MSCI Russia Capped UCITS ETF (HRUD), which physically replicates a basket of Russian equities.

As ETF issuers continue facing this seemingly unwinnable scenario and market makers wrestle to untie their money from ailing Russian brokers, it remains a waiting game to see if investors will recoup any of their money and whether some Russia ETFs may even resume normal service in years to come once the war reaches a conclusion.

This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full issue, click here.

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