It almost seems trivial, in the wake of the awful human toll Russia’s invasion of Ukraine has created, to talk about financial markets and the investments that depend on their orderly functioning. But the widespread disruption in the immediate aftermath of Russian aggression needs to be addressed.
For ETFs, this represents yet another unique set of circumstances to navigate, even as the market volatility that came with the COVID-19 pandemic still features heavily in client and industry conversations.
Focus has quickly shifted to the greater challenges of simultaneous market structure degradation and wide-ranging sanctions.
In the weeks immediately preceding the invasion, Russian securities had already experienced significant losses. This was further catalysed as governments stepped up intelligence releases. A near vertical decline ensued, halted only by the Moscow Stock Exchange closing its doors at the end of February.
By this point, the market had already become inaccessible for many due to skyrocketing credit risk and margining requirements, with many securities experiencing significant losses by late February.
The transformation of Russia from emerging to a stand-alone market branded “uninvestable” for institutional investors happened at breakneck speed. The implementation of pricing at 0.00001 by some index administrators acted as final confirmation of a modelled tail risk becoming reality.
As the impact of sanctions bit, Russian Depositary Receipts (RDRs), after a short period serving as a market proxy, were suspended from trading.
As the local Russian market and its global offshoots became near impossible to hedge and absent of liquidity, in the following 48 hours, European exchanges extended listing suspensions to ETFs with a material Russian exposure.
However, it should be kept in mind that closed markets are a regular occurrence, especially for broad exposures. They trigger non-transaction dates in the primary market or delayed execution of the impacted countries, but this is normal.
Brokers act as an interface between these regularly occurring circumstances in the primary market. They manage inventory and optimise hedges to create a frictionless trading environment for those in the secondary market. For example, the closure of certain Middle Eastern stock exchanges every Friday does not inhibit emerging market ETFs from being priced and traded in sync.
The difference with the Russian situation is that, even though the Moscow Stock Exchange has recently taken steps to open the exchange for trading, in a global financial market this represents a mere nod toward a functioning
Russian investment market where, distinct from a holiday triggered closed market, the restriction on foreign investors' exchange access is currently blocked-in perpetuity.
ETFs have proven to be robust trading instruments during previous volatility events such as the Global Financial Crisis of 2008, and of course the more recent pandemic-related volatility. The rare ousting of a highly integrated financial market is different and has far-reaching consequences.
For all intents and purposes, Russian securities are akin to distressed instruments with any investment case speculative in nature. And even though the crisis perfectly demonstrates the speed financial markets can implement structural reform in a crisis scenario, with limited and often opaque news flow, many questions remain on the time that will elapse before the inevitable unwinding of currently locked-in positions.
It is, therefore, more important than ever for those supporting the ETF ecosystem to work together and ensure a plan is in place as to how, in concert, we unravel this trading lockdown.
But as we rise to meet that challenge, we should be mindful of the people of Ukraine and what they are facing. They are the ones dealing with truly challenging circumstances.
Keshava Shastry is head of capital markets at DWS, chair of ETF task force at EFAMA and chair of the ETF committee at the Investment Association
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