Blocked depositary receipts are converted into shares

2022 is a year of great trials for the Russian stock market and private investors. First, the Bank of Russia closed trading on the Moscow Exchange for a whole month, then, due to sanctions, securities of foreign issuers were blocked from clients. After such events, many had to urgently change their broker – to move to a company that was not subject to restrictions.

In July, investors whose shares were frozen had the opportunity to return their assets. By agreement between the National Settlement Depository (NSD) and Clearstream, and after amendments were made to the current legislation that regulates the operation of the securities market, the automatic conversion of depositary receipts (DR) into shares has become a reality. We will analyze which papers will be unblocked, as well as in what time frame and how the process will go.

Why were securities blocked?

Depository receipts make it possible to trade foreign shares without buying the securities themselves. This makes available shares of foreign issuers that cannot be bought by a regular investor, such as those without qualified status . And issuers can attract foreign capital through receipts without going through a strict selection and listing on foreign stock exchanges.

Restrictions for Russian investors on trading in the stock markets appeared due to Western sanctions.

  • In February 2022, quotations of depository receipts on Western exchanges fell sharply , for example, Sberbank (SBER) receipts on the London Stock Exchange fell to $ 0.01 per security, and the owners could not sell them for a fair price at which the shares are quoted the same issuers.
  • One of the first to fall under the sanctions were the largest banks and subsidiaries – the brokerage companies of Sberbank and VTB ; brokers’ assets in foreign accounts were frozen.
  • In February and March, two of the world’s largest depositories, Euroclear and Clearstream, blocked NSD’s accounts. Through them, Russian brokers entered foreign markets and bought securities for clients on their behalf. It is no longer possible to trade foreign securities and receive dividends through a broker who has accounts with NSD.
  • On April 27, 2022, the Central Bank of the Russian Federation introduced a ban on the issuance of depositary receipts by Russian issuers.

In response to the blocking of foreign accounts of the country’s central depository, NSD, on May 30, 2022, the Bank of Russia introduced a ban on trading in foreign shares that were blocked by foreign depositories. The main goal is to protect investors from risks when dealing with foreign assets.

When buying securities, Russian brokerage companies usually used the following schemes of interaction with foreign banks:

  • broker depository – NSD – Euroclear or Clearstream – foreign bank – depository, for example, Citibank;
  • broker’s depository – “Best Efforts Bank” – a bank – depository of the SPB Exchange, Euroclear or Clearstream – the US Central Depository (Depository Trust Company).

Some Russian brokerage companies have not been banned because they use direct access through their accounts rather than through NSD to access international stock exchanges and depositories.

Is it possible to sell blocked assets.

After the Central Bank banned companies from issuing depositary receipts in April and ordered issuers to start converting securities into shares, most Russian investors had a problem. Foreign depositories, where some Russian investors hold depositary receipts, refused to perform such operations. Then the Central Bank issued an order for automatic or, in some situations, forced conversion. The process started on August 15, 2022.

Which receipts are converted

The conversion of receipts became possible thanks not only to the initiative of the Central Bank of the Russian Federation, but also to the decision of Clearstream, which resumed the conversion on July 18, 2022. Thus, they are trying to help foreign investors get rid of the assets of Russian companies. And Russian clients will be able to exchange receipts at the market price of the shares of these issuers.

At the same time, according to the statistics of the Central Bank of the Russian Federation, in the total volume, the share of depositary receipts stored in all IIAs opened by investors is minimal – 3%. For example, there are eight times more Russian shares – they make up 25% of the total volume of securities owned by residents.

Dynamics of the structure of IIS assets, %

Rice. 1. Structure of IIS by types of securities. Source: CBR data

According to the quarterly report of the Central Bank of the Russian Federation, which regularly analyzes the structure of portfolios of trading participants on Russian stock exchanges, the share of depositary receipts is extremely small. The least popular instrument is considered to be bonds of foreign issuers – they account for only 1%.

For the conversion of depositary receipts of Russian issuers, the international depository set a condition: NSD should not receive economic or financial benefits from operations. Therefore, the Russian depository has canceled fees for such work, initially until the end of July 2022, and in the latest announcement, the moratorium on fees was extended until October 15, 2022.

Sberbank started converting depositary receipts on July 20. Other issuers whose receipts will also be automatically converted are Gazprom, Gazprom Neft, RusHydro, Mosenergo, Cherkizovo Group, Acron, Aeroflot, FGC UES, MTS, “Novorossiysk Commercial Sea Port”.

Not all companies, after the April instruction of the Central Bank of the Russian Federation on a ban on the issuance of depositary receipts, abandoned this practice. In this regard, issuers whose receipts continue to be traded on international markets are not subject to automatic conversion. For such situations, the process can be initiated at the request of the securities holder.

In Russia, depositary receipts are serviced by five banks – Citibank, Raiffeisenbank, Gazprombank, J. P. Morgan Bank and Sberbank. All banks have a legal entity registered in the territory of the Russian Federation, therefore they are considered Russian and are subject to automatic conversion.

A complete list of receipts and depositaries where they are stored can be found on the website of the Central Bank of the Russian Federation. For example, the receipts of Severstal (CHMF) are kept by Sberbank, and the receipts of Sberbank itself are kept by J. P. Morgan Bank.

How will the conversion take place?

Depending on which depository – Russian or foreign – receipts are stored in, the conversion process may differ.

Automatic. The main requirement for automatic conversion is that the depository where securities are stored must be Russian. And those companies that have retained the right to issue depository receipts since April may not participate in the automatic conversion. The main condition for this is to submit an application to the government commission for foreign investment before August 17, 2022. Automatic conversion will take place without the participation of the investor. The depository, on whose account the papers are, will carry out all the processes on its own – write off the receipts from the client’s account and credit the shares instead. The Central Bank of the Russian Federation recommended that brokers notify clients about the start of the process.

Forced.If the receipts are registered with a foreign depository, the securities are not converted without the participation of the investor. To start the process, the client must contact the broker, but he may refuse to conduct the operation – this is not part of the company’s responsibilities. You can also contact the depository with a request for conversion in a free form. In addition to the request, the investor will have to provide any documents that confirm the right to own receipts. Such an application must be submitted from July 14 to October 11, 2022. If the sanctions do not affect the work of a foreign depository, then it will carry out the conversion. If there are restrictions on the work of a foreign partner, on whose account the receipts are, the client needs to contact the custodian bank (depository). Or to the credit institution that holds the shares themselves – one of the five banks,

Terms of the conversion

In a press release, the Central Bank of the Russian Federation indicates the average conversion time is 2.5-3 weeks.

Those companies that will not carry out automatic conversion had to apply to the government commission by August 17. Clients can forcefully request conversion from such issuers, but the rules for conducting the operation in this case are governed by the terms of service and issue of securities.

Earlier, Citibank announced that it would not participate in the automatic conversion of receipts for such issuers as Tatneft (TATN), MMK (MAGN), Rostelecom (RTKM). But this statement was made by the American holding bank. Citibank, registered in Russia, will carry out the conversion on a par with other Russian custodian banks, as required by law.

Also, one company is known that applied for a refusal to carry out the conversion – AFK Sistema (AFKS).

What will happen to depositary receipts?

The situation with the blocking of depositary receipts of Russian issuers showed that such an instrument has additional risks that the underlying asset – shares – does not have. On the one hand, they open access to trading on foreign platforms. On the other hand, the risks may be higher than the potential profit.

Issuers have also considered issuing depositary receipts on venues other than the US or Europe. Among these options are Hong Kong or other countries included in the list of friendly countries.

The Central Bank of the Russian Federation recommended that brokers limit the access of unqualified investors to such securities. For a Russian investor without a qualified status on Russian exchanges, there are enough other trading instruments that can bring good profits at lower risks without high investments.

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