Russia Sanctions: Q&A and Resources

Published on April 24, 2022

The Russia sanctions resulting from the invasion of Ukraine in February have created confusion in the market. These sanctions are the first to affect many publicly traded equities on US and European Exchanges in recent memory. As a result, listings have been suspended, and trading has been limited for nearly two months now.  

What can investors expect from here, and what can we learn from this ordeal? 

I am writing a Q&A today covering the mechanics of what is happening from my perspective. I’ll also share some resources so investors can follow future developments beyond this article’s publication.

The Russia sanctions also provide a reason to better understand the plumbing of financial markets. Governments set up restrictions that had further implications for the market.  Understanding how these actions rippled through the infrastructure is valuable information.  

Unfortunately, with the way the world may be heading in terms of volatility, multipolarity, and conflict, investors may need this knowledge in the future. 

Q&A

1. Will my broker sell my Russian position(s)?

It depends on whether you own shares in Russia or you own an ADR or GDR listed outside of Russia. For those unfamiliar with the actual mechanics of an ADR or GDR, this is a decent summary from Investopedia. Note that a GDR (G for Global) is akin to an ADR but listed in another global market like London.

If you hold shares in Russia, your broker is not legally allowed to sell them according to Russian rules. Furthermore, suppose the company you own is on the US or EU Russia sanctions list (and you are a US or EU national or using a US or EU broker). In that case, you will have another restriction limiting your broker’s ability to sell your position.  

Sanctions do not typically restrict existing ownership. Instead, they eliminate the possibility of transacting. As an analog, I hold a position in Venezuelan government bonds. They are still in my portfolio, but I cannot sell them or add more (even if I wanted to). It has been this way for several years now.

Finally, your broker could also restrict your trading. For example, Interactive Brokers limited trading Russian assets for its clients before and beyond legal requirements. Therefore, your broker would also have to loosen its restrictions if it had them.  

So based on where we are, your broker is not in a position to liquidate your local shares.

ADRs and GDRs are more complicated, and not because of your broker. First, no exchanges or venues are currently trading ADRs or GDRs, so your broker cannot sell them transparently, which, for legal reasons, would probably be necessary.  Finally, many key Russian ADRs/GDRs will be under full sanctions by next month. That means US and EU companies and individuals will not be able to transact in the securities, and investors will keep their position but be unable to trade it. 

The wrinkle for ADRs and GDRs is that the Russian government recently approved the forced delisting and canceling of ADRs and GDRs. The new law means that any Russian company must be traded solely in Russia. ADRs and GDRs usually allow investors to exchange their ADR for the local shares, but you need a local Russian account. I do not know what will happen to ADR/GDR investors who cannot take local shares in exchange for their ADR/GDR, but they could be liquidated in that circumstance.  This liquidation would likely occur within the Russian legal system and be beyond a broker’s control.

One final note related to the last point: If the conflict drags on or escalates, I would not rule out the possibility of Russia nationalizing the assets of non-resident investors or citizens of “unfriendly nations.”  There is certainly precedent for that globally and in Russia. 

2. Why did the London Stock Exchange (LSE) suspend trading Russian GDRs even for unsanctioned companies?  

The UK has been as aggressive as the US and EU in its Russia sanctions, so specific GDRs were immediately subject to restrictions on trading (VTB) in late February. Others like Gazprom and Sberbank were shortly suspended, but before the Government sanctioned their share-trading. 

I believe the LSE did this because of the knock-on effect of the Russian authorities closing the local market on February 28th. As a result, the LSE-listed GDRs became the main venue for investors to cut their exposure to Russia with a limited pool of buyers.  

The LSE statement on March 3, 2022, was as follows: 

“Further to recent sanctions in connection with events in Ukraine, in light of market conditions, and in order to maintain orderly markets, the London Stock Exchange (the “Exchange”) has suspended the admission to trading of the instruments listed below, in accordance with Rule 1510 of the Rules of the London Stock Exchange, with immediate effect. The Exchange will continue to keep this situation under review,”

For those curious, Rule 1510 is as follows from the LSE rulebook:

3. What is the most critical restriction in place?

The most critical restriction FOR PRICE DISCOVERY right now is the Russian local restrictions on non-resident sales. Freely trading underlying shares are necessary for efficiently pricing the foreign ADRs/GDRs, and the local trading limitation creates a lopsided market. Therefore, the rule will likely keep any price action upward muted until Russia announces a more definitive solution for foreign shareholders.

Practically, though, and for most foreign investors, the US and EU sanctions are the most impactful. They have halted or added extra complications for any security or asset exposed to Russia. 

To protect themselves, companies, custodians, exchanges, and other market stakeholders will likely go beyond the letter of the sanctions to protect themselves.

4. Does trying to exchange ADRs/GDRs for underlying Russian shares make sense?

BNY, the leading depository for ADRs/GDRs, has said that it is open to canceling ADRs in its program subject to certain restrictions.  

But so long as there are local restrictions on trading, you would not be able to sell the local shares anyway.  

Furthermore, depending on where you live and where your broker is based, you would not be able to legally sell your shares subject to sanctions.  

Finally, you or your broker have to have a local account to take the shares. Converting to local shares will not increase your immediate flexibility, but you can avoid any complications arising from the forced ADR delistings mentioned in the first answer above. 

I am trying to do this for the one ADR position I have.  

The major disadvantage of exchanging is that Russian legal protections are not as robust for shareholders. When an investor exchanges, it is taking a security under Russian rules. On the other hand, the investor must determine how/if one can enforce a US or European legal claim on a Russian company. The answer may vary by company.

5. What has to happen for me to be able to trade Russian stocks and bonds again?

Many things will need to happen that will not likely occur anytime soon. First, the Russians will have to ease non-resident trading and FX restrictions, which will occur only after the current conflict de-escalates.  

In addition, for most investors reading this, the US and EU will need to drop financial sanctions on the major Russian companies, which will also require de-escalation.  The rollback of sanctions will eliminate many knock-on trading restrictions emanating from stock exchanges, Index providers and ETFs, brokers, and custodians.  

6. What about the Russian ETFs?

They have the ADR problem from question one in spades. Most ETF’s holdings were in the GDRs, and sanctions will similarly restrict them. If we look at the holding compositions of RSX, for example, we see that it is 1) no longer tracking its index, and 2) has reduced its exposure to GDRs despite the shares being suspended on the LSE and equivalent OTC exchanges in the US.

My speculation is that the manager has been able to sell GDRs in the secondary market off exchange, and that they are preparing to close the fund by raising cash.

Since the constituent securities of RSX underlying index remaining restricted, it is unlikely that Russia-focused ETFs will be allowed to trade again because market participants will not be able to arbitrage the price of the ETF vs. the underlying holdings, which is essential for an ETF to function correctly.

7. This is not “fair.”  Why?!?!?!?!

Sanctions limiting secondary trading—trades that do not involve companies raising new capital via IPO or a new bond—generally have a checkered history.  For example, they have not generally been effective at achieving policy goals in Venezuela or Iran.

In the case of Russia, you can make a case that secondary trading restrictions prevent key Russians from liquidating their assets to raise cash. After all, many Russian companies have the state or key “oligarchs” that own controlling stakes.  

But why not just feeze those assets? In many cases, these restrictions had more impact on sanctioning nation investors than those of the sanctioned.

This is not the first recent example of market restrictions becoming a more common investment phenomenon. For the few proud nickel investors out there, the LME’s recent actions negated huge trading volumes for the benefit of a single overextended investor.  

Recalcitrant investors may also remember that many brokers limited their clients’ ability to add new positions to certain stocks during the 2021 GameStop mania.

One takeaway is that governments, regulators, and those in power are more emboldened to limit investing activity in the name of the public good and “orderly markets.”

8. What did you learn from this ordeal?

The point just mentioned is probably the biggest. There will be more active market restrictions, and factoring that into the analysis is now a base rather than a worst-case scenario.

For my investing style, I also realize that sanctions risk is a “jump to default” risk. In about 2-4 trading days, there was a move where shares went from normal to frozen.  

In the days leading up to the freeze, once initial sanctions were announced, prices dropped dramatically and quickly. It was doubtful that one could have exited (using stops) at a price that would have been near the stops.

That is not to say that stops shouldn’t be used. In my recent newsletter, I talked about failing to keep mine in place during February and March. It simply means that stops may be insufficient for risk management and that sizing should be adjusted for sanctions risk.  

Another indirect phenomenon is the impact of corporate self-sanctioning. It’s remarkable how quickly companies have written off businesses connected to Russia. It complicates policy-making and the calibration of sanctions and amplifies the non-linearity of the sanctions.  Self-sanctioning has been a significant catalyst for the upward price action in many commodities exported by Russia that are critical for the energy and food markets.

I am trying not to take a side on whether cutting Russia off from global supply chains is the right political decision. However, I believe that the implications of these actions were either not adequately understood or communicated to the western citizenry.

Finally, I will do my best to ensure that I own the underlying securities in the markets I invest in.  Doing this would not have avoided all of the pitfalls investors have seen in Russian assets, but it would simplify the number of outcomes. Investors have spent a lot of energy figuring out if/how/when/what they can do with their ADR positions.

Resources

Here are a few sites you can follow to keep up with things. None of this is a substitute for checking with your broker. These are the base rules, but your broker may have additional restrictions that affect you separately.

OFAC Sanctions List: The list of entities and individuals under US sanctions. If a name is on this list, Americans and American companies cannot do business with them.

White House Briefing Room: Sanctions in the US are generally imposed by Executive Order.  The White House will usually issue a statement here announcing the framework. There are many other things available here, so you either have to know what you are looking for or show up the day the new sanctions are announced.

EU Sanctions Map: The EU analog to the items above, you can search by country and understand what activities and entities are sanctioned.

LSE Notices: If there is a change to the trading of securities on the LSE, it will be posted here. You can access the prior restrictions placed on Russian securities as well

BNY DR Publications: This is where BNY has been posting when Russia ADRs/GDRs are open for exchange or other operational changes.

Central Bank of Russia: The CBR is not responsible for all rules, but it is responsible for implementing many of them. Like the White House Briefing Room, it will post when new items are to be implemented.

Capital Controls Blog: This is a blog I wrote last year talking about capital controls in developed and emerging markets. Both sanctions and capital controls utilize similar tools for different sociopoltiical objectives. Familiarizing oneself with both will likely prove useful.

Conclusion

Sanctions are complicated and create a chain reaction of further restrictions. I hope I have shed some light on what’s happened in the markets due to Russia sanctions and that you can use that information for your future betterment.

To your investing adventure,

The Castaway Capitalist

For questions, comments, and feedback, please go to the contact page or email contact@castawaycapitalist.com.

IMPORTANT DISCLOSURE: As of the publication date, the Castaway Capitalist owns the following Russia positions: SGTPY, TRNFP and SBER.

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