Ukraine, Turkey and Russia crises pose banking challenge

Violent political unrest in Ukraine has presented banks and international investors with a dilemma

Political turbulence in the Ukraine, Russia and Turkey this year produced disagreement between senior financial industry executives at a FIX Trading Community conference in London Thursday, with some arguing that politics should not be allowed to detract from the longer-term rise of non-western economies, and others arguing the opposite.

This week, dramatic political events overtook the Ukraine, where Russia and the US among other western powers have become embroiled in a diplomatic wrangle over the status of the disputed Crimea region, which has a significant Russian population.

As a consequence of the unrest, the Russian market collapsed by 12% on Monday, recovered around 3% the following day but then fell again.

And earlier this year, a series of riots in Turkey followed by a corruption scandal centred on the increasingly authoritarian government of prime minister Erdogan led to fears about the stability of Turkish democracy.

As Erdogan began interfering with the judiciary, giving himself and his family immunity from prosecution and threatening to close Facebook and YouTube, the Turkish stock market declined to the point where Hermes Fund Managers called it the “worst-performing” in the world in dollar terms.

“We’ve had 18 weeks of outflows from emerging markets,” said one senior bank analyst. “There’s been structural problems and even dual account deficits in some countries. Political risks in Turkey earlier this year and Russia more recently have been issues, as has the China credit bubble. People are wondering when America’s interest rates are going to go up as that’s going to have a profound impact on the emerging markets. We are not at the bottom yet.”

Participants generally acknowledged that present conditions are challenging across a number of emerging markets including Brazil, as well as Turkey and Russia. Some suggested that political tensions were simply an occupational hazard of investing in emerging markets, and should be viewed as the natural price to pay for generally higher returns. However, others noted that the recent success of emerged markets may also be deterring investors from developing markets.

“If you get 20-25% return on the S&P 500, why would you take the risk of investing in emerging markets?” asked one stock exchange representative. “One of the reasons you invest is that you will get better returns, but you are going to get days where there’s risk.”

The participant went on to cite Russia’s move to T+2 settlement last summer, along with the introduction of the NSD as the nation’s central securities depository in November, as infrastructure changes that would have a long-term impact beyond that of current affairs.

Others decided to take a much more long-term view still, drawing on the book Civilisation by Niall Fergusson.

“I’m still quite bullish about emerging markets,” said one representative of a major stock exchange in the eastern Mediterranean region. “Look at the long view. In the year 1500, Paris was the only European trading city in the top ten. The rest were all in Asia, and Beijing was the largest. But by 1900, there had been a complete reversal: there was only one Asian city in the top ten, and it was Tokyo. By 1990 the average US citizen was 70 times richer than a Chinese citizen. But since then, there has been another reversal. China is on track to overtake the US in GDP. I’m not interested in today, tomorrow, or next week. The emerging world is on the rise.”

Members of the panel cited moves in Turkey to consolidate the equities, derivatives and gold and precious metals markets into a single Borsa Istanbul, and bring in a new trading platform from Nasdaq OMX to underpin it. The exchange also plans to bring in FX trading and a special segment for agricultural products over the next two years.

They also noted that in Turkey, foreign companies hold nearly 65% of the free float in the stock market, which provides some indication of liquidity. Meanwhile, in the fixed income market 85% of trading activity currently passes through the exchange, rather than the OTC market.

A contribution from a member of the audience involved in consulting suggested that at least some firms still have confidence in the Turkish market. The member, from a consulting firm, pointed out that one of his clients was supporting a major construction project in the country and had decided to go ahead with it after careful consideration, based on the belief that the current political disputes have been blown out of proportion and represent merely a ‘blip’ in the country’s otherwise upward trajectory.

However, other members of the audience pointed out that IPO activity would be a significant component in whether a market would be successful or not in attracting international flows.

“In most emerging markets, a large part of the economy has traditionally been dominated by the state,” said one senior representative of a global financial technology provider. “A lot of the appeal of emerging markets is the opportunity presented by IPOs listing on the exchange. Istanbul has aggressive targets for listings business by 2020, while Russia has presented a $60 billion carrot to investors thanks to Putin’s drive to bring listings onto the Moscow Exchange. The key is listings.”