Russian Stocks, Bonds Face Rising Risk of Ejection From Indexes

(Bloomberg) -- The mounting sanctions against Russia have increased the risk the nation's stocks and bonds will be kicked out of major global benchmarks, effectively cutting them off from a big segment of the investment-fund industry.

MSCI Inc., a provider of major emerging-market indexes, is seeking feedback from market participants on the appropriate treatment of Russian equities, it said in a statement Monday. The Interncontinetal Exchange Inc. said it will remove debt issued by sanctioned Russian entities from its fixed-income indexes at a rebalancing exercise on March 31.

MSCI is closely monitoring just how accessible and investible the market is for foreigners and plans to say more by the end of the week, according to the statement. An MSCI executive previously indicated the firm was consulting with clients to understand the implications of sanctions.

Its move follows warnings from Goldman Sachs Group Inc. regarding the risk of Russian debt being removed from a widely followed JPMorgan Chase & Co. index. Such steps may worsen the already steep selloff in Russian assets by preventing funds that track the indexes from buying them. A main Russian equity gauge is down 35% this year in local currency terms, while credit-default swaps insuring the government's bonds have signaled a more than one-in-two chance of default. The ruble is the world's worst-performing currency this year.

Russian bonds account for 6.23% of JPMorgan's Emerging Market Global Diversified index, the company said in an email. It didn't say whether it was studying the possibility of removing Russia's securities from the gauge.

Bloomberg Equity Indices said it will remove Sberbank of Russia PJSC from its equity indices at the close of March 2 following the sanctions, according to a Feb. 28 statement.

Bloomberg Index Services Ltd., the administrator of Bloomberg Indices, is a wholly-owned subsidiary of Bloomberg LP.

Sweeping sanctions and capital controls have already wiped billions from the value of Russian assets as the country faces an escalating economic toll from its decision to invade Ukraine. The U.S. and its allies have imposed broad restrictions on Russia's biggest lenders, including the central bank.

The sanctions are increasingly isolating Russia and diminishing the liquidity of the nation's assets --- an important threshold for being included in benchmark indexes. Russia on Monday halted stock trading, though companies listed abroad tumbled.

“The critical point here is that our indexes need to be investible,” Dimitris Melas, head of index research and chair of the index policy committee at MSCI, said before the company's official announcement that it is seeking feedback. “This is precisely what we are focusing on right now to make sure that we deal with the situation with Russia, and the lack of accessibility to the market, in a timely but considerate manner.”

Any changes to major indexes would mean uncertainty for investors in exchange-traded funds that track benchmark gauges. The iShares Core MSCI Emerging Markets ETF, which trades under ticker IEMG, holds about $1.1 billion of Russian assets at current market value, according to data compiled by Bloomberg.

JPMorgan Index

The impact could also be seen in Russian debt, which is currently included in the JPMorgan GBI-EM Global Diversified Index. On Friday, JPMorgan said in a note to clients that there was “no immediate impact from sanctions on the February 28, 2022 rebalance of the JPMorgan EM indices.”

When dealing with sanctions, the bank will often publish an update after an observation period on the affected markets. Potential steps could include maintaining the status quo or winding down the sanctioned entity's weight over time. Another could be the outright exclusion of securities from an index, according to the bank.

ICE also said starting with the Feb. 28 rebalancing, indexes will exclude any new sovereign debt issued by the Russian central bank, its wealth fund and the finance ministry.

“In our view, index providers will remove Russia from the benchmark if sanctions are so significant that liquidity gets impaired to the point where the index cannot be replicated anymore,” said Gustavo Medeiros, head of research at Ashmore Group. For example, “if the vast majority of market makers stop showing prices on bonds,” he said.

“Any benchmark exclusion of a large country like Russia is likely to be staggered across many months in order to allow existing investors to exit their positions,” Medeiros said.

There's heightened risk of a “technical default” of Russian corporate and sovereign hard-currency bonds due to potential payment restrictions and therefore they're likely to drop out of the indexes, said Dhiraj Bajaj, head of Asian credit at Lombard Odier Investment Managers in Singapore.