Stock market background design

One of the world’s largest index providers is considering removing Russian listings from its indexes, putting the fund industry in “uncharted waters,” says ETF expert Daniel Straus.

On Monday, Reuters reported that Dimitris Melas, MSCI’s head of index research and chair of the Index Policy Committee, said removing Russian listings from its indexes is a “natural next step” following a barrage of Western sanctions and the closure of the Moscow Exchange.

MSCI has since begun a consultation with market participants “on the appropriate treatment of the Russian equity market within MSCI indexes up to and including the potential reclassification of the MSCI Russia Indexes from Emerging Markets to Standalone Markets status,” the company said in a release.

Straus, director of ETF research and strategy with National Bank Financial, said in an email to Investment Executive that “as new sanctions are announced by the minute, we are truly in uncharted waters in terms of how the fund industry (and not just ETFs) will react.”

Russia comprises about 3.24% of MSCI’s emerging market benchmark and about 0.3% of the global benchmark, Reuters reported. “That’s several billion dollars worth of Russian stocks held in U.S. ETFs alone, not to mention the US$1.3 billion held in RSX, the largest Russia ETF listed in the U.S. (for now),” Straus said.

If sanctions make transacting in Russian securities difficult, impossible or illegal, he said, “there will be no one to buy them if western fund managers are forced to divest — which is why I say we are in uncharted waters.”

Straus said ETFs tracking Russian securities could continue to trade existing units, but there would be no redemptions or new units created until sanctions are lifted.

That has been the case for other ETFs when their underlying markets were completely closed, Straus explained, such as the Global X MSCI Greece ETF during the Greek referendum and the VanEck Egypt Index ETF during the Tahrir Square uprising in Egypt.

Indeed, BlackRock Inc. stated in a release today that the iShares MSCI Russia ETF (NYSE Arca: ERUS) has temporarily suspended the creation of new shares until further notice, with units of ERUS still trading on secondary markets.

As would be the case for any ETFs facing liquidity issues and a suspension of this nature, BlackRock cautioned that ERUS may experience increased tracking error and significant premiums or discounts to its net asset value, as well as bid-ask spreads wider than the historical average.

And for large emerging market and global ETFs that hold billions in Russian securities, “it’s hard to say what will happen to that portion of its portfolio if MSCI deletes those securities from the index,” Straus said.

Straus noted that markets have managed through sanctions before.

“We have a mild precedent for this sort of action when the U.S. banned a small handful of China-domiciled defence companies,” he said. “For instance, this executive order was announced in June and took effect in August last year, giving index companies and other financial institutions the time to divest their positions in those Chinese stocks.”

However, Straus said, “the case of the Russia sanctions may be more immediate and of a larger scale.”

MSCI said it will issue further communication “before the end of the week following the review of feedback from market participants.”

On Monday, Fitch Ratings reported that a number of European mutual funds that focus on investing in Russia have suspended redemptions, with more likely to follow.

The rating agency reported that 10 European mutual funds that are focused on Russia or emerging markets more generally have suspended redemptions so far. The funds represent about €4.2 billion in assets under management.