One of Russia’s major metallurgical companies–-ref.htmk Nickel alsocompleted restructuring in 2001, designed to enhance transparency andefficiency of the company mana-ref.htmAs a result of the reform, thecapitalization center was moved from RAO Norilsk Nickel to the MiningMet-ref.htmal Combine (GMK) Norilsk Nickel by way of a share swap, as a resultof which the GMK became owner of 96.5 percent of the RAO assets. TheRAO’s cross holding of17 percent of the GMK’sshares is to be removed by reducing the GMK Charter capital by 17 percent. Theshares of GMK Norilsk Nickel are currently the key traded stock of the company.They are also included in the list of shares for computing the RTS index. It isnecessary to mention the legal proceedings, related to restructuring, whichnearly paralyzed trading in RAO Norilsk Nickel shares on thecountry’s main tradingsites. Under a claim filed by a shareholder of three shares (!), a districtcourt of the Kemerovo oblast forbade GMK to use the УNorilsk NickelФ brand nameor perform any actions designed to include the shares of OAO GMK Norilsk Nickelin the listings of the Russian and foreign stock exchanges. One more instanceof corporate blackmail has again emphasized the domestic companies’ legal vulnerability and adverselyimpacted on the image of Russian companies.

In November, the Government approved andrecommended for application the Code of Corporate Conduct elaborated by theFCSM. The Code is a set of rules which major joint stock companies, comprisedof over a thousand shareholders, should abide by. The Code describes the rulesof conducting shareholder meetings, the rights and responsibilities of theBoard of Directors, etc. It is designed to improve corporate governance in thecountry.

Table 39

Movements in stock indices

1.4.4. The corporate bondmarket

In 2001, the Russian corporate bond marketwent through a stage of intensive development. In the first place, the domesticcorporate bond market had doubled, amounting to $2.5 bln by the year end. Inthe second place, the issue of corporate Eurobonds resumed for the first timeafter the 1998 default – Rosneft, Gazprombank and the telecommunications company MTS raiseda total of $600 mln. through Eurobond issues.

The domestic corporatebond market

As at the year end 2001, the value of thedomestic corporate bond market accounted for 75 bln. RF Rubles ($2.5 bln). Over100 issues of corporate bonds floated by 50 leading Russian companies weretraded in the market.

The corporate bond yield exceeded by 4-6%the yield of government securities (GKO -"government short-term bonds" and OFZ- "federal loan bonds") with similar maturity dates, it was by 2-3% lower thanthe bank loan rates (except for the Sberbank's loan rates) and by 1-2% lowerthan the rates of floated bills.

Most bond issues had been placed throughand were traded at the Moscow Interbank Currency Exchange, although barely ahalf of them were enjoying a fairly liquid market. According to estimates, theMoscow commercial banks made up 75% of investors in the corporate bond market,regional banks accounted for 15%, and the remaining 10% included insurance andpension funds, and other investor groups. The volume of the corporate bondmarket approximated 1/3 of the volume of the GKO-OFZ market, with a turnoverratio of 1/5.

Prior to the August of 1998, the Russianmarket of domestic corporate bonds was underdeveloped. For a long time itsdevelopment had been impeded by the high cost of internal loans dictated by theGKO-OFZ market. In addition, the market was affected by the discriminatorytaxation rules applicable to corporate bond issuers, which did not allow(contrary to the cost of bank loan servicing) interest on corporate bonds inthe cost. As a result, Russia's fairly high pre-default credit rating madeforeign loans more attractive, including those acquired through the issue ofEurobonds.

In 1999, however, the situation changed. Inthe first place, due to a combination of fiscal and monetary political measures(the budget surplus, monetary expansion through the purchase by the CentralBank of exchange proceeds) the real interest rates went sharply down, evenreaching negative values on the government loans. In the second place,Resolution № 696 of the RF Government, dated 26 ofJune 1999, allowed in the cost the interest (discount) paid by the issuer onits bonds (within the effective refinancing rate of the RF Central Bankupgraded by three points)33. And finally, the Eurobondmarket was closed for Russian borrowers until the second half of 2001.

An important factor that served to speed upthe development of the corporate bond market was the scheme used for therestructuring of governmental obligations to non-resident GKO and OFZ holders.Under the proposed arrangement, the bulk of their receipts could not for a longtime be repatriated and were instead to be accumulated on the so-called Сaccounts, with a possibility for investment in financial instrumentsdenominated in the RF Rubles. As a result, the С accounts had accumulatedsome $5 bln, which became a major source of funds for the issue of Russiancorporate bonds in 1999. The corporate bonds of the OAO LUKOIL, the ОАО Gazprom, the АК Alrosa, the RAO UES ofRussia and the OAO Tyumen Oil Company, which were floated in the second halfof 1999, were oriented towards these investor groups.

Later, the issuers, which in 2000-2001 included natural monopolies, commercial banks,telecommunications companies, metallurgical and other sectoral enterprises,started to turn towards domestic investors.

The principal tendency in the changingfinancial arrangements of loan schemes was the transfer from the issue ofindexed bonds, whose value was pegged to the Ruble-Dollar exchangerate, to the issue of Ruble-denominated instrumentswith fixed coupons or coupons linked to the Ruble rate (the OFZ rate of return, the refinancing rate of the RF CentralBank).

In addition, the compromise between theissuer's penchant for long-term bonds and the investor's desire to raise theasset liquidity resulted in the issue of optional bonds or the issuer's offerof put options.

The issuers' policy aimed at enhancing theattractiveness of their securities gradually increased the number of relativelyliquid bond issues. As a result, the number of exchange traded corporate bondsrose between December 2000 and December 2001 from 10 to 62, the number ofmonthly transactions also increased from 185 to 1 355, and the monthly salesrose from 0.3 bln. RF Rubles to 3.6 bln. RF Rubles. At the end of December2001, MICEX accounted for 96.7% of the monthly trading operations withcorporate bonds, the respective shares of SPCEX and RTS came to 1.2%, while theKBST and MSE made up 0.01% of the sales.

Market participants predict that the growthrates of the corporate bond market would remain high (in 2000 the market grewfrom 12 to 40 bln. RF Rubles, and in 2001 – from 40 to 75 bln. RF Rubles). Thecorporate bond market is estimated to amount to 150 bln. RF Rubles by the endof 2003, with the number of traded bond issues increasing to 200. The generaloutlook shows that within the next two or three years, given a favorableenvironment, this market may level with the market of governmentsecurities.

The securitization of the corporate bondmarket hinges upon the intention of commercial banks to diversify and raise theliquidity of their assets, and the development of non-banking financialinstitutions, i.e. insurance, pension and unit investment funds. In themedium-term perspective, the introduction of accumulation pension schemes isexpected to give a powerful boost to the corporate bond market.

The revival of rating agencies is a signand, at the same time, a positive factor of market development.

In the first place, the major internationalrating agencies, apart from assigning international credit ratings in foreignand domestic currencies, begin to assign ratings according to the internal scale. Due toa higher differentiation of rating values available to domestic issuers, theinternal credit rating scale is far more sensitive to the changes of theircreditworthiness and, consequently, provides more information toinvestors.

At present, Russian issuers receive theinternal credit ratings from the Russian agency EA-Ratings, which was purchased inDecember 2001 by the international rating agencyStandard&Poors34. Besides, the Interfax rating agency is expected to raise its marketprofile in the aftermath of the cooperation agreement signed in October 2001with the Moody’s international rating agency.

It is worth remembering that the operationsof the corporate bond market are also affected by various unfavorablefactors.

In the first place, the tax levied on theissuer at the time of registration of a corporate bond issue is still veryhigh. Pursuant to the Federal Law On tax levied on securities transactions,the tax rate accounts for 0.8% of the issued value, irrespective of thematurity dates of the floated securities or the placement results. Forinstance, with the bond yield of 10% APR, the existing tax rate increases thecost of loan proceeds up to 11.8% APR (for 6-month bonds) or up to 13.2% APRfor 3-month bonds. In the event of partial placement, i.e. 50% of the statedvalue, the cost of loan proceeds under applicable legislation, which requiresfull advance payment of the tax, rises up to 16.5% (for 3-monthbonds).

Thus, the existing mechanism actuallyprecludes the possibility of floating short-dated bonds, increasing the cost ofloan proceeds for enterprises and negatively affecting the liquidity offinancial institutions. It is noteworthy that in the mature markets (i.e. in anumber of Western European states) the issue tax is not levied, or the relevanttax rate is 30-50 time lower than in Russia (USA, Germany, South-EastAsia).

Table 40

Issued corporate bonds

Table 40 (cont’d)

Data source: Thenews letter Corporate and bank bonds, 2002, №1.

In addition, the FSCM registrationprocedure of issued bonds is too complicated. The preparation stage lasts, at best, from 2 to 4-5months, defeating the purpose of the short-dated bond issue. The new Standards for theissue of bonds and relevant prospectuses approved by FSCM Resolution # 27 of 19 of October 2001, donot simplify or speed upthe procedure. Under the circumstances, a possible venue of corporate bond market development shouldentail the creation in Russia of a sector of commercial securities, i.e. short-term bonds liablefor fast-track registration procedures.

The Eurobond market