Gazprom and Russian stocks: what to do with Russian ADRs?

Following the events of recent months, those who own ADRs issued by Gazprom finds itself with an investment that can no longer be traded on Western markets. The same applies to any other Russian ADR or GDR.

The parties affected by this situation range from private investors with small holdings to pension funds that have invested millions to benefit from high dividend yields. Investments currently "locked in" amount to tens of billions of dollars.

There has been an enormous degree of uncertainty about how the situation will evolve further and what investors can do at this stage-if anything at all.

I have been following the topic since the situation emerged, as I had previously written about Gazprom's ADRs as a promising long-term investment. Since the war in Ukraine broke out, I have used my network of readers and contacts to gather a lot of feedback on the ground. Although I cannot offer absolute clarity, some new information has emerged in recent weeks.

Future scenarios for holders of Russian ADR shares and Gazprom shares

1. The delisting of ADRs

The delisting of ADRs (and GDRs) is almost certain. Western stock exchanges want to get rid of anything that gives them exposure to Russia, and the Russian government has forced its domestic companies to delist from foreign markets. However, behind the scenes there are discussions about some Russian companies asking the Russian government for an exception, including Norilsk Nickel and Gazprom. The Russian government will reportedly make a decision on these potential exceptions. Without further details, it is difficult to say whether any of these exceptions have a chance of being granted. I would not expect much, given the general political situation. It has been reported that Gazprom's request has already been rejected and Norilsk Nickel's has been approved, but details are still hard to come by. The basic assumption is that all these ADRs and GDRs will expire.

2. The conversion of ADRs into Russian shares

The conversion of ADRs (and GDRs) into Russian shares should only be an administrative matter, since ADRs and GDRs are not much more than repackaged shares. Depositary receipts can always be converted into the underlying shares and should involve nothing more than filling out some paperwork and paying a fee. However, in our particular case, there are two problems:

Western banks and brokers no longer cooperate with the National Settlement Depository ("NSD"), Russia's clearing and settlement organization.
Western banks and brokers who previously offered custody of Russian securities to enable their clients to trade in Moscow have discontinued this service.
Under the contracts on which the ADRs and GDRs were based, Western banks and brokers would now have to report the holders of the underlying shares to the NSD, which would then create a register of foreign shareholders. However, in the absence of Western banks and brokers talking to the NSD, this is not happening.

Internationally oriented Western banks and brokers, such as UniCredit, BNP, and Interactive Brokers, were among those that previously offered custody of Russian stocks. From what I have been able to ascertain, none of these banks and brokers intend to offer Moscow trading and custody of Russian stocks anymore.

One obvious solution would be to open an online brokerage account in Russia, so that you can at least transfer the underlying shares to a brokerage account in your name. Reportedly, there are some brokers in Russia who have said they are willing to open accounts for foreigners and receive the shares if that becomes necessary. I am currently investigating possible options (and if you read to the end, you will discover a potential surprise candidate).

However, the option of opening a local brokerage account will probably not work if you have a U.S. passport. Even before this political situation arose, U.S. citizens were considered toxic by banks around the world because of the actions of previous U.S. governments. Citizens of other nations have the option of getting an account, but it depends on the passport you hold, the bank you talk to, and the size of the business you can offer. Obviously, institutional investors with assets in the tens of millions of dollars will find it easier to get help from service providers than a private investor with a $5,000 investment.

However, even if you were able to obtain an account in Russia, you would still not be free. If you are a citizen of a country that has sided against Russia, you will be subject to sanctions that will prevent you from exercising voting rights, collecting dividends, or selling shares, at least for the time being. The dividend will be held in trust (potentially, but not necessarily, for a period limited to three years), but you will not be able to record it in your account.

As you may have guessed, the complexity of this procedure is quite difficult to follow.

The three actionable options for holders of Gazprom and Russian shares

1. Sell to anyone who makes an attractive purchase offer.

There have already been a few takeover bids for Gazprom's ADRs, albeit at a bargain price (e.g., 1 cent). Even if someone accepted such an offer to simply get rid of their exposure, they would still have to solve the problem of liquidating the sale.

However, sooner or later (and probably within the next few months), some sort of viable avenue should open up to sell ADRs or GDRs to arbitrageurs and settle the transaction. I also expect that there will be a way to transfer potential ruble payments, such as through a transfer mechanism involving countries like China or Kazakhstan. I expect Western or Russian hedge funds to find a way to make public bids for these securities. These offers would be made at steep discounts from the price paid for these securities on the Moscow Stock Exchange. My guess is that this would be a discount of 50%. Such offers would offer a way to liquidate the position, if nothing else. This would not be a financially attractive solution, but perhaps better than forced liquidation (see point 3) or accepting abusive 1-cent offers.

2. Open a Russian brokerage account

If you have at least US$30,000-50,000 in ADR/GDR and are not a U.S. citizen, it may be worthwhile to open a Russian brokerage account. There will be fees to pay for translation and authentication of documents, but for a position of this size it will probably be worth it. There also remains the obstacle that it is unclear which Russian brokers-if any-will accept foreign clients at this stage, and if so, whether they will exclude specific countries.

Gazprombank, the Gazprom-controlled bank, is offering foreigners the opportunity to open an account that provides a reasonable procedure and level of costs.

The company has launched a website in which it reads:

"If you do not have an account to receive the Shares, Gazprombank. (www.gazprombank.ru/en) ... offers holders of Depositary Receipts (DR) not resident in the Russian Federation to open a type "C" securities account to receive Shares and a type "C" bank account to credit dividends paid on Shares, following a simplified procedure.

To open a securities account, a DR holder who is not a resident of the Russian Federation must complete a subscription application (the "Subscription Application") (the application form - natural person-foreign citizen or stateless person and the application form for subscription-legal person, foreign entity without incorporation of legal person are attached hereto).

After completing the client application, you must sign, scan or photograph it and send the scanned copy or photograph of the completed and signed client application to the following e-mail address: depo@gazprombank.ru.

Once the customer's application is accepted, the customer will have a type "C" securities owner account for maintaining securities records and a type "C" bank account for crediting dividends paid on the Shares. Details of the type "C" securities account and type "C" bank account opened with Gazprombank will be sent to the e-mail address specified by the customer in the application within 3 business days from the date of opening."

Will it really work? The information is new and and is being tested by several investors. There will be potential hurdles to overcome, including some Western banks and brokers who refuse to deal with it (instead leaving their clients completely stuck).

There is also the obvious question of whether Gazprombank will decide to extend this service to holders of other Russian ADRs or GDRs.

The Russians have a real opportunity to make many Western investors happy, particularly those who feel misled by claims such as those made by Deutsche Boerse that the Russian ADR trading halt was designed to "protect investors." Will the Russian government and Gazprom (through Gazprombank) take advantage of this opportunity? I don't know, but it would not surprise me at all. This is also a media war, and Russia could engage in first-rate trolling against the financial sector. Also, very importantly, it could help stabilize Russian stocks.

In any case, by opening a Russian brokerage account (with Gazprombank or another alternative), investors should be able to endure this period and wait for better days.

3. Forced liquidation by ADR sponsors.

The third option is the least attractive. Unfortunately, it has a significant probability of occurrence.

The custodians of Gazprom ADRs are cancelling the ADR program. By August 3, 2022, ADR holders must decide whether they want to receive the underlying Russian shares and, if so, where they can be transferred for safekeeping.

If the underlying shares cannot be received, the depositary will proceed to liquidate the shares and pay out the proceeds-at least, that is the theoretical course of action. At present, foreigners are not allowed to sell Russian shares, which means that depositaries cannot proceed with forced sales. If the rules were to change and depositaries were allowed to liquidate shares, they would probably have to sell at a low price and/or accept rubles, which in turn they cannot repatriate.

This option is probably the worst of all worlds and is a real risk at the moment, unfortunately. Although so far the indications are that it would take quite some time, that is, it is not likely to happen in the immediate future. In the meantime, much can change in the overall situation.

Final considerations

It seems that obtaining a Russian brokerage account is essential to protect one's investment in Gazprom (or other Russian ADRs), but it is far from simple and involves effort and expense. So far, the option of setting up a limited securities account with Gazprombank through a simplified procedure seems the most promising route, and it could be extended to other Russian ADRs and GDRs.

Although there is currently no clarity on the subject, the whole issue seems to have made some headway in recent weeks. I have heard different stories from readers who have confronted their banks and brokers; I recommend that you do your own investigations, as it is almost impossible to make general statements.

Meanwhile, Gazprom (and Russia) are gaining well from the rise in energy prices.

As complex and unpleasant as the whole issue has become, we wonder if these distortions will create new opportunities for investors. When an entire asset class becomes difficult to trade, opaque, and politically charged, it usually creates opportunities that then end up in the financial market history books. We started jotting down ideas for a potential investment research trip to Russia, and I have seen tremendous interest in this initiative. It is probably too early to invest in Russia, and a research trip might well conclude that there is nothing that can or should be done-but it would be an interesting intellectual exercise.

Meanwhile, we are doing the following:

1. Monitoring whether any opportunities open up to sell deposit receipts at a not-too-painful discount.
   
2. We keep our ears open about the possibilities of opening a Russian brokerage account as a foreigner (without having to travel to Russia).

Russian ADRs and RPGs have become an interesting testing ground for such issues as:

• The reliability of ANY security custody in times of political crisis.
• The ability of governments to wipe out asset classes at the push of a button.
• The age-old question of what might happen to Chinese ADRs.

This is a niche topic in some respects, but it could point the way for some broader developments that are coming to the financial markets, such as the introduction of central bank digital currencies and how these will allow governments to exercise total control over their citizens' financial assets.