Financial Markets: Increasing Complexity, Maintaining Stability

3–5 July 2019, ST. PETERSBURG

    The Bank of Russia proposes introducing new restrictions for private investors, limiting the list of instruments in which they may invest funds of individuals without experience and education

    The Bank of Russia is proposing to raise the requirements on qualified investors and introduce a new category of ‘professional investor’. This is mentioned in a speech (available to RBC) given by Mikhail Mamuta, head of the Bank of Russia Service for Protection of Financial Services Consumers and Minority Shareholders, at the XXV International Financial Congress in St. Petersburg.

    At the Central Bank, it is believed that investment risks cannot always be objectively evaluated by the investor. So the regulator is proposing to restrict the rights of unqualified investors to purchase ‘complex investment instruments’, including derivatives, and to prohibit them from concluding unsecured transactions (transactions using borrowed funds of the broker). They will be able to invest in derivatives and other risky instruments only with the help of an independent investment adviser. The regulator intends to require such an adviser to compensate the investor for any losses if it invested money in instruments with an unacceptable risk.

    At the end of June, the State Duma adopted, at the third reading, amendments to the law ‘On the Securities Market’, legalizing the status of investment advisor – brokers, management companies, financial consultants – those who make recommendations to clients on the stock market. They will have to join a self-regulating organisation and meet the qualification requirements set by the Central Bank. On Wednesday, June 29, however, the Council of the Federation rejected the amendments and returned the documents for reworking.

    The regulator also intends to make the investor qualification criteria more stringent. Private investors trading on the stock exchange may currently receive qualified status on the basis of a petition from a broker or management company if they have assets of at least RUB 6 million, a higher education in economics (or qualification certificate as a financial market specialist) or experience of working on the securities market. If one of these conditions is observed, the investor receive the possibility to work with a broader range of assets, such as foreign shares or units in closed trust funds and direct investment funds.

    “Compliance with one of the above criteria does not always guarantee the necessary level of understanding by such an investor of the characteristics, specifics and risk of financial instruments intended for qualified investors,” the Bank of Russia report states. For instance, just by making a single investment in securities to a specific sum, the investor may not acquire the necessary experience for concluding transactions with complex financial instruments. Moreover, the regulator notes, qualified investors are often recognised according to formal features and they simply place paper worth RUB 3 million in a client’s account, recognise him as a qualified investor and then withdraw the paper.

    For this reason, the regulator believes, in order to acquire qualified investor status, an individual should not only have substantial savings (RUB 6 million or more) but also experience of active trading on the stock market (at least 1 year) or a qualification certificate. Exceptions are private investors whose assets exceed RUB 12 million and income of RUB 4 million or more: they may be recognized as qualified investors without professional experience or specialised education. The asset restrictions do not apply to those who have worked in an investment company or have actively traded on the stock market for over two years.

    The Bank of Russia is also intending to introduce a new category for private investors: ‘professional investor’. This covers those who are prepared to invest from RUB 300 million (and have an annual income of RUB 10 million or more), or those who have actively traded on the stock market or held a leading position in a company working on the financial market, and have assets worth at least RUB 150 million. Professional investors will be released from the investment restrictions.

    President and Chairman of the Board of Directors of Finam Vladislav Kochetkov said that the proportion of qualified investors does not exceed 10% of all those trading on the stock market. “Yet they perform over 30% of all the operations, since they make use of gearing. This is a very valuable and profitable category of clients,” he said. In Mr. Kochetkov’s opinion, the Central Bank’s decision to change the current system for appraising investors will allow brokers to use a more flexible approach in assessing clients’ risk profiles: “We will be able to recognise as a qualified investor a client who has experience of trading on the market but savings of less than RUB 2 million.”

    Ultimately, Vladislav Kochetkov believes, a more flexible approach to appraising investors will make financial instruments more accessible for all categories of investor and trigger an inflow of private capital on to the stock market.

    “Qualification of private investors according to several criteria is usually applied on developed markets. The regulators made sure there were restrictions in place for people when complex, high risk products began to appear on the market. In this sense, by making the requirements more stringent, the Central Bank is following the same path,” says Oleg Chikhladze, Managing Director of BKS Broker. He notes that the regulator is endeavouring to reduce the risks people face. “Sale of risky products is profitable for the sales personnel of financial companies and banks, because the commission on them is higher than on standards bonds or shares,” Mr. Chikhladze explained. Consequently, according to him, if the new qualification requirements of the Central Bank come into effect, on the one hand this will raise the level of investor protection but, on the other, might squeeze the market for the sale of such products and reduce people’s interest in risky products.