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We had one fundamental difference – an enormous well of trust

In an interview with Vedomosti, Ruben Vardanyan, Chairman of the Troika Dialog Group Board of Directors, discussed what moves he and his company’s clients have made in recent days, described the history of the crisis, and analyzed its causes and consequences.

Ruben Vardanyan Troika Dialog Manager

Date: 10 October 2008

Source: Vedomosti

In an interview with Vedomosti, Ruben Vardanyan, Chairman of the Troika Dialog Group Board of Directors, discussed what moves he and his company’s clients have made in recent days, described the history of the crisis, and analyzed its causes and consequences.

The financial crisis in Russia was first felt by the brokers. Russia’s largest broker managed to stay on its feet – even promising to pay out employee bonuses at year-end – but is not counting on any profits this year.

For the past two weeks, market participants have taken a grim outlook on Troika, thinking that the crisis will ruin the company. But the company has survived.

When did you realize that a crisis was inevitable?

In May, 2006, when we discussed Troika’s strategy for the next five years. Analyzing the situation on the market, we realized that it was not natural, and would not last for long. We did not know when the crisis would start, but we were sure that it would come before 2009. This was one of the reasons why we considered selling the company. One year ago, when the mortgage crisis in America had already started, it was obvious that the market was in a fever. We expected there to be occasional bankruptcies and problems with liquidity, but we did not expect a global, systemic crisis. The true severity of the situation became clear literally the day before the meeting between the Russian Union of Industrialists and Entrepreneurs and the President (September 8). I said at the meeting that the most important thing in a crisis is quick decision-making, and that the crisis would be far more serious than anyone thought at the time. But, even then, nobody could have imagined that the crisis would completely alter the face of the banking system, and that the global market would become entirely overestimated.

When did it become clear that the scale of the crisis was far more severe than it seemed from a distance? And why did it take the form that it did?

There are several interrelated reasons for this. The first one is that the crisis has been happening for a while. This is a very uncomfortable situation for all players involved. One year ago, when the subprime crisis began, it was clear that there were some bad assets, ones that were difficult to put a value on, but no one could have understood the full scope of the calamity. The banks that had fallen into difficult situations did not disclose information about themselves, resisting to the end, not wishing to admit they hand gone bankrupt. The second reason – which can’t be stressed enough – is everything that was purchased, especially what was purchased with leverage and complicating factors. A certain problem arose: how much does all this cost? A lot of instruments simply had no price at all. The third problem is regulation. How many times lately have you heard about the Securities and Exchange Commission making one decision or another? The whole time they were talking about the Federal Reserve and the Treasury (USA). So it suddenly became clear that the commission in charge of the stock market actually controlled very little. The regulator who was supposed to supervise (over the market participants) – checking, examining, punishing – turned out to be irrelevant to the matter. The main player and decision-maker on the stock market turned out to be the organ that handles money policy. It decided who to buy and who not to buy, who to give guarantees, while taking a totally different view on this problem (than the stock market regulator). In these conditions, decision-making was not systematic, but “reactionary,” made in response to everything happening. The first decision was not to help Lehman Brothers, in order to not give the signal that they will support everyone. The next decision was to help AIG, because the organization is so large that, without help, it could take down the whole market. As Lehman was tumbling – and this was a serious player – and then AIG, it became clear that the situation had slipped out of control. The choice was not between good and bad, market or non-market – a real fire had started. When there’s a fire, the first thing people save is either what’s in their hands or what’s most valuable. The system is already not functioning. Everyone is in a panic, running and shouting “Guards, fire!” The whole system tumbled. The crisis that happened in America was one of the trust shown toward the system of coordinators: toward the regulators, the rating agencies, the auditor, bank accountability, evaluation, what qualifies as a risk, what doesn’t. People lost more on AAA-rated bonds than they did on junk bonds. What, only now Lehman’s balance reaches this level, the volume of leverage wasn’t apparent before? What used to be considered sensible has all of a sudden become impossible. A situation has arisen in which people do not understand what is happening and do not know who to believe.

And what do you do in such a situation?

The majority of money circulating in the system is short, and it quickly turned into cash – money in accounts. This is a normal reaction. The result was a unique liquidity crisis. There is an enormous amount of money in the world. The liquidity crisis means that money is becoming scarce, and yet here we have an enormous volume of money – and a liquidity crisis.

And where is this money?

It turns out that the money has accumulated in different countries, among certain players, and within institutions like sovereign wealth funds and pension funds. Take a look at what is happening in our country. Lending rates (for inter-bank credit) were at 3–5%, while for repo – 22%. Although security deposits in repo agreements were in the form of securities. But when bonds from several of the major state-controlled companies offer yield of 18–30%, what is this – a risk estimate, that the given issuer will go bankrupt and the government will not fulfill its obligations? This is a crisis of trust in the system.


How is it that we ended up with a liquidity crisis? Russia just so happens to be one of the places where a mass of money has accumulated; we have sovereign funds…

First of all, we have basically no long-term financial investors, meaning that our market is strongly dependent upon international investors. While the crisis of trust was happening in the world, we experienced a surge (in quotes); in the II quarter, the RTS index was 2300 points, and many were thinking: prices on raw materials are growing, everything in Russia is fine… When everyone realized that the global crisis was continuing, mass panic set in – everything was for sale. Nothing mattered anymore; China fell, Russia fell, and only small, isolated countries were left standing. Large countries, like ours, were the first ones to face an outflow of capital. As soon as money started leaving, the second Russia-specific problem surfaced: we have quite a few speculators and market players who placed share blocks in order to continue buying assets. Major company shareholders – even the occasional minority shareholder – bought up these blocks, and then used them to buy into different projects. When the entire market started to drop, this system led to a domino effect: the greater the drops in price, the more margin calls you have, and the more you are forced to sell. And, with a small free float on a small market, the downward pressure becomes stronger and stronger…

They mortgaged blue chip blocks?

Blocks in their very own companies.

But not all of them are public companies. For example, UC Rusal is a private company.

True, it’s private. Nobody has seen the audits, but, most likely, Norilsk Nikel was also mortgaged by them (UC Rusal refuses to comment on the issue – Vedomosti), and, possibly, this is one of the reasons why the company dropped so far. Margin calls started, and the question was whether there would be enough money to fulfill all of them. Here is the root of Russia’s third problem. We have a very weak financial system. On the whole, it is undercapitalized, there are few major players, and, with the crisis, it once again proved itself flawed.


The repo market ended up between two structures. The Central Bank did not have entire control, because it is part of the stocks and bonds market: these are deals with a reverse buyback, and are not directly related to credit. In addition, not just the banks were working on this market. The Federal Financial Markets Service regulates it only in terms of legality – making sure everything is properly registered – but in no way having an impact on the level of liquidity it holds. There was no central player capable of becoming a counterpartner for everyone. Liquidity was provided by several major banks. As soon as they saw the increase in risk all over the world, they left the market, and the entire system shut down completely. The result was stunning: the Western banks, seeing that they had a lot of assets in security deposits and that margin calls had started, closed basically all of the (credit) lines to Russia; a large number of players suddenly had to put down money (and receive securities in return); major Russian players – the ones who provided the entire system with its money – stopped and took a look around; two of them had developed their own problems: KIT Finance and Sviaz Bank. The entire market simply fell into a stupor. A clot took shape. If this situation had not been stopped, it could have taken everyone out. These are the four factors that led to the outbreak of Russia’s most severe economic crisis – one without serious economic causes. Meanwhile, Russia continues to see economic growth. The level of debt and particularly the embededness of the stock market are insignificant. We have several accredited industries, but they were not the dominant ones. Less than one million accounts exist on the stock market, in a country of 142 million people. What was the problem with all of the government officials: the Government, the Prime Minister, and the President? They did not understand what the problem was about, whether it was just a small, separate market, bearing no direct relation to the economy. The (financial) system contains a lot of money, and the Central Bank has reserves that exceed all of the short-term credits (private sector), and the entire external debt. There are a number of statistics proving that the economic situation in Russia is stable.

So how did the crisis spread from a small, isolated market to the banking system?

It’s a question of transparency in the financial system. Everyone is spreading rumors. Everyone knew that some banks were taking money from the market and issuing long-term credit to their clients, money that went toward, for example, major, long-term construction projects or long-term investments. And they received stakes in the companies in return. This is a well-known, established practice. As soon as people started feeling that this is coming to an end, and that you can no longer be sure in your counterparty, everyone’s limits were frozen in order to prevent further harm. This is a normal reaction, to do nothing, stand still and watch. This is when inter-banks were stopped. Because one or two banks in Russia provide 80-90% of loans. If Sberbank leaves the market, this will be a serious hit to the entire banking system.


How did they manage to then save the market?

As always – the old-fashioned way. By hand, sitting all night. [the acting President of the MICEX Group, then Deputy Chairman of the Central Bank Konstantin] Korischenko, [the Director of the Open-Market Operations Department of the Central Bank Sergei] Shevtsov, [President of the MICEX Exchange Aleksei] Rybnikov sat down and started working out who owes how much to whom. Nobody could think of a different way. This is done by hand in the U.S. as well. This is both the strength and the weakness of Russia: we have only a few financial institutions, the (market) volume is rather small, and the two main exchange floors are the MICEX for repos and the RTS for futures. The regulators react quickly, able to accumulate information and manually look through it, sorting out who owes how much to whom. Plus, there was a quick decision to help the two troubled banks. Plus they stopped trading (on the exchanges). When they stopped trading on Wednesday, KIT and Sviaz Bank were in debt to 15 market participants. If trading had continued, this number would have expanded to 39. If trading had been stopped two days later, it would have been entirely impossible to unravel the repo market. However, in addition to the MICEX, which was possible to unravel, there was another market, where debts were invisible. And, as it turned out, we as well did not have a regulator who was able to say: “Everybody, the entire repo market on the table! Let’s look at the position everyone is in, how much capital is lacking, and what the debts are like.”

Who did they start with?

With KIT, the largest debtor on the market at the time.

Who coordinated this work? In Russia it is really difficult to do work with two agencies.

True, it’s difficult... There is a certain problem of complex agency relationships (between the Central Bank and the Federal Financial Markets Service), although they are a lot better than they were in previous years. I was not a witness to these meetings. At the first meeting with the FFMS, which was attended mostly by brokers, the topic was the need to restore the market. Rumors were rife that two of the key banks from the repo market were frozen. There was a certain danger that the banks would not be able to make their payments, and they were the major players, the ones supplying all the liquidity. The Central Bank was supposed to have accurate information about them. But nobody said: “We took a look, they have no problems,” or “They have problems, we are aware, we solved them, they were bought out by somebody.” Then there was a conference with [the President of Sberbank Herman] Gref. He turned out to be an active participant, using his authority to break through the wall of a certain underestimation of the crisis. Herman Oskarovich played one of the key roles in enabling major strides on the level of the Government, the Central Bank, and the FFMS. Troika played a certain role. I immediately returned from a business trip, attended all the meetings I was invited to, and tried to explain what was happening and what steps were necessary. It was important for all of the regulators to get together [First Vice Premier Igor] Shuvalov played a major role. He brought everyone together and tried, together with [Minister of Finances Aleksei] Kudrin, [Chairman of the Central Bank Sergei] Ignatiev, to understand what was happening.

The chain of repo deals was unraveled, but where is the guarantee that the crisis will not be repeated?

The market has now been reduced 3–4 times, and it is easier to work. The volume of operations was significantly reduced, and not a lot of money is needed. But it can’t go on like this for long, without a liquidity injection, the market will gradually wither away.


What was happening at Troika during this time?

Three things. First, we tried to participate as much as possible in unraveling this clot. We participated in hearings, prepared paperwork, met with market participants. Second, we actively communicated with our counterparties. The Western banks started closing our credit lines, just as they closed everyone else’s credit lines. But we had one fundamental difference – an enormous well of trust. It is quite simple. You establish trust over the years, and when the crisis comes, the trust begins working for you. We made use of these relationships that we built over years, which allowed us to make calls and say: “Don’t close the line, everything with us is fine, we are going to keep on working.” Sometimes decisions are made not at the formal level – by a risk committee – but rather by individuals in bank management who understand the situation. Several of the major banks stayed with us. Some of them made us a due diligence one year ago, and therefore knew Troika well. The third thing was working with the clients, who, clearly, were in a difficult state. Many of them lost money, and did not understand what was happening. We had to explain it to them. It was a very difficult time…

What was the volume of credit lines kept open to you?

I can say that six out of eleven banks closed our credit lines. This is quite a lot of money. Certain clients transferred money to us in this situation, rather than taking it away. This was a surprise for me: people made calls, reaffirming that they believe in Troika, and wish to support it.

Did you make use of these proposals?

Two clients made transfers, although I said that there was no need. They said: “Keep it for a while, no big deal.”

How much?

Two hundred twenty million dollars altogether. I was in shock.

What was Troika’s position during this time?

We have two separate volumes: our own positions and the customer business. The customer business was quite large – no less than 50 billion rubles over different instruments: futures, ADR… Our own trading positions made up approximately 20% of our own capital ($550 mln).

However, during this time, people – and not just any people – were certain that Troika had borrowed $300–500 mln from Sberbank.

Everyone was in a panic, and saw that I was speaking a lot with Mr. Gref. People have a hard time believing that in a time of collapse people can be involved with market problems, and not their own problems. I would like to say again: firmly and unequivocally (after every word knocking on the table.). Over all five days of the crisis we fulfilled virtually all of our obligations, with rare and minor incidents of 1–2 day delays. We did not face any specific conditions from anyone. Not from the Central Bank, not from Sberbank, with the exception of everything that was withdrawn as part of normal operations, and what was available to all the others when the situation was unraveled. I think that everyone was in a state of shock, because such a major player, a dominant player – we enter the top-three in all segments – was left standing. They understood how many losses there were, and, what’s more, how business was conducted. They probably thought that we should have suffered far greater losses. The most important thing is that Troika had practically no external borrowings, only a syndicated credit ($150 mln), and inter-banks not exceeding $100 mln. Our business model turned out to be correct, although, of course, it was not entirely free of mistakes.


What stage of the crisis are we at now?

The market is currently on life support; it comes to and then falls into a coma. The main questions now are how much time it will take to restore it, and whether this is even possible. Right now the main thing is to prevent a situation in which depositors begin withdrawing their money from the banks. Things will become clear close to year-end.

Who should regulate the repo market, and how?

It is necessary to determine who the regulator is, and what he can do. What are the capabilities for influencing the system. Not only from the point of view of sanctions, but also of support. This should happen under the transparency of all market players, who should produce regular documents showing accountability.

The repo market has been reduced and no longer represents a threat. Where else could a crisis break out?

There will not be a crisis like this one. At least not on the stock market. It is possible that companies will go bankrupt; for example, a large number of issuers of ruble bonds. But this kind of collapse, one in such a short period, will not occur on the stock market.

What other weak points are there?

All the players collapsed for different reasons. The market could be moved to London. Because of growth in the cost money, the efficiency of business may be reduced. Some clients will simply depart and will not be able to work. The number of instruments will be reduced, the free float will drop, some of the public companies will turn private, the number of defaults will increase. But none of this is deadly.

The government has set aside 500 bln rubles to buy “blue chips.” Is this worth doing?

If you look at the government as if it were a shareholder, this is definitely the right decision. The cost of securities – both stocks and bonds – of many companies in which the government is a leading shareholder is undervalued and bears no relationship to reality. However, if the government is a regulator, and an institute managing the country, they probably should not do this. Everyone believed in the invisible hand of Adam Smith, that the market should regulate itself. As it turns out, the market is not a regulator.

The first consequences

“At first, clean profit over three quarters totaled $220–250 mln. At the end of the year, after we have paid all bonuses, I will be happy if we break even,” Mr. Vardanyan confesses. He promises to pay Troika employees bonuses, even if the company balance is reduced. “Of course, the bonuses will be less than last year ($180 mln).” The plans for company development have already been reviewed, Mr. Vardanyan confirms. “For example, instead of 25 regional branches, we will open 5–7. Business will obviously be reduced, and there will be a lot of shifting around.”