Gazprom & Co: what to do with Russian ADRs?

Following the events of the past 2.5 months, anyone owning ADRs issued by Gazprom (ISIN US3682872078) is stuck with an investment that can no longer be traded on Western markets. The same holds true for any other Russian ADR or GDR.

Parties affected by this situation range from private investors with small holdings to pension funds who invested millions to benefit from high dividend yields. The investments that are currently "stuck" total in the tens of billions of dollars.

There has been a huge degree of uncertainty as to how the situation will evolve further and what investors can do at this stage – if anything.

I have been following the subject ever since the situation arose, since I had previously written about Gazprom ADRs as a promising long-term investment. Since the war in Ukraine broke out, I have used my network of readers and contacts to collect a lot of on-the-ground feedback. While I can't offer any iron-clad clarity either, some new information has emerged during the past week.

Here is a summary of the status quo, and which options ADR holders might be able to pursue going forward.

How it should work (in theory)

The delisting of ADRs (and GDRs) is almost certain to go ahead. Western bourses want to get rid of anything that gives them exposure to Russia, and the Russian government has mandated its domestic companies to delist from foreign markets. However, discussions are going on behind the scenes about some Russian companies asking the Russian government for an exception, including Norilsk Nickel and Gazprom. The Russian government is reportedly going to make a decision about these potential exceptions on 16 May 2022. In the absence of further details, it's difficult to say whether any of these exceptions have a chance of being granted. I'd keep expectations low given the overall political situation. There have been reports that the application of Gazprom has already been turned down and that of Norilsk Nickel has been approved, but details are hard to come by as yet. The base case is to expect that all of these ADRs and GDRs will come to an end.

The conversion of ADRs (and GDRs) to Russian shares should merely be an administrative matter, as ADRs and GDRs are not much more than repackaged shares. Depository receipts can always be converted into the underlying shares, and it should involve no 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 organisation.
• Those Western banks and brokers that previously offered custody for Russian stocks to allow their clients to trade in Moscow have stopped this service.

Based on the contracts that the ADRs and GDRs were based on, Western banks and brokers would now have to disclose the holders of the underlying shares to the NSD, and the NSD would then create a register of the foreign shareholders. However, in the absence of Western banks and brokers speaking with the NSD, this doesn't happen.

Internationally-minded Western banks and brokers, such as UniCredit, BNP, and Interactive Brokers, were among those who previously offered custody of Russian shares. From what I have been able to establish, none of these banks and brokers intend to offer trading in Moscow and custody of Russian stocks any longer.

One obvious way around this would normally be to open an online brokerage account in Russia, so that you could at least have the underlying shares transferred to a brokerage account held in your name. Reportedly, there are some brokers in Russia that have indicated their willingness to open accounts for foreigners and receive the shares were that to become necessary. I am currently researching which options there might be (and if you read till the end, you'll learn about a potential surprise candidate).

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

However, even if you did get an account in Russia, you would not be home free yet. If you are a citizen of a country that has taken a stance against Russia, you will be sanctioned; this would include not being allowed to exercise voting rights, collect dividends, or sell the stock, at least for the time being. The dividend will be held in trust for you (potentially, but not necessarily, limited to three years), but you can't get it booked into your account.

As you will have gathered by now, the intricacies of this are all rather difficult to follow.

Focussing on solutions, what are realistic options?

Speaking generally about all such ADRs rather than just Gazprom, the following seem to be the three options on the table:

1. Sell to anyone who makes a realistic tender offer

There have already been some public tender offers for ADRs of Gazprom, albeit involving someone offering a joke price (such as 1 cent). Even if someone accepted such an offer to simply get rid of their exposure, they'd still have to resolve the issue of clearing the sale.

However, sooner or later (and probably within the next few months), some kind of viable route should open up to sell the ADRs or GDRs to arbitrage players and settle the trade. I'd also expect that there will be a route to transfer potential ruble payments, e.g. through a transfer mechanism involving countries like China or Kazakhstan. I'd expect that Western or Russian hedge funds will find a way to make public tender offers for these securities. These offers would come with steep discounts compared to the price paid for these securities on the Moscow Stock Exchange. My handwaving guess would be a 50% discount. Such offers would offer a way to liquidate the position, if anything. It would not be a financially attractive one, but possibly a better one than to be forcible liquidated (see point 3) or to accept abusive offers of 1 cent.

2. Open a Russian brokerage account

If you have at least USD 30,000-50,000 worth of ADRs/GDRs and are not a US citizen, it could pay to go through the hassle of opening a Russian brokerage account. There'll be fees to be paid for translating and notarising documents, but for a position of such a size it will probably be worth it. There also remains the hurdle that it's not clear which Russian brokers – if any – will accept foreign clients at this stage, and if so, whether they exclude specific countries.

Maybe – and that's still a maybe – an altogether different option will open up. I had already alerted Undervalued-Shares.com Members to one such option, and its availability was confirmed (at least in theory) the evening before this Weekly Dispatch was published.

Gazprombank, the bank subsidiary of Gazprom, will offer foreigners an option to open an account that involves a reasonable procedure and level of costs.

The company has launched a website which states:

"If you do not have an account to receive the Shares, Gazprombank (www.gazprombank.ru/en) ... offers Depository Receipt (DR) holders who are non-residents of the Russian Federation to open a Type "C" securities account for receiving the Shares and a bank account Type "C" for crediting dividends paid on the Shares, following a simplified procedure.

To open a securities account, DR-holder being non-resident of the Russian Federation need to complete a client application (the "client application") (the client application form – an individual – a foreign national or a stateless person and the client application form – a legal entity, a foreign entity without establishing a legal entity are attached hereto).

After completing the client application, you should sign it, scan or photograph it and send the scanned copy or the photograph of the completed and signed client application to the following email address: [email protected]  

After the client application is accepted, you will have a Type "C" securities owner account for maintaining record of securities and a Type "C" bank account for crediting dividends paid on the Shares. The details of the Type "C" securities account and the Type "C" bank account opened with Gazprombank will be sent to the email address specified by you in the client application within 3 business days from the date of their opening."

Is this really going to work? The information is brand new and it will now have to be put to the test. There'll be potential hurdles to clear, including some Western banks and brokers refusing to deal with any of this (and instead leaving their customers stuck altogether).

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

The Russians do have a real opportunity to make a lot of Western investors happy; particularly those that are feeling fooled by claims such as of Deutsche Boerse that the trading stop of Russian ADRs was designed to "to protect investors". Will the Russian government and Gazprom (through Gazprombank) make use of this opportunity? I don't know, but it wouldn't surprise me at all. This is also a media war and Russia could engage in some first-class trolling of the financial sector. Quite importantly, it would also help to stabilise Russian stocks.

In any case, by opening a Russian brokerage account (whether with Gazprombank or another alternative), investors should get the option to simply sit through this period and wait for better days.

3. Forced liquidation by the ADR sponsors

The third option is the least attractive one. Unfortunately, it's got a significant likelihood of happening.

The depository providers behind the Gazprom ADRs are cancelling the ADR programme. By 3 August 2022, holders of ADRs need to decide if they want to receive the underlying Russian shares, and if so, where they can be transferred for custody.

If you cannot take the underlying shares, the depository will proceed to liquidate the shares and pay out the proceeds – at least, that's the theoretical course of action. Right now, foreigners aren't allowed to sell Russian shares, which means the depositories cannot proceed with the forced sale. If the rules changed and the depositories were able to liquidate the shares, they'd probably have to sell for a low price and/or accept rubles which in turn they currently cannot repatriate.

This option is probably the worst of all worlds and currently represents a real risk, unfortunately. Although indications so far are that it would take quite some time, i.e. this isn't likely to happen in the immediate future. In the meantime, much can change in the overall situation.

The bottom line

It appears that getting a Russian brokerage account will be crucial to protect your investment in Gazprom (or other Russian ADRs), but this is anything but straightforward and involves effort and expenses. So far, the option of setting up a limited securities account with Gazprombank through a simplified procedure seems the more promising route, and it may be expanded to cover other Russian ADRs and GDRs.

Much as there is currently no clarity on the subject, the entire issue seems to have edged forward somewhat over the past few weeks. I hear different stories from readers who have engaged with their banks and brokers; I recommend you make your own enquiries since it's nearly impossible to make any general statements.

All the while, Gazprom (and Russia) are making good money off the increased price of energy.

Source: Radio Free Europe/Radio Liberty, 28 April 2022.

Complex and unpleasant as this entire matter has become, I do wonder if these distortions will create new opportunities for investors. When an entire asset class becomes difficult to trade, intransparent and politically charged, it usually creates opportunities that later turn up in the history books of financial markets. I have started to jolt down ideas for a potential investment research trip to Russia, and found TREMENDOUS interest in such an undertaking. It is probably too early to invest in Russia, and a research trip might even conclude that there is nothing that can or should be done – but it'd be an interesting intellectual exercise and a great way to meet with readers, get a first-hand impression of the situation, and debate controversial subjects. If you are interested in joining such a trip, drop me a quick email (titled "Russia investment trip") and I'll contact you if or when this becomes a more concrete plan.

In the meantime, I'm doing the following:

• Monitor if any avenues for selling the depository receipts at a not-too-painful discount will open up.
• Keep my ears on the ground for possibilities to open a Russian brokerage account as a foreigner (without having to travel to Russia).

Undervalued-Shares.com Members will be the first to hear about any developments as soon as I've got some news.

Those who prefer to engage actual legal help for this matter can contact Grigory Marinichev at Morgan, Lewis & Bockuis in New York. As a subject matter expert, he is currently dealing with a large number of enquiries; he also gave an insightful, quite technical interview to German-language newspaper, Frankfurter Allgemeine Zeitung.

Russian ADRs and GDRs have become an interesting test case for issues such as:

• The reliability of custody of ANY security during times of political crisis.
• Governments' ability to essentially wipe out asset classes at the push of a button.
• The long-standing question of what could happen to Chinese ADRs.

It's a niche subject in some aspects, but it could show the way for some broader developments that are coming the way of financial markets, such as the introduction of Central Bank Digital Currencies and how these will enable governments to exert total control over their citizens' financial assets. In this entire context, you might also want to check back to last week's Weekly Dispatch: "Capital controls – a return to the 1970s?".

Needless to say, Undervalued-Shares.com will continue to report about such developments, both for readers of the free Weekly Dispatches and Undervalued-Shares.com Members.

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