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Stuck owning sanctioned stocks
A year after Russia’s full-scale invasion of Ukraine, foreign pension holders and other investors are still left with ownership stakes in sanctioned Russian entities that they can’t get rid of.
Within days of Russia invading Ukraine, the Moscow Stock Exchange Index went into freefall, with some of the country’s most prominent international companies becoming junk stock overnight.
In response to the sudden sell-off, the exchange suspended trading the next day. Although some activity has since resumed, foreign investors are still banned from selling their shares.
The Financial Times estimated that non-Russian investors held about $170 billion in Russian stocks at the start of 2022. After a year of grim violence in Ukraine, the value of these shares has gone down substantially, but their ownership remains broadly the same. If you have a pension, there’s a good chance you still have Russian equities in your portfolio. Many of these will be companies sanctioned by the US and Europe, like state-owned oil giant Rosneft or Russia’s biggest lender, Sberbank.
A case in point is the Government Pension Fund of Norway. Also known as the Oil Fund, it carries around a quarter of a million dollars per Norwegian citizen and is one of the world’s largest pension pools.
Its investments in Russian companies were never large compared to other parts of its portfolio, but nonetheless, it still holds almost $300 million in Russian equities despite a commitment to divest made three days after the invasion.
The world’s largest asset managers find themselves in a similar bind. Despite both making commitments to divest, BlackRock and Vanguard — which manage money on behalf of tens of millions of pensioners and investors worldwide — have almost the same volume of Russian shares as they did at the start of 2022. The Bureau of Investigative Journalism took a closer look at BlackRock’s Russian holdings in May last year.
The major way in which foreign investors are exposed to Russian stocks is through passively-managed Exchange Traded Funds (ETFs), which track the performance of a basket of assets, often shares. In recent years, ETFs have become a hugely popular way to invest because they can be bought and sold quickly on exchanges and have lower fees than their actively managed counterparts.
In June 2022, BlackRock shuttered its two Russia focussed ETFs — iShares MSCI Eastern Europe Capped UCITS and the iShares MSCI Russia ADR/GDR. The funds had held $343 million in assets before the invasion, much of which had become untradeable.
BlackRock promised to return the cash it could to shareholders from the sale of non-Russian components in its Eastern European fund. It decided to hold on to the shares of Russian companies until a point at which trading resumes for foreign investors on the Moscow Stock Exchange.
Investors in Russia-focussed “synthetic” ETFs had no such option. These ETFs tracked derivatives based on Russian equities but had no claim on the underlying shares. When key indices shut down, there was no benchmark by which to calculate the price of derivatives. Shareholders in Invesco’s swaps-based RDXS ETF lost all their money when it closed following the Vienna Stock Exchange’s decision to stop calculating related Russian indices.
What’s ESG got to do with it?
Pension holders and retail investors sensitive to ESG risk have also been affected, and they might legitimately ask why their money was in the stocks of state-owned Russian companies in the first place. After all, Russia’s invasion of Ukraine was hardly the first time it broke international norms — its annexation of Crimea in 2014 and the wave of sanctions that followed could have been taken as a sign of things to come.
ESG ratings providers and asset managers took a strangely rose-tinted view of Russian firms in the months and years before the invasion. At the end of 2021, Sustainalytics and MSCI bumped up the ESG scores of the majority state-owned Russian lender Sberbank. A group of academics found that companies with Russian subsidiaries were on average given significantly higher ESG ratings than those without local activity.
The inclusion of Russia’s state-owned fossil fuel companies in ESG funds casts the ratings themselves in an even worse light, given the role these firms have in weaponising energy and extracting vast amounts of oil and gas, including from so-called “carbon bomb” projects.
Two of BlackRock’s ESG ETFs still have stakes in both Rosneft and Gazprom: the iShares EM IMI ESG Screened UCITS and the iShares ESG Aware MSCI EM. The iShares website describes its ESG Aware MSCI EM ETF as tracking “emerging market equities with positive environmental, social and governance characteristics”.
The bar for what counts as having “positive” environmental characteristics is somewhat low, only screening out those companies involved in the most polluting energy industries, such as thermal coal and oil sands.
Putting the E aside, it’s perhaps surprising that Rosneft wasn’t dropped from the iShares funds on the basis of the G for governance. For the last 12 years, the CEO has been a close ally of Putin, Igor Sechin, who was sanctioned by the US as far back as 2014.
It’s been documented elsewhere that ESG metrics have (so far) been a blunt instrument for directing capital away from fossil fuels to renewables, and Rosneft isn’t the only oil company you’ll find on the books of supposedly ESG-sensitive funds. But as retail investors and pension holders weigh both the financial and moral burden of having their cash locked in Russian fossil fuel companies after a year of war, those that thought they were putting their money into sustainable activities have every reason to ask what the point of ESG is.