Just over a year ago, so much foreign money was pouring into cheap Russian stocks that at least one Moscow brokerage executive thought investors had gone completely mad.


"I have never in my life seen people behave this way," he said, asking to remain anonymous. "It was the ugliest, most lemming-like mad rush I've ever seen, and it went on insanely until September 1994."


At that time registrars in far-flung regions had never encountered the term "nominee shareholder," and nobody had bothered to learn -- or spell out -- the rules of the game. The market was simply not equipped to support monthly inflows of as much as $500 million, and it came down with a thud.


"The boom never should have happened when it happened," said Bernard Sucher, managing director of brokerage Troika Dialog. "It came at a time when the market was wholly unprepared for it."


Investors were buying blind, and neither brokers nor government officials had a clear view of how to interpret existing legislation, particularly regarding payment issues.


According to Sucher, the mood of the spring and summer of 1994 was such that investors were willing to overlook details considered critical in other markets just to get hold of the undervalued stocks.


"Everyone was interested in things being to some degree easy," he said. "It became market practice very quickly -- just get the shares, hurry!"


Since then, the market has remained stagnant, still more than 40 percent below its value on the Moscow Times Index in September 1994, when the index was established to encourage transparency on the market. A lot, however, has changed.


As foreign investors hold back, training a watchful eye on the run-up to December's parliamentary elections, the infrastructure needed to draw serious cash to Russia is quietly being built. Its progress alone does not ensure another upturn in equities, but it does indicate that the next boom will be more easily sustainable.


"There has already been a real and necessary shift of emphasis to the side of developing and strengthening the capital markets infrastructure," Dmitry Vasilyev, deputy chairman of the Federal Commission on Securities and Capital Markets, said in a statement to The Moscow Times.


At the core of this push for infrastructure is the Professional Association of Stock Market Participants, known by its Russian acronym, Paufor. The group regulates over-the-counter equities trade among members and provides a centralized trading system. It works with other regulatory organizations, such as the Depository and Clearing Company, which settles share transactions and in turn may work with the new National Registry Company, which will maintain company registers and offer other registrar services.





Paufor blazes self-regulatory trail


Established in July 1994, when 15 brokerage houses banded together to tackle self-regulation, Paufor was for some time derided as a do-nothing club. But this year, Paufor has been growing fast, and is now 89 members strong. On Nov. 1 it launched the country's first, though still limited, stock market index to track real trades.


Paufor's greatest contribution to the market has been the Russian Trading System.


Launched in April, the RTS is based on the electronic Portal system developed by the U.S.-based National Association of Securities Dealers, for use by NASDAQ. Only Paufor members and some regional affiliates are permitted to use the system, which enables brokers to make firm online share price quotations. Actual trades are still done by telephone, but brokers are required to report each one to the system within 10 minutes.


The firm bids and offers -- the prices at which brokers are willing to buy or sell blocks of shares -- mean that participants are obliged to carry through with a trade at their announced price. This allows for better market transparency than before, when indicative quotations -- prices While acknowledging that in many ways the infrastructure here is still in its infancy, he expressed optimism about the pace of the Russian market's development.


"NASDAQ didn't have real-time trade reporting for its first 10 years," said Bob Riess, managing director of NASDAQ International Market Initiatives.


"I bet it takes Russia a lot less than 10 years for the market to develop in the same way," he said from Washington.


NASDAQ International Market Initiatives was founded in late 1993 to provide electronic and technical assistance in creating over-the-counter markets outside the U.S. It was established "just at the time that it became useful for projects going on in Russia," Riess said.


Also in the pipeline, Ponomaryov said, are plans to certify traders, making sure they are competent with the RTS and knowledgeable about trading rules and disciplinary procedures. The goal is, by the end of the year, to allow members access to the RTS only if at least two company traders have been certified.


In December 1994, the association formed its third-party arbitration court, and in April it adopted a third-party arbitration clause. Now all members must include this clause in any purchase-sales agreement with another member. It stipulates that any dispute must be referred to the court for settlement. The arbiters are either other Paufor members or professional lawyers.


The group also formed a disciplinary committee and adopted disciplinary procedures. According to Ponomaryov, the most serious breach of rules is refusing to conclude a transaction. He said there was one such incident in May, and immediately after that a rule was written forbidding that behavior.


"We need precedents," he said. "When something [like that] happens, we write a rule." The penalty for refusing to complete a transaction is revocation of RTS trading privileges, but the most serious punishment for Paufor members is expulsion from the association. That hasn't happened yet, Ponomaryov said.


The association has plans to establish a financial reporting committee, which will have two main purposes: to verify on a quarterly basis that all members meet the $100,000 capital requirement for membership, and to create its own accounting procedures for securities operations.


But perhaps Paufor's most ambitious undertaking is to expand into a nationwide association. Counterpart organizations exist in St. Petersburg, Yekaterinburg and Novosibirsk, with some members having access to the RTS.


"Since we have one national trading system, we would like to have one national set of rules," said Ponomaryov. "They have the right to establish rules, but sometimes the rules differ, and that is the basis for the union."


At a Nov. 10 meeting, basic principles of forming the All-Russian Association of Stock Market Participants were adopted. Under the declaration, only members of the new national organization who agree to make a minimum of three one-sided quotations, or one two-sided and one one-sided, will be permitted to trade on the RTS.


Paufor has been at the forefront of building the market's infrastructure, but its growth along with the sophistication of a number of other institutions has led Ruben Vardanian, its chairman, to hail 1995 as a benchmark year in the development of Russia's stock market infrastructure.


"I think 1995 will be a historic time for the securities market," said Vardanian, who is also the director of Troika Dialog and board member of the Depository and Clearing Company.





Settling, registration next in line


Improvements in settling and clearing operations, as well as the pending opening of a super share registry, ensure that the market will be better equipped to handle the next upswing, though these developments have been slower than Paufor's.


Other key organizations filling out the securities market infrastructure include the Depository and Clearing Company and the National Registry Company.


The DCC -- whose title for the moment is a misnomer, since it performs depository operations but not clearing -- has acted for most of its short life as a courier, flying to company registers to perform re-registration and confirmation services. Recently it began nominee shareholder services, registering shares in its name within one or two days, said Vardanian. It does not financially guarantee those shares.


A number of Western banking institutions -- such as Chase Manhattan and Morgan Grenfell -- also provide custody services for clients.


The DCC does not hold a Central Bank license for banking activities, and thus cannot alone provide delivery versus payment services.


In October, however, the DCC's board of directors was restructured to add five top banks to the existing five brokerages. One or more of these banks, or an outside bank, could be chosen to handle clearing for DCC shareholders before the end of the year, chairman of the board Konstantin Merzlikin said at a securities conference Thursday.


"Today the DCC is not part of monetary settlements, although the dream is to set up delivery versus payment," he said at the two-day conference, sponsored by the Adam Smith Institute. Delivery versus payment ensures simultaneous or near simultaneous delivery of both cash and shares.


The DCC's board now consists of Chase Manhattan, International Moscow Bank, Uneximbank, Sberbank and Vneshtorgbank on the banking side, and CentreInvest Securities, Grant Financial Services, IFC Moscow Partners, Rinaco-Plus and Troika Dialog on the brokerage side.


"We are waiting anxiously for developments at the DCC," George Schidlovsky, chief of operations at Renaissance Capital, told the conference. "Hopefully they will choose a shareholding bank to be a clearing bank."


Both the DCC and the RTS were developed with funding from the U.S. Agency for International Development and with assistance from international accounting and consulting firms.


A third organization rounding out the capital markets infrastructure is the National Registry Company. This aims to become the country's first national super-registrar, centralizing registers mostly here in Moscow, though it plans to open regional offices. Shareholders in the company are The Bank of New York International Stock Transfer Corporation, the International Finance Corporation, the European Bank for Reconstruction and Development, Uneximbank, and NIKoil, the company which maintains LUKoil's registrar.


The NRC has come under criticism for claiming to be an independent registrar, when it has ties with the LUKoil giant. But no single shareholder has a majority stake, said the NRC's president, Dimitry Schatiloff.


"There is no controlling entity within the organization," he said in an interview, adding that both NIKoil and Uneximbank intend to sell down their shares in the company, to further ensure "that public perception is correct."


The NRC's plans to be operational by mid-September were foiled by a prolonged process registering the entity as a closed joint-stock company. So far it has no clients, but company officials are "in the process of finalizing documentation on a couple of clients," Schatiloff said.


While eventually the NRC will offer other services, such as dissemination of corporate information and helping coordinate shareholders' meetings, its primary goal is to keep company registers under one roof, eliminating arduous trips across the country and ensuring independence.


Now, many Russian enterprises have either an in-house department which registers shares, or they work with an affiliated company, which could be a subsidiary of the company. These registrars have also charged hefty fees for their services.


Schatiloff told the conference that the independence of registrars is of paramount importance to investors.


"Since the registration of stocks is normally performed by issuers ... the most widespread problem now is lack of confidence in registrars," he said.





Equities key, legislation welcome


The stock market's sophistication is vital if the country is to experience another boom, as market players both here and abroad are faced with an increasing number of non-equity investment options.


Of special interest to foreign investors are government treasury bills, which have been offering returns of 100 percent or more and are less of a risk than the volatile stock market. It is unlikely that fixed-income instruments will replace the attraction of equities, but the development of the stock market will help convince foreigners to sink money into restructuring companies, instead of in government debt.


And while Russia has made great strides in the development of the equity infrastructure, a number of key issues need to be worked out before foreign investors feel confident about this market.


Foremost among them is legislation underpinning the changes of the last year. Ponomaryov said Paufor has the full backing of Vasilyev, but the commission has few teeth to take action against Paufor members who break the rules.


Paufor membership is not legally obligatory, as it is with the NASD, and expelled members may legally continue their trade, unlike in the United States.


Many questions will be answered when draft securities legislation currently before the State Duma is adopted. The bill was vetoed by President Boris Yeltsin in August, and with the holidays and the elections approaching, it is unlikely the legislation will be approved before the end of the year, and perhaps not until after the presidential election in June.


Even if passed, there is no guarantee the law will be as tough as market participants hope.


"As far as I know, according to this law on securities which is before the Duma, the ability of the Russian [Securities Commission] to take disciplinary measures against market participants is very, very limited," said Ponomaryov.


But with Paufor leading the way, the growth of these institutions vital to strengthening Russia's securities market has come with remarkable speed.


Sucher of Troika Dialog, who has nearly a decade of experience in emerging markets, called the pace at which the securities market infrastructure has developed here extraordinary.


"From a standing start, I've never seen anything go faster," he said. "It's extraordinary. It actually gets scary, it's so overwhelming."