Russian stocks are 'essentially worthless' after the Ukraine invasion based on pricing in a key derivatives market, MSCI says

• Russian stocks are "essentially worthless" based on pricing in the credit default swaps market, according to MSCI.
• The disconnect between pricing in Moscow's stock exchange and the derivatives market is driven by trading restrictions for foreigners.
• Russian stocks could find redemption if the war against Ukraine ends and sanctions by Western countries are quickly lifted, MSCI said.

Russian stocks are "essentially worthless" despite the perceived value they hold on the Moscow stock exchange, MSCI said in a note on Thursday.

Since Russia's invasion of Ukraine, the Moscow Exchange plunged by as much as 44% before recovering a chunk of those losses. A combination of economic sanctions and reduced trading have crippled the Russian economy, though sky-high gas prices have helped Russia's oil exports business.

Still, Russian stocks are likely not worth their perceived values on the Moscow exchange, MSCI said, pointing to current pricing in the credit default swaps market. A CDS is a financial contract that allows investors to eliminate possible debt losses that would arise from the default of an issuer of bonds.

The five-year CDS probability of default for five of Russia's largest stocks has surged to more than 80% from a pre-war level of just 20%.

The disconnect between what the derivatives markets are pricing for Russian stocks and what the Moscow exchange currently trades at is driven by the fact that Russia restricted foreign investors' ability to trade Russian stocks.

"A basic explanation for the disconnect is that investors trading on one market are not trading on the other. Most foreigners are unable to trade Russian stocks, and CDS are only accessible to institutional investors," MSCI said.

Additionally, the disconnect in the derivatives market for Russian stocks could be driven by a combination of technical-default fear, failure of the underlying CDS auction mechanism, and restrictions on trading CDS linked to Russian companies that have been sanctioned, according to MSCI.

"Furthermore, impediments in making bond payments due to sanctions could trigger a technical default, where the firm is not actually bankrupt but is unable to pay coupons or principal for other reasons," MSCI explained.

That juxtaposition could be jarring for investors, as Russian companies may continue to generate revenue and pay dividends, which means they hold value for the small number of investors that can buy them, while a majority of global investors values the stocks at zero in the CDS market.

While MSCI highlights that Russian stocks are pretty much worthless today based on CDS pricing, there is still hope they can recover their value. That would likely be driven by Russia's ability to reopen its markets to global investors and reintegrate its economy into the global financial system For now, that scenario hinges on the country halting its invasion of Ukraine, and there is no indication that is imminent.