Graham Stack in Kyiv -

The Ukrainian Exchange (UX) is only two years old, but already accounts for roughly three-quarters of total equity trading volumes, replacing the cumbersome former monopolist PFTS as Ukraine's main share trading platform. Its meteoric rise is the result of better technology and greater transparency, CEO Oleg Tkachenko tells bne.

Ukrainian stock prices soared in 2006-2007 as investors piled into the market, but the infrastructure on the main trading platform PFTS remained rudimentary - a quote-driven market only useful for handling low-liquidity stock, with market-makers determining prices but impairing transparency.

Tkachenko winces as he remembers the paperwork and time it took to conclude a trade on the old PFTS. "We could simply not continue like that. You have to remember, there was not even a real-time index. The PFTS index used to be calculated once a day on close of trading, which was the equivalent of taking the average temperature in a hospital."

"So the PFTS stagnated in terms of infrastructure development, market participants were increasingly unhappy, but the owners were not responsive to their complaints. At the same time, Russia's state-of-the-art RTS exchange was looking to expand into Ukraine seeing a lot of potential," recalls Tkachenko.

After RTS' initial attempts to buy the PFTS were rebuffed, in 2008 Ukrainian market participants clubbed together with the RTS to set up an entirely new and modern exchange based on RTS' Quik online system. As is the case with the RTS, market participants were co-owners. And in stark contrast to the antiquated PFTS system, RTS technology supported a modern order-driven market, transparent, anonymous and online, and also compatible with internet and futures trading

While the impulse for the new exchange came from the preceding years' stock market boom, ironically it was set up against the background of the post-Lehman collapse, which saw Ukraine's PFTS index fall into the abyss. But instead of spelling doom for the project, Ukraine's economic meltdown proved a boon for the new system, says Tkachenko. "All brokerages were badly hurt by the meltdown and a crisis of mistrust broke out on the market due to non-cleared trades, where parties to a trade failed to pay or to supply," he says.

But a guiding principle of UX has been that it would take responsibility for clearing and require 100% pre-depositing of cash and securities to cover all trades in advance. "We thus provided a solution to the problem of counter-party trust. We have now passed 600,000 trades, and not a single trade has failed to clear," says Tkachenko.

According to Dorian Foyil, owner of brokerage Foyil Capital, the new standards and ease of trading mean the exchange is attracting much more local money from private investors who used to invest in areas like real estate.

Within the first month, UX launched Ukraine's first online real-time index. "If you now look at the volatility within the course of a day, it seems unimaginable now to think of trading without seeing this," says Tkachenko.

The timing of UX's launch also proved to be successful in that it coincided with the start of the post-crash rally. "The rally of course wasn't caused by the launch of UX," jokes Tkachenko, "but it's worth noting that we launched the index on March 26 at 500, and by the end of the year it had reached just under 1,500 - i.e. over 190% growth."

Although the PFTS has since desperately tried to play catch-up with UX, launching an order-driven market two months later, by August 2009 UX already held the number-one spot in terms of volume of share trading "and became the centre of liquidity for share trading," according to Tkachenko.

Ukraine's stock market is still firmly in the frontier market category with total market capitalisation of around $60bn, compared with Poland's nearly $170bn. But Tkachenko firmly believes it now has the infrastructure in place for more sustainable development.

Look to the law

Tkachenko sees two fundamental problems confronting Ukraine's stock market: lack of demand and lack of supply. "Before the crisis, around 80% of trading volume was foreign investors, now it is well under 50%," he says. Tkachenko repeats the age-old cry for pension reform to finally bring "Ukrainian-based long money" to the exchange, but acknowledges this will be a good while coming.

Supply is also limited by the very small free float available on the market, says Tkachenko - the average free-float among blue chips is 8%. Engineering company Motor Sich with its nearly 34% free float is the leading light.

In terms of increasing supply, Tkachenko sees one opportunity and one risk. The opportunity could come from opening Ukraine's stock market to Ukrainian companies traded abroad, and consequently registered as foreign companies, although their assets are in Ukraine. "These included well-known brands such as MHP, Ferrexpo and Avangardco," says Tkachenko. "If these names were traded on Ukrainian exchanges, it would attract investors."

Tkachenko highlights Russian legislation requiring Russian companies placing shares on foreign stock markets to place 15% of the share issue volume domestically as well. This could require legislative changes - Tkachenko sees this happening before the end of 2010 in a best-case scenario.

The biggest risk to supply is also linked to legislation. While Tkachenko sees the 2008 law on joint stock companies - an attempt to bring Ukraine's corporate law closer to European models - as generally supportive of stock market development in Ukraine, an amendment to the law that passed its first reading in parliament in July could have potentially disastrous effects. The amendment introduces a squeeze-out option for shareholders with 95% or more of a company's stock. Given Ukraine's small average free float, the clause, if enacted, could have broad application. "This will inevitably deter investors in companies with a 5% free float or less, since they will fear that they could be forced to sell their shares at an unfavourable price if the market falls," says Tkachenko, who believes the amendment is backed by big business owners. Five of the 18 companies included in the index basket have free floats of only 5% or less.

While there is much hysteria in the air about Russian investors snapping up Ukrainian assets - in December 2009, Russia's other main exchange, Moscow Interbank Currency Exchange, or Micex, bought PFTS - investment of Russian stock exchanges in Ukraine has brought Ukraine's stock market into the 21st century. "RTS has contributed technology, expertise and experience," says Tkachenko, "and we are now expecting increased activity on the Ukrainian market of Russian brokerages and investors."