The Russian financial market is developing rapidly in both size and scope. This is a reflection of both Russia's intent to create an international financial centre in Moscow and the large flows of capital that have run through the country in the wake of high commodity prices. To keep pace with increasingly sophisticated transactions and market participants, the Russian government, with the assistance of its securities regulatory body, the Federal Service on Financial Markets (FSFM), has steadily introduced new laws and regulations. Although some of these laws and regulations require modification to meet the practical needs of business and the usefulness of others is limited due to uncertainty of application, an independent and competitive market for financial instruments is quickly evolving.
This article covers some of the most material legislative and regulatory changes of 2009 including: (i) changes in the offering of Russian issuers' shares abroad; (ii) the requirements to be recognised as a qualified investor; and (iii) the overhaul of derivative legislation.
Offering Russian securities abroad
Over the past decade, a lot of large and medium-sized Russian companies offered their equity securities abroad, including by listing on foreign stock exchanges. The London Stock Exchange has been the most popular, though Russian companies have also listed on the Deutsche Börse, NYSE, Nasdaq and others. Major reasons for offering securities abroad are deeper capital pools, which result in higher pricing, and higher liquidity.
The FSFM maintains a policy of promoting the domestic securities market and strives to limit the listing of Russian equities abroad. In the 2000s it started limiting the number of shares of a Russian entity that it can circulate abroad. Such limitations have increased over time. At present, circulation abroad is subject to restrictions in FSFM Order 09-21/pz-n "On Approval of Regulations Regarding Procedures for Granting Permission by the FSFM for Placement and/or Circulation of Securities of Russian Issuers Outside of the Russian Federation" (the Regulations), which came into force on January 1 2010.
The Regulations apply to securities issued directly by Russian entities and financial instruments and securities, such as depositary receipts, representing interests in the underlying Russian securities (together "Russian securities"). Companies wishing to place Russian securities abroad need to obtain prior consent from the FSFM. The Regulations do not apply to offshore vehicles holding shares in Russian companies or Russian assets. Although the FSFM has in the past expressed the view that foreign holding vehicles run counter to its policy of developing a more robust Russian securities market, it remains legal as a matter of Russian law.
Limitations on circulation abroad
The Regulations state that no more than 50% of any single offering, whether primary or secondary, of any class of securities may be made abroad. In addition, subject to the exceptions described below, the Regulations limit the overall level of securities of Russian issuers that may circulate abroad to no more than: (i) 25% of the charter capital of issuers on the A-level quotation list of a Russian stock exchange (the premium quotation list); (ii) 15% of the charter capital of issuers on a B-level quotation list; and (iii) 5% of the charter capital of issuers on either a V-level or I-level quotation list.
However, if a depositary or another issuer of the instruments or securities representing interests in Russian securities is incorporated in a jurisdiction whose securities regulator has a cooperation agreement with the FSFM, the Regulations allow circulation abroad of up to 25% of the charter capital even if the Russian issuer has a B, V or I-level listing. As of the date of this article, the FSFM has signed cooperation agreements with the regulators in France, Oman, Syria, Venezuela, Germany, Cyprus, China, the United Arab Emirates, Brazil, India, Belarus, Turkey and Kyrgyzstan. Since none of the companies that usually act as depositaries for depositary receipt programmes is incorporated in these jurisdictions, it would be difficult to use this exemption in practice.
Special rules apply to strategic sub-soil companies. The Regulations limit circulation of their securities abroad to no more than 5% of their charter capital. However, if a strategic sub-soil company receives approval in accordance with the Russian Strategic Investments Law, the FSFM will permit circulation abroad of up to 25% of its charter capital. Though not specifically provided for in the Regulations, we take the view that the limitations associated with a share class's quotation list level discussed above apply here as well. Thus, even with permission from the FSFM and approval in accordance with the Strategic Investments Law, a strategic sub-soil company listed on the B-level quotation list may offer only 15% of its shares abroad.
Recognition of qualified investors
In 2007 the concept of a qualified investor was introduced into the Russian regulatory scheme. As further discussed below, its importance increased in 2009 upon implementation of restrictions on the offer and sale of certain securities and other financial instruments to non-qualified investors. At the same time, new procedures were put into place requiring execution of transactions by certain qualified investors only through Russian brokers.
Types of qualified investors
Russian law divides qualified investors into: (i) investors designated as qualified investors by law and (ii) investors certified as qualified investors by Russian brokers or asset managers in accordance with the procedures set out in the law. So-called designated qualified investors comprise mostly Russian entities including Russian brokers, dealers, asset and fund managers, credit organisations, joint-stock investment funds, insurance companies, non-state pension funds, the Central Bank of Russia, Vnesheconombank, the State Corporation Deposit Insurance Agency and the Russian Corporation of Nanotechnologies. In addition, the law designates as qualified investors certain non-Russian international financial organisations including the World Bank and the International Monetary Fund. Other non-Russian entities, including foreign brokers, dealers, asset and fund managers, fall into the second category and must be certified as qualified investors in order to engage in transactions reserved for qualified investors in Russia.
On December 21 2009 the FSFM published for public comment a draft order that introduces the concept of a regulated foreign company for foreign licensed broker-dealers and market intermediaries. The draft order proposes to exempt regulated foreign companies from the requirement that execution of transactions with securities and derivatives reserved for qualified investors may be done only through Russian brokers. However, since the draft order goes beyond specific provisions in the Securities Markets Law, should the draft order be adopted in its current form the effectiveness of such an exemption would be doubtful.
Certification procedure
FSFM Order 08-12/pz-n On Approval of Regulation on Procedure of Certification as a Qualified Investor, which came into force on May 23 2008, sets out the eligibility criteria for investors to allow a broker or asset manager to certify them as qualified investors. The order allows Russian brokers and asset managers to establish additional requirements for recognition at their own discretion, but in practice they have declined to do so.
Currently legal entities seeking certification as qualified investors must comply with any two of the following requirements:
1. Meet minimum capital requirements of R100 million ($3.3 million);
2. Execute not less than five securities or derivative transactions each quarter within the last four quarters totalling not less than R3 million;
3. Have revenue of not less than R1 billion ($33.7 million) in the last financial year;
4. Possess assets, as set out in the previous year's financial statements, of not less than R2 billion.
Once certified, the investors must demonstrate that they continue to satisfy the eligibility criteria on an annual basis. In addition, certification extends only to the specific services, securities or financial instruments as determined at the time of certification. In contrast, designated qualified investors automatically qualify to deal in all services, securities and financial instruments designated for qualified investors.
Reliance by third parties
The law is unclear on whether a person may rely on a third-party's certification of a qualified investor. Unofficially the FSFM takes the view that Russian brokers and asset managers should qualify each investor in accordance with their own procedures. This uncertainty in the law creates problems for parties who are not allowed to certify qualified investors themselves. Depositaries, for example, are forbidden to transfer certain securities to non-qualified investors and must therefore rely on third-party certification of qualified investors when registering a transfer of such securities.
This problem is compounded by the fact that Russian brokers and asset managers are reluctant to risk liability for improper certification and as a result to allow third parties to rely on their certification of qualified investors. Investors improperly certified as qualified investors may put the securities back to the broker or, in the case of an asset manager, require that the securities be sold to a third party, and recover from the broker or asset manager any losses. To reduce their risk profile Russian brokers and asset managers tend to limit certification only to transactions qualified investors undertake with the certifying broker/asset manager and its affiliates or certify investors for each separate transaction.
Offering restrictions
In addition to limiting certain transactions only to qualified investors, the new legislation prohibits offering in any form and by any means to persons who are not qualified investors certain financial instruments and securities. These include foreign securities that have not been admitted to public circulation in Russia and foreign financial instruments that are not qualified as securities through a special procedure that the FSFM oversees. When dealing in such securities and foreign financial instruments, certified qualified investors must trade through Russian brokers. Designated qualified investors, on the other hand, are not required to use a Russian broker.
Derivative transactions
Federal Law 281-FZ On Amendment of Part One and Part Two of the Tax Code of the Russian Federation and Certain Legislative Acts of the Russian Federation (the Amendment Law) amends a number of existing laws (including the Securities Markets Law, the Tax Code, the Law on the Central Bank and the Law on Pension Funds) to clarify the regulation of derivative transactions and introduce changes to their taxation. Except as noted, the portions of the Amendment Law discussed below became effective on January 1 2010.
Definition of derivative transactions
Although the Russian Civil Code, the Securities Markets Law and the Law on Commodity Exchange have long referred to derivatives, prior to the adoption of the Amendment Law derivative transactions were not clearly defined.
The Amendment Law addressed this problem by introducing into the Securities Markets Law a definition of derivative transactions (proizvodnie finansovie instrumenty) that includes:
1. Transactions linked to commodities, securities, foreign exchange rates, interest rates, indexes of inflation, derivatives and other conditional triggering events;
2. Call options and put options; and
3. Obligations to deliver securities, currency or commodities not earlier than three days after making the agreement.
In addition to introducing a working definition of derivative transactions, the Amendment Law granted the FSFM rulemaking authority for the regulation of derivatives. The FSFM recently used this authority to publish a draft rule that classifies assets, rates and indexes to which derivatives are linked as underlying assets and states that a derivative may be linked to one or several underlying assets. The rule also identifies options, futures, exchange forwards and swap agreements as derivatives. Commentators from the FSFM have indicated that, as drafted, the list of derivatives is not meant to be exhaustive.
Master agreements for derivatives
The Amendment Law provides that parties may enter into both master agreements that employ standard terms (such as the Isda Master Agreement) and bespoke agreements drafted to meet the special needs of the parties. Standard documentation for the Russian market was recently jointly published by the National Association of Securities Market Participants (NAUFOR), the Association of Russian Banks (ARB) and the National Foreign Exchange Association.
Master agreements may include a provision for determining the close-out sum payable at the termination of multiple transactions. The Amendment Law does not, however, cover close-out netting as is common in the US and western Europe. As a result, in a bankruptcy a party may be required to pay the bankrupt counterparty monies owed under a derivatives contract without the benefit of offset against amounts owed it. A draft law intended to fix this problem was submitted to the State Duma and passed first reading in June 2009 but has yet to become law.
Credit derivatives
The Amendment Law provides that trading in credit derivatives on Russian stock exchanges may take place if (i) both parties to the transaction are members of the exchange; (ii) the seller of the credit derivative is both a legal entity and a qualified investor; and (iii) the acquirer of the credit derivative is a legal entity. If the trade is over-the-counter, the seller of the credit derivative must be a credit institution, a broker or a dealer and the counterparty must be a legal entity.
Exchange-traded derivatives
With effect from July 1 2010, transactions in exchange-traded derivatives will only be possible if the clearing organisation responsible for settling trades for the exchange acts as a market maker. Under the Amendment Law, exchange-traded derivatives may be traded on both stock exchanges and commodity exchanges.
Derivatives containing a foreign element
The Amendment Law is silent as to whether derivatives containing a foreign element (derivatives made with a foreign counterparty, linked to a foreign security or financial instrument or governed by foreign law) are considered foreign financial instruments. As discussed above, transactions in foreign financial instruments may be undertaken only by qualified investors. Pending further clarification from the FSFM we take the view that investors should be certified as a qualified investor and use a Russian broker to execute trades involving derivatives containing a foreign element.
Potential compliance issues
As a result of changes introduced by the Amendment Law, derivative trading now falls within the definition of brokerage activity for regulatory purposes. This triggers an obligation for brokers to include derivative transactions on reports which they submit to the FSFM. The form prescribed for these reports does not contemplate reporting derivative transactions other than derivative transactions in options and futures. Fearing negative consequences for failure to comply with their reporting requirements, some brokers have opted not to participate in non-options or futures derivative transactions until amendments to the regulations prescribing new reporting forms are in place.
Taxation of derivatives
The Amendment Law substantially revises provisions in the Tax Code relating to derivatives. While some of the revisions are technical and aimed at clarifying existing rules such as those relating to VAT, others introduce material changes into the law – particularly in relation to tax on corporate profits and tax on personal income. In addition, the Amendment Law removed the definition of derivative from the Tax Code and defined it by reference to the definition introduced into the Securities Markets Law.
One of the biggest changes was made in relation to the deductibility of derivative-related expenses. Previously, the law did not limit the deductibility of losses from derivatives governed by non-enforceable contracts under Russian law. The new law, however, clearly states that such losses are not deductible for purposes of tax on corporate profits. While derivative agreements concluded prior to July 1 2009 are exempt from this restriction, going forward it is doubly important for parties to ensure that their derivatives contracts are properly structured to ensure they are enforceable under Russian law so that losses can be deducted.
An important clarification relates to the proper treatment of non-delivery transactions. Under Russian law, it has long been the case that a company may, in accordance with its tax accounting policy, elect to treat a delivery transaction either (i) under the special tax rules applicable to derivatives or (ii) under the general tax regime applicable to supply agreements with deferred delivery. It was unclear, however, whether the same treatment applied to non-delivery transactions. The Amendment Law clarifies that in the case of non-delivery transactions companies have no choice and must simply apply the special rules governing derivatives.
Another clarification related to language previously used in the Tax Code that raised concerns about whether employing set-off (netting) in derivatives would disqualify the transactions from being treated as derivatives for tax purposes. The Amendment Law has clarified it is proper to treat derivatives employing set-off as derivatives for tax purposes.
Finally, although under the previous rules, some derivatives were subject to periodic revaluation due to certain price fluctuations, the Amendment Law states that it is no longer necessary to revalue derivatives if they were entered into after July 1 2009.
Tax on personal income
Under the Amendment Law, individuals may now carry losses arising from trading in listed derivatives (as well as other listed securities) forward for 10 years. Though a relatively small amount of individuals engage in derivatives trading, the change in law is expected to attract more in the long term.
| Author biographies |
 |
Evgeny Zelensky
Herbert Smith
Evgeny Zelensky is a partner at Herbert Smith in Moscow where he specialises in corporate law (including M&A, joint ventures and corporate restructurings), capital markets and securities regulation. In 2009 the Guide to the World's Leading Capital Markets Lawyers named Zelensky one of the 10 best lawyers advising on capital markets law in Russia. He has worked on many of the biggest capital markets transactions in Russia, which has resulted in significant experience in IPOs and private placements of corporate securities and interests in investment funds. He also serves as a legal expert on the advisory council of the Civic Chamber of the Russian Federation. Zelensky received a Juris Doctor degree from Notre Dame Law School in the US. Prior to joining Herbert Smith he served as the co-head of the legal and compliance department at a leading emerging markets investment bank.
|
 |
Oleg Konnov
Herbert Smith
Oleg Konnov is a partner at Herbert Smith in Moscow where he advises foreign and local companies, including international tax treaty analysis and OECD guidelines. Konnov has represented clients at all stages of disputes with tax authorities, including tax audits, administrative and court appeals against decisions rendered by tax inspections or the tax police. He is a frequent writer on international and domestic taxation matters for journals and other publications.
|