Russia's ambitious goal of transforming the country into a leading global financial center by 2020 has finally gained momentum. Among the recent measures aimed at radically improving the investment climate in Russia is the Federal Law on the Central Securities Depository (the CSD). The CSD is a fundamental institution that has been lacking from the Russian securities market infrastructure, and has been long anticipated by Russian and foreign investors. Once the CSD Law (as defined below) comes into full force on July 1, 2012, it should help allay the fears of many investors by ensuring the transparency and finality of settlement of transactions with certain Russian securities. However, there is still considerable confusion surrounding the new system as we will discuss in this article.
After almost a decade in the making, then-Russian President Dmitry Medvedev finally signed Federal Laws No. 414-FZ "On the Central Securities Depository" (the CSD Law) and No. 415-FZ "On Amendments to Laws in Connection with the Law on the Central Securities Depository" (the Law on Amendments) in December 2011 into Law. Most provisions of these laws came into force on January 1, 2012, with the remainder due to come into force on July 1, 2012, subject to several exceptions.
Moreover, the CSD will most likely meet the requirements of Rule 17f-7 of the United States Investment Company Act of 1940, as the CSD will not only be subject to independent annual audits of its records, but will also be required to undergo organizational audits and to ensure the transparency of its fees.
Establishment and Functions of the CSD
The CSD is a non-banking credit institution, to be formed as a joint-stock company, duly authorized to act as the CSD by the Federal Service for Financial Markets (the FSFM), the Russian securities regulator, on the basis of an implementing regulation that is being developed jointly by the FSFM and the Russian Ministry of Finance. The CSD Law sets out a list of requirements that a legal entity (existing depository) must comply with in order to be considered a candidate for CSD status. Among other requirements, a prospective CSD must have net assets of no less than RUB 4 billion and be duly licensed by the FSFM to act as a depository in the securities market, as well as a solid track record as a depository of no less than three (3) years. It is widely speculated in the Russian media that the primary contender for the CSD role is the settlement depository of the MICEX group (a leading Russian stock exchange), CJSC National Settlement Depository. It is anticipated that the regulation on granting CSD status will become effective this month, after which the FSFM will have four (4) months to review the applications. Accordingly, the market expects that the CSD will be created by the end of summer 2012.
According to the CSD Law, the CSD will have certain exclusive rights; in particular, it will be the only entity authorized to open depository accounts in the registers of securities owners of the following issuers:
Issuers that must disclose information under Article 30 of the Russian Federal Law "On the Securities Market" (Securities Market Law), i.e. almost all Russian public companies. These include issuers that have registered a securities prospectus and are, therefore, required to disclose certain information to the FSFM, their shareholders and the general public; and Issuers of "investment units" (for example, in a Russian investment fund), or the issuers of mortgage certificates, if these instruments may be traded on a stock exchange.
The CSD will have one (1) year from its foundation to become the nominee in the registers of these issuers. Thus, in effect, the CSD will become the only settlement organization for publicly traded Russian companies and investment funds in Russia. At the same time, it should also be noted that the CSD Law will not apply to all issuers of securities in Russia.
The creation of the CSD should radically improve and simplify the existing market structure where settlement is performed either directly on the books of the registrars of Russian issuers of securities acquired by investors in the OTC market and held through local custodians, or, in case of exchange transactions, settlement is performed through two settlement depositories: National Settlement Depository Closed Joint Stock Company (for trades on the MICEX) and Depository Clearing Company Closed Joint Stock Company (for trades on the RTS).
From July 1, 2012, the CSD Law will also allow for the creation of nominee accounts for global custodians, foreign brokers and foreign banks in the form of:
- foreign nominee holder (FNH) accounts, if a foreign organization is authorized to register and transfer rights to securities under its domestic legislation (i.e. foreign global custodians, custodians, banks and broker-dealers); and
- foreign authorized holder (FAH) accounts if a foreign organization is authorized to act in its own name on behalf of other persons under its domestic legislation (i.e. foreign trustees).
These changes will significantly improve the protection of foreign investors, as the current securities laws do not recognize foreign nominees, and therefore, global custodians and brokers are considered the ultimate owners of securities that they hold for their clients. In practice, this has meant that, for example, votes at shareholders meetings represented by shares held by custodians on behalf of foreign investors cannot be split to reflect different investors' views, since the custodian is obliged to vote with its entire stake. Also, investors that are expected to accumulate an aggregate of 25% or more in a Russian company through their custodian are obliged to apply to the Russian anti-monopoly authority, or make a mandatory tender offer to all remaining shareholders if the stake exceeds 30%, even though the investors' individual holdings may be well below the respective thresholds of 25% and 30%. Although, in practice, parties have tended to circumvent this requirement, the new law will resolve this inconsistency. Once foreign investors are allowed to open FNH and FAH accounts under the CSD Law, these and other obstacles to investing in Russian securities should clear up.
Further, the new laws are also widely expected to enhance the Russian federal bond market by allowing foreign investors to settle ruble bond trades through international clearing houses such as Euroclear and Clearstream, thus having a positive impact on the spreads between ruble-denominated federal debt and Eurobonds.
Significantly, the Law on Amendments introduces new disclosure obligations on foreign nominees. Specifically, as of January 1, 2013, foreign nominee holders of securities will be obliged to disclose information on their ultimate beneficiaries to:
- the CSD, and/or
- other Russian custodians, where foreign nominees have opened depo accounts.
It is not yet clear to what degree of ultimate ownership this disclosure must be made. The Law on Amendments is not specific on this point and the regulation on how and in what form this information needs to be provided has yet to be adopted by the FSFM.
Further, the same information on ultimate beneficiaries must be disclosed by foreign nominee holders of securities upon demand of a Russian issuer, courts, judges, the FSFM and/or enforcement agencies (investigators). This provision will come into legal effect on July 1, 2012.
Depository Receipts Programs
The CSD Law will also facilitate the creation of accounts in a special Depository Receipts Program. Specifically, the issuers of foreign securities that are derived from Russian securities (for example, various DR programs) (Institutional Issuers) will be allowed to open special depository program accounts with Russian depositaries, which, in turn, will be obliged to open nominee accounts with the CSD. The CSD Law requires Institutional Issuers to disclose the actual holders of depository receipts on a quarterly basis in a manner to be promulgated by the FSFM. Failure to comply with this disclosure obligation may result in the suspension of operations for the applicable depository program accounts. Institutional Issuers will also be obliged to disclose the holders of depository receipts on an ad hoc basis, in order to exercise the voting rights attached to the underlying securities and to receive dividends.
As mentioned above, the CSD will be subject to annual financial and operational audits. The CSD is also obliged to establish an internal oversight department, which will be responsible for regulatory compliance. In order to ensure transparency of operations and non-discriminatory treatment of its members, the CSD will be obliged to publicly disclose a number of its internal documents and regulations, including (but not limited to) its charter, audited year-end financial statements and the terms, conditions and fees for the CSD's services.
The Law on Amendments also implements a range of important changes to other Russian securities legislation, most notably by introducing the concept of a "transfer-agent" into the Law on the Securities Market. A number of revisions necessitated by the CSD Law are also being introduced in the Joint Stock Companies Law, the Law On Enforcement Proceedings and the Bankruptcy Law.
The new legislation is widely expected to improve the efficiency and increase the transparency of the Russian securities market. It should enhance liquidity, lower settlement costs and ensure that domestic broker-dealers and international investors are operating on the same post-trading platform and in the same fashion. Combined with the recent merger of the two leading Russian trading platforms – RTS and MICEX – there is a lot of enthusiasm that once the CSD is fully functional, it will improve the appeal of purchasing Russian-issued securities.
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