Russian Federation: Russian Capital Markets Introduce A New Financial Instrument

Last Updated: 25 November 2008
Article by Roman Belenkov

In 2007, the Russian security market brought in a new financial instrument, Russian Depositary Receipts (RDRs), intended to attract investment. The idea of RDRs was announced in 1998, when the Federal Commission on Securities Market (predecessor of the Federal Financial Market Service of Russia) jointly with the Russian Central Bank and the Ministry of Finance, formed a working group for elaboration of a instrument similar to the American depositary receipt. However due to some instability in the political situation and a prolonged legislation reforming process, the project was postponed until 2004. Since then, the Russian legislator has worked on the draft law "On Amendments to the Federal Law "On the Securities Market", which was enacted and came into force as late as 2007 and set a legal basis for RDRs as a new type of registered security of no par value, representing the title over a certain number of underlying foreign shares/bonds of a particular class (or type) and entitling its holder to claim from the RDRs' issuer a corresponding number of securities and exercise of the rights, represented thereby.

To date, the launch of RDRs can be considered an appropriate innovation for the securities markets. There are two reasons. First, depositary receipts facilitate the market's structure, which the Russian market desperately requires. Second, the Russian capital markets are still overcoming negative consequences from the financial crisis of 2007. The crisis has had a direct impact on the Russian economy, and entailed stagnation forcing many domestic issuers to postpone or even cancel the placement of their securities scheduled for early 2008 in anticipation of the general stabilisation forecast by experts. Russian investors chose to wait for better times and not invest in financial instruments, preferring fixed-income state securities instead.

RDRs enable Russian investors to diversify their investments risks. They significantly expand the scope of investment opportunities and do not limit the choice merely to Russian issuers, providing the investor with protection against certain economic downturns. Given that Russian securities law prohibits a direct public circulation of foreign securities on local markets, previously investors had to purchase such securities abroad via their foreign-based affiliates, whereas now RDRs allow them to accomplish the same goals in a time and cost effective manner.

The launch of RDRs was initially intended for foreign companies spreading their financial interests to Russia, notably those from Central and Eastern Europe. Such companies are formally recognised by Russian law as non-residents, but actually exercise their principal activities in the Russian territory through numerous subsidiaries. The Russian capital markets can be also an attractive investment vehicle for CIS companies (companies of developing financial markets) without substantial presence in Russia due to the broader range of opportunities for their securities compared to local markets. Also, the RDR is viewed as a promising financial instrument by major Russian banks working with foreign companies. The issue of RDRs is interesting to the companies, as depositary receipts are already actively traded on stock markets abroad and have gained a good reputation. Following the issue of RDRs, these companies can strengthen their financial position and obtain additional liquidity in the Russian Federation.

It should be noted that the Russian regulator (FFMS) has simplified the issuance procedure for RDRs compared to other securities and has reduced the stages involved. There is no need to adopt a placement decision to issue RDRs, which has enabled foreign issuers to avoid holding meetings with an authorised managing body, thus resolving problems with the convention and arrangements of such meetings, which may be time and cost consuming for companies with numerous shareholdings.

The issuance of RDRs does include three stages: first, approval of the Issuance Decision by the authorised body of the depositary issuer; second, state registration of the RDRs issuance; and finally, placement of RDRs. An additional issue of RDRs does not require a separate state registration; the company can merely amend the original Issuance Decision to increase the maximum number of securities allowed for circulation. A traditional requirement of the Federal law "On securities market" for an obligatory completion of securities placement within a year is not applicable to the placement of RDRs placement, the term of which is unlimited. RDRs can be admitted to public circulation after their issue registration with the governmental bodies, whereas the additionally issued receipts can be admitted to trading following the state registration of the amendments to the original issuance decision.

Besides the general authorisation requirements applicable for the issue of RDRs, a foreign company is expected to demonstrate a sufficient income and cost efficiency level, maintain its short term liabilities at low rates (to prevent a default) and to ensure high liquidity of its securities already circulating in the market.

An issuer of RDRs is requested to prepare its financial statements in accordance with IFRS, regularly disclose certain information and establish contractual relationship with the local depositary, which are deemed to be the most significant costs and expenses within the process.

RDRs are expected to enhance the attractiveness of the Russian capital markets and have a positive impact on its development. The Russian economy enjoys macroeconomic stability and increasing domestic investment, stabilisation of the RUR liquidity and rising consumer demand. It is a fertile ground for the development of this new type of security, capable of bringing foreign issuers to the Russian market

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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