Russian Federation: Regulation Of Derivatives And Repos In Russia

Last Updated: 16 February 2010

Article by Tamer Amara, Arthur Iliev and Alexander Anichkin

Introduction

This article discusses the recent amendments to a number of Russian laws (including the Securities Market Law, the Central Bank Law, the Private Pension Funds Law, etc.) that were signed into law on 25 November 2009 and will become effective on 1 January 2010.

These amendments are extensive and develop the legislative framework for the regulation of derivatives in Russia. In particular, the amendments introduce the definitions of a 'derivative' and a 'repo transaction' and clarify certain aspects of trading in derivatives with Russian counterparties.

For a discussion of the recent changes to Russian tax legislation, please refer to our publication entitled "Taxation of Derivatives and Transactions with Securities New Rules".

Background

In order to better assess the impact of the amendments, it is helpful to understand the regulation of derivatives and repos in Russia that existed before the forthcoming changes.

Apart from the occasional reference to derivatives and repos in the Russian Central Bank (the "CBR") regulations and a couple of sections in the Tax Code dealing with the taxation of derivatives and repos, historically one would struggle to find a reference to a derivative or a repo in Russian laws and regulations.

In February 2007, Article 1062 of the Russian Civil Code was amended to expressly provide for the enforceability of derivative transactions linked to commodities, securities, FX and interest rates, indexes and rates of inflation provided that at least one of the parties to such a transaction is an entity with a banking or professional market participant ("PMP") licence. It remains unclear whether the enforceability protection granted by this article would be limited to Russian entities only or whether it would also extend to foreign banks and PMPs.

In December 2007, the Securities Market Law was amended to include the concept of 'qualified investors' ("QIs"). An investor may be a QI either by operation of law1 ("QIs by operation of law") or be recognised as such if it satisfies certain qualitative and quantitative criteria (relating to own capital, assets, revenues, volume of trading in financial instruments, etc.) ("QIs by recognition") set out in the Securities Market Law and regulations of the Federal Financial Markets Service ("FFMS"). The determination of whether an investor is a QI is required to be made by a Russian broker or asset manager with respect either to a particular security or instrument or a portfolio of securities or instruments.

Further changes to the Securities Market Law were introduced in May 2009 and dealt with the offering of foreign securities and 'other financial instruments' (defined as cash- and, arguably, physically-settled derivatives linked to the underlying assets listed in the Civil Code) to QIs and non-QIs. In particular, paragraph 13 of Article 51.1 of the Securities Market Law established that 'foreign financial instruments' that have not been recognised as foreign securities (in accordance with the procedure set out in the Securities Market Law) may only be offered to, and may only be bought and sold by, QIs.

As the concept of 'foreign financial instruments' captured the majority of derivative instruments, the amendments introduced a degree of uncertainty as to how non-Russian entities should structure their derivative trades with Russian counterparties that are not QIs by operation of law. The resulting market practice varied, with certain institutions continuing to execute direct derivatives trades with Russian corporates that were recognised as QIs on the basis of standalone arrangements; others utilised more conservative structures interposing Russian brokers who performed the QI recognition and executed derivative trades on behalf and at the expense of Russian corporates (acting as their agent).

The Amendments

Regulation of Derivatives

Definition

The amendments introduce the concept of a 'derivative' (proizvodniy finansoviy instrument) which covers (a) transactions linked to commodities, securities, FX and interest rates, rates of inflation, derivatives and statistical information as well as weather and credit derivatives and other transactions where payments depend on the occurrence or non-occurrence of another event provided for in the legislation or FFMS regulations "the possibility of the occurrence of which is unknown"; (b) call and put options; and (c) transactions providing for the transfer of securities, cash or commodities to the other party not earlier than the third day after the trade date provided that the transaction documentation indicates that such a transaction is a derivative.

The new definition provides for an extended list of derivative transactions as compared to that in the Civil Code (thus expanding the range of transactions enjoying enforceability protection) and the previous version of the Securities Market Law and includes credit, weather and emission reduction-linked derivatives as well as trades that are linked to statistical information (which is presumably intended to cover transactions like mortality and longevity derivatives) and authorises the FFMS to expand that list of eligible underlying assets for the purposes of the definition.

The other important point to note is the definition might potentially extend to any forward transaction (providing for the delivery of securities, cash or commodities) that is settled on a T+3 or more basis thus affecting deliverable FX and securities forward transactions that are customarily entered into in the Russian domestic market. It is therefore important to ensure that the documentation (including master agreements) under which such deliverable transactions are executed expressly state that these transactions are not derivatives.

Master Agreement

Although the concept of a master (framework) agreement is contained in Russian law and master agreements were widely used in the Russian market, the Securities Market Law is amended to include express references to the possibility of documenting derivative transactions under master agreements which can now incorporate by reference the terms of standard form documentation adopted by self-regulating organisations ("SROs") in the securities markets that is published in the press or on the Internet (such as the standard documentation that was published by the Association of Russian Banks, NAUFOR and the National Foreign Exchange Association earlier this year).

Also, although the amendments go on to say that a master agreement may establish the grounds and the procedure of termination of all derivatives transactions concluded under that master agreement and establish the procedure of calculation of a single termination (close-out) amount to be paid by one party to the other, they do not refer or allow close-out netting (presumably to be covered by the netting legislation currently undergoing the approval of the Russian Parliament).

Exchange Traded Derivatives

The amendments allow exchange traded derivatives to be traded on (i) stock exchanges; and (b) commodity exchanges (but only with respect to derivatives specified in the Russian legislation on commodity exchanges). Exchange traded derivatives should be traded on the basis of FFMS regulations-compliant specifications and any amendments or additions to those specifications should also be registered with the FFMS. It is also worth noting that the Securities Market Law requires that the clearing organisation (house) must act as the central counterparty for exchange trading of derivatives (current market practice varies, with RTS Clearing Chamber being the central counterparty while the legal analysis with respect to MICEX is less clear).

Credit Derivatives

The amendments also establish certain limitations with respect to trading credit derivatives with Russian counterparties. In particular:

  • with respect to exchange traded credit derivatives, the Securities Market Law states that the seller of the credit protection must be a QI (either by operation of law or by recognition) and the buyer must be a legal entity; and
  • with respect to over-the-counter derivatives, credit protection can only be sold by a bank, a broker or a dealer and bought by legal entities.

Although the wording of the relevant provisions is not entirely clear, in practical terms, the restriction is likely to result in the prohibition of (a) credit default swaps with Russian corporates acting as sellers of credit protection and (b) arguably, sales of credit linked notes to Russian entities other than banks, brokers and dealers. There is also a risk that this restriction might affect the market for extinguishable (vanishing, cancellable) derivative products.

Trading with Russian Counterparties

The Securities Market Law is also amended to clarify the manner in which derivative transactions should be executed with Russian entities that are not QIs by operation of law. Article 51.4(7) states that derivatives intended for QIs can only be executed through brokers, with the exception of QIs by operation of law and cases established by the FFMS. The list of derivatives intended for QIs is established by the FFMS; however, the Securities Market Law also provides that foreign financial instruments that have not been registered with the FFMS (which would be the case with derivatives) can only be sold to, or bought by, QIs.

In light of the above, it is unclear how one should structure derivative trades between non-Russian entities and their Russian counterparties that are not QIs by operation of law. While it is now sufficiently clear that such a trade should involve at least one Russian broker (acting at the expense of the Russian counterparty), it is also possible to argue that both parties need to act through brokers.

Regulation of Repos

The amendments introduce new Article 51.3 of the Securities Market Law that includes the concept of a 'repo transaction'. The definition itself is quite extensive and deals with a number of important concepts incidental to cross-border repo transactions, including margining, substitution of purchased securities, payments of manufactured dividends, etc..

As is the case with derivatives, the Securities Market Law allows parties to conclude master repo agreements and incorporate the terms of published standard form repo agreements developed by SROs in the securities market. Master repo agreements may also establish the procedure of termination of all repo transactions following the occurrence of an event of default and establish the procedure of calculation of a single termination (close-out) amount.

Individuals may enter into repo agreements only through brokers and only if the counterparty is a broker, dealer, custodian, asset manager, clearing organisation or bank.

We also note that although any restrictions on the ability of the purchaser to dispose of the purchased securities would affect the true transfer of title analysis as a matter of English law, Russian law, on the contrary, expressly allows for such a possibility and goes on to say that any such restriction should be registered in the purchaser's custody account.

The introduction of the concept of a repo will result in the further reduction of the risk of recharacterisation of repo transactions into secured loans and establish a legislative backdrop against which the Russian repo market will continue to develop.

Conclusion

To recap, the key principal changes introduced by the new legislation are as follows:

  • expansion of the list of eligible transactions enjoying enforceability protection under Russian law (subject to the continuing uncertainty with respect to eligible counterparties);
  • introduction of restrictions on the ability of Russian corporates to enter into credit derivative transactions;
  • further clarification of structuring of cross-border derivative transactions between non-Russian entities and Russian counterparties that are not QIs by operation of law; and
  • incorporation of the concept of a 'repo transaction' into the Securities Market Law thereby reducing the recharacterisation risks.

However, as is usually the case in Russia, the wording of the amendments is not ideal and sometimes conflicting allowing for multiple interpretations. Also, the implementation of the new rules remains subject to FFMS regulations that are yet to be adopted and the practical application of these rules will, to a significant extent, depend on those regulations.

Footnote

1 The relevant definition includes Russian banks, brokers and dealers, fund managers, investment funds, private pension funds, asset managers, insurance companies, the CBR, Bank for Development Vnesheconombank (VEB), Russian Deposit Insurance Agency, supranational financial organisations, etc..

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions