Cash & Liquidity ManagementInvestment & FundingCapital MarketsRussian Securitisations: Just Around the Corner?

Russian Securitisations: Just Around the Corner?

Russia is on the verge of securitising domestic receivables. Russian banks in particular appear to be closest to reaping the benefits of this financing tool. But before Russian debts (as opposed to offshore debts) can be securitised, the country’s legal infrastructure first requires a certain amount of harmonisation if it is to accommodate with certainty all the legal relationships needed to make such a securitisation operate to investors’ satisfaction. In addition, the originators and SPVs involved will need to have climbed to an investment grade rating.

Deals currently under discussion

Russian exporters are accustomed to borrowing money against future export receivables, such as against income streams from the sale of oil and metals. Such loans charge interestrates of 12% above LIBOR, typical of competitive international borrowing rates. Receivable income is generated offshore from income from off-takers and the corporate majors that underpin the structure are considered safe bets even during economic crises.

Although the above type offundraising frameworkhaslong been in place, Western-style securitisation structures based on strictly Russian law debts have not proceeded beyond discussion stage. For example, it is reported that the bank Russky Standart is planning a securitisation with a rouble-denominated bond on the back of its domestic consumer debt portfolio. It remains to be seen whether this proposal is in fact achievable. Obstacles to this transaction will be ensuring its overall attractiveness to investors and effectively transferring eligible receivable assets that arise in Russia to a bankruptcy remote, taxneutral SPV, all essential features of a classic securitisation.

In contrast to the Russky Standart scenario, transactions proposed in the pastin Russia (see diagram) have concentrated on keeping as much of the securitisation structure as possible outside the Russian jurisdiction. They have proposed a licensed Russian bank acting as originator, which acquires receivables from offshore debtors and assigns them to an offshore SPVthat in turn issues asset backed securities (ABS) to foreign investors. Structures like this one were being analysed prior to the Russian financial crisis of August 1998 but were then aborted.

The Russky Standart proposal aside, securitisation deals that are now under discussion relate mostly to either offshore credit card receiptsor to domestic mortgage receipts. Rosbank and MDM Bankare evaluating the possibility of deriving ABS from credit card receipts incurred mostly by tourists visiting Russia and consequently owed by Visa to the Russian banks as the local Visa agent. This receivable would be assigned by the Russian banks to an offshore SPV. Such a structure would essentially replicate the arrangements set out in the diagram and will be ultimately based on the AAA rating enjoyed by Visa.

A new law on mortgages was passed in November 2003 and could create some, but it is suggested not all, of the legal foundations for mortgage-backed ABS. If achievable, a securitisation of mortgage payments would representan entirely new structure for securitisation in Russia as it would be derived from Russian-based debt. Some of the implications of this new law are discussed further below.

One of the reasons legislators are focusing on securitisation reform specifically in the area of mortgages is that Russian banks are probably one ofthe few categories of privileged originator that could make securitisation workin practice. Broadly speaking, this is because they have in place the necessary regulatory consents (essentially, hard currency approvals) as well as the necessary data collection and managementsystemson their debtportfoliosto provide the level of tailored information demanded by rating agencies.

Clearly, the commercial advantage to the Russian banking sector, which underlies in part the push to improve legal regulation of this field, will be the dramatic saving on interest rates for money borrowed. The conventional direct loan and corporate bond market is growing fast in Russia but because these corporate borrowers are located inside Russia they pay considerably more interest for a corporate loan than is typical on the international market. For example, the rate is often 5% or more above the interbank rate. If a securitised bond isallocated an AAA rating, interest could be charged at only 0.5% above the interbank rate.

What are the major hurdles to securitisation?

As indicated, Russian law currently presents structuring issues that will need to be resolved in connection with a securitised transaction, particularly for a cross-border securitisation in which a Russian originator holding Russian debt aims to underpin an arrangement where a foreign SPV issues ABS denominated in a currency other than roubles.

Methods of true sale

A core issue is determining the governing law of the receivables sale agreement and crucially whether Russian mandatory law (relating to assignment, bankruptcy law, tax law or otherwise) would interfere to undermine the true sale nature of the transfer. The law applicable to the transfer will depend on the nature of the receivable in question and the jurisdiction of each of the debtor, the originator and the SPV and requires analysis in terms of private international law. Where the transaction involves a Russian originator and Russian SPV, the transfer must be subject to Russian law. Where a transaction involves a Russian originator and an offshore SPV, the transfer may be made subject to foreign (ie, English) law.

The most likely available means of transferring receivables between an originator and an SPV is by assignment. The receivable debt will be a rouble-denominated debt, if it arises as a consequence of a contract entered into between a Russian debtor and a Russian originator. (It is almost impossible for a Russian debtor to remit payment for its debt to a Russian originator in foreign currency.) The rouble debt will therefore be subject to the Russian law on assignment.

Russian law on assignment raises a number of issues with regard to securitisation structure. Whether the assignment is legal and binding will dictate whether a true sale has occurred and whether a Russian debtor must recognise the assignment.

There are doubts under Russian law whether it is possible to assign future receivables. This is because, on a conservative view, the contract of assignment at the date it is signed must describe in writing in sufficient detail all rights to be transferred (including quantum) in the manner prescribed by mandatory Russian law.

The transfer of assets at a discount (for the purpose of covering funding costs) or with a deferred element (to cover overcollateralisation levels) risks challenge under Russian bankruptcy law if the amounts involved are significant. This is because a liquidator of the originator has the power to set aside transactions made at an undervalue.

Owing to the fact that Russian case law is insufficiently developed, doubts generally surround the area of assignment. The net adverse result of such lack of clarity is that, if the assignment/transfer is not correctly effected, there is a risk that it may be challenged by the debtor/liquidator of the originator. The transfer could be reduced to being the SPV’s unsecured contractual claim over the originator’s right to a third party receivable.

Russian law provides for factoring and this, it is tentatively suggested, could be explored as an alternative basis for transferring a future receivable. The use of a factoring arrangement to transfer assets would be complicated by the fact that the SPV would, under Russian law, be required to hold a factoring licence, unless it was a bank or other type of credit organisation. A further obstacle is that, at present, there exists no implementing legislation or commentary explaining the use in Russia of factoring schemes or indeed the procedure for obtaining a factoring licence.

Foreign exchange control

Individual currency transactions applying to each step within the securitisation structure will need to be analysed in the context of Russian currency exchange controls. Depending on the nature of each currency transaction that occurs in the chain, this regime may impose, among other things, mandatory hard currency conversion and account opening requirements. This is another reason why (as shown in the diagram) one realisable structure may be for the originator to be a Russian ‘authorised bank’, ie, a bank licensed by the Russian Central Bank, which enjoys certain privileges in relation to hard currency law. This, however, runs against the more typical assumption that securitisations are best when by-passing the requirement to insert a bank into the structure.

Another impact of the hard currency regime is that, where the SPV is offshore, it may be Russian-owned only where such investor has first obtained a Russian Central Bank licence, which is difficult to achieve in practice. Broadly speaking, a Russian may not hold shares in a foreign entity without such permission. This could operate to prevent any person who is associated with the originator from being a founder/controller of the SPV.

Jurisdiction of SPV

To consider a Russian SPV, the general point is that a Russian corporate SPV is unlikely, as yet, to receive a sufficiently high credit rating to issue a securitised bond. The character of an SPV as Russian will also affect in various ways its ability to perform its securitisation role in a manner considered typical in other jurisdictions. For example, Russian corporate law applies minimum equity capital rules in the context of bond issues. A guarantee (often used in a securitisation as an external credit enhancement) may permit the charter capital limitation to be exceeded but this has not so far been tested in the context of a securitisation.

A Russian SPV would not be exempt from Russian profit taxation despite the fact that gains realised on the sale of ABS are passed by the SPV on to the originator. Furthermore, for tax reasons, in other developed jurisdictions an entity known as a ‘grantor trust’ is frequently used because it does not generate tax at the trust level. However, in Russia, the trust concept is not developed. Both these issues could adversely affect the Russky Standart example mentioned above.

Regulatory issues

Under a standard form securitisation, the originator also acts as the service provider, acting as the entity which collects payments from debtors. It will be important to consider carefully how legally to separate assigned receivables from the originator’s other assets where the originator continues to manage their collection, given that escrow and similar account structures are problematic in Russia. It is not yet clear under Russian law whether, depending on the nature of the assets securitised, the originator could be required to obtain a business/financial licence to service those receivables.

New law on mortgage-backed securities

The new law on mortgages constitutes a leap forward for securitisation in Russia. It creates two possible types of securitisation structures, each with its own possibilities and (currently still) legal pitfalls. Each structure envisages a different type of issuer and a different type of corresponding security that is to be held by investors.

Under the first possible structure, mortgage ‘bonds’ are issued either by a bank or by a special mortgage lending agency. A mortgage bond is defined by the new law as a bond secured on a pool of mortgages which gives the bondholder all the rights of a mortgagee. The law addresses the true sale problem mentioned above in that it states that a right to demand payment under a mortgage may be transferred from a bank to a mortgage lending agency by assignment or other type of legal transfer.

If a bank itself (as opposed to the mortgage lending agency) is selected as the bond issuing vehicle under this structure, the new law still leaves investors having to deal with the potential risk of the insolvency of the issuing bank. Moreover, as the underlying assets will not be removed from the balance sheet of the issuing bank, the bank presumably would not be in a position to achieve certain advantageous tax and accounting treatment. Alternatively, if the mortgage lending agency were to be chosen as the bond issuing vehicle, it may be that this entity would not be considered to enjoy a sufficiently good standing to win the trust of investors.

Under the second possible structure presented by the new law, mortgage ‘certificates’ are issued to investors by an entity which must first hold a licence to manage investment funds. The investor that holds a mortgage certificate has a property right over the pool of mortgages, the right to receive payments from mortgagors and the right to have the pool managed by a trust management company. It seems that under this option the SPV could also act as trust manager of the mortgage pool or, alternatively, engage a third party (which would need to be licensed) to perform the role of trust manager.

In respect of both types of structures described in the new law, the bankruptcy implications of the structures proposed will need to be clearly addressed in Russian insolvency legislation as conflicts currently exist between the two regimes.

Conclusion

There is no shortage of suitable assets and cashflows in Russia. The country is probably about to enter a boom in consumer credit. Given this economic reality, all that is needed is the right support and encouragement for securitisation to emerge as a successful financing tool. Reliance on statute in this civil law jurisdiction, rather than case law precedent, means that, unfortunately, it may take a while to introduce the required changes in all the relevant legislation.

The new law on mortgage-backed securities should have the effect of jump-starting these required legislative refinements. A working group, formed in late 2002 to prepare a draft law specifically on securitisation of assets, is due to report. Amendments to the Russian Civil Code and to aspects of the investment fund and banking laws are under consideration. A ruling from the Russian tax authorities will also be required to formalise an appropriate accounting treatment, as well as to ensure neutral tax treatment of securitisation structures.

Ultimately, securitisation in Russia will only be possible when rating agencies allocate investment grade to securitised bonds. A precursor to this will be rating agencies becoming comfortable with the country’s macroeconomic reform process before the sovereign rating for Russia (a barometer for ratings allocated to securitised bonds) reaches the appropriate investment grade. The government’s foreign debt is currently rated Baa3 by Moody’s Investors Service, the lowest investment grade rating. Some predict a further significant upgrade may occur to the rating of sovereign debt after the presidential elections in March 2004.

Guy Grayson has a wide-ranging experience of international capital markets and corporate finance transactions derived from time spent in London, New York and Moscow.

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