In March 2005, the IFC Technical Working Group on Securitization published its final report aimed at improving Russia’s legal and regulatory environment to support the development of a securitization market. The IFC Report discusses the legal environment in Russia and sets out proposed amendments to Russian law to facilitate securitization in the country.
The Russian Federal Service on Financial Markets (FSFM) has now prepared a number of draft laws that will amend existing legislation in order to facilitate securitization of assets in Russia (the Draft Laws). The proposed changes are intended to facilitate securitization of various assets, both in the domestic and international contexts, as well as generally to provide a more creditor-friendly environment for financing in Russia.
Aside from domestic mortgage securitization, this is the first substantial attempt to establish a legal framework for securitization in Russia. The Draft Laws are currently under consideration by various Russian regulators and it is likely that a number of changes will be introduced to improve the Draft Laws before they become law.
Unlike the IFC Report, the Draft Laws do not contemplate the adoption of a separate securitization law but rather provide for changes to existing laws including the Russian Civil Code, the Insolvency Law, the Banking Law, the Tax Code and certain other laws. The key proposed changes are summarised below.
Special Purpose Entity
The Draft Laws introduce a new corporate entity – the special finance company (spezializirovannoe finansovoe obshestvo, or SFC), which is incorporated in the form of a Russian joint-stock company set up specifically for the purchase of receivables and the issuance of bonds backed by such receivables as its principal activity. Any ancillary activity relating to the purchase of the receivables and the issuance of the bonds (including management, consultancy and accounting agreements) is also permitted. Any transactions outside the scope of the permitted activity do not create any liabilities for the parties. An SFC may not be reorganised and any voluntary liquidation is possible only once the bonds have been repaid in full.
The SFC cannot have staff and should be managed by a company having an FSFM licence to manage investment and non-state pension funds. Accounting responsibilities should be outsourced to a third party other than the management company.
There are a number of detailed requirements with which the SFC should comply. For example, the constituent documents of the SFC should indicate the total number of bond issuances for which the SFC is organised and this number may not be changed subsequently. The nominal amount of the bonds issued by an SFC may not exceed its charter capital by more than a factor of 20. The FSFM should also issue special regulations detailing the requirements for the structure and valuation of the assets that back the bonds issued by the SFC.
True Sale
Under Russian law, receivables can be transferred by way of an assignment or by way of factoring. The Draft Laws introduce certain changes to Chapter 43 of the Russian Civil Code regulating factoring, however, no changes have yet been proposed to Chapter 24 of the Russian Civil Code regulating assignments.
Factoring is subject to a separate legal regime and provides for a more securitization-friendly transfer mechanism. However, factoring can currently be used to sell only a limited type of receivables (i.e.receivables arising from the delivery of goods or rendering of services). Therefore, it is generally accepted that loans, mortgages and consumer credit receivables may not be transferred by way of factoring and the Draft Laws do not propose expanding the scope of the factoring regime to cover loans and other receivables. In addition, the uncertainty about the licensing of factoring activity in Russia has not yet been completely removed by the proposed changes. The key proposed changes include:
- The Draft Laws provide for the public registration of the factoring agreement. The state authority and the procedure for registration are to be determined by the Russian government. Registration is optional and, while failure to complete the registration would not render the factoring agreement or the receivables transfer invalid, a registered factoring agreement has priority over a non-registered agreement in the case of competing assignments;
- The Draft Laws clarify that a future receivable is transferred as of the moment it is originated, unless a later date is provided by the factoring agreement. In addition, they provide that other laws may provide for the transfer of a future receivable as of the date of the factoring agreement. Although no such ‘other laws’ have yet been proposed, this option may be particularly helpful in the context of future flow securitizations; and
- Proposed changes to set-off rights would enable the debtor to reduce its payment obligation by offsetting against the factor any claims that it has against the seller regardless of whether a notice of sale was given to the debtor. However, the set-off right can be prohibited in the underlying contract with the debtor (e.g. a goods sale and purchase agreement).
The Draft Laws also propose certain changes to Russian insolvency legislation in order to support a true sale, including a prohibition on invalidation of the transfer of the receivables in favour of an SFC or a closed unit investment fund if the sale (assignment or factoring):
- Has an executory element (e.g. the sale has not been completed and certain obligations remain outstanding); and
- Constitutes a preference provided that the bonds secured by such receivables have been publicly placed or are publicly traded and the nominal value of such receivables does not exceed the nominal value of the bonds by more than 20%.
Note, however, that no specific ‘safe harbour’ provisions have been proposed that would allow a sale (including a sale to the SFC) to be treated as a sale rather than as a secured loan.
Pledge of Receivables
The Draft Laws introduce a new paragraph into the Russian Civil Code specifically regulating pledges of rights (receivables). Some of the key changes, which would be helpful in the context of securitization include:
- Clarification that it is possible to pledge future receivables (both under existing and future contracts) as well as part of the receivables. A pledge of wholesale receivables is expressly recognised and the Draft Laws provide that the parties may identify such receivables by any generic description in the pledge agreement that allows identification of the pool, including by providing information on the type, term, underlying contracts and debtors;
- The pledgor will be required to notify the debtor in writing of the pledge of the receivable within seven days from the date of the agreement unless otherwise provided in the pledge agreement. Failure to notify would entitle the pledgee to accelerate the principal obligation (e.g. a loan provided to the pledgor). The Draft Laws also set forth certain requirements for the notice to the debtor;
- Unlike pledges over other assets, the pledge of the receivables can be enforced through a simple assignment (by operation of an agreement between the pledgor and the pledgee or by operation of law through court proceedings) rather than through a public auction; and
- Law No. 2872-1 of the Russian Federation ‘On Pledge‘ will cease to have effect once the Draft Laws come into effect. Some of the questionable requirements of that law, including the requirement to maintain a corporate pledge book recording all pledges, will no longer be an issue.
Pledge and Nominal Bank Accounts
The Draft Laws introduce two new types of accounts that may be helpful in the securitization context: a pledge bank account (zalogoviy schet) and a nominal bank account (nominalniy schet). A pledge bank account is specifically introduced to expressly allow pledges of bank accounts in Russia. Such an account may not be unilaterally closed by the pledgor without the consent of the pledgee. The pledge agreement may also impose limitations on the operation of the account by the pledgor. The bank account pledge can be enforced by the secured creditor simply by reducing the credit balance of the pledged account to satisfy its claims.
A nominal bank account is a bank account used for operations with funds belonging to a third party that is not the account-holder. The nominal account agreement should identify who is the beneficiary of the funds held in such an account. Operation of the nominal account may be restricted by the beneficiary of the account. Significantly, funds held in the nominal account would not be included in the bankruptcy estate of the account holder. This may be helpful in addressing the servicer commingling risk that currently exists in Russian securitizations. The Draft Laws expressly clarify that information in respect of pledge bank accounts and nominal bank accounts, including information that constitutes bank secrecy, may be provided to the secured creditor and the beneficiary respectively.
Tax Issues
The Draft Laws propose certain amendments to the Russian Tax Code to support the activity of the SFC and the tax treatment of the sale of the receivables. Importantly, any income received by the SFC in connection with its activity would be exempt from Russian profits tax.
The Draft Laws establish the procedure for determining the tax base for calculating VAT on the sale of receivables that are not subject to VAT (e.g.mortgage loans, car loans, consumer receivables). Essentially, the Draft Laws confirm the existing practice in which the tax base is defined as the difference between the income received from the sale of the receivables and the amount of the receivables. Therefore, where receivables are sold at par no adverse VAT consequences should arise. In addition, a VAT exemption on any sale of the receivables to the SFC is also under consideration.
Securities Law
The Draft Laws also introduce a number of changes to the Russian Securities Law to further develop Russian capital markets, including the possibility of subordination of different bond issuances, the introduction of a new concept of a “representative of bondholders” and the general meeting of bondholders, and the introduction of the concept of qualified investors (which include brokers, dealers, asset managers, banks, investment funds, insurance companies, etc.).