Developments in the Russian Securities Market

This article was originally published in Baker & McKenzie’s Securitisation & Structured Capital Markets Newsletter – Edition 7, July 2008.

Russian legislation governing international securities and capital markets had not been substantially amended for some time until the Russian government stated that Moscow is to become a regional financial centre in due course. As a result, a number of changes to existing Russian legislation, including amendments to the Federal Law on the Securities Market dated 22 April 1996 have recently been announced or introduced. In particular, as a result of proposals made by the Federal Service for Financial Markets (the FSFM), there is movement towards opening the public Russian securities market to foreign securities. In addition, the introduction of the concept of a ‘qualified investor’ is a change that will allow the diversification of the securities market, generally aiming at admitting securities with ‘restricted circulation’ (e.g. riskier securities or those with a simplified registration procedure) into the market, while protecting unsophisticated investors from the risks associated with trading in these new classes of securities.

Opening the Russian Market to Foreign Securities

Unlike public trades, over-the-counter trades in foreign securities were not prohibited or otherwise regulated in Russia until the recent regulatory action by the FSFM. Therefore, Russian institutional investors, particularly since currency control liberalisation in July 2006, have traditionally conducted private trades in foreign securities with due regard to the prohibition on their initial offering and advertisement.

In December 2007, the FSFM adopted a Decree approving regulations on the qualification of foreign financial instruments as securities (the Decree)¹, which states that only foreign securities that qualify as securities in accordance with the Decree’s rules (i.e. have been assigned both ISIN² and CFI³ codes) could be privately circulated in Russia. The Decree was later amended⁴ and now allows unrestricted private trading in qualified foreign securities, as well as trading in non-qualifying foreign securities. However, trades in non-qualifying securities are restricted to ‘qualified investors’, a group of investors introduced by the Law on the Securities Market in December 2007 and discussed in further detail below. At the moment, the Decree’s main effect is to protect Russian investors that are not qualified investors from the risks related to trading in non-qualifying foreign securities (for instance ADRs and derivative instruments). Further changes to this regime are expected alongside amendments to the Law on the Securities Market allowing public trading in foreign securities meeting criteria also set out in the Law on the Securities Market.

Introduction of the Concept of ‘Qualified Investor’

Whilst this concept is not unfamiliar to western, in particular European, markets, and while there is agreement in general that differentiating amongst investors in Russia is useful, since being introduced into Russian law in December 2007 its implementation has been substantially criticised.

Article 51.2 of the Law on the Securities Market establishes two types of qualified investors: a ‘statutory’ qualified investor, where the qualification of the investor is provided for directly by law; and an ‘admitted’ qualified investor, where the qualification is regulated by subordinate regulations of the FSFM detailing the criteria for such qualification. Such subordinate regulations⁵ have been recently adopted by the FSFM, but have not yet been officially published therefore the date of their entry into force is still unknown. According to the draft of the subordinate regulations, a legal entity, in order to become an ‘admitted’ qualified investor, must meet any two of the following criteria (unless stricter criteria are adopted by the statutory qualified investor):

• Have own capital of not less than 100 million roubles (approx. US$4m),
• Have concluded not less than five transactions per quarter with securities or other financial instruments within the last four quarters, the aggregate value of which for such four quarters is not less than 3 million roubles (approx. US$125,000),
• Have a turnover from the realisation of goods (services) according to financial reporting for the last reported year of not less than 1 billion roubles (approx. US$40m),
• Have aggregate assets according to financial reporting for the last reported year of not less than 2 billion roubles (approx. US$80m).
• An individual may be admitted as a qualified investor if they meet any two of the following criteria (unless stricter criteria are adopted by the statutory qualified investor):
  • Holds securities or other financial instruments the aggregate value of which is not less than 3 million roubles (approx. US$125,000);
  • Has experience of working for a Russian or international organisation which has traded in securities or other financial instruments, for:
    • not less than one year, if such organisation is a statutory qualified investor in the securities market;
    • not less than three months if such organisation is a statutory qualified investor, and the individual is an employee of such organisation on the date on the individual’s admission as a qualified investor; or
    • not less than two years in other cases.
• Has concluded not less than 10 transactions per quarter with securities or other financial instruments within the last four quarters, where the aggregate value of such transactions within the last four quarters is not less than 300,000 roubles (approx. US$12,500), or has concluded not less than 10 transactions with securities or other financial instruments during the last three years, where the aggregate value of such transactions is not less than 3 million roubles (approx. US$125,000).

Statutory qualified investors will be responsible for maintaining the register of admitted qualified investors, for reporting on such registers to the FSFM, and will be subject to liability for the unfair admission of any person or legal entity as a qualified investor.
However, the concept of a qualified investor has little meaning in practice unless the law identifies securities that are restricted to circulation among such qualified investors. There is currently no definition of the concept of ‘restricted’ securities, neither in the Law on the Securities Market nor in subordinate regulations enacted by the FSFM. Therefore, only non-qualifying foreign securities (in accordance with the Decree as discussed above) and non-deliverable derivative instruments (if they are traded through a broker), are currently restricted from trading by persons other than qualified investors, as a result of a direct prohibition contained in the Law on the Securities Market.⁶

Funds for Qualified Investors

In December 2007, a change was introduced to Federal Law No. 156-FZ on Investment Funds dated 29 November 2001, which aimed to create a new type of investment fund – a fund for qualified investors that would be able to invest in ‘restricted’ securities and financial instruments. However, since the necessary subordinate regulations, including regulations of the FSFM regarding the contents and structure of such a fund’s assets, have not yet been enacted, the real impact of this legislative development on the Russian securities and funds market remains to be seen.

Further Steps to be Implemented

In order to continue the development of the Russian regulatory framework for securities markets in accordance with the trends discussed above, the following legislation would need to be implemented:

• The introduction of amendments to the Law on the Securities Market to allow public trading in foreign securities qualifying in accordance with the Decree, as discussed above. This major change to the securities law would also require amendments to be made to a number of existing FSFM regulations on the issuance and registration of securities, disclosure requirements and exchange trading requirements.
• Publication of the regulations adopted by the FSFM on the criteria for ‘qualified investors’.
• Adoption of regulations by the FSFM identifying which securities and financial instruments are limited to trading by qualified investors.
• Adoption of regulations by the FSFM on the contents and structure of funds for qualified investors.

All the above actions are expected to be taken in 2008, further ensuring the development of Moscow as a regional financial centre, as is the intention of the Russian government.