Baker & McKenzie: New Legislation on Derivatives and Repos

 

The Russian legislation regulating the taxation of derivative financial instruments and trading in them as well as in repo contracts has been changed by Federal Law No. 281-FZ of November 25, 2009 "On Amendments to Parts One and Two of the Tax Code of Russian Federation and Certain Legislative Acts of Russia" (the "Amendments").

The taxation changes were dealt with in the Legal Alert entitled "Tax Reforms Towards the Creation of an International Financial Centre in Russia", which was circulated by the Moscow office of Baker & McKenzie on February 16, 2010. In this Legal Alert, we discuss the other changes made to the "Certain Legislative Acts of Russia".

 

1) Derivative instruments

a) Rules for stock exchange/OTC trading in derivative instruments

According to the Amendments, trading derivative financial instruments ("derivative instruments") on stock exchanges has to be carried out through central clearing, and one of the parties to such trades has to be a clearing organization. Derivative instruments that involve an obligation to pay money in case of non-performance by a legal, municipal, or state entity (typically referred to as credit default swaps) may be traded outside a stock exchange only if the entity obliged to pay is a qualified investor, and the recipient of such payments is a legal entity. Both types of qualified investors (see the more detailed definitions below) in Russia can be parties to this type of transaction. A transaction concluded in violation of the above rules is deemed invalid.

Apart from stock exchange trades, under art. 1062 of the RF Civil Code, derivative instruments shall only be enforced by Russian courts if one party is either a bank or a professional participant in the securities market (i.e., a broker).

b) Foreign derivative instruments

The Amendments define a derivative instrument as one of two types of financial instrument, the other being a security. Under Article 51.1.13 of the RF Securities Law, the offering of foreign financial instruments to Russian residents who are not qualified investors is not permitted. While there is no guidance with regard to how to determine whether a financial instrument, including a derivative, is considered foreign, we believe that a foreign financial instrument would most likely be deemed one that is issued under foreign law, or is governed by it.

As it is also unclear where, in a cross border setting, the offering takes place, the Russian resident who is party to a foreign derivative instrument would need to be a qualified investor (see more details about qualified investor status below). Unlike statutory qualified investors, admitted qualified investors may acquire foreign financial instruments only if they act through a Russian licensed broker.

It is not entirely clear what the sanctions for a violation of the above provision are. In the worst case scenario, a violation may lead to a transaction's invalidity because of its contradiction of Russian mandatory rules. Hence, the invalidation risk may still be relevant in cases where foreign law is validly chosen to govern a derivative transaction.

c) Qualified investor status

Russian law was amended in 2007 to introduce the concept of qualified investors, which, as discussed above, is relevant in terms of the Amendments. Qualified investors can be both those directly mentioned in law (e.g., banks, brokers, and other investors that, because of their status, are deemed qualified investors) and those that meet certain trading criteria established by the regulator and are admitted as qualified investors by statutory qualified investors (admitted qualified investors).

A legal entity may be admitted in Russia as a qualified investor if it is a commercial company and complies with any two of the following requirements:

  1. its capital amounts to at least 100 million rubles (approx. 3.5 million USD);
  2. it has concluded no less than five trades in securities and/or other financial instruments during each of the last four quarters, the aggregate value of such trades being no less than three million roubles (approx. 100,000 USD);
  3. it has a turnover (income) from selling goods (works, services) as per its balance sheet for the last accounting year of no less than one bln roubles (approx. 35,000,000 USD); and/or
  4. its aggregate assets as per the balance sheet for the last accounting year amount to no less than two billion roubles (approx. 70 mln USD).

The status of an admitted qualified investor is granted by entities named in the law (currently they include brokers, asset managers, and managing companies of investment funds) ("admitting entities") based on an application accompanied with documents confirming the conformity of the applicant to the qualification requirements.

 

2) Repo transactions

Repo transactions were not regulated under Russian law prior to the Amendments, and it had been feared that they could be re-characterized as pledges. This likelihood has been substantially diminished by a repo transaction now being defined by the Amendments as an agreement in which two parties agree on the sale of certain securities and on their return sale on specified dates.

The Amendments also provide detailed procedures for the execution and performance of repo transactions, and establish the rights and obligations of the parties thereto. Securities eligible for repo transactions are limited to Russian shares, investment units of a unit investment fund under the trust management of a Russian managing company, foreign shares and bonds, and a foreign company's securities certifying rights to securities of a Russian and/or foreign company.

 

Questions regarding this issue may be addressed to Max Gutbrod, Partner, and Anna Butenko, Associate, at Baker & McKenzie, Moscow (+7 495 787 2700), or to Igor Gorchakov, Partner, at Baker & McKenzie, St. Petersburg (+7 812 303 9000).

 

 

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