November 15, 2021
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In review: capital markets law in Russia - Lexology

An extract from The International Capital Markets Review, 11th Edition

Introduction

i Overview of the structure of the law

While Russian capital markets regulation has come of age after more than two decades of rapid, and at times erratic, development, it still has some way to go before it reaches maturity. The process of Russian capital markets regulation started with the dismantling of the centrally planned Soviet economic model during the last decade of the 20th century, and a search for the most suitable market-oriented substitute for a defunct legal and regulatory regime. Apart from some scant financial market concepts and terminology antecedent to the Bolshevik revolution of 1917, Russian law provided little (if any) of the frame of reference needed to jump-start market reforms. The legislative reforms of the 1990s were heavily influenced by the US model of securities regulation, which at the time was given credit for governing the most liquid and efficient capital markets in the world. Russian financial regulation has since been decoupled from the US model proper, while largely following international trends. Significant strides have been taken in recent years, with the aim of expanding the product line of financial instruments and enhancing discipline in financial markets. Some other initiatives and commitments, including those taken within the G20 process, are still work in progress.

The centrepiece of Russia's capital markets regulatory framework is the Federal Law on the Securities Market (Securities Market Act). The first version was enacted in 1996, which has since been amended more than 40 times, including most recently in 2016 (as discussed in more detail below).

The Securities Market Act:

  1. defines the scope and types of regulated market activities;
  2. establishes broad principles applicable to the various categories of regulated market participants;
  3. defines the various types of securities as well as the procedure for their issue and distribution;
  4. sets out the general rules applicable to secondary market trading activities;
  5. sets out the standards for continuous disclosure;
  6. regulates exchange trading;
  7. prohibits insider trading;
  8. defines repo transactions and derivative instruments;
  9. sets out the main principles of government regulation of the securities market; and
  10. bestows regulatory and supervisory authority on the Bank of Russia.

There also exists an interwoven web of other laws and regulations that influence the behaviour of market participants, including:

  1. the Civil Code;
  2. the Law on Joint Stock Companies;
  3. the Law on Organised Markets;
  4. the Law on Commodity Exchanges and Exchange Trading;
  5. the Law on Central Depository;
  6. the Law on Clearing and Clearing Activities;
  7. the Law on Protection of Legal Rights and Interests of Investors in the Securities Markets;
  8. the Law on the Crackdown Upon Unlawful Use of Inside Information and Market Manipulation;
  9. the Law on Mortgage-Backed Securities;
  10. the Law on Investment Funds; and
  11. the Law on Private Pension Funds.

In addition to these, a myriad of regulations are being passed, amended, repealed and superseded by new regulations on a continual basis.

ii Regulation of international capital market transactions

Russian legislators and financial regulators have long been concerned with finding an equilibrium between ensuring access to international capital markets for Russian issuers and preventing a liquidity drain to foreign markets. Measures to find this balance include, most notably, a requirement for a Bank of Russia approval of an offshore issue or trading on an organised market of equity securities by a Russian issuer. This approval for equity securities is conditional upon:

  1. the registration of the new issue of securities in Russia;
  2. the securities being listed on a Russian exchange
  3. the number of shares (or securities convertible into such shares) traded outside Russia not exceeding a prescribed threshold (varying between 5 and 25 per cent, depending on a number of factors, including local free float, Russia's strategic interests, inter-regulator agreements); and
  4. in relation to depositary receipts, a restriction on the exercise of voting powers by any persons other than the security holders (i.e., foreign custodians or nominees may not exercise the voting rights of such securities without express instruction from the holders).

Notably, however, the quantitative restrictions on the number of shares available for an offshore offering by the most liquid Russian issuers do not apply, provided that the offering meets certain additional requirements. A Bank of Russia approval is not required for an offshore issue of securities that are not shares or securities convertible into shares.

Foreign issuers are also restricted in their ability to tap into Russian capital markets, although in a different manner. Foreign issuers may issue sponsored Russian depository receipts and place them in the Russian market in accordance with Article 27.5-3 of the Securities Market Act. Alternatively, securities issued by foreign issuers may be directly eligible for trading in Russia if certain requirements, as set out in Article 51.1 of the Securities Market Act, are met.

First, securities issued by foreign issuers must be assigned a CUSIP2 number and a CFI3 code and recognised as securities for Russian law purposes following a specified procedure.

Second, they must be issued by a qualifying issuer, which is defined to include:

  1. a qualifying foreign sovereign issuer or its administrative subdivision or a foreign central bank;
  2. a qualifying multinational organisation;
  3. an entity incorporated in an Organisation for Economic Co-operation and Development, Financial Action Task Force or MONEYVAL4 Member State, or in a jurisdiction whose financial regulator has signed a cooperation agreement with the Bank of Russia; or
  4. an entity that has listed its securities on an exchange approved by the Bank of Russia.

Placement (i.e., offering in the primary market) of securities issued by foreign issuers requires registration of a prospectus by the Bank of Russia. In most cases, the prospectus must be co-signed by a local broker that also assumes liability for the contents of the prospectus. In contrast, admission of foreign securities for trading in the secondary market may be effected without the registration of a Russian prospectus if the securities are listed on an eligible foreign exchange (FX) and are given a dual listing by a Russian exchange. Any other offering of or trading in foreign securities requires specific permission from the Bank of Russia, which should generally be granted if certain criteria are met. The Securities Market Act allows admission to exchange trading of unsponsored foreign securities without the issuer's consent, provided that the securities are admitted to on-exchange trading outside the exchange's principal listing, but that the securities have been included in the primary listing of an eligible foreign stock exchange (this latter requirement may be disapplied for debt securities) and that the securities are not restricted from public offering in Russia under their governing law. To date, however, the number of foreign securities distributed or admitted to trading in Russia (including in the form of Russian depository receipts) remains insignificant.

Foreign securities that have not been admitted for distribution or public trading may be offered without a registered prospectus to qualified investors through a bilaterally negotiated secondary market transaction or through an offering on a Russian exchange restricted to qualified investors. Similarly, 'foreign financial instruments that are not recognised as securities' (for Russian law purposes) may only be offered to persons who are ipso jure qualified investors (various types of regulated financial institutions) or have been categorised as qualified investors by a Russian broker. This awkwardly-phrased provision, which amounts to a suitability-like selling restriction, has resulted in a caution-driven choice by most international dealers to have their cross-border derivative transactions with unregulated Russian corporate clients intermediated by a local broker. Local brokers alone may classify a client as a qualified investor. Because the term foreign financial instrument is undefined and the regulator has to date declined to provide any interpretative guidance on its definition, these burdensome structures (which increase transaction costs and may limit the throughput capacity of a local broker) tend to be used for all underlying assets involving foreign currency, securities or other benchmarks. The choice to use a local broker also often stems from a lingering uncertainty over the enforceability of cross-border cash-settled derivative transactions with Russian unregulated entities under the gaming provisions of the Russian Civil Code.

The measures designed to lower the entry barriers for foreign securities into the domestic market were mirrored by changes to liberalise the outbound flow of securities trading flows. Most importantly, recognition of the status of foreign nominee holders of securities (even if by way of a phase-in approach sequentially encompassing government and corporate debt securities and equities) and the creation of a central depository are designed to streamline the infrastructure for a seamless cross-border flow of interests in securities and facilitate offshore trading in Russian securities.

iii Roles of local agencies and central banks

Historically, the regulatory landscape represented a patchwork of rule-making and oversight jurisdictions of a number of government agencies. Over time, however, the regulatory functions came to be concentrated first within two principal agencies – the Federal Financial Markets Service (FFMS) and the Bank of Russia – and then, since 2013, at the Bank of Russia.

During the period of regulatory duopoly, which ended on 1 September 2013, the principal regulatory body for capital market activities was the FFMS. The Securities Market Act delegated a considerable amount of authority to the 'federal executive agency for the securities market' – the role of the FFMS for many years – in relation to both rule-making and oversight over the activities on the financial markets, except banking, insurance and audit activities. The federal executive agency for the securities market set the rules applicable to the distribution of securities, registered prospectuses for the issue of securities by non-bank issuers (except sovereign and sub-sovereign issuers), as well as taking enforcement action against delinquent issuers. With respect to regulated market participants, it set out regulatory requirements for the activities of the professional securities market, defined capital requirements, granted licences to engage in regulated activities and enforced regulatory requirements against non-compliant firms.

The Bank of Russia, for its part, determined the procedure for the issue of securities by credit organisations and registered their prospectuses. It had oversight authority over banks, including banks' investment activities on the capital markets. It had limited rule-making jurisdiction over banks' fiduciary asset management activities, and prescribed the rules applicable to custodian activities. Through its equity stake in principal market infrastructure projects (such as the Moscow Exchange, formerly MICEX) and its leverage as a bank regulator, the Bank of Russia had the ability indirectly to exercise considerable influence on the functioning of the market. All these factors, viewed against the backdrop of the dominant role played by banks in many sectors of the Russian capital markets, made the central bank a powerful player in the regulation and monitoring of domestic capital markets in Russia even during the period leading up to September 2013.

On 1 September 2013, however, the regulatory jurisdictions of the FFMS and the Bank of Russia were merged, the FFMS was dissolved and the Bank of Russia assumed the overall regulatory and supervisory jurisdiction across all market segments, thus becoming the single 'mega-regulator'. To ensure continuity, core FFMS staff members were transferred to the newly formed regulatory arm of the Bank: the Financial Markets Service of the Bank of Russia.

iv Structure of the courts

The Russian court system comprises the Constitutional Court, courts of general jurisdiction, state commercial courts (arbitration courts) and military tribunals. As a general rule, disputes involving natural persons are adjudicated by the courts of general jurisdiction. Commercial disputes between legal entities or registered entrepreneurs are adjudicated by the arbitration courts. In addition, certain categories of disputes fall within the subject matter jurisdiction of the arbitration courts irrespective of the identity of the disputing parties: all insolvency cases, corporate disputes (including derivative lawsuits, challenges to corporate governance actions and other causes of action affecting shareholders' rights), claims against securities custodians and certain others. Given the substantial interest on the part of financial institutions to enter into complex financial transactions with high-net-worth individuals, suggestions have been made that the above list should be expanded to include financial market disputes within the exclusive subject matter jurisdiction of the arbitration courts, which are far better equipped to handle them than the courts of general jurisdiction, but this change has yet to be implemented.

There are more than 80 arbitration courts at the trial level across Russia (i.e., courts of first instance), each covering a geographically defined judicial district. These courts handle both the trial per se and the first level of the appeal process. The appellate division is composed of different judges of the same court. The next level of the appeal process – the cassation division – is made up of 10 federal circuit courts that have appellate jurisdiction over the decisions rendered by the appellate division of the arbitration courts within the relevant judicial circuit. Finally, the Supreme Court is the highest state court in Russia for both the courts of general jurisdiction and – since 2014 – the arbitration courts, and has ultimate (but largely discretionary) appellate jurisdiction over cassation decisions, as well as original jurisdiction over a limited number of matters.

The internal structure of the arbitration courts often accommodates the need for specialist expertise in various areas of commercial disputes. Panels specialising in corporate law, insolvency and other matters are often created within the structure of the courts. Since 2012, special financial panels have been created in a number of courts in key financial centres, including the Arbitration Court for the City of Moscow and the Federal Arbitration Court for the Moscow circuit. This was the judiciary's response to the ever-increasing complexity of recognised financial instruments that regulatory developments have spawned in the Russian capital markets.

v Trends reflected in decisions by the courts and other relevant authorities

The trends reflected in legislative amendments and actions by the Bank of Russia indicate a policy of promoting further integration of domestic financial markets into the international network while gradually lowering protection barriers for both inbound and outbound investments. Recognition of foreign nominees (a status long denied to foreign brokers, custodians and other nominee holders), Russia's commitment to the G20 financial regulatory reform objectives, the introduction of new concepts such as special purpose vehicles, securitisations, note issuance programmes, asset-backed securities, escrow accounts, recognition of close-out netting, further liberalisation of FX controls and large-scale amendments to the Civil Code (as discussed in the previous edition), which have been favourable to financial market transactions, are the latest manifestations of the trend. Simplification of the procedure for issuing new securities in the domestic market and the introduction of additional protections to bondholders also represents long-awaited market-friendly measures designed to encourage companies to tap the securities markets amid diminishing liquidity in the domestic capital markets.



source: https://www.lexology.com/library/detail.aspx?g=d3b284d4-11ba-4082-be08-08d23bc93da2

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