Law in the bear market
Robert Lang-Anderson, Partner at Denton Wilde Sapte in Moscow, talks us through recent developments in trade finance in Russia and their legal ramifications: the growth of rouble lending; taking Russian law security assignments; and currency control changes.
The last seven years have brought a measure of legal and economic stability that Russia could not achieve in the 1990s. Russia is enjoying strong public finances as a result of high oil prices and has benefited from a series of credit rating upgrades. The political climate has allowed the successful implementation of significant legal reforms. As a result, the Russian finance market is developing rapidly and is becoming increasingly sophisticated in terms of structures and pricings.
Russia is increasingly attractive to new lenders as the perceived legal and economic risks decrease. There is a marked growth in unsecured and less structured lending in the large oil, gas and metals financings. Unsurprisingly for a country which holds such a vast array and quantity of natural resources, the market for trade and structured finance products continues to grow. We are seeing increasing demand for these products for a wider variety of commodities and lower tier borrowers.
This article gives an overview of some of the current issues in the Russian legal market and some of the factors to consider when lending to a Russian borrower and in particular looks at three areas: (i) the growth of rouble lending, (ii) taking a Russian law security assignment; and (iii) recent currency control changes.
One of the developments that we have seen in the last year is the increase of Russian borrowers seeking rouble-denominated loans ie, lending to a Russian borrower in roubles. This makes sense as most of the working capital costs of Russian companies will need to be met in roubles and many companies’ revenues are earned mainly in roubles.
Indeed this trend has also been seen in the booming bank-to-bank syndicated lending market where some Russian banks are seeking to borrow in roubles which are in turn used to fund trade contracts of their customers. Rouble lending loans raise a number of interesting issues.
Rouble-denominated loan agreements may be governed by English and Russian, however, in most cases where a foreign bank is involved the loan agreement will be governed by English law. Understandably most lenders would expect the governing law of the document to be English law as this is an established and stable form of law often used for international financings. In particular, where the loan is to be syndicated then English law will be preferred choice.
However there is an argument (sometimes put forward by Russian borrowers) that an agreement which deals with the lending of Russian currency to a Russian borrower should be governed by Russian law. Where the lender (for example the lending entity is the Russian subsidiary of a foreign bank) is also Russian and if there is no foreign element to the contract, according to Russian law, the contract should be governed by Russian law.
English law prevails in most cases, however, this choice can sometimes result in interesting and challenging negotiations with the borrower. New Russian borrowers may have only borrowed from Russian banks under Russian law loan agreements. These loan agreements will often be comparatively short documents which do not contain the representations, undertakings, defaults and other clauses found in its English equivalent. This can often result in lengthy negotiations (conducted by both the lawyers and bankers) to explain much of the document to the borrower.
In some cases it can be difficult to persuade the borrower that an increased cost clause or an indemnity is essential when the borrower is used to getting the same product without these added extras.
In the event that Russian law prevails, the foreign bank (or more likely its subsidiary) is faced with a slightly different problem and a sort of converse problem to that above. What should the Russian law loan look like
- Should the loan contain all the conditions set out in the usual English law loan agreements or should it be a short Russian style document.
In our experience, when acting for the Russian subsidiary of a foreign bank, the former prevails but with an instruction to make the necessary amendments so that the document complies with Russian law.
Nevertheless sometimes clauses remain in the document that are not enforceable under Russian law (for example the representations and warranties) simply because the lenders are used to seeing them there. It will be interesting to see, as more Russian law loan agreements come to the market based on their English equivalents, what impact this will have on the Russian legal market and jurisprudence.
By dual lending we mean the lending to the same borrower by a foreign bank and its Russian subsidiary. In some cases we have even seen the foreign bank lend under an English law loan agreement while its Russian subsidiary enters into a Russian law loan agreement. The borrowings can be secured by security over the same assets – by way of a security sharing or inter-creditor agreement.
MosPrime vs Libor
The growing demand for rouble-denominated debt has also been reflected by the activities of banks active in Russia and, in particular, the recent establishment of Moscow Prime Offered Rate (MosPrime Rate) – a rouble loan (deposit) reference rate in the Moscow market. While rouble-denominated loans by foreign banks have been around for some time (for example at the end of 2001 the EBRD entered into its first rouble loan with the City of St Petersburg) the reference rates used for these early loans were often based on Libor.
While it may be possible to use Libor to quote a number of currencies (not only to the pound sterling, but also to major currencies such as the US dollar, Swiss franc, Japanese yen and Canadian dollar) roubles are not traded on the London market and the use of Libor was rather artificial.
From April 25, 2005, Russia’s National Foreign Exchange Association (NFEA) began calculating a new indicator – MosPrime Rate. The reference rate is fixed based on the offer rates of the leading participants of the Russian money market to first class financial institutions.
At present, the list of participant banks in the MosPrime Rate project includes: ABN AMRO, WestLB Vostok, Vneshtorgbank, Gazprombank, International Moscow Bank, Sberbank, Citibank and Raiffeisenbank. The calculation procedure for MosPrime is similar to that for Libor and quotes are provided for one, two and three-month periods at 12.30 Moscow time and published on the MosPrime Reuters page.
As is usual in a trade finance transaction when a borrower has a stream of hard currency payments, such as from export of products, the preferred security is an assignment of the benefit of this contract. The export contract is not usually governed by Russian law and so the security interest is usually governed by jurisdictions that are either more flexible or more creditor-friendly (such as the US and the UK). The terms of the assignment often require the proceeds of the export contract to be paid to an offshore escrow account and the borrower is required to instruct the counterparty under the export contract accordingly.
We have over the last few years documented an increasing number of loans where part of the security package includes some form of security over contracts governed by Russian law. These contracts are usually between two Russian entities, although this is not always the case.
We are often asked to advise on the most appropriate security to take over a Russian law contract and increasingly we are being asked to consider whether it is possible under Russian law to take a Russian law assignment as security. We set out some of the matters for consideration below on this question based on the assumption that the lender is interested primarily in an assignment of the receivables due under a Russian law-governed contract.
Generally, under Russian law it is possible for the borrower to assign its right to receive payments due under an agreement to a third party. However under Russian law an assignment does not fall within the category of security interests and constitutes a regular bilateral or multilateral contract (ie, it must be signed both by the assignor and the assignee, as opposed to an English law security assignment which can be signed by the assignor alone).
Russian law provides that the list of security interests is not exhaustive and that the parties can designate that other instruments are intended to create a security interest. However, this has never been tested and Russian legal practice does not usually involve the creation of any new types of security interests.
Therefore the position under Russian law of the use of an assignment to create a security interest is largely untested and there are a number of practical and potential difficulties when considering taking a Russian law assignment as a security instrument including:
Unlike an English law assignment, an assignment under Russian law is an ‘absolute’ assignment of the assignor’s contractual rights to the assignee (however, the parties may agree that not all of the rights be assigned, eg, only the right on receiving rental payments due under the lease agreement).
However, the parties may agree that the assignment only becomes effective on the occurrence of a certain event and on the occurrence of that event, only the rights currently in existence will be assigned. Because of this, a practice has arisen whereby Russian law assignments are created conditionally. That is, the assignments do not become effective until a certain condition, usually an event of default, occurs.
Following such an event, the assignment comes into effect. Notice to the counterparty is usually given at the time that the assignment is created with a further notice given when the assignment becomes unconditional at which time the rights and obligations under the assignment arise and become enforceable.
Let us assume that the assignment has become unconditional upon the bankruptcy of the borrower and that the relevant notices have been sent to the counterparties. It is not clear whether a court or bankruptcy manager would declare that the conditional assignment was a preference since it came into effect at a time when the assignor was bankrupt, or at least it became effective during the six-month ‘hardening period” (this period can be extended for up to three years in the case of the insolvency of a credit institution, which includes banks and insurance companies) before the assignor’s bankruptcy.
As far as we are aware this has never been the subject of any comment or discussion by the courts and legal commentators and remains unresolved. Additionally, the bankruptcy manager may challenge an assignment by a third party in certain circumstances.
It is not clear whether or not an assignment under Russian law can extend to future contracts and for this reason assignments are usually only granted in respect of contracts which are existing at the time that the assignment is executed.
This is based on the interpretation of the law that a right which does not exist at the time of the assignment cannot be assigned. However, there is no clear statement to this effect in the law. If future contracts are assigned, this will usually be achieved by way of a new instrument executed at the time that the contract comes into effect.
As a result of the above difficulties the parties need to consider carefully whether a Russian law assignment would provide sufficient security. Where a foreign legal entity (such as a foreign bank) is involved we usually recommend that an English law assignment be obtained.
It is possible to take an English law assignment over a contract governed by Russian law provided that the assignment does not contradict the contract. The lender’s lawyers will need to do due diligence on the contract to check that there are no prohibitions on assignment contained therein.
Currency controls since 2004
In the last few years there have been some significant changes to and liberalisation of the currency control regime in Russia. This has involved some important practical changes and indeed has also been significant on a broader level as the new currency laws fundamentally change the approach to regulation in Russia.
Perhaps most significantly, the underlying governing principle has swung from ‘everything is subject to central bank licensing unless specifically permitted’ to ‘everything is permitted unless specifically regulated by the currency law”.
The changes should simplify foreign currency payments and reduce regulatory interference permitting a greater flow of capital both into and out of Russia. Below we outline some key changes.
Since January 1, 2007, the provisions of Russian law relating to opening, operating and maintaining special accounts that were previously necessary in certain cross-border transactions no longer apply. Currency operations may be executed without use of special accounts.
The Russian law requirements relating to mandatory reserves and mandatory currency conversion have also been abolished. Lenders are no longer required to maintain reserves in respect of their lending to Russian companies. There is now no need to convert foreign currency proceeds into roubles when crediting such proceeds to onshore bank accounts of Russian borrowers.
Russian companies and individuals can now open accounts offshore without the need for preliminary registration with the Russian tax authorities. Instead, the Russian resident must simply notify the local tax authorities within one month of opening the overseas bank account. This means that funds in offshore bank accounts of Russian companies can now be used to repay loans.
While the currency control framework has been considerably relaxed, banks should be aware that certain restrictions remain in force.
- Parties wishing to enter into import/export transactions are still required to obtain transaction passports.
- Export proceeds must at present be repatriated (subject to certain exemptions) where, for example, the proceeds of the loan are being used to repay a loan facility.
- Foreign currency transactions between Russian residents are prohibited (subject to certain exemptions).
- The crediting/debiting of Russian bank accounts denominated in foreign currency can only be done if the account holder executes a foreign currency transaction certificate.
- The sale and purchase of foreign currency can only be made through authorised Russian banks.
The fast pace of legislative change and the enthusiasm to attract foreign investment mean that these restrictions are likely to be relaxed in the future but no further changes are in the pipeline at present.
In the meantime, the new currency control regime will go a long way towards simplifying the structuring of finance transactions in Russia.