1 November 1995
Current Developments in Russian Securities Law

Mutual Funds to be Established in Russia

As of October 4, 1995, the Russian Federal Commission for Securities and Stock Markets under the Government of Russia ("Russian SEC") adopted nine various regulations and several standard forms concerning establishment and governance of mutual funds. These documents will come into legal force immediately after publication by the government.

On September 1, 1995 the Russian SEC issued Resolution #9 by which it adopted a Program for Development of Mutual Funds (abbreviated in Russian as "PIFs"). The main objective of this program is to "foster the conditions for effective and secure investment of savings of the Russian population, as well as creation of the new vehicles for investment and guaranteeing the legal rights of investors". In order to attain this objective, the Program calls for the following actions:

development of a sound legal basis for PIFs;

research existing funds which are operating without a license; formulate proposals to reorganize them into licensed PIFs;

research the voucher investment funds and assist them, if they so desire, to reorganize into licensed PIFs;

begin one or two "pilot" PIFs;

train professional staff for the PIFs, such as fund managers, appraisers, and depositories;

train government officials in licensing procedures, including program abroad supported by government scholarships.

In order to form a legal basis for the PIFs, the following documents are expected to be drafted soon by the government with the participation of other interested parties:

sample by-laws of PIF;

sample prospectus of PIF;

sample agreement between a fund manager and depositary, auditor and appraiser. (The latter documents were adopted by the Russian SEC as of October 4, 1995 but have not been signed into effect and published yet).

Other forums, including standard management chart for PIFs, reporting requirements and portfolio management standards, are expected to be drafted by the end of October. The first PIF is set to be announced by December, 1995.

New Licensing for the Registrars

On August 30, 1995, the Russian SEC passed Resolution #6 by which it adopted the Temporary Procedure for Licensing of Registrars. The following conditions must now be met to obtain such license:

the company's charter must reflect that the registrar business is the only authorized business of the company (except for PIF depositories, banks, etc.);

the minimum authorized and paid-in capital of the company must be no less than 5,000 minimum monthly wages;

issuers (companies) whose shares are registered by the registrar must not own more than 20 percent of the equity of the registrar;

the authorized capital of the registrar cannot be paid-in with securities issued by the registrar's shareholders and/or founders;

all registrars servicing joint-stock companies with more than 1,000 shareholders in each company, must obtain a license no later than March 31, 1996.

The Russian SEC will grant licenses to registrars. The oversight of their activities will be conducted by the Russian SEC together with a self-regulating professional association that had recommended that particular registrar for licensing.

According to the Resolution, certain information will be provided by the registrars free of charge, such as notice of the general shareholders meeting, notice of refusal to register an entry in the register, notice of transfer of the register to another registrar.

The price ceiling for certain other services is set out.

By the end of the year the Russian SEC is required to form, together with various national and regional professional associations, large independent registrars in several major regions, to maintain at least 500,000 securities accounts.

Self-regulating professional associations approved by the Russian SEC and formed by the registrars will have the right to:

recommend to the Russian SEC to grant, suspend or withdraw a registrar's license;

conduct oversight of the proper use of the registrar's license by the registrars;

provide expert opinions to the Russian SEC in regard to the applications for a registrar's license.

The Resolution also calls the Professional Association of Registrars, Transfer Agents and Depositories (known as "PARTAD") to submit proposals to the Russian SEC for standardization of operating procedures of the registrars.

Registrars' licenses are valid for one year and are not assignable to a third party. A license is valid throughout the entire Russian Federation. The Russian SEC will maintain a list of all licensed registrars.

"Loans-for-Shares" Initiative

On August 31, 1995, President Yeltsin signed Edict #889 Regarding the Procedure for Securitization of Shares Owned by the Federal Government in 1995. The objective of this Edict is to uncover untapped financial resources in the free market in order to reduce the budget deficit of the federal government. The Edict describes in detail a procedure for collateralizing of shares to both domestic and foreign investors in exchange for loans on the basis of competitive bidding.

Under the Edict, the first auctions of "loans for shares" may be held as early as October or November, 1995. The Edict contains the Rules for Executing the Agreements of Loan, Collateral and Commission and the Compulsory Terms for the above agreements.

Under the expected procedure, the winner of the auction will be the one who offers the "largest" loan for the shares. The winner will enter into a loan agreement with the Ministry of Finance, and into a collateral agreement with the State Property Committee ("GKI"), and into an agreement of commission with the Federal Property Fund.

Under the loan agreement, the winner lends; under the collateral agreement, the winner takes custody of the shares; and, under the commission agreement, the winner shall have the right to sell these shares after January 1, 1996. The winner - the holder of the collateral - is registered in the State Registry as a nominal holder of securities and has the right to appoint a depository for these securities.

It should be noted, however, that the holders of collateral are limited as to the type of voting power for the shares they hold.

Holders of collateral may not, in their sole discretion, vote to (i) reorganize or liquidate the company in which they are holding government stock; (ii) amend the charter and other founding documents of the company; (iii) change the authorized capital of the company; (iv) collateralize, lease, sell, barter or otherwise transfer the assets of the company in excess of 10 percent of the size of the authorized capital of that company; (v) obtain loans in the amount exceeding 10 percent of the size of the authorized capital; and some other decisions.

The list of companies whose shares are eligible under the "loans for shares" initiative is now available.

Gold-Backed Government Securities

On September 5, 1995, President Yeltsin signed Edict #899 Regarding the Issue of Government Securities Backed by Gold. The Edict supports the proposal made by the Government of Russia (Council of Ministers) earlier this year to issue such securities in the amount equal to the sum of the domestic debt of the federal government in 1995. The gold will be deposited in the State Fund of Precious Metals and Stones of the Russian Federation in the quantity not exceeding 30 tons. The Government of Russia is instructed by the President to come up with a legal procedure to conduct transactions with the gold bullion.

Easier Access to Government Securities

The Central Bank of Russia has announced its intent to ease the access of foreign traders to government securities by increasing the foreigners' allowed position in the initial offerings and simplifying settlements.

In the past, foreign investors who wanted to buy Russian government securities were required by the Central Bank to open an account at a Russian bank. They were also prohibited from exchanging ruble- denominated sale proceeds in the event of sale of the government securities into foreign currency. The Central Bank intends to issue, within the next two months, a regulation allowing foreign investors to buy government securities directly from abroad, thus bypassing the ruble-denominated accounts at Russian banks.

The Central Bank is also considering a regulation which will permit foreign banks and traders to become authorized dealers for GKOs [a type of government debt securities] so that they could be traded from remote terminals. The expected sites will include London, Frankfurt and Paris. Former Soviet-owned Eurobank in Paris has already made known its interest in becoming an authorized GKO dealer.

It is yet unclear, however, whether the Central Bank intends to lift these restrictions on foreigners with respect to transactions in GKOs and OFZs [a type of government debt securities], or to increase the maximum allowed position of foreigners in any government securities from 10 percent to 20 percent of the total issue. Today, foreigners are holding up to 1 percent of all government securities. Given that the current market of GKOs and OFZs is worth in excess of 50 Trillion Rubles, the position of foreign traders in the next months may increase to 5 Trillion Rubles. Remote trading from foreign terminals can be technically implemented probably within 1 to 3 months from the time when the Central Bank actually adopts this resolution.

Due Diligence Disclosure on Bank Stocks

On August 4, 1995, the Central Bank of Russia adopted Regulation #183 Regarding the Due Diligence Disclosure of Banks and Other Credit Organizations - Issuers of Securities in the Russian Federation. The document was adopted in the form of compulsory instruction letter from the bank. The information subject to disclosure by the banks at the time of issue of their securities includes a balance sheet (including accounts of second degree) and information about the bank's operations in the financial markets.

As is typical in Russia, this regulation implements a previous legislative intent expressed earlier in more general legislation but never actually enforced. Enforcement in Russia in financial matters usually begins with the implementing regulations.

On September 15, 1995, the Central Bank entered into agreements with six various information news agencies of Russia regarding the terms of distribution of the said disclosures. The agencies are mandated to provide free and equal access to this information to all interested persons. This information will specifically include:

full issue prospectuses for securities of Russian commercial banks and other credit organizations organized as joint-stock companies of the open type;

full issue prospectuses for securities of Russian commercial banks and other credit organizations organized as joint-stock companies of the closed type, provided these banks had issued before securities other than stocks;

full issue prospectuses, excluding accounts of second degree, for Russian commercial banks and other credits organizations organized as joint-stock companies of the closed type;

full copies of applications for registration of the issue prospectuses of banks;

reports on the subscriptions resulting from initial public offerings (IPO's);

annual reports - for companies of the open type and for companies of the closed type if the latter had issued securities other than stocks; and

annual reports excluding accounts of second degree - for companies of the closed type.

The Russian SEC is planning to issue a similar regulation regarding disclosure for all Russian public issuers, not just commercial banks.

Convertible Bonds

First convertible bonds finally appeared in Russia. On May 31, 1995, State Committee for Property ("GKI") issued Executive Order #750-r regarding public bidding sale of LUKOil convertible bonds.

Coupled with the Resolution of the Russian SEC #4 of August 17, 1995 Regarding convertible bonds of NK LUKOil, these documents created a legal basis for the first issue of convertible bonds in Russia. Pursuant to the Executive Order of the GKI, LUKOil debt will be secured by LUKOil stock owned by the Government of Russia (which is 59.5 million shares, or 11 percent of the total stock).

LUKOil has registered its convertible bond issue prospectus with the Ministry of Finance. According to the prospectus, the bonds will be issued in two tranches: a foreign tranche of 350,000 bonds and a Russian tranche of 110,000 bonds. A foreign financial institution will serve as the depository for the shares which serve as collateral for the bonds. The foreign institution will be appointed by the GKI after consultations with the Central Bank of Russia and LUKOil. GKI will be the Russian party to the agreement with the foreign depository.

On the date of maturity of the bonds, the bonds will be converted into LUKOil stock, subject to the terms as set forth in the issue prospectus. The title to this stock passes to the holders of the convertible bonds as of the date of registration of the conversion.

The bonds will be placed competitively by the Russian Federal Property Fund which will be allowed to hire intermediaries.

The Executive Order also sets forth the procedure for competitive placement of LUKOil convertible bonds, the terms of participation in the bidding by Russian and foreign financial institutions, the procedure for reviewing the bids and the rights of financial intermediaries.

New Upcoming Securities Legislation

The following legislation related to securities is being completed now and will be submitted to the Russian legislating authorities soon:

1) The Law On the Securities Market (which was vetoed by the President last summer);

2) The Law On Amendments to the Law On Securities Transaction Tax (adopted in the third reading by the Duma, the lower chamber of the Parliament);

3) The law On Amendments to the Law On Privatization of State and Municipal Enterprises (adopted by the State Duma in the second reading);

4) The Law On the State Program for Privatization of State and Municipal Enterprises in Russia After July 1, 1994;

5) The Law On Joint-Stock Companies; and

6) The Law On Investment Trust Funds.