16 February 2007
Russian Depositary Receipts: An Idea Whose Time Has (Almost) Come
Russian Depositary Receipts:
An Idea Whose Time Has (Almost) Come
By Mark M Banovich, Yulia Cherkassova, and Olga Ponomarkenko
LeBoeuf, Lamb, Greene & MacRae
February 13, 2007
The much discussed and long awaited legal framework for a Russian Depositary Receipt (RDR) product was finally enacted in December 2006 and came into force in January 2007. Depositary receipt products are not new to the Russian market – American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs) have been widely used by Russian issuers for over ten years to facilitate offerings and listings of their securities (typically equity securities) in the international capital markets. The novelty of the RDR product is that it facilitates the movement of capital in the opposite direction.
Currently, the securities of foreign issuers may be offered and listed in Russia only if (i) permitted by an international treaty, or an agreement between securities regulators in the Russian Federation and the issuer’s jurisdiction , and (ii) the issue of the securities, a report on the results of the placement of the securities and, in the case of public circulation of the securities (e.g., listed trading), a prospectus for the securities are registered with the Russian Federal Service for the Financial Markets (FSFM). Even if an applicable treaty or inter-governmental agreement were in place, the FSFM has not established procedures that would permit foreign issuers to effect the necessary registrations. Accordingly, the offering and listing of foreign securities in Russia is, de facto, not possible.
The RDR product is directed at addressing this problem insofar as RDRs are Russian securities issued by a depositary that is a Russian legal entity. By depositing foreign securities with the Russian depositary against the issuance of RDRs, a foreign issuer would be able to offer and list, and its shareholders can hold and trade, a Russian security representing such foreign securities.
Much of the demand for the RDR product is expected to be generated by foreign holding companies for Russian operating companies or Russian assets. Some such companies have already offered and listed their shares or depositary receipts in New York or London, and may seek to list their shares in the form of RDRs in Russia in order to address FSFM allegations that their international offerings and listings circumvented Russian listing requirements. Other foreign holding companies may be contemplating an international offering and listing, and may wish to capitalize on their brand name recognition in Russia by adding an RDR tranche and a Russian listing.
However, there are certain issues relating to the legal framework for the RDR product that need to be resolved, and implementing regulations that need to be adopted, to facilitate product development.
RDRs may only be issued by a depositary which is organized under Russian law. In addition, the RDR issuer must have performed depositary activity for at least 3 (three) years, and meet capitalization requirements set by FSFM. It is not clear whether FSFM intends to apply the same capitalization requirements to RDR issuer depositaries that it generally applies to all depositaries, or to establish special capitalization requirements for RDR issuer depositaries.
Furthermore, FSFM is preparing a draft law to organize a central depositary, and FSFM may decide to give the central depositary exclusive rights to issue RDRs.
Optimally, an RDR product should enable Russian resident RDR holders to deposit underlying securities with the Russian resident issuer of RDRs, and to withdraw the underlying securities against the surrender of RDRs. Under the Currency Law, RDRs can be characterized as internal securities and the underlying securities as external securities. Deposits and withdrawals of underlying securities by Russian resident holders in the ordinary course of the RDR program can be viewed as an exchange of internal securities for external securities with the Russian resident depositary. Unfortunately, transfer of external securities between Russian residents is one of the few currency operations which is subject to a blanket prohibition under the Currency Law. Development of the RDR product would benefit from clarifications to the legal framework that permit such ordinary course operations.
Rights to Underlying Securities
An RDR is a “registered issue security” without nominal value evidencing title to the securities of a foreign issuer. These underlying securities may be either primary or secondary securities. The RDR holder is entitled to instruct the RDR issuer to exercise the rights conferred by the underlying securities for the benefit of the RDR holder.
The rights of the RDR issuer in respect of the underlying securities must be recorded in the name of the RDR issuer on the books of foreign organizations to be included in a list which has yet to be approved by the FSFM. Because Russian law generally does not recognize a distinction between legal and beneficial ownership, RDR depositaries face an important accounting issue of how to record the “beneficial” rights of RDR holders to the underlying securities separately from the RDR depositary’s rights therein.
Any given issue of RDRs may evidence title to only a single class of underlying securities of only a single foreign issuer. While this requirement appears to be prima facie sensible, if strictly construed, it also creates uncertainty as to whether RDR issuers may perform the otherwise customary operation for depositary receipts programs of receiving and holding for the benefit of the RDR holders securities (other than the underlying securities) or other property distributed by the foreign issuer in respect of the underlying securities.
Terms and Conditions of the RDRs
RDRs may be issued by a Russian depositary without the agreement of the foreign issuer (an “unsponsored” depositary receipts facility) only if the underlying securities are quoted on foreign stock exchanges included in a list which has yet to be approved by FSFM.
Sponsored RDRs can be issued by the Russian depositary on the basis of an agreement with the foreign issuer of the underlying securities (a “sponsored” depositary receipts facility). Such an agreement forms part of the RDR issuer’s decision on issuance, and must be submitted to FSFM along with other relevant documents for state registration of the RDR issuance. FSFM can refuse to register the RDR issuance if the agreement between the RDR issuer and the foreign issuer fails to contain certain mandatory provisions, such as: a prohibition on termination of the agreement without consent of the RDR holders; the choice of Russian law as governing law of the Agreement; and dispute resolution by tribunals in the Russian Federation whose decisions would be recognized in the foreign issuer’s home jurisdiction pursuant to an applicable international treaty.
The requirement of consent of RDR holders to terminate the agreement is commercially impractical, and the choice of Russian law and Russian forum may mean that many concepts of Anglo-American common law which have been central to the development of ADRs and GDRs (including among other things separation of legal and beneficial title; representations, warranties and indemnities; and exclusions of legal liability and waivers) either will have to be painstakingly translated into a more formalistic civil law framework, or will prove to be untranslatable (or even if translated, unenforceable in practice by courts unfamiliar with the relevant concepts).
Disclosure and Reporting Requirements
In any Russian law prospectus relating to RDRs, the RDR issuer will have to disclose information about itself as well as about the foreign issuer and the underlying securities. The scope of such information is yet to be determined by FSFM in a special regulation. Depending upon the scope of information ultimately required, the Russian depositary may seek reimbursement and/or indemnification from the foreign issuer for preparing such disclosure.
Following registration of an RDR prospectus, the RDR issuer would have to disclose information on all registered amendments to the decision on issuance from time to time in the form of a disclosure of a material fact. The RDR issuer will also be subject to certain periodic reporting requirements, including the submission of quarterly reports to the FSFM containing information on the actual amount of outstanding RDRs and the amount of underlying securities held for its account.
Russian depositaries would therefore have to ensure that disclosure and reporting infrastructure is in place before rolling out an RDR product.
Accordingly, the pace of RDR product development will depend in part upon the resolution of Currency Law issues, further rulemaking by FSFM, and demand for the product from foreign issuers and their shareholders. But while much remains to be done, the law has at least taken a step in the right direction.
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Copyright LeBoeuf, Lamb, Greene & MacRae LLP March 2006. Some rights reserved. This material or portions hereof may be used in any form with express acknowledgement of the source.
 Federal Law of the Russian Federation No. 282-FZ "On Amendments to the Federal Law 'On the Securities Market'" dated December 30, 2006, amending Federal Law of the Russian Federation No. 39-FZ "On the Securities Market" dated April 22, 1996, as amended.
 According to the FSFM official website (URL: http://www.fsfm.gov.ru/document.asp?ob_no=8668).
 Federal Law of the Russian Federation No. 173-FZ "On Currency Regulation and Currency Control" dated December 10, 2003, as amended.
 While there is a limited number of exceptions from such prohibition, none of them currently seems to be capable of being applied to the transfers of underlying securities between Russian residents.