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Derivatives - Russia

Background

 

The development of the derivatives market started in the mid-1990s, when foreign investors purchasing government bonds hedged the risk of changes in the rouble's value against foreign currencies by entering into currency forward contracts with Russian banks. These early derivatives were intended to lock the value of the US dollar to the rouble.

 

During the 1998 financial crisis the rouble dramatically decreased in value against foreign currencies, resulting in heavy losses for banks due to outstanding currency forward contracts. A number of banks challenged the validity of these contracts, seeking relief in the courts. The courts interpreted derivatives contracts as 'gambling transactions' and thus not enforceable under the Civil Code. This judicial interpretation of the code hampered the development of the derivatives market in Russia for several years.

 

Challenge

 

Under these circumstances, proper judicial protection for such contracts became a prerequisite for the development of a derivatives market. In 2002 the Russian affiliate of a major European bank challenged the judicial interpretation in the Constitutional Court. The court evaded the question, stating that although there is no clear exemption of derivatives products from the gambling provision, each case should be judged on the basis of its specific circumstances, and that derivatives trading should not necessarily be interpreted as gambling.

 

Exemptions

 

Derivatives have also been considered as gambling in other jurisdictions. However, the United Kingdom, the United States and Japan, for example, have enacted exemptions to the laws against gambling to ensure the enforceability of derivatives agreements. Similarly in Russia, Article 1062 of the Civil Code was amended in 2007.

 

Under the amended article, which came into force in February 2007, the rule does not apply: (i) to transactions on which a party's obligation to pay is contingent on changes in the prices of commodities, securities, currency exchange rates, interest rates, the level of inflation or any combination of these; or (ii) in certain circumstances which are stipulated in the law but which may or may not take place.

 

These claims are granted judicial protection if (i) at least one of the parties is a legal entity licensed to conduct banking operations or activities on the securities markets, or (ii) the transaction has been entered into on an organized exchange and one of the parties is licensed to trade on that exchange. Claims by individuals relating to derivatives transactions are granted judicial protection only when these transactions are conducted on organized exchanges.

 

Comment

 

The amendment to the Civil Code has greatly enhanced the confidence of the financial markets when dealing with derivatives, but the wording of the article still leaves room for doubt. Various derivatives transactions currently in use are not covered by the amended article because either the participants or the characteristics of the transaction fall outside its scope. For example, because of the article's narrow definition of parties to an enforceable transaction, derivatives transactions between Russian non-financial institutions and foreign counterparties remain unenforceable. This means that derivatives transactions cannot be carried out directly with a foreign company on a cross-border basis. The licensed entity requirement limits the liquidity of derivatives products and should be kept in mind when assigning claims from derivatives contracts to other financial market participants. In addition, the narrow definition of the transactions covered by the article may hamper the development of more complex derivatives products as the underlying trigger event must be stipulated in law.

 

Nevertheless, the amendment of Article 1062 has removed the primary legal obstacle to the development of a Russian derivatives market. The amended article does not use terms such as 'derivatives transactions' or 'derivative financial instruments', but does set forth guidelines for the courts when determining the enforceability of a derivatives contract that could be characterized as a gambling transaction. This is a significant advancement in the creation of a predictable legal environment for derivatives contracts, which are common instruments in international financial markets, but were previously denied judicial protection in Russian courts.

 

 

International Law Office