Hamburg University
School of economics an social science, department of
International economics an politics
International Risk + Finance II
Master of international Business Administration
in conjunction with HSH Nordbank
MASTER THESIS

THE INFLUENCE OF THE NEW RUSSIAN CURRENCY
LAW FZ №173 ON WESTERN CREDITORS:
avoiding risks when doing Business with Russia

by:
Yelena Rusakova

05.2005

CONTENT

List of tables ... V
List of illustrations ... VI
List of schemes... VII
Abbreviations ... VIII
Definitions... X
Executive summary... XIII

1. Introduction ... 1
1.1. The description of the problem ... 1
1.2. The workflow of the research... 2

2. Russia and its current economic and political situation... 4
2.1. What rating agencies believe about Russia ... 4
2.2. The industrial sector in Russia ... 6
2.2.1. General characteristics of the industrial sector ... 6
2.2.2. The Russian commodity market... 11
2.3. The banking sector in Russia ... 15
2.3. The banking sector in Russia ... 15
2.3.1. Credit granting system in Russia... 16
2.3.2. State owned banks... 17
2.3.3. Private owned banks... 20
2.3.4. Syndicated credits in Russian commodity markets... 22
2.4. SWOT analysis of Russia: overview... 24
2.4.1. Political risks ... 24
2.4.2. Economic risks ... 25
2.4.3. Legal risks ... 27

3. The description of the federal law №173 “on Currency Regulation and Control... 28
3.1. The old payment flow regime ... 28
3.1.1. General characteristics ... 28
3.1.2. The structure of the old payment regime ... 31
3.1.3. Alternative structure... 33
3.2. The new payment flow regime... 36
3.2.1. Entry into effect and the ‘transitional period’ ... 36
3.2.2. Basic principles of new currency regulation ... 37
3.2.2.1. Transaction passport... 38
3.2.2.2. Resident repatriation of foreign currency... 39
3.2.2.3. Preliminary registration... 39
3.2.2.4. Obligatory sale of proceeds (conversion) ... 40
3.2.2.5. Special accounts (SA) ... 40
3.2.2.5.1. Special accounts for residents ... 41
3.2.2.5.2 Special accounts for non-residents ... 41
3.2.2.6. Mandatory reservation of currency ... 42
3.2.3. Types of currency operations ... 44
3.2.3.1. Regime for foreign currency loans ... 44
3.2.3.2. Regime for loans in Russian Roubles ... 46
3.2.4. The instructions of Central Bank of Russia to the FZ №173 ... 47
3.2.5. The new structure ... 48

4. The influence of the new currency law on western credit lenders and the risks associated with this law ... 50
4.1. Capital flight as a main risk of Russian government ... 50
4.2. Offshore accounts as a main advantage for both lender and borrower ... 51
4.3. SWOT analysis of the new currency law ... 52
4.4. The controversies of the FZ №173 ... 55

5. Minimizing and preventing the risks associated with doing business in Russia ... 56
5.1. Risks Overview ... 56
5.1.1. Offshore risks ... 59
5.1.2. Onshore risks ... 62
5.2. Dealing with risk ... 65
5.3. Hedging the risks ... 66
5.3.1. Derivatives ... 66
5.3.2. Barter ... 70
5.3.3. Documentary collection ... 70
5.3.4. Letter of credit (L/C) ... 72
5.3.5. Credit insurance (CI) ...  75
5.3.6. Sureties and guarantees ... 77
5.4. The explanation of risk categories on the example of OJSC Rosneft ... 78
5.5. Inspection and monitoring ... 82

6. Conclusion  ... 84
Literature ... 86
Attachments ... 92

Executive summary

When doing business in Russia, foreign companies face a number of risks, mainly: economic, political and legal risk. However, the rapid economic growth during the last four years and a new progressive legislation have created favourable conditions for foreign direct investments (FDI) to the country. This fact was also noted by rating agencies like Moody’s, S&P and Fitch who gave Russia an investment grade and stable outlook this year.

A need of modernization of the Russian banking sector was an incentive for the initiation of the federal law (FZ) №173 “on currency regulation and currency control”, which came in force in June 2004. This law has replaced the old currency regulation law from 1992. The new currency regulations in Russia shall ease the trade between Russian residents and non-residents, bringing more flexibility to western credit lenders – banks, insurers and other financial institutions. However, the FZ №173 does not only provide the liberal opportunities to financial institutions, but also presents new risks. Doing business abroad, investors face sovereign risks: economic, political and legal ones. Despite the stabilization of Russian economy in the last few years, there is still a need for foreign investments in industrial sector and a need of reforms of the banking sector. At present there is a very poor coordination between industrial and banking branches: the commodity export dominates over its inland processing in industrial sector and the banking sector adjusts to the industrial needs very slowly. The sectors are ripe for changes and any big merger or foreign investment may trigger their restructuring.

After the breakup of the Soviet Union, the government took several measures to strengthen the exchange rate of RUR, which had a large influence on currency market and foreign trade. Changing the normative threshold for the compulsory sale of exporter’s currency profit is a tool the Russian government used in order to regulated the currency flows. In November 2004 the normative threshold was decreased to 10%, when just in 1998 the maximum normative stood at 75%. The new FZ №173 makes a clear distinction between the roles of the Central Bank of Russia (CBR) and the government in currency regulation: CBR will be responsible for foreign trade and government for credits and securities. Both the CBR and the government cannot interfere in transactions unless the currency law explicitly specifies it. The basic achievement of this law is the possibility for Russian residents to open offshore accounts and so conduct the whole transaction offshore. The new currency law allows to avoid repatriating export proceeds back to Russia, which are meant for credit re-payment abroad. Similarly, there is no further need to convert the proceeds in RUR or make reservation from export proceeds on special accounts. However, the transaction still has to be registered preliminarily with the issuance of according transaction passport. Some requirements of the FZ №173 like special accounts, mandatory reservation, conversion and repatriation are temporary and will stay in force until January 2007.

After the law came into force, there was no currency revolution and the fear of capital flight has cooled down. The new currency law is quite liberal; however, the numerous instructions of CBR might restrict the control and regulation of currency operations. FZ №173 has a large influence on creditors since it determines the new ways of currency flow; thus, it determines a new approach to estimate the business profitability. As a disadvantage, many analysts see the fact that the purchase of internal securities and the payment the insurance premium by the policyholder can be conducted in RUR only. Similarly, Russian residents, if they are not banks, cannot lend loans in foreign currency to other residents. With these measures Russian government tries to protect the country from its biggest risk – capital flight.

There are many classifications of risks. When doing business in a foreign country, creditors face two types of risks: onshore and offshore ones. The possibility to conduct transactions completely offshore provided by the FZ №173, allows creditors to eliminate Russian onshore risks. However, the remaining offshore risks like price-, political-, transport-, delivery- and credit-default risk have to be considered by creditors in international trade. Typical instruments to hedge the credit default risk in Russia are letters of credit, sureties and the assignment of export proceeds. By assigning export proceeds from offtakes directly to creditors, the risks associated with the default of Russian borrowers are minimized. This form of financing is very typical for the structured commodity trade.

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