SECURITIZATION IN RUSSIA – AN OVERVIEW OF THE MARKET, LEGAL SYSTEM AND TAX MECHANISM
[Page updated by Anurag Pareek]
General Introduction:- After a slow start European emerging market securitisation is beginning to pick up pace.Securitization in Russia is coming of age. Over the past two years issuance of asset-backed notes in the region has taken off and, indeed, is poised for further growth. The Russian securitization market is enjoying a newfound confidence by local originators and Western capital investors alike.
Originators in Russia are being drawn to securitization as a more diversified funding source. Capital markets are continuing to develop and legal frameworks are starting to become more accommodative. Improving credit quality in the region and greater exposure to, and acceptance of, structured finance is also providing further impetus for growth.
Overview of the Market and Market Activity:- Russia saw a number of securitisations in the first half of this year.Future flow structures currently remain the most prevalent in the region. This may be attributable to the fact that the structure typically mitigates certain sovereign risks, allowing for a rating higher than that on the sovereign. In addition to this there is also sufficient scope for the growth of the current asset securitisation market such as housing loans and consumer loans are also the key areas for domestic securitizations, and lease payments. The need for housing finance is growing and is expected to grow significantly in the coming years. The residential mortgage market is estimated at around $400 to $500 million today. The long term market potential is estimated at about $10 to $30 billion. Securitization can help Russian mortgage lenders obtain the funding they need to meet rising demand for mortgage finance and help keep rates affordable. It has played a crucial role in helping to keep the US and European mortgage markets roaring.
A similar story exists in the consumer loan market. According to Standard and Poors, retail loans rose 2-1/2 times during 2004 — from $4 to $10 billion. Russian Standard Bank’s consumer finance portfolio more than tripled during the same period — to about $350 million. The ability to securitize consumer loans should help Russia meet this demand as well.
Recent transactions, such as the $69m (£36.62m) residential mortgage-backed security by CityMortgage's, showed that investors have discounted convertibility risk given Russia's investment grade rating and its high level of currency reserves.
Instances of some of the successful Securitsation transaction in Russia are -Gazprom International S.A., Russia International Card Finance S.A., Alfa Diversified Payment Rights Finance Company S.A., and also of existing receivables, e.g. Russian Auto Loans Finance (RALF), Eurasia Structured Finance No. 1, S.A., Russian Consumer Finance No. 1 S.A..
Legal System:- Governments appear to have recognised the value of effective capital markets and are working together with legal communities to develop the legal infrastructure to provide greater confidence in the legal entities and structures that are at the centre of the securitisation process.
The legal system in Russia is, however, at a relatively early stage of development, and securitisation structures that under the common law system rely on fairly complex principles of jurisprudence have not yet been tested in the Russian courts. This does not preclude securitisations, but creates uncertainty as to how Russian courts will interpret concepts such as bankruptcy remoteness, true sale, limited recourse special purpose vehicles (SPVs) and tax neutrality.
In November, 2005 the Russian government adopted Federal Law No. 152-FZ “On Mortgage-Backed Securities” The Law was the result of long-term discussions over the different MBS models and has long been awaited by the market participants to boost domestic mortgage loans securitizations.
The law essentially lays down two types of mortgage backed paper – mortgage bonds and mortgage certificates.
A mortgage bond is seemingly similar to the pfandbriefes or mortgage bonds prevalent in continental Europe where as a mortgage certificate is apparently similar to the mortgage pass throughs in the US market. The Russian model is not an exact replica of either the European model or the US model but seems to be an amalgam of the two.
Mortgage certificates may be issued by management companies of investment or pension funds to the owners of mortgage-backed loans in exchange for the contribution of such loans to a "mortgage pool," which may consist of mortgage-backed loans, mortgage certificates or cash generated as the result of performance of obligations under the mortgage-backed loans and mortgage certificates or levy of execution under the mortgage-backed loans. The owners of MCs are regarded as the owners of "mortgage pool" managed by a management company acting as a fiduciary manager for those owners. However, the MBS Law leaves a number of issues including the rights to the property in the pool and execution of joint rights, unresolved.
In a recent paper presented by the IFC some of the major obstacles and the actions needed to remove these obstacles and create an enabling environment were identified. Several key areas are highlighted for change mainly:
– Expand the scope of receivables eligible for securitization
– Guarantee the true sale of securitized receivables to the Purchaser of those receivables
– Clarify the legal status of the Purchaser
– Guarantee the bankruptcy remoteness of the Purchaser
– Allow traditional credit enhancement mechanisms to be used in securitization transactions
– Allow for securitization to be treated in a tax neutral way
Hence, a designated securitisation law would certainly help to codify concepts relevant to securitisation, creating more legal certainty in a judicial system that often takes a formalistic approach, but the lack of a designated law is not in itself preventing the development of an effective Russian securitisation market.
Witholding Tax:- There is no withholding tax on interest payments that would be payable to the seller whether acting as a principal or an agent for the purchaser. However, any interest payable by Russian debtors or the seller to the purchaser having no permanent establishment in Russia would be subject to 20% withholding tax. The purchaser may be exempt from Russian withholding tax pursuant to a double tax treaty(currently there are more than 70 such treaties in force, including treaties with the UK, Luxembourg, Cyprus, USA,Germany and other countries).
The double tax treaties with, amongst others Germany, Luxembourg, the Netherlands, USA and the United Kingdom allow for the reduction of the withholding tax to zero upon compliance with certain procedural requirements.
Accounting Policy:- No specific accounting policies need to be adopted for tax purposes by the seller or purchaser in the context of a securitisation.
Stamp Duty Expenses:- Under Russian tax law, there are no stamp duties or other taxes or fees when assigning receivables other than when mortgages have to be re-registered and certain registration costs thereby incurred.
VAT/ Sales Tax/ Service Tax:-If the receivable contracts were subject to VAT (e.g. lease contracts, sale of goods, servicing agreements), the sale of such receivables to the purchaser would be also subject to VAT (currently 18%). The tax implications of this can however be mitigated by offsetting VAT that is paid on the sale against VAT which is collected together with the receivables (e.g. leasing payments). Banking operations (loans, deposit, settlements, bank guarantees, etc.) are generally exempt from VAT. The seller of receivables would be subject to Russian profits tax on the margin, i.e. the difference between the price paid by the purchaser for the receivables and the nominal value of receivables (if any) at a rate of 24%. Where receivables are transferred for a discount or at par, the seller would receive no margin and, hence, no profits tax would apply.
The servicing of receivables is VAT taxable when it is performed in Russia.