For securitization devotees, Russia has long been a story of unfulfilled potential. Sounding like the inert characters of a Chekhov play, talk among players was always of things to come. Action finally came in late July, when gas exporter Gazprom placed a $1.25 billion structured deal. Its success - underlined by a $250 million upsizing - fed hopes that other exporters and even banks would start tapping flows from abroad. But onshore assets face more daunting obstacles, with the laws required for a securitization sector often either unfriendly or nonexistent.

"While there is a lot of interest from the side of arrangers and originators, there are big problems from the side of legislation," said Igor Iassenovets, assistant general counsel at the Moscow office of Standard & Poor's. He belongs to a working group of lawyers, bankers, regulators, investors and other players that has been discussing securitization issues monthly since 2002 and pushing for comprehensive legislation in the sector.

Russian law does not govern any of the transaction documents in the Gazprom deal; in fact, no less than seven jurisdictions are involved.

That highlights the fact that domestic legislation, in its current form, is to be avoided in a structured deal, sources said. For offshore assets - such as the export receivables assigned to the Gazprom structure - that's easier than for onshore assets such as mortgages, consumer debt or auto loans.

For starters, under Russian law selling receivables is anything but straightforward. Among potential problems, Iassenovets pointed out that Russian courts could strike down a sale if receivables are sold at a discount since the discounted portion can be deemed a gift and gifts between companies are prohibited.

Setting up an SPV in Russia is no walk in the park either. While a joint stock or limited liability company can be established to act as an ABS-issuing SPV, achieving bankruptcy remoteness appears to be impossible, sources said. In addition, under Russian law the entity doubling as a SPV would enjoy the inviolable right to liquidate itself and reorganize - far from ideal for an ABS vehicle. A genuinely limited purpose is "hardly achievable under Russian law," Iassenovets said.

And then there's a bankruptcy clause that can portend serious headaches down the road. Under Russian law, courts can annul the sale of assets into a bankruptcy estate if the assets were sold six months prior to the bankruptcy for non-bank firms and three years for banks. "You can imagine where a bank doing credit card receivables becomes insolvent and the court invalidates the assignment of receivables," said Andrei Yakovlev, counsel with the London office of Dewey Ballantine. "Although in practice invalidation of such assignments may not occur too often, the possibility of this happening will certainly affect credit ratings of Russian ABS."

Even for offshore deals, the fact that domestic bankruptcy law is tougher on banks might appear to hurt the prospects for banking transactions more than for non-bank entities, but Fitch Ratings analyst Jennifer O'Neil offers an encouraging caveat. "[The clawback provision] is not a clear right," she said, adding that it would most likely be applied in a situation where the asset sale itself could arguably have triggered the company's decline.

But banks face another barrier on the offshore front. For a cross-border future flow deal - which for emerging market banks often means electronic money flows - the going concern of a financial institution is crucial to determining whether the structure can top the originator's local currency rating. What shapes the going concern of a given bank is the history of government support (or non-support) for the sector, the bank's position within the industry, and the country's legal environment, among other factors, according to Fitch.

The government's track record on this front is not exactly comforting. Two financial crises in the country since the mid-90s provoked the failure of large banks, indicating that the same could occur again. "We're looking at the likelihood that the government would support a bank if it went into financial distress. That's why we've found it difficult to provide much uplift over the local currency ratings [for Russian banks]", O'Neil said.

In other countries - such as Turkey where the government has a history of bolstering banks - the going concern assessment can stand a few notches above the bank's local currency rating. In the case of Russia "we might be looking at only one notch," O'Neil said.

On the existing asset front, the government has been most keen to develop an MBS market. To that end, in November 2003 Russia enacted a law enabling mortgage-backed securities, which some say was rushed. Amendments to the law - that, as it turns out, are crucial for MBS - were added later on. "As it was adopted, the law did not quite make these securities bankruptcy-proof," said Dewey Ballantine's Yakovlev. But even now, players are not entirely satisfied with the results and no MBS have surfaced.

"We believe [MBS] is a product that will be important for Russia in the future," said Alison Harwood, principal securities markets specialist at the International Finance Corp., which catalyzed and has been supporting the securitization working group. "More work is needed to make the legal and regulatory environment conducive for securitizing a broad range of assets and receivables."

Just as critical for a genuine MBS market, origination volumes are not up to par. The IFC puts the entire mortgage industry in Russia at between $300 million and $500 million, accounting for no more than 0.02% of the country's GDP, as compared with 40% to 75% among countries in the Organisation for Economic Co-operation and Development (OECD), a grouping of mostly wealthy nations. With origination not growing fast enough, it is also doubtful a bank could use the proceeds of an MBS fast enough to generate more mortgages.

Mandated with fostering a secondary mortgage market, the government-controlled Agency for Housing Mortgage Lending holds a mortgage portfolio originated by local banks, estimated at Rbs2.8 billion ($96 million). So far, the agency has issued Rbs2.6 billion of government-guaranteed paper that are not mortgage-backed. Another Rbs2.3 billion of vanilla bonds are planned for the fourth quarter.

While some see the first MBS coming from the Agency, others are skeptical. "They purchase mortgages at below-market rates," said one source, implying that heavy enhancement would be needed to attract investors.

Also, the government's guaranty of regular paper from the agency weakens the funding incentive to issue a mortgage-backed deal. Mortgage originators in Russia include state-owned Sberbank, Delta-Credit, Raiffeisenbank and MDM.

As it stands, Russia's MBS law envisages two types of securities: mortgage-backed bonds (MBBs) to be issued by banks and mortgage agents, and mortgage certificates (MCs), to be issued by pension- and investment-fund managers, according to a report by White & Case authored by associate Olga Okouneva and Ekaterina Suchkova, who has since left the firm. "In trying to choose between the two, they ended up implementing both," said S&P's Iassenovets.

The MBBs are bonds secured by "mortgage coverage." While flows from the coverage can come from instruments, cash and other assets other than mortgages, a least 80% must be secured by mortgages. But as White & Case points out, the law "does not clarify what should happen upon the natural amortization of such claims into cash. Some financial analysts note that such uncertainty will likely result in low or no ratings for MBBs."

The agent must be established as a joint-stock company with limited capacity. Already a law has been passed that exempts these agents from paying profit taxes on their "charter" activities, essentially snapping up mortgages and issuing MBS. The perk takes effect next year.

MCs establish a right to a co-ownership share in a pool of mortgage-backed claims. The management company acts as a trustee. But, as envisioned, the securities are far from trouble-free. The law "leaves a number of issues including the rights to the property in the pool and the execution of joint rights, unresolved, thus limiting the reliability and attractiveness of MC as a financial instrument," White & Case said.

Still, the government's will to jump start the sector is clearly there. Russia's Parliament, the Duma, recently cut the income from both MBS types to 9% from 24%, as long as the paper is issued before Jan. 1, ( 2007. The rule takes effect next year. Notary fees for certifying mortgages have also been slashed.

While the path to mortgage-backed territory is riddled with potholes, the one to other domestic assets may be even bumpier, given the lack of necessary legislation. Nevertheless, for at least one asset class, critical mass does not seem to be a problem.

On the consumer front, personal loans in the Russian banking sector have swelled to Rbs409 billion as of May 31, from Rbs45 billion at the end of 2000 (see graph). Sberbank accounted for 40% of the total through the end of 2003, according to a report by S&P. "The most common form of lending to individuals is through overdraft lines that are part of the payroll services that banks provide to the employees of a corporation," the agency said in a report published June 16.

The emergence of other asset classes is even further down the road. While in its report Fitch points to an unmet need for medium- to long-term financing for Russian leasing companies, authorities in that sector dismiss its potential. "Leasing is way back at the queue," said Derek Soper, principal at the Alta Group, which specializes in equipment leasing worldwide. He cites the lack of legal architecture, low volumes and the small number of leasing companies as precluding the development of ABS in leasing. What's more, some 60% of leasing companies secure funding abroad, Soper said. He also pointed out that, unlike in the U.S., securitization of equipment leasing has not reached meaningful volumes in Europe. Can Russia eventually overcome these obstacles and break out a viable business in leasing ABS? "Not within my lifetime," Soper said.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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