LawFlash

Update: Russia Adopts Draft Law Allowing DR Conversion Without Reference to Foreign Infrastructure

July 01, 2022

The State Duma, Russia’s parliament lower chamber, adopted draft law No. 116264-8 on June 29, 2022, containing rules allowing the conversion of depository receipts into the underlying Russian shares without a need to go through non-Russian depositary banks, custodians, brokers, and other similar institutions.

Russia considers draft law No. 116264-8 (the Draft Law) to be in response to international sanctions that have made it impossible to proceed with the conversion as contemplated by the DR programs in many instances. The Draft Law needs to be approved by the Federation Council, Russia’s parliament upper chamber, and then will be signed into law by the president and published. It is expected that this will be completed very shortly. Once published, the Draft Law, in its relevant part, will become effective immediately upon publication (the Effective Date).

Background

Recently, Russia adopted Federal Law No. 114-FZ of April 16, 2022 (the Delisting Law), which in effect required Russian issuers to terminate the DR programs on their shares (the underlying Russian shares), unless exempt by the Russian government commission on control over foreign investments. Many Russian issuers decided to have their DR programs terminated, and in several instances those Russian issuers that intended to keep their DR programs were not granted the requisite exemption. As result, many DR programs are now being terminated and the DRs need to be converted into the underlying Russian shares.

Under the Delisting Law and other Russian legislation, a DR holder must do the following to have its DRs converted into the underlying Russian shares:

  • Open a depo (custody) share account with a Russian custodian directly or via a so-called foreign nominee (omnibus) account of its non-Russian broker or custodian with a Russian custodian.
  • Give a cancellation notice to the DR program depository bank to cancel the DRs.
  • Make a request through the Russian custodian to receive the underlying Russian shares.

Existing Conversion Procedure

DR holders have been experiencing several practical difficulties in converting the DRs under the procedure set out by the Delisting Law.

First, the European clearing systems blocked the accounts of Russia’s National Settlement Depository (NSD). Further, in June 2022, the European Union imposed blocking sanctions on NSD, making it impossible to do the conversion by those investors whose DRs are held through Euroclear, Clearstream, and other EU institutions. This also resulted in DR holders with DRs accounted in the Russian custody system to not be able to proceed with the DR cancellation.

Second, some of the Russian issuers were sanctioned by several countries, which made it impossible for many brokers, depositary banks, and other institutions to deal with DRs related to such Russian issuers’ shares without a license from a sanctions authority, if at all.

Third, some international brokers and clearing systems suspended the transactions with DRs related to the Russian issuers and decided to abstain from the conversion process.

In response to this situation, the Draft Law amends the existing conversion procedure and contains additional conversion mechanics depending on whether DRs are held at the accounts of a non-Russian custodian, broker, or other institution (a non-Russian organization), or a Russian custodian.

Mandatory Conversion

Under Russian law, the total number of underlying Russian shares for each DR program is recorded at a special DR program depo (custody) account (the DR program depo account) opened in the name of such program depositary bank and maintained by a Russian custodian (the DR Program Russian Custodian).

In general, the Draft Law proposes that if a DR holder’s title to the DRs is recorded via a non-Russian organization, and the DR holder cannot complete the conversion and receive the underlying Russian shares due to any sanction restrictions or as a result of any “unfriendly actions of foreign states towards Russia,” such DR holder (or beneficial owner of the DRs, as the case may be) will now be entitled to apply to the DR Program Russian Custodian to demand that it directly completes the mandatory conversion of the DRs into the underlying Russian shares (the Mandatory Conversion).

DR holders or beneficial owners wishing to apply for the Mandatory Conversion must do so within 90 days from the Effective Date.

When applying for the Mandatory Conversion, a DR holder or beneficial owner must present to the DR Program Russian Custodian, among other things, the following evidence:

  • Proof of title to the DRs.
  • Confirmation that the DR holder or beneficial owner is entitled to the Mandatory Conversion.
  • Information on the chain of non-Russian custodians (nominee holders) in which the relevant DRs are recorded.
  • Information on any encumbrances and restrictions imposed on the DRs.

The DR Program Russian Custodian is entitled to assess the application and evidence provided. It will then either (a) open a depo (custody) share account for the DR holder or beneficial owner, as the case may be, and credit it with the underlying Russian shares; or (b) refuse the application when it has “reasonable doubt” as to the completeness or accuracy of the information and documents provided.

Although not specifically provided in the Draft Law, as a matter of Russian law, a DR holder or beneficial owner should generally have the right to challenge a refusal to conduct the Mandatory Conversion in a Russian court.

Mandatory Transfer of Underlying Shares Recordkeeping

Many DR holders that did the conversion through non-Russian brokers ended up having the underlying Russian shares recorded in their brokers’ accounts, with such brokers having foreign nominee (omnibus) accounts with Russian custodians. It is not uncommon for the shares held on such broker accounts to be blocked because the broker is unable to transact with those shares due to sanctions, countersanctions, internal policies, or other factors. For example, as a matter of Russian law, all foreign nominee accounts have a “type C” regime (which is de facto blocked in Russia).

The Draft Law provides for a procedure similar to the Mandatory Conversion that would allow a holder or beneficial owner of the Russian shares to apply to the DR Program Russian Custodian to demand that it transfer the underlying shares from the broker’s foreign nominee account to a holder (beneficial owner) depo (custody) share account directly with the DR Program Russian Custodian (the Mandatory Transfer of Recordkeeping). No consent of the broker is needed.

Upon the Mandatory Transfer of Recordkeeping, the title to the underlying Russian shares will be recorded by the DR Program Russian Custodian in Russia. This means that, as a matter of Russian law, the holder (beneficial owner) will be free to transact with such shares freely, unless the holder (beneficial owner) is a resident of an “unfriendly state” (a jurisdiction that has imposed sanctions on Russia) or controlled by such resident. In this case, the DR Program Russian Custodian will put the shares into a blocked “type C” account of the holder (owner).

Remaining Uncertainties

The Draft Law leaves many issues unclear, including the following:

  • What proof would a DR Program Russian Custodian require from a DR holder that the ordinary conversion procedure is impossible because of “unfriendly actions of foreign states towards Russia”?
  • What degree of discretion does a DR Program Russian Custodian have in deciding whether a DR holder is eligible to receive the underlying shares?
  • Will it be possible for a DR holder to open a Russian depo (custody) account remotely without the need to attend in person or instruct an attorney?
  • Would a DR Program Russian Custodian be able to open accounts to non-Russian holders (beneficial owners)?

It is expected that some of these issues will be clarified by subordinate legislation.

Most importantly, the Draft Law is designed to allow DR holders or beneficial owners to bypass the usual conversion and holding routine. For example, it allows the DRs to be converted into the underlying Russian shares directly in Russia, instead of through DR program depositary banks as prescribed or contemplated by the DR program documentation.

The Draft Law creates a number of complex jurisdictional, compliance, and other issues for all affected persons, including depositary banks and brokers as well as holders and beneficial owners. We do not address these issues in this LawFlash; rather, we focus only on Russian law matters.

Taking into account the relatively short periods prescribed by the Draft Law and the many uncertainties invoked by the Draft Law, affected persons should seek legal representation in dealing with matters resulting from the Draft Law.

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Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:

Ukraine Conflict Task Force
Giovanna M. Cinelli
Alexey Chertov
Joanna Christoforou
Bruce Johnston
Grigory Marinichev
Michael Masling
Kenneth J. Nunnenkamp
Georgia M. Quenby
Christina Renner
Melanie Ryan
Vasilisa Strizh
Pierre Trippel
Carl A. Valenstein
Abaigael R. Clifford
Dr. Axel Spies
Jiazhen (Ivon) Guo
Katelyn M. Hilferty
Nicola Kelly
Christian Kozlowski
Charles C. Rush
Eli Rymland-Kelly

Trainee associate Maxim Sidorenko contributed to this LawFlash.