The Russian connection

As new currency control rules come into force in Russia, Grigory Marinichev, associate at Gide Loyrette Nouel in London, and Massimo Ruocco, head of export finance at SG CIB in Milan, examine the mechanics of conducting export finance business in the region and discuss how the country’s restrictive regulatory framework impacts trade transactions.

As a developing country with bountiful natural resources and a pressing need for advanced foreign plants and technology, Russia will remain an attractive target for future export finance transactions.

“Russia’s growing economy and increased competition pushes the companies that operate in a highly capital-intensive environment towards a more accurate and thorough analysis and purification of their cost structures,” says Pavel Tatyanin, financial director of EvrazHolding. “One of the important elements in this race for savings is the modernisation and upgrading of the fixed asset base through the replacement of non-ecological, worn-out and morally outdated machinery. Putting all this together makes export finance an attractive source of funding for our capital expenditure programmes providing longer-term – ten to 12 years – unsecured debt for the company. This is bound to bring in advanced technology in combination with a strong positive effect on cash flows.”

Export finance is defined as the financing of the export of capital goods equipment and services to a buyer in a developing country, backed by a guarantee or insurance policy issued by an export credit agency (ECA). Most ECAs, such as SACE (Italy), Finnvera (Finland), EDC (Canada) etc, are governmentally-controlled institutions whose objective is to support domestic producers’ export to the emerging markets.

The support offered by ECAs provides, on the one hand, lower financing costs for foreign buyers, and, on the other, gives exporters and banks a guarantee against the various political and economic risks associated with the country of the importer.

The principal guidelines for export finance are contained in the OECD arrangement for officially supported export credits (‘Consensus’). Although the Consensus itself states the guidelines are to be considered as a ‘gentlemen’s agreement’ rather than a binding document, in reality when entering into a facility agreement the borrower usually contractually undertakes to respect its terms.

One of the most frequently used export finance structures in Russia is a buyer credit, where, unlike a supplier credit, which is granted to the exporter, a loan is extended to a Russian buyer to finance 85% of the contract value of the capital goods purchased by it from the foreign supplier under the export agreements (‘contracts’).

Compared to local funding rates, the advantages of buyer credits for Russian borrowers are low financing costs* and long facility terms which, according to the Consensus, may amount to ten years. As a rule, there is no requirement to provide security, save for corporate or sovereign guarantees, which may be requested by the ECAs depending on the nature of the transaction. [*Russian banks rarely provide long-term financing. The interest rates for short-term foreign currency loans up to one year are generally in the range of 9% to 11%].

At the same time, the borrower must be aware that the buyer credit facility may only be used for the limited purpose of financing the purchase price under the relevant contract. In particular, according to ECA rules, the facility may not be used for payment of customs duties for the equipment purchased under the contract, and thus the borrower must ensure it has sufficient free funds to pay duties and other local costs [average Russian customs payments, including import VAT, comprise 30% to 40% of the value of the imported goods].

The broad experience of foreign banks in export finance in Russia has encouraged the development of a number of buyer credit schemes which take into account the specifics of the Russian legal and regulatory environment.

Most of the structures described in this article are frequently used when financing Russian buyers. The choice of one particular approach over another will depend on a number of factors.

Standard structure

Under a standard structure, which is usually used to finance the buyers in less strict regulatory jurisdictions, the exporter after receipt of a 15% down payment and delivery of goods to the buyer under the contract, submits to the lender or to its local bank acting as a paying agent, a drawdown request accompanied by the relevant documents evidencing the delivery of the goods. Having checked the documents submitted from a formal standpoint (or having received such confirmation from the paying agent), the lender makes a drawdown which is credited directly into the exporter’s bank account. A buyer that has not ‘physically’ received the funds will be free from any payment obligations to the exporter under the contract and must instead repay the loan to the lender.

In contrast to other countries*, this structure cannot be implemented in Russia under the current regulatory framework. The Russian currency control rules require that a drawdown under a cross-border loan facility must be made to a bank account of the borrower maintained with a Russian bank, and disbursement to a third-party offshore account is not allowed. [*In Ukraine, for example, starting from June 2004 (amendments to National Bank of Ukraine Regulation No. 602), Ukrainian borrowers are entitled to enter into loan transactions where disbursement is made to a foreign exporter abroad, provided that the documents confirming the importation of goods have been submitted in turn to the local bank.]

From 19 June 2005, when new currency control rules become effective, Russian borrowers will be permitted to open bank accounts abroad and use them for crediting disbursements under the cross-border facilities. Although, under the new rules, disbursement will still need to be made to the account of the borrower, rather than directly to the exporter, this restriction can be overcome by using, for example, an account of the borrower opened with the lender. This enables the lender, once the funds have been disbursed to the borrower’s account and the requirements of Russian currency control law have been formally complied with, to immediately transfer the loan amount to the exporter.

Although the new rules could significantly facilitate the disbursement procedures, it is still unclear how they will be applied in practice, particularly given the current lack of clear explanatory guidelines from the Russian Central Bank. For that reason, it is likely that other buyer credit schemes, which are currently used in Russia and which comply with the currency control regime, will continue to be implemented in export finance transactions.

Prepayment structure

The easiest way to comply with Russian regulations and benefit from ECA insurance is to provide, in the transaction documents, that the buyer undertakes to make a 100% payment to the exporter under the contract after which the lender finances the buyer for 85% of the contract value.

Under this option, the bank’s risks are fully covered by the ECA insurance, because when disbursement is made, the exporter has already received the purchase-price payment under the contract. Although the buyer must use its own funds to pay this, it can quickly refinance the payment from the bank under favourable export credit conditions.

Even though this scheme significantly simplifies the transaction structure, its use in large facilities (over $100m) can be problematic, since the borrower may simply fail to find enough free funds or domestic financing to pay 100% of the purchase price. For this reason, the buyer’s payments under the relevant contract are usually split into several installments, which are refinanced by the corresponding tranches under the buyer’s credit facility. Each tranche, in turn, is used to finance the payment of a further installment under the contract.

At the same time, unless the buyer has made a 100% prepayment under the contract, it is the exporter that takes the risk of the buyer’s non-payment under the contract for the supplied goods rather than the lender. The exporter is not covered by the ECA insurance in such cases.

Local bank structure

An alternative, should the prepayment mechanism be unsuitable for a particular transaction, is the ‘local bank structure’. Under this option, the borrower opens a disbursement account with a local bank (which, as a rule, is a branch of the lender), and enters into a special banking agreement. Then the buyer gives irrevocable payment instructions to the bank to transfer funds drawn under the facility to the exporter abroad, once such funds have been credited to the borrower’s bank account.

Despite Russian law expressly allowing for the possibility to enter into such banking agreements, the lenders and the exporters should consider the following additional risks while using this structure.

According to the policy of most ECAs, ECA insurance becomes effective only when the exporter has received payment due to it under the contract. And in case of default, the lender, in order to apply for compensation, needs to submit to the ECA, evidence that the amounts disbursed have been credited in favour of the exporter. Therefore, in the local bank structure, the lender’s risks are covered by ECA insurance only when the payment has been collected by the exporter, rather than immediately from the drawdown date. Although the period of time between the drawdown and the receipt of payment by the exporter can be limited to only one day, a number of circumstances preventing the transfer of funds to the exporter may arise.

First, Russian civil law entitles the customer to close its bank account at any time with prior written notice to the bank. Any contractual provisions limiting this right of the customer have been constantly declared void by Russian courts. The issue for the local bank is whether, once it receives a termination notice, it should make the relevant payment to the exporter, before closing the bank account and returning the remaining balance to the buyer. This is not expressly governed by Russian law and, therefore, remains unclear. However, where a bank makes a payment to the exporter despite the buyer’s application to close the bank account, the local bank faces the risk of legal proceedings in Russian courts which, as a rule, tend to favour the customer in actions against banks.

Secondly, various governmental actions, eg, a so-called foreign currency block*, may prevent local banks from transferring payments abroad. In such cases, the exporter will not be paid for its goods, and the lender will not receive accelerated repayment of the drawdown made. [*A prime example of a foreign currency block in Russia was the governmental decision of January 1992 prohibiting Vnesheconombank, which at that time maintained the bank accounts of most of the post-soviet enterprises, from making any payments abroad. The claims of some foreign contractors that did not receive payments are still being considered by the courts.]

Finally, during this time, the borrower’s bank account is open to judicial seizures which may be imposed by Russian courts under tax or commercial claims against the borrower.

Consequently, despite its frequent use in Russia, the ‘local bank structure’ appears to be a relatively risky option, although it is in complete compliance with both ECA rules and Russian regulatory requirements.

LC structures

In order to devise a disbursement mechanism free of potential Russian risks, quite frequently local banks are invited to participate in the financing of the buyer under the contract [one of the leaders among Russian banks in export-finance transactions is Vneshtorgbank, the second-largest Russian bank, with 99.9% state participation]. The local bank issues an irrevocable letter of credit (LC) which is advised by the lender, and the exporter receives payment against the submission of the specified documents. After the payment has been collected by the exporter, the lender makes a disbursement to the buyer’s account through the local bank, and, according to irrevocable payment instructions from the borrower, the disbursed funds are automatically offset against the buyer’s obligations under the LC financing.

Alternatively, ECA rules authorise lenders to re-finance local banks directly for the LCs issued to the exporters. In this case there are no contractual relations between the lender and the buyer who receives LC financing from the local bank. As a rule, the lender and the

local bank enter into a framework agreement to cover several potential export finance facilities.

The role of local banks and foreign lenders’ branches in financing importers is widely recognised by Russian borrowers. “Disbursement of an ECA-covered loan has to be made directly from the financing bank to the exporter bypassing the accounts of the borrower. That is why the involvement of local subsidiaries into the financing structures is absolutely critical,” notes Tatyanin of EvrazHolding. “Through local bridging facilities they effect payments for the invoiced equipment to the exporters and the company gets reimbursed with a mirror disbursement out of the ECA-backed loan once the exporter confirms receipt of the payment to the financing bank.”

In all of the options, where the local bank is participating in the financing by issuing a LC, it provides the lender with sufficient comfort, at the moment of disbursement (either to the buyer or to the local bank), that its risks are covered by the relevant ECA insurance. However, from the borrower’s point of view, this scheme could be less attractive, since the local bank charges additional fees for participating in the financing and taking over certain risks, thus increasing the aggregate financing costs for the borrower.

Foreign banks’ domination

Legislative uncertainties and onerous currency control restrictions have restrained further development of Russian export finance and caused the lenders to seek ever more complicated financing structures. Nevertheless, export finance in Russia will remain an attractive area both for local borrowers that obtain access to low-cost financing and for foreign lenders which, until Russian banks are in a position to provide competitive conditions for long term finance, will continue to dominate the market.

Pavel Tatyanin believes the improved anticipation of Russian risk in general, and of individual corporate standing, in particular that of Evraz, on behalf of the ECAs is evidenced by the trend for changes to structures from the so-called ‘bank-to-bank’ (where an ECA would lend through a western financing bank to a Russian bank that would on-lend to a corporate in a back-to-back manner some 1.5 to two years ago) towards direct corporate lending (ie, without the involvement of a Russian intermediary bank).

“Some of the ECAs show more flexibility than others in terms of due diligence and time frames for issuing the promise of guarantees, but the tendency for taking direct risk applies to all ECAs we have dealt with,” he adds. “Banks that are represented in Russia are, in our view, in an advantageous position versus the banks without subsidiaries on the ground. We tend to get the financing not only under the ECA cover but also as a package transaction. We ask the banks to take the residual 15%, cover the ECA premium, and extend local facilities to meet the requirements of certain ECAs that are not in line with Russian currency control regulations.”