The pledge law in Russia is undergoing significant change. Recently President Vladimir Putin signed the law amendments which imply setting up a database of all registered notarial documents, and in particular, a unified register for movable property pledges. The European Bank for Reconstruction and Development (EBRD) assisted in working out some of these provisions.
Frederique Dahan, Lead Counsel and Head of Financial Law Unit of the Legal Transition Programme of the EBRD, talks about new developments in the pledge law of Russia in an interview to the AK&M Information Agency (Moscow).
What are main projects of the EBRD Financial Law Unit in Russia?
At the moment in Russia we are working at a number of initiatives. The first one is advising the Ministry of Economic Development on the pledge law reform. This is something we have been involved for a couple of years now. Our cooperation consisted of developing a few provisions and also commenting on the current Civil Code draft provision that relates to pledge. We also were discussing the development of registration system for the pledge of movable property.
Another project where we have been very much involved is with the Ministry of Agriculture. We assisted the Ministry in setting up the legal framework for a system of public grain warehousing receipts. The system will allow the storage of grain in safe, technically and financially sound public warehouses. It will also give the possibility of raising finance against this grain via the receipt which is issued. The system will include also state grain reserves that, according to the draft, will be stored in these public warehouses.
Another project is what we have been working over with the Ministry of Economic Development. It relates to insolvency law regime, in particular the strengthening of the profession of insolvency administrators (sometimes referred as bankruptcy trustees). In Russia this profession is self-regulated, and, as it is relatively new, it needs the development and adaptation of professional standards. We’ve been advising the Ministry of Economic Development in conjunction with the Union of Self Regulating Organisations of Insolvency Administrators for the development of these targets.
How the work is technically organized?
It varies from project to project, but generally the EBRD is there because it’s a very large investor. It has been operating in Russia for twenty years and it knows the environment very well. We create an interface between the private sector and the public one. We convey the concerns of the private sector to the public one and we also convey the objectives the government wants to achieve to the private sector.
Most of the expertise that is needed to carry out a legal reform project can usually be found in Russia. If the Ministry of Economic Development needs help in supporting its departments in the developing of documents, such as drafts, commentaries, economic analysis etc, and we are able to mobilize this expertise quickly, we do that.
The EBRD also tries to facilitate the exchange of information as much as possible. To give you an example, eighteen months ago we organized a visit of Russian authorities to Brazil to look at the agricultural system and how its segments were financed using an interesting legal instrument — the crop receipt, which is exactly what we are now discussing in Russia. The Brazilian experience is really unique, and there was a strong interest in Russia, given a similarity in the role of agricultural sector, the size of the country etc.
When we worked on professional standards in insolvency, we also organized a number of events. We brought experts from Germany, the Netherlands and India, where this profession has been developed.
Obviously we don’t do handover ‘key turn’ products, draft laws which just need to be translated and adopted. It would never work. The goal is to facilitate mobilization of the expertise existing in Russia and open the exposure to other experience. That all, of course, in the context of us being an investor that sees other investors operating in Russia and experiences all the same difficulties, problems and opportunities.
In 2005 you wrote that Russia's pledge law was a ‘malfunctioning, out-dated system with no effective publicity’. How are things today?
I think that Russia since 2005 has made tremendous progress — e.g., until recently it was legally very difficult to undertake syndicated lending in Russia. First of all, syndicated lending requires typical standardized documentation, because lenders in the syndicate need to be comfortable with documentation that will apply to all of them. The Association of regional banks of Russia created a working group which aims at developing this documentation.
Another problem that has been holding back syndicated lending is the possibility that the security (pledge or mortgage) the syndicate takes can be shared among all of the lenders. In such a way banks can enter or leave a syndicate without their security being affected. Until now it was impossible. The Civil Code simply did not recognise the possibility of sharing the security among several pledge holders and having it managed by so-called pledge managers or trustees. But the current draft provisions of the Civil Code recognise this technique, and it’s a great step forward.
Or let’s take another example. Your agency has recently reported the development of the unified notarial registration system. Ten years ago experts in Russia believed that such an electronic system could never exist here. Today it is about to happen. It is a massive breakthrough.
We can’t analyze any law or a reform in abstract. They are driven by economic and social objectives. We talk a lot about Moscow as an international financial centre, and that’s precisely an economic goal. It’s against this objective that a law needs to be analyzed or reformed.
My understanding from discussing with the Ministry of Economic Development and others is that businesses in Russia tend to suffer from a significant lack of access to credit. And the objective is to encourage access to credit, and the law needs to reflect this. Generally, the law has to facilitate access to credit and not prevent or limit it. Personally I find that there is still in Russia a bit of a dichotomy between economic objectives and legal provisions that are at times too rigid.
We have provided a lot of comments over pledge provisions in the Civil Code. There are some more provisions, e.g. taking a pledge over bank account which is a technique that was missing in Russia. We think there are still a number of important provisions that are unnecessarily limiting, so we have to see how the Civil Code will be amended during the second reading in the State Duma.
Recently President Vladimir Putin signed the law amendments which imply setting up a database of all registered notarial documents, and in particular, a unified register for movable property pledges. What do you think about these amendments?
They are very important for improving access to credit in Russia. When you take security, what is the most important for you as a lender is the confidence that the security right you have over these assets will be efficient and enforceable at the time when you’ll need it most. That requires certain transparency. In particular, you don’t want to discover at the time of enforcement that there was another creditor that had a prior security above you.
Having certain assets allocated to you is the basis of the secure lending. If you have a security, you want to have a certainty that your rights will be recognised, valid and can be opposed to other parties, so nobody can jump the queue, so to speak. If you have this certainty, you can take more risk and lend on better terms. All international financial institutions need laws that reinforce flexibility, certainty, transparency of lending. That encourages access to credit.
I know there have been a lot of reports about this system as facilitating the trade of cars. It’s absolutely true, but it’s a narrow perspective. For lay people, people in the streets, it’s only about second hand cars, because they are going to buy cars in a safe way. But it is much more than this. It’s a system to assist various types of financial activities in Russia, e.g. project financing and corporate finance. All the finance institutions focus on this register, because it’s going to revolutionize the way they undertake lending.
When the law amendments were discussed, there have been two different approaches: the register of movable property pledges could be kept by credit history bureaus or notaries. The second one prevailed. Why have notaries been chosen?
In theory, there is no ‘right’ institutional structure that should operate the register of pledges. But it is important to understand that credit bureaus and pledge registers do not serve the same purposes. One provides information about the creditworthiness of an individual; the other provides transparency about creditors’ rights. You could not just merge credit bureaus with pledge registers. But you could have credit bureau histories play the role of a centre that would create a database for pledge register.
I think the decision to choose the Chamber of Notaries was motivated by a number of factors. First of all, it’s crucial that the pledge register is widely available. And notaries have de facto a very wide network. The scale of Russia makes this factor particularly important.
Another factor, I think, was that notaries were very willing to pay themselves for the development of this service. We made a seminar back in June at the EBRD Moscow office where we invited the Federal chamber of notaries to discuss this question. They listened to the presentations made by the EBRD and other experts about the recent trends in pledge registers. They visited a number of countries in Central Europe, in particular, Slovakia where it is precisely the Chamber of Notaries that operate the pledge register, to understand how the system was set up and a wide range of institutional structures that exist. This was very successful.
What could be the role of notaries in mortgage deals, should their participation in mortgage deals be obligatory? This point is included in the Civil Code amendments now undergoing the second reading in the State Duma, but there is a strong opposition. Opponents say it will not reduce number of frauds and only lead to extra cost of mortgage deals. What are international practices in this issue?
This question is absolutely not specific to Russia. All the countries in Europe have been facing this question on the role of notaries, in particular in mortgage agreements. It is always the balance between the protection of parties, especially the debtor, against the cost and the time involved. The question is: what do we achieve by imposing (as opposed to allowing as an option) participation of notaries in the deal? This is the question that needs answering in Russia.
I do not believe in drafting laws to prevent fraud. Law is a tool to facilitate activities. Criminal law, investigation – that is what prevents fraud. There is often a problem: you can make a system super safe, but when it is too costly and rigid, you have killed what you were trying to achieve.
I think that the cost of transaction is very important. We all know who is bearing this cost – the borrower. If the objective of Russia is to encourage financial activity, the question of costs of transaction versus the benefits derived needs to be addressed very carefully.
I think, those issues need to be look at dispassionately against the economic objectives of a particular area of law, and the research should be done. After all, Russia has abolished the compulsory notarial deed of mortgage agreement several years ago. What has been the effect? Have there really been more frauds? What are the data to support this proposal? Russia is a country where excellent economic and sociological research is being carried out, so I’m certain that these data can be available.