Imprisoned Shares: Will it be possible to unblock foreign securities in the accounts of Russian investors?

After February, many Russian investors faced the blocking of their securities due to Western sanctions. According to the Bank of Russia, there are more than 5 million of them. What should they do now? The current difficult situation is analyzed by Ekaterina Zemskaya.

 

 

Ekaterina Zemskaya,
Advisor on Legal Issues to the Director of the NGO “Forum Analytical Center.”

 

 

 

At the beginning of March 2022, the European depositories Euroclear and Clearstream blocked the accounts of the National Settlement Depository (NSD). Since NSD acts as the nominal holder of the assets of most of the Russian investors in the European Union, these assets were also frozen. On June 3, 2022, the Council of the European Union imposed blocking sanctions on the NSD, which reinforced the freezing of its assets in the European Union.

The assets of many Russian investors are structured, at the first link of the chain of ownership, through Russian banks that perform a brokerage and depository function – some of which are also under blocking sanctions. That is, the chain of ownership in most cases involves two entities which are both under the blocking sanctions of the European Union. In addition, some other Russian financial institutions (in addition to NSD) are also under US blocking sanctions, so Euroclear and Clearstream may be afraid of “secondary” US sanctions when interacting with them.

According to the Bank of Russia, more than 5 million Russian investors faced the blocking of their securities after February 24 due to sanctions. The UK has blocked Russian assets worth 18.39 billion pounds (approximately $ 21 billion), including more than 1200 individuals and more than 120 companies in the sanctions list. Since the beginning of the Russian special operation, it has frozen the assets of 19 Russian banks.

EU countries have frozen Russian assets – located in Austria, Belgium, France, Germany, Ireland, Italy and Luxembourg – worth 17.4 billion euros. An international group, created in the United States to search for Russian assets, has blocked more than $ 30 billion belonging to sanctioned Russians.

In August, the NSD filed a lawsuit in European court, challenging the freezing of its assets. Also in mid-­August, the European Commission began to look for solutions, putting forward two conditions for unlocking NSD assets, which the Russian organization eventually fulfilled. This allowed the European Union to take the next step forward in early October.

On October 7, 2022, the European Commission (as part of the eighth package of sanctions against Russia) issued a recommendation regarding the assets of Russian investors. According to this document, the competent authorities of each member of the European Union – regulators or ministries of finance – can allow in their respective countries the unfreezing of funds and assets of non-sanctioned investors who have fallen under the sanctions against the NSD. According to the order, the unfreezing of assets is allowed to be carried out strictly in order to complete contracts and other agreements concluded with NSD before June 3, 2022. It is recommended that foreign counterparties complete all operations with the depository before January 7, 2023.

In order for the unfreezing of assets to be approved, Russian investors need to obtain a separate permit from European regulators – that is, from the Belgian Federal Public Service Finance organization and the financial regulator of Luxembourg (Commission de Surveillance du Secteur Financier), since NSD’s accounts were initially opened in Belgium’s Euroclear and Luxembourg’s Clearstream. In September, the NSD sent requests to the finance ministries of Belgium and Luxembourg for general licenses to release assets. However, these licenses have not yet been received by the NSD.

The Moscow Exchange has organized the Investor Rights Protection Club, which includes the Moscow Exchange Group, NAUFOR, NFA, and the Association of Banks of Russia, as well as more than 100 companies with direct contractual relations with NSD. If the NSD does not receive these licenses by the end of October, the Club members agreed to send requests to European regulators for individual licenses to unblock the securities of non-sanctioned investors, in accordance with the explanations of the European Commission of October 6, 2022.

In early November, the SPB Exchange opened access for brokers and their clients to a part of the foreign securities blocked on non-trading accounts of its settlement depository. To transfer part of the securities to trading sections from non-trading sections, SPB Exchange reached agreements with a foreign institutional investor. This investor will exchange within St. Petersburg Bank its freely tradable foreign securities, for which NSD is not in the rights accounting chain, for an equal number of securities of the same issuers from the non-trading sections of the market participants, the chain of rights for which includes the NSD.

With such an exchange procedure, there are no discounts – since such operations are depository, and not purchase and sale transactions. Securities that will be transferred to trading sections will change their rights accounting chains, which now will not include NSD. Investors will be able to make exchange transactions with such securities after the completion of the depository operation by St. Petersburg Bank. The procedure for transferring foreign securities to trading sections will occur automatically for investors, without incurring any additional costs, and no additional actions from investors will be required.

This operation will affect those brokers who currently provide access to trading in foreign securities on the “SPB Exchange,” and who have securities to be transferred in non-trading sections. Foreign securities are stored in the non-trading sections of the depositary’s sub-accounts, the chain of accounting for the rights of which includes NSD and international depositories Euroclear or Clearstream. Also, over-the-counter trading in frozen assets has been launched by Tinkoff Investments. BCS World of Investments and Finam both plan to join them.

Following communication with Euroclear, the NSD plans to send questions to the US Internal Revenue Service (IRS) about taxes on the blocked assets of financial market participants affected by the EU sanctions against NSD. When market participants apply for individual licenses to unlock assets, they will have to indicate the amount of income before and after taxation and the amount of taxes (gross, net, tax), in connection with the need to fulfill tax obligations to the IRS.

Not only securities of foreign issuers, but also depositary receipts of Russian companies were blocked due to sanctions. On April 16, 2022, Federal Law No. 114-FZ was adopted, which required ending programs of depository receipts, converting them into shares. The beginning of this process was laid at the end of February 2022, when the New York Stock Exchange and NASDAQ suspended trading in securities of Russian companies. In early March, the London Stock Exchange (LSE) took the same step after the price of most receipts of Russian companies fell to almost zero amid the introduction of tough sanctions against Russia. For example, the value of Sberbank’s securities fell by 95%, to $ 0.01, the lowest in its entire history.

At the same time, issuers that are registered abroad do not fall under the scope of this law: Ozon, TCS Group, FixPrice, and others. A government commission has also allowed 15 additional Russian companies to keep depository receipt programs. For example, Norilsk Nickel and Novatek received such permission. Such companies also had to apply separately for the postponement or cancellation of the automatic conversion of depositary receipts – but this was done by only one company, AFK Sistema. All other companies have already gone through the automatic conversion process.

There are two mechanisms for converting depositary receipts into shares – automatic and forced. Those receipts that were stored in Russian depositories generally fall under automatic conversion. Their owners did not need to do anything; the receipts were annulled and corresponding shares of Russian issuers were calculated instead. NSD reported that it had automatically converted 36 issues of depositary receipts into ordinary and preferred shares.

If receipts are recorded in a foreign depository, their owners may request forced conversion if:

• the receipts are stored in NSD, and the company has received permission from the Bank of Russia not to carry out automatic conversion;
• the receipts are stored outside NSD (bought directly on a foreign exchange) – for example in the accounts of foreign brokers – but the investors cannot receive shares due to some kind of restrictions.

In the case of a forced conversion, the investor contacts the depository in which the shares issued against receipts are stored, and asks to credit the shares to his account with any Russian broker. If the securities have an encumbrance, it will remain after conversion.

The cancellation of receipts through foreign infrastructure began in April, but was suspended after the European Union imposed sanctions against the NSD. Clearstream and Euroclear have resumed manual processing of requests for converting depositary receipts into Russian securities, as NSD has stopped charging fees for converting receipts.

The deadline for filing a petition for forced conversion of depositary receipts into Russian shares ended on November 10, 2022. No later than November 24, 2022, Russian depositories will have to open accounts for investors who apply and credit Russian securities to them, or refuse to conduct operations.