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. Last Updated: 07/27/2016

Bank, FSC Hold Key To New Russian Funds

For Russia's small-time investors wary of capital markets after bad experiences with some poorly regulated privatization and pyramid-style funds, the country's new unit investment funds should prove safe and attractive enough to coax money back from beneath Russian mattresses.

Akin to U.S. mutual funds, unit investment funds, or PIFs, will enable large numbers of investors to pool their resources and minimize risk.

Most PIFs are expected to invest in Russian government debt and blue-chip Russian stocks. The majority of these securities are not represented by stock certificates or any other tangible evidence of ownership. As a result, Russian law requires PIF fund managers to employ specialized depositories, or custodians, to maintain records of which stocks, bonds and treasury bills the PIFs hold.

With no tangible certificates to hold, these "custodians" maintain computer databases which record each fund's holdings. Given the importance of maintaining an accurate account of PIF assets, it is not surprising that this apparently mundane task is of keen concern to both the Federal Securities Commission, or FSC, and Russia's Central Bank.

Unfortunately, the development of custodian regulation has been marred by the lack of coordination between these two bodies. The FSC and the Central Bank have each propounded regulations which are, for all practical purposes, mutually exclusive; both parties will need to make substantial concessions to reach a uniform position.

The Central Bank may find it more difficult to reach a compromise. It began implementing its custody regulations more than five years ago, well before the FSC was even organized. A change of custody practice along FSC guidelines would mean dramatic reorganization of the standard banking procedures that have been in place since the early 1990s.

While the FSC may soon have the exclusive legal authority to regulate custodial activities (banks may engage in custodial activity by virtue of their banking licenses only until April 22 unless, as expected, the FSC extends this authority until Oct. 1), it does not have, unlike the well-established Central Bank, the personnel and infrastructure necessary to perform this task effectively.

Both sides have now begun to work together, establishing a task force to investigate the feasibility of a centralized custodian that would, by necessity, be organized with Central Bank resources. Cooperatively resolving these mundane but important custodial issues will go a long way toward assuring a skeptical public that capital markets can serve as a reasonably safe, effective way of investing in the country's future.

Dan Matthews and Peter Malyshev are attorneys in the Moscow office of Baker & McKenzie.