Sberbank

56. The strategy for dealing with the development of the banking sector will require careful consideration of the role of Sberbank given the potential risk associated with banking systems dominated by one or a few banks. Given its size, Sberbank is in a unique position to extend loans to large customers, and its loan portfolio has increased rapidly; although more recently the rate of growth has been in line with that of other banks. Publicly available information about its balance sheet would seem to indicate that it is a profitable enterprise. Nevertheless, the rapid increase in Sberbank’s credit to the enterprise sector, together with the breach of the prudential limit on loan concentration and a (small) decline in loan loss provisioning, gives cause for concern. Moreover, as confirmed by the CBR, the bank’s heavy exposure to the raw materials sectors would make it vulnerable to a significant downturn in commodities prices.⁷

57. Measures are needed to address potential risk factors in the short term. It is welcome that the CBR has instructed Sberbank to bring its operations in line with all prudential ratios, including risk concentration by June 2003. In view of the sharp increase in its loan portfolio, the CBR needs to pay particular attention to a review of the quality of Sberbank’s loan portfolio during the next on-site examination. If necessary, the CBR may need to take measures to limit undue risk taking on the part of Sberbank by containing the growth of the bank’s lending portfolio. Finally, as the major shareholder of the bank, the CBR should introduce—as a matter of priority—safeguards to strengthen the governance of Sberbank and to ensure that it is run on commercial principles, subject to a hard budget constraint.

58. The authorities need to flesh out their plans for leveling the playing field between state-owned and private banks over the medium-term. They see the introduction of partial deposit insurance for private banks as a key element followed later by a reduction in the rate of insurance coverage of Sberbank, and eventually by changes to the structure of Sberbank, including possibly privatization. While there may be some merit in the introduction of deposit insurance, this will require prior introduction of essential safeguards as discussed in the next section. Irrespective of this decision, but interlinked with its implementation, the authorities will need to consider when, and how to change the structure and/or ownership of Sberbank. In spite of firewalls, the ownership of Sberbank by the CBR continues to give rise to, at a minimum, the perception of conflicts of interest, and should not be maintained over the medium-term.

59. A decision on Sberbank would need to be arrived at carefully in the context of an in-depth strategic review of its operations that should be undertaken on an urgent basis. Concrete plans would need to be carefully prepared and their implementation would need to take into account the rate of progress in strengthening the private banking sector. For example, should a decision be made to transform Sberbank into a narrow bank by restricting its lending, one possible option, it would be crucial that deficiencies of private banks have been addressed sufficiently to permit them to safely take up the slack. Also, the authorities might wish to see the share of Sberbank in household deposits mobilization and in lending having been reduced to such a level that a quasi-monopoly no longer exists before privatizing it.

General

92. The banking supervisory system of the Russian Federation was assessed for its compliance with the Basel Core Principles for Effective Banking Supervision. The assessment was conducted using the Basel Core Principles Methodology. The overall assessment was based on the discussions with the authorities and drew upon a completed self-assessment by the Russian authorities.

Institutional and macroprudential setting, market structure—overview

93. Russia has recovered strongly from the 1998 crisis, with economic outcomes representing a clear break from the pre-crisis period. More broadly, macroeconomic conditions have improved in recent years, with inflation considerably reduced to the level of 18.6 percent in 2001 last year and the fiscal position, a major factor in the 1998 crisis, dramatically improved, toward a surplus in the state budget.

94. The legal framework for banking supervision is based on a number of laws, including the Federal Law on the Central Bank of the Russian Federation (CBR Law), Russian Federation Federal Law on Banks and Banking Activities (Banking Law), Federal Law on Insolvency (Bankruptcy) of Credit Institutions (Law on Insolvency), Federal Law on the Restructuring of Credit Institutions (Law on Restructuring of Banks), Federal Law on Countering the Legislation of Earnings Received in an Illegal Way (Anti-Money Laundering Law), and their associated enforcement directives and regulations issued by the CBR and the joint CBR/Government of Russia Strategy of the Development of the Banking Sector of the Russian Federation (Strategy Paper) adopted in December 2001.

95. The Russian banking system is characterized by a large number of banks—more than 1,300 of which about 130 have foreign ownership. The CBR maintains a number of foreign subsidiaries and has controlling stakes in the large domestic bank (Sberbank). In the Strategy Paper, the authorities recognize that there is a need to consolidate the sector. The consolidation of the number of banks should facilitate the task of efficiently supervising the banks and support the creation of stronger, better-capitalized banks. As part of the post-crisis reconstruction, ARCO was established to administer a number of credit institutions and is at the stage of winding up its responsibility. The challenge ahead is to clean up the system of unsound banks and to lay the foundation for an effective prudential supervision of banks in readiness for the introduction of a deposit insurance scheme. However, the authorities perceive the scheme as the tool by which they will clean up the system.

General preconditions for effective banking supervision

96. The objectives and the institutional framework for the regulation and supervision of credit institutions are broadly defined in the CBR law and the Banking Law and provide the basis for the supervision of credit institutions. Although the supervisory staff of the CBR head office is well trained to efficiently discharge their responsibilities, there is scope for improving the focus and quality as it applies to enforcement of regulations and conduct of on-site and off-site supervision. Changes in the laws have not always been accompanied by immediate reviews of regulations and there is considerable overlap in a number of guidelines. There have been, however, marked improvements during 2002. The CBR is working on strengthening, simplifying and gearing prudential regulation toward the adoption of best international practice.

97. Although the CBR has developed an early warning system, the analytical work done by the off-site supervisors still concentrates on the completeness of the reports and the compliance with the prudential standards (rule and ratio-based), but not on the underlying risk reflected in the reviews. Therefore, the off-site supervision is not always able to direct the on-site inspectors to those areas in the credit institutions that need special attention. The CBR has embarked on the introduction of systems to enhance qualitative analyses through improvements in the on-site inspection tools. The CBR is concentrating its efforts in improving the supervisory standards at both headquarter and branch levels. To this end, there have been continued restructuring of supervisory responsibilities to create a more responsive framework for timely corrective action.

Compliance with the principles

98. Preconditions for effective banking supervision and CP 1. Although there is a system of business laws including corporate, bankruptcy, contract, consumer protection and private property laws, this system neither is consistently enforced nor provides a mechanism for fair resolution of disputes in a timely manner. The Russian Accounting Standards (RAS) are not comprehensive and do not command wide international acceptance since the accounts do not provide a true and fair view of the financial position of companies. The quality of audits is generally poor; only the international and a few domestic auditing organizations are respected for providing reliable financial statements. Supervision of other financial markets is weak or still in a nascent status.

99. Licensing and structure, CPs 2 to 5. The CBR broadly complies with the Basle Core Principles for Corporate Governance and Licensing (CPs 3 and 4). In order for the criteria for compliance of the management and members of the supervisory board of licensed institutions with qualification requirements and business reputation to be met fully, however, supplemental powers will need to be granted to the CBR by legislation. Systems for establishing the compliance of the founders and acquirers of banks with requirements accepted in international banking supervision practice need to be improved. The banking legislation should be expanded to include provisions stipulating that the banking supervision autority has sufficient powers to ensure transparency in the structure of ownership of banks.

100. Prudential regulations and requirements, CPs 6 to 15. A step was taken, in 2001, in the direction of encouraging the establishment of better-capitalized banks by increasing the minimum capital level for newly licensed banks to €5 million (the minimum capital level applied within the European Union). According to the Strategy Paper, commencing in 2005 a rule will be applied whereby the licenses of banks below €5 million are automatically revoked if their capital adequacy falls below 10 percent. This would represent a considerable tightening of the current legal framework as specifically applied to small banks. Currently, similar action can be applied to all banks, but only if their capital adequacy ratio falls below 2 percent. The 10 percent capital adequacy requirement rule will apply to all credit institutions and so will the €5 million minimum capital requirement.

101. Methods of ongoing supervision, CPs 16 to 20. The legal framework provided by the CBR law and the Banking Law broadly meets the requirements for banking supervisors to have the necessary means for collecting, reviewing, and analyzing prudential reports and statistical returns from credit institutions on a solo and on a consolidated basis. However, there is need for improvements in the quality of the information that goes into the various analyses, and at the same time reducing the extent of the reporting required from the credit institutions. Recently, the CBR enhanced the collaboration among the departments charged with the day-to-day responsibilities for the supervision of banks and the Department of Foreign Exchange Regulation and Control by having them sign a Cooperation Protocol for mutual access to supervisory information.

102. Information requirements, CP 21. The CBR materially complies with the requirement for the maintenance of adequate records for the assessment of the condition of a credit institution. However, the accounting standards established by the CBR and based on the RAS do not provide a reliable view of the financial situation of credit institutions.

103. Remedial measures and exit, CP 22. The CBR is largely compliant in taking remedial action for identified weaknesses. However, there are aspects of the organizational structures and relationships with the supervised banks that may delay prompt action. The relationship of the CBR as owner and supervisor of some of the banks is clearly a conflict of interest and may hamper an arms-length prudential relationship in case of the need to take remedial action and in avoiding forbearance.

104. Cross-border banking, CPs 23 to 25. Although Article 51 of the CBR law generally allows the necessary exchange of information with foreign supervisors, the still existing secrecy requirements in Article 51 and 57 of the CBR law are a hindrance to effective supervision. The CBR is not allowed to provide information on transaction of particular customers of the credit institution. Nevertheless, the CBR has engaged arrangements with domestic and with a number of foreign supervisors to allow sharing of information. The CBR has engaged in the signing of bilateral agreements with relevant foreign supervisors, which arrangement provides condition and procedures for exchange of supervisory information.

Table 4.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

Table 4.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

Reference Principle	Recommended Action
Corporate Governance and Licensing (CPs 3 and 4)	Apply stricter qualification criteria for shareholders, directors and management of credit institutions and should embark on a program for the identification of real owners of credit institutions.
Capital Adequacy (CP 6)	Improve accounting standards to support a reliable calculation of the capital adequacy ratio.
Credit Policies, Provisioning and Loan Exposures (CPs 7, 8, 9 and 10)	Develop guidelines for specific requirements on prudential credit granting and investment criteria, policies, practices, and procedures. Participation of a creditor bank in a borrower company (group of borrower companies), with the exception of a bank’s participation in subsidiary and dependent legal entities, as well as in resident credit institutions of the Russian Federation––––in cases when the amount of participation is subtracted from the capital of the creditor bank, should be included in the definition of large exposure. The definition of “insider” should at least include companies owned or controlled by the “insiders.”
Internal Audit (CP 14)	Enhance the internal control process by requiring, e.g., a segregation of duties and an appropriate balance in the skills and resources of the back office and the front office. Regular reporting by the internal service control to the supervisory board (at least twice a year). The CBR should work toward the adoption and implementation of the draft on Organization of Internal Control in Credit Institutions and Bank Groups.
Money Laundering (CP 15)	Establish a mechanism for receipt of data by the CBR from the KFM summarizing information related to money laundering activities and suspicious transactions.
On- and Off-Site Supervision (CPs 16–19)	Review on- and off-site supervision methods to facilitate better analysis for qualitative supervision. The CBR should consider opening cooperation lines with [he credit institutions it supervises to facilitate on the job training for its inspectors.
Consolidated Supervision (CPs 20 and 23)	Legislation should allow for exchange of information between members of a consolidation group to facilitate risk management on the group level.
Accounting Standards (CP 21)	The CBR should promote the use of International Accounting Standards for the banks and for the corporate borrowers.
Remedial Measures (CP 22)	The legal powers to fine managers of credit institutions should be enhanced, to hold them more accountable.
Exchange of supervisory information (CPs 1 (6), 24-25)	Provide the CBR with the right to exchange information on customers based on the extent of exposure with both foreign and other domestic supervisory agencies

View Table

Table 4.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

Reference Principle	Recommended Action
Corporate Governance and Licensing (CPs 3 and 4)	Apply stricter qualification criteria for shareholders, directors and management of credit institutions and should embark on a program for the identification of real owners of credit institutions.
Capital Adequacy (CP 6)	Improve accounting standards to support a reliable calculation of the capital adequacy ratio.
Credit Policies, Provisioning and Loan Exposures (CPs 7, 8, 9 and 10)	Develop guidelines for specific requirements on prudential credit granting and investment criteria, policies, practices, and procedures. Participation of a creditor bank in a borrower company (group of borrower companies), with the exception of a bank’s participation in subsidiary and dependent legal entities, as well as in resident credit institutions of the Russian Federation––––in cases when the amount of participation is subtracted from the capital of the creditor bank, should be included in the definition of large exposure. The definition of “insider” should at least include companies owned or controlled by the “insiders.”
Internal Audit (CP 14)	Enhance the internal control process by requiring, e.g., a segregation of duties and an appropriate balance in the skills and resources of the back office and the front office. Regular reporting by the internal service control to the supervisory board (at least twice a year). The CBR should work toward the adoption and implementation of the draft on Organization of Internal Control in Credit Institutions and Bank Groups.
Money Laundering (CP 15)	Establish a mechanism for receipt of data by the CBR from the KFM summarizing information related to money laundering activities and suspicious transactions.
On- and Off-Site Supervision (CPs 16–19)	Review on- and off-site supervision methods to facilitate better analysis for qualitative supervision. The CBR should consider opening cooperation lines with [he credit institutions it supervises to facilitate on the job training for its inspectors.
Consolidated Supervision (CPs 20 and 23)	Legislation should allow for exchange of information between members of a consolidation group to facilitate risk management on the group level.
Accounting Standards (CP 21)	The CBR should promote the use of International Accounting Standards for the banks and for the corporate borrowers.
Remedial Measures (CP 22)	The legal powers to fine managers of credit institutions should be enhanced, to hold them more accountable.
Exchange of supervisory information (CPs 1 (6), 24-25)	Provide the CBR with the right to exchange information on customers based on the extent of exposure with both foreign and other domestic supervisory agencies

General

106. This assessment focused on the CBR payment system, but also took into account other interbank and most especially intrabank networks (where the Sberbank’s own internal payment network provides a major clement of the payment infrastructure).

Information and methodology used for assessment

107. The assessment made use of the CBR’s self assessment against the ten core principles, and detailed answers to the CPSIPS questionnaire, as well as the ‘Red Book’ descriptive chapter that the CBR is preparing on Russian payment and settlement systems for the CPSS.

108. The assessor had meetings with Deputy Chairman Chugunova, and with officials from the Department of Payment Systems and Settlements, the Legal Department and the Security Department. Outside the central bank, meetings were held with FSVC directors, the chairman of the Payment Systems Committee of the Association of Russian Banks, and with the Executive Director of the Russian National SWIFT Association.

109. While it could be argued that the CPSIPS assessment should focus on a particular CBR component/platform (e.g., Moscow or St. Petersburg), the assessor took the view that a unified approach to the assessment was the most appropriate. This approach has some parallels with the CPSIPS assessment of the TARGET system (another decentralized network); and is in tune with the strategic objective of developing a uniform, centrally coordinated RTGS for Russia.

Institutional and market structure—overview

110. The CBR not surprisingly dominates the payment system environment. The statistics suggest that the CBR payment system processes around two thirds by value (half by volume) of all non-cash transactions (including transactions of intrabank networks, notably Sberbank). In terms of oversight/regulation, Federal law provisions have clearly established the CBR’s authority in the field, onto which the CBR has superimposed its own regulatory regime within which systems operate and (in the case of private systems) develop their own procedures and contractual arrangements. It is also the case that private systems/networks can only be operated by credit organizations, and as such have to be licensed by the banking supervisors.

111. The CBR payment system (to which all credit organizations have to belong) is a distributed gross settlement system, made up of 78 regional systems. Of these, 59 use centralized payment processing with the remaining 20 having a number of separate processing sites. Most of the centralized regional systems provide continuous, item-by-item, processing of payments; the remainder provide designated time settlements. In the Moscow region, both methods of settlement are available. In all of the decentralized regional systems, batches of intraregional payments are transferred at designated times. All electronic payments and the vast majority of paper-based payments passing through the CBR system are credit transfers. Paper-based payments still make up a sizable but rapidly falling proportion of total payments processed (dropping from 25 percent in 1999 to 7 percent in 2002). Each regional system offers an intra-regional and an inter-regional service. Intraregional transactions dominate: over 90 percent by volume, 85 percent by value. Electronic inter-regional payments instructions are routed between the 78 regional head offices via the CBR’s Inter-regional Informatization Center, with settlement between the regional head offices on a bilateral basis.

112. Intraday credit can be extended by the CBR to banks in two regions currently (Moscow and St. Petersburg); the facility is being extended to other regions. The facility, which has to be collateralized, is not used extensively (daily average of Rub 400 million). Correspondent account balances are very high: Rub 143 billion at end-2001 compared with average daily turnover of around Rub 250 billion. In particular circumstances as laid down by the CBR, banks may be allowed to reduce their required reserves requirement for intra-month liquidity management purposes.

113. Intra bank payment networks are dominated by Sberbank’s payment system. The latter has five components: (a) the System of Interbranch Settlements (SIBS), which links its 1,500 branches and enables the customers of those branches to send non-cash payments to each other; (b) bilateral correspondent payment links with other commercial banks; (c) settlement agent function for Europay International payment card transactions; (d) cash settlement agent function for participants on the Moscow Stock Exchange; and (e) the SBERCART payment card settlement. There is a substantial volume and value of Sberbank customer payments which have to be settled across the CBR payment system (e.g., tax and other public sector payments); Sberbank therefore needs to have some CBR correspondent accounts to effect such payments. It is evident that many banks have a correspondent relationship with Sberbank and use its network to make funds transfers, as an alternative to the CBR system.

114. As of July 2002, there were 41 private sector NBCOs, settling on a gross basis. 16 of the NBCOs have the right to settle on a net basis and 8 settle the payment legs of securities transactions. All are licensed and regulated by the CBR. Membership varies substantially between the different NBCOs, depending on the nature of the transactions that are being settled. Thus, some have been established to settle the obligations of particular card schemes. Others are very local payment operations, and may have both bank and nonbank members or just nonbank members. The market participants on MICEX and RTS (the two securities trading systems) make up the membership of the special-purpose NBCOs created to settle the cash legs of securities trades. The bulk of NBCO payments by value and volume is accounted for by these securities market settlement vehicles. Bilateral correspondent payment arrangements, established between pairs of banks, and often using the SWIFT communication network and standards, have become more important in recent years.

115. Plastic cards (particularly debit cards) are the only real non-cash retail payment instrument; their use is growing strongly but from a very low base. There are nearly 550 banks issuing payment cards or acting as merchant acquirers, and nearly 10.5 million cards in circulation. Checks are little used- mainly on a bilateral interbank or intrabank basis—and they are not settled through the CBR system. The postal organizations (federal and private) do not provide non-cash payment services directly, but use the services of commercial banks; they also provide the usual postal cash transfer services.

116. In 2001, the total volume of the non-cash payments to GDP ratio was low at around 12 percent overall and just 7 for the CBR system (compared with figures of over 50 for a number of EU countries), and the cash/GDP ratio (even before taking account of the very substantial stock of U.S. dollar banknotes also in circulation) is high at 6 percent (the EU average as a whole is less than 5 percent).

117. A new concept paper on the reform of the CBR payment system (including development of RTGS) is now being prepared within the CBR. This will again be presented to the CBR Board for approval, hopefully in the very near future.¹¹

Payment systems infrastructure

118. The CBR has made substantial progress in developing a legal framework within which the payment systems, central bank and private, can operate. A substantial body of regulations has already been developed, and Federal laws relating to funds transfers and electronic documents are now in the pipeline. It remains the case that the contractual basis underlying the obligations within private payment systems remains untested in a court of law.

119. The need to redevelop the CBR payment system into an RTGS system appears to be accepted in principle within the CBR. The absence of a national RTGS system was also highlighted by another recent IMF mission as a factor inhibiting the development of effective monetary management techniques.

120. The view of this assessment is that the CBR has to adopt a forward-looking strategy, and develop a payment system that can meet both international standards and user requirements in an environment where the banking sector is generating a much higher noncash payment turnover and is operating with more normalized liquidity levels.

121. The current decentralization of the CBR system extends to banks’ settlement/correspondent accounts, where most branches of commercial banks have a correspondent account at their local CBR office. The aim should be to enable banks to operate with a single head-office account at the CBR, with back office efficiency and in resulting improvement in banks and CBR liquidity management. (Some banks’ internal systems are, however, not currently geared to such centralization.) There would also be benefits to supervisory oversight.

122. The assessor was aware of a number of other difficult issues for the CBR that have to be addressed if the concept paper is to become a successfully implemented project. These include:

• whether the project should also include building of a bulk retail (ACH) system, and how (or if) this should relate to or involve the existing Sberbank payment network;

• how to develop the new system: in-house or purchase off-the-shelf;

• what data communication network to use: SWIFT or the CBR’s own network;

• what data format standards to use;

• simplification of bank identification codes;

• how to achieve proper separation of the payment system accounting system from the CBR’s general ledger accounting system. The latter is currently very complex, with a number of different systems in use; any project to rationalize it will be a major one, and will need to provide the necessary interfaces with the new payment system accounting module;

• the number of processing centers to build: one plus back-up, or multiple centers.

123. An early resolution of differences of views within the CBR is essential, particularly given the previous unsuccessful attempts to develop an RTGS project. After agreement has been reached, the CBR should (a) publish a consultation paper before committing to a time-bound action plan, and (b) appoint an experienced and full-time project manager with full decision-making powers on non-policy-related matters related to the project. The CBR should ensure that the internal risk management procedures of internal bank (intrabank) payment networks—and particularly those of Sberbank—are adequate. (Sberbank report that they are intending to tighten risk management procedures. This should be followed up) Similarly, were any NBCO payment schemes to develop SIPS characteristics, then the CBR would need to ensure that it had the oversight procedures that enabled regular monitoring and assessment of their CPSIPS compliance or progress toward compliance. The CBR should also be giving thought to how best to ensure that oversight of its own payment system and of individual private systems is in all aspects carried out consistently.

Recommended actions

Table 5.

Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—CBR Payment System

Table 5.

Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—CBR Payment System

Reference principle	Recommended action
Legal foundation CP I–The system should have a well-founded legal basis under all relevant jurisdictions.	The implementation of new Federal laws on electronic documents and funds transfers should be speedily concluded. The future RTGS project will need to address a range of legal issues. This should be flagged in the concept paper; and the issues addressed by a legal working group reporting to the overall project manager during the project itself.
Understanding and management of risks CP II–The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks that they incur through participation in it. CP III The system should have clearly defined procedures for the management of credit and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks	For the future RTGS, the CBR should consider a separation of the operating rules and procedures from the formal regulations. The future RTGS should be designed with appropriate liquidity risk management capability (e.g., intraday liquidity, queue management, differential tariffs, throughput rules or guidelines).
Settlement CP IV–The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day	The future RTGS service should incorporate clear and coordinated time-tabling for the intraday, real-time, settlement of payments between all regions and across all time zones.
Security and operational reliability, and contingency arrangements CP VII–The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily settlement	The future RTGS should have remote back-up capability (based upon the arrangements now in place in the Moscow region) and a formal business continuity plan that is regularly tested with the participation of the major banks.
Efficiency and practicality of the system CP VIII–The system should provide a means of making payments which is practical for its users and efficient for the economy	The CBR should urgently secure internal agreement on the concept paper for the future payment system, including the proposal for developing a bulk payment capability.
Criteria for participation CP IX–The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.	The CBR will need to decide whether to maintain die existing 100 percent direct participation of all credit institutions in the future RTGS system. If it opts for a two-tier participation, the criteria will need to be clearly described. Exit criteria will also need to be defined.
Governance of the payment system
CP X–The system’s governance arrangements should be effective, accountable and transparent	The CBR will need to consider how best to delineate internally the responsibilities of, on the one hand, the operators of a more centrally controlled payment system and, on the other, the responsibilities of the oversight department.
Central Bank Responsibilities in applying the CPs Responsibility A–The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems. Responsibility B–The central bank should ensure that the systems it operates comply with the core principles. Responsibility C–The central bank should oversee observance with the core principles by systems it does not operate and it should have the ability to carry out this oversight. Responsibility D–The central bank, in promoting payment system safety and efficiency through the core principles, should cooperate with other central banks and with any other relevant domestic or foreign authorities.	The CBR should submit the payment systems concept paper to a limited period of public consultation once it has been agreed by the CBR Board. See Recommended action under CP X above. As part of its future payment systems strategy, the CBR should develop a more formalized oversight relationship with private sector schemes, whether systemically important or not. A closer oversight relationship with Sberbank is strongly recommended. The CBR should ensure that there are contact lines in place with foreign overseers and regulators in case a Russian bank experiences liquidity problems in a foreign payment system or vice versa.

View Table

Table 5.

Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—CBR Payment System

Reference principle	Recommended action
Legal foundation CP I–The system should have a well-founded legal basis under all relevant jurisdictions.	The implementation of new Federal laws on electronic documents and funds transfers should be speedily concluded. The future RTGS project will need to address a range of legal issues. This should be flagged in the concept paper; and the issues addressed by a legal working group reporting to the overall project manager during the project itself.
Understanding and management of risks CP II–The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks that they incur through participation in it. CP III The system should have clearly defined procedures for the management of credit and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks	For the future RTGS, the CBR should consider a separation of the operating rules and procedures from the formal regulations. The future RTGS should be designed with appropriate liquidity risk management capability (e.g., intraday liquidity, queue management, differential tariffs, throughput rules or guidelines).
Settlement CP IV–The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day	The future RTGS service should incorporate clear and coordinated time-tabling for the intraday, real-time, settlement of payments between all regions and across all time zones.
Security and operational reliability, and contingency arrangements CP VII–The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily settlement	The future RTGS should have remote back-up capability (based upon the arrangements now in place in the Moscow region) and a formal business continuity plan that is regularly tested with the participation of the major banks.
Efficiency and practicality of the system CP VIII–The system should provide a means of making payments which is practical for its users and efficient for the economy	The CBR should urgently secure internal agreement on the concept paper for the future payment system, including the proposal for developing a bulk payment capability.
Criteria for participation CP IX–The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.	The CBR will need to decide whether to maintain die existing 100 percent direct participation of all credit institutions in the future RTGS system. If it opts for a two-tier participation, the criteria will need to be clearly described. Exit criteria will also need to be defined.
Governance of the payment system
CP X–The system’s governance arrangements should be effective, accountable and transparent	The CBR will need to consider how best to delineate internally the responsibilities of, on the one hand, the operators of a more centrally controlled payment system and, on the other, the responsibilities of the oversight department.
Central Bank Responsibilities in applying the CPs Responsibility A–The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems. Responsibility B–The central bank should ensure that the systems it operates comply with the core principles. Responsibility C–The central bank should oversee observance with the core principles by systems it does not operate and it should have the ability to carry out this oversight. Responsibility D–The central bank, in promoting payment system safety and efficiency through the core principles, should cooperate with other central banks and with any other relevant domestic or foreign authorities.	The CBR should submit the payment systems concept paper to a limited period of public consultation once it has been agreed by the CBR Board. See Recommended action under CP X above. As part of its future payment systems strategy, the CBR should develop a more formalized oversight relationship with private sector schemes, whether systemically important or not. A closer oversight relationship with Sberbank is strongly recommended. The CBR should ensure that there are contact lines in place with foreign overseers and regulators in case a Russian bank experiences liquidity problems in a foreign payment system or vice versa.

Authorities’ response

124. The CBR was broadly in agreement with the report, though felt that the assessments for two of the CPs were unduly harsh (CP1 and CP4). There was also a general comment that in places the assessment attempted to be too forward-looking—i.e., many of the action points focus on issues that are being covered in the forthcoming ‘concept paper’, and its vision of a new CBR payment system infrastructure, rather than on measures that could be taken in the short(er) term to improve the CP compliance of the existing arrangements. However, the CBR understood the need to relate this assessment exercise to the longer-term objective.

General

125. The assessment focused on the two central securities depositories (CSDs), the National Depository Centre (NDC) and the Depository Clearing Company (DCC). However, because a number of the CPSS-IOSCO recommendations concern issues other than simply CSD operations, the assessment also looked at securities market infrastructure more generally.

Institutional and market structure

126. Russia’s securities markets and supporting clearing and settlement infrastructure (including custody and registration) are extremely fragmented, with different pieces of the infrastructure being used by different sub-sets of market intermediaries for processing trades in particular stocks or groups of stocks. There are some signs that consolidation and rationalization is starting to take place (e.g., among exchanges and registrars).

127. Among organized exchanges, MICEX dominates. It is the only market for the majority of debt securities but also trades equities. But the biggest securities market is provided by RTS (Russian Trading System), primarily an OTC market but also now operating an organized securities exchange.

128. The markets are currently served by two CSDs. NDC settles MICEX members’ trades (and is half-owned by MICEX); and DCC settles for RTS members. There is a bridge/link between NDC and DCC to enable settlement of cross-exchange trades. However, a major share of securities settlement in Russia takes place outside the two CSDs, i.e., across the books of the large number of custodians and other depository companies. Less than one third of Russian equity market capitalization is held on the books of NDC and DCC.

129. Stock registration is also highly fragmented, with around 100 stock registrars. Given the existence of so many custodians/depositories, ownership is often recorded in nominee form. A paper-based re-registration process for trades between customers of different custodians/depositories can add substantially to settlement cycles. (Trades settled across the NDC/DCC bridge do not require re-registration; and both CSDs provide their members with a service designed to short-circuit the process.)

130. NDC provides DVP for the majority of MICEX trades, though on a pre-funded basis. DCC also offers a DVP service (in rubles and U.S. dollars), but the majority of its transactions are settled on a free of payment basis. The funds transfer legs of ruble DVP transactions are settled across the books of specially licensed ‘settlement chambres.’

131. The FCSM is the agency responsible for the regulation of the securities markets. Formal responsibility for regulation of the markets’ clearing and settlement infrastructure has recently been clarified, with the FCSM responsible for securities clearing and transfer and the CBR responsible for the associated funds settlement.

132. Discussions are now underway on how best to create a more unified clearing and settlement infrastructure for Russia’s securities markets.

Main finding—summary

Other issues (recommendations 13–19)

• The current ownership structure of NDC (50 percent MICEX, 44.6 percent CBR) raises some questions as to the adequacy of representation of user/member interests. DCC has recently completed a governance restructuring specifically designed to improve member representation.

• DCC’s access criteria appear objective and all members are subject to the same rules. (NDC’s access criteria were not accessed; however, NDC has over 500 members.)

• A fragmented and relatively inefficient infrastructure is widely seen as an impediment to the development of Russian securities markets.

• Both NDC and DCC accommodate ISO 15022 message standards and use securities identification number (ISlN) codes.

• Both NDC and DCC appear to give adequate information to their members regarding the services they provide. This seems to be especially the case for DCC, which is appropriate given the emphasis on FOP delivery and the potential risks that that may present.

• The respective responsibilities of FCSM and the CBR as regards regulation and oversight of securities clearing and settlement have recently been clarified. Development of the oversight function should be a priority.

• There are as yet no cross-border links between NDC/DCC and other, foreign, CSDs.

Table 6.

Recommended Actions to Improve Observance of CPSS-IOSCO Recommendations for Securities Settlement Systems

Table 6.

Recommended Actions to Improve Observance of CPSS-IOSCO Recommendations for Securities Settlement Systems

Reference principle		Recommended action
Pre-settlement risk
	4. Central counterparties	Once the CBR has embarked on a project to introduce RTGS, a debate should begin on whether the Russian capital markets would benefit from developing a CCP.
	5. Securities lending	Securities lending facilities should be developed. Any legal impediments should be addressed by the appropriate authorities.
Settlement risk
	6. CSDs	The authorities should consider how to ensure that the greater share of dematerialized securities are recorded on the books of CSDs. whether in own or nominee name.
	7. Delivery versus payment	The settlement needs of the securities market should be factored into the user requirements of an RTGS system, as and when the CBR launches such a project.
	10. Cash settlement assets	See recommended action under reference principle 7 above.
Operational risk
	11. Operational reliability	The supervisory authorities should ensure that NDC and DCC develop appropriate remote contingency sites.
Other issues
	13. Governance	The authorities should review the appropriateness of the current ownership structure of NDC.
	15. Efficiency	See recommended actions for reference principles 4, 5, 6 and 7 above
	18. Regulation and oversight	The FCSM and CBR should consider how to develop the systemic oversight of securities market infrastructure, alongside the FCSM’s prudential supervision and licensing activities.

View Table

Table 6.

Recommended Actions to Improve Observance of CPSS-IOSCO Recommendations for Securities Settlement Systems

Reference principle		Recommended action
Pre-settlement risk
	4. Central counterparties	Once the CBR has embarked on a project to introduce RTGS, a debate should begin on whether the Russian capital markets would benefit from developing a CCP.
	5. Securities lending	Securities lending facilities should be developed. Any legal impediments should be addressed by the appropriate authorities.
Settlement risk
	6. CSDs	The authorities should consider how to ensure that the greater share of dematerialized securities are recorded on the books of CSDs. whether in own or nominee name.
	7. Delivery versus payment	The settlement needs of the securities market should be factored into the user requirements of an RTGS system, as and when the CBR launches such a project.
	10. Cash settlement assets	See recommended action under reference principle 7 above.
Operational risk
	11. Operational reliability	The supervisory authorities should ensure that NDC and DCC develop appropriate remote contingency sites.
Other issues
	13. Governance	The authorities should review the appropriateness of the current ownership structure of NDC.
	15. Efficiency	See recommended actions for reference principles 4, 5, 6 and 7 above
	18. Regulation and oversight	The FCSM and CBR should consider how to develop the systemic oversight of securities market infrastructure, alongside the FCSM’s prudential supervision and licensing activities.

Authorities’ response

138. The authorities were in broad agreement with the assessment. The FCSM, however, stressed that according to the law “On the Securities Market”, the FSCM was responsible for both securities clearing and transfer and the associated funds settlement, irrespective of the CBR’s general role in the payments area.

General

139. The assessment reviews the regulation of Russian Federation capital markets, which is the main responsibility of the FCSM. The objective of the assessment was to determine the levels of observance with the IOSCO Principles and to suggest areas where further development may be appropriate.

Information and methodology used for assessment

140. The assessment utilized the IMF/World Bank Guidance Note for Assessment of the IOSCO Objectives and Principles of Securities Regulation.

141. The assessment was based upon the responses to the IOSCO self-assessment questionnaires by the FCSM, in addition to a review of the Securities Law. and other relevant laws and regulations, interviews with staff of the FCSM, MICEX, RTS, NAUFOR, the NFA and market participants.

Institutional and macroprudential setting, market structure

142. The Federal Commission for the Securities Market is the supervisory agency responsible for implementing government policy on the securities market, regulating professional participants of the securities markets, and protecting the rights of investors and shareholders. The major laws governing the securities markets in Russia include Federal Law No. 39 FZ of April 22,1996 On the Securities Market, Federal Law No. 46-FZ On Protection of Rights and Legal Interest of Investors on the Securities Market, the Federal Law On Investment Funds and the Federal Law No. 208-FZ of December 26, 1995 On Joint-Stock Companies. These laws are supplemented by several presidential and governmental decrees and regulations of the FCSM.

143. The responsibilities of the FCSM include oversight of issuers and professional securities market participants, licensing professional activities on the securities market, licensing investment funds, unit investment funds, management companies, special depositories and independent appraisers, registration of issues and reports on the results of securities issues, information disclosure on the securities market, development of regulatory legal framework on the securities market, determining key directions for development of the securities market, and review cases involving violations of legislation on protection of investor rights and impose sanctions on market participants.

144. The Ministry of Anti-Monopoly is responsible for regulation of related party transactions and changes of corporate control (take over bids etc.) as well as derivatives. This review was unable to assess the operations of the Ministry but evidence of market participants and the FCSM suggests that the Ministry is not active in these areas. There is no law specific to derivatives products or trading. The FCSM has proposed amendments to the Securities Law that would give it responsibility for derivatives regulation.

145. There are four Self-Regulatory Organizations (SROs) in the Russian Capital Markets licensed by the FCSM: the National Association of Securities Market Participants (NAUFOR) with a membership of organizations engaged in broker, dealer, trust management and depository activities, the National Securities Market Participants Association (NFA) with a membership of credit and non-credit institutions engaged in broker and dealer activities or trust management of securities, the Professional Association of Registrars, Transfer Agents and Depositories (PARTAD) established by professional participants of securities market engaged in registration, depository and clearing activities and the National League of Management Companies founded by investment fund management companies. The stock exchanges in Russia do not have SRO-status, although they have membership requirements and monitor the activities of their members in coordination with the FCSM in order to ensure the integrity and efficiency of the markets.

146. There are 11 stock exchanges in Russia, the most important ones being the RTS and the MICEX. There are also regional exchanges that are usually affiliated or technically connected to the major exchanges. According to data obtained by the clearing corporations 62 percent of trading is done in the OTC market, with a major part of the remaining 38 percent taking place in the “off list” market (securities not accepted for listing but with markets posted on the exchanges by market makers).

147. There are 1911 market operators (brokers, dealers and investment managers), including 670 credit institutions in Russia. Almost half of market intermediaries are located in Moscow, while the remaining have operate across the regions of Russia, mainly in St. Petersburg and the Urals. In spite of the large number of broker-dealers, the market is quite concentrated with almost half of all trading being carried out by 10 companies.

148. Russian securities law requires that all issuers should register and any transfer of security should be recorded in the issuer company’s registrar. There are about 110 registrars in Russia; of which the Central Moscow Depository and the National Registry Company are the largest and best known.

General preconditions for effective securities regulation

149. TOSCO lists numerous preconditions for effective securities supervision, but perhaps the most critical ones include sound and sustainable macroeconomic policies conducive to investment and savings, enforceable property rights, a well developed infrastructure (such as legal and accounting practices, clearing and settlement systems, payment system), and an effective judicial system, as well as corporate governance and insolvency mechanisms. These appear only partially in place in Russia. The enforceability of property rights, for example, is impeded by legal uncertainties and a lengthy court process, accounting and auditing standards require improvement and the clearing and settlement infrastructure is cumbersome and inefficient.

150. The IOSCO also enumerates several attributes for effective regulation: no unnecessary barriers to entry and exit from markets and products, markets should be open to the widest range of participants who meet specified criteria, regulators should consider the impact of requirements when developing policy, and all who make financial commitments or promises must bear an equal regulatory burden. These appear to be generally met in Russia.

Findings and Recommendations

151. Regulator—The FCSM operates as an independent organization and has a broad range of authority over markets, market participants and issuers. Independence could be strengthened with a clearer separation from government in carrying out its day-to-day operations. Staffing and resource levels are insufficient to carry out the full mandate of the regulator and this is a particular problem with respect to attracting skilled and experienced staff. A number of legislative initiatives are underway to address various issues but there remain a number of gaps in regulation including a lack of authority over derivatives products and markets and takeover bid and related party transactions. Supervision of banks with respect to their securities activities is the responsibility of the FCSM, however there appears to be no coordination between the securities and banking authorities. The FCSM is active in consulting industry and provides a great deal of information to the public but it should improve its attention to transparency, for example, with annual public reports.

152. Cooperation and information sharing—The legislative framework allows for information sharing with both foreign and domestic counterparts and a number of information sharing arrangements have been entered into between the FCSM and foreign securities regulators. There appear to limitations on the ability of the FCSM to share confidential information regarding client identity and client transactions, even within the framework of a MOU. It is clear that domestic information sharing is hampered by a lack of consensus on jurisdictional issues and cooperation between the banking supervisors and the FCSM, between the Ministry of Anti-Monopoly and the FCSM. This may have implications for the supervision of the securities activities of banks (including depository, mutual fund and trading activity) and regulation of derivatives, respectively.

153. Self-regulatory organizations (SROs)—The Russian system makes self-regulatory organizations and exchanges to perform various regulatory functions. The supervision of both exchanges and the SROs could be strengthened in order to bring about strong enforcement of market regulation (both issuer and market intermediary activity). The current approach appears formalistic and duplicative. It is also unclear that the FCSM has sufficient authority to supervise the MICEX exchange which is controlled and operated by the central bank.

154. Inspections, investigations and enforcement—The FCSM generally has sufficient authority to carry out inspections, investigations, surveillance and enforcement activities although additional power to levy penalties on investment fund management companies and to revoke investment management company licenses, take prompt corrective action against failing intermediaries and investigate and sanction market abuse practices is required. In addition, a substantial increase in the amount of fine that can be imposed would improve the FCSM’s effectiveness—the current level is insufficient. The practice of enforcing compliance with existing regulations is weak—there are relatively few inspections and those that take place focus on formal requirements rather than quality of information gathering. The number of investigations and enforcement actions appears to be low. Resolving the issue of insufficient funding of the FCSM would have a positive impact effect on the quality of enforcement as well. Enforcement by exchanges is also lacking—there appears to be a lack of willingness to take action against members and issuers and there are few investigations initiated at the exchanges. It is unclear that the FCSM has authority over derivatives trading and it is clear that no regulation of derivatives trading is taking place, other than real time market surveillance. The lack of trade reporting in the OTC market (the greater part of the market) impairs effective surveillance of the equity market.

155. Issuers—The framework for issuer disclosure is largely in place although prospectus and disclosure requirements should be expanded to include disclosure of major risks, business plan and governance policies. The lack of requirement to disclose beneficial ownership and weak accounting and auditing standards, a fragmented share registration system and limited resources at the regulator negatively impact quality of disclosure. The timing requirement for material event disclosure, currently 5 days, is too long and should be shortened. The monitoring of issuer disclosure by exchanges should be significantly improved. Criminalization of insider trading and the development of an insider reporting system are required.

156. Collective investment schemes;—The legislative framework for collective investment schemes is in place with amendments in the works. The legislative framework is new and there are a very small number of collective investment schemes in existence—it is therefore difficult to judge the level of implementation of legal requirements. The FCSM should be granted the authority to withdraw licenses from collective investment schemes.

157. Market intermediaries—Market intermediaries are subject to licensing and supervision. Rules are largely in place although improvement should be made to client account documentation, and minimum entry standards (especially the use of background checks and scrutiny of ownership structures). Supervision requires strengthening both at the SRO and FCSM level—a clear plan of division of labor between the various regulatory bodies is required. The FCSM does not have sufficient information or flexibility to act in case of market intermediary financial failing—this should be remedied both with additional powers and a more robust financial reporting system.

158. Markets—All exchanges are subject to licensing and oversight although the practical ability of FCSM to oversee the MICEX exchange is in doubt. The FCSM has an oversight program in place but it would appear that exchange’s performance of regulatory responsibilities could be improved. The FCSM should have the ability to impose administrative sanctions on market operators and depositories. The FCSM does not have responsibility for derivatives markets and as a result there is effectively no regulation of derivatives trading. This situation will be ameliorated if the recently proposed Securities Law amendments receive final approval—the FCSM is encouraged to develop a full set of regulations in this area under the legislation once it is in place. Market abuse regulation requires the addition of an insider trading law, which is presently under development, and the development of a legal consensus on market manipulation as well as the enhancement of the FCSM’s authority to successfully investigate and sanction both market manipulation and insider trading. Transparency in markets is weak since the greatest portion of the equity market trades over the counter where there is no trade reporting requirement. Further there is no requirement that a trade in a listed security reported to the exchange or at a price quoted on a exchange—a situation which further compromises transparency and prevention of market abuse. There is no best execution rule and no practice of protecting the customer’s best interest with respect to trade conduct. Large exposure monitoring and risk management are weak as a result of a lack of coordination among entities with information regarding intermediary exposure, and by a lack of derivatives regulation. The clearing and settlement system, although consisting of a large number of institutions, appears to be adequate.

Recommended actions and authorities’ response to the assessment

Recommended actions

Table 7.

Recommended Plan of Actions to Improve Observance of the IOSCO Objectives and Principles of Securities Regulation

Table 7.

Recommended Plan of Actions to Improve Observance of the IOSCO Objectives and Principles of Securities Regulation

Reference Principle	Recommended Action
Principles Relating to the Regulator	Clearer demarcation of authority regarding derivatives, take over bids and related party transactions and the securities activities of banks should be established in legislation Improvement to coordination with CBR and Ministry of Anti Monopoly is required, ideally in formal agreements Greater independence from government on day to day basis Greater attention to transparency, including continuous publication of annual reports Development of confidentiality rules for the regulator and rules for handling of insider information
Principles for Self-Regulation	Oversight of SROs requires improvement, including an inspection and reporting plan
Principles for the Enforcement of Securities Regulation	Additional resources for enforcement are required Market abuse laws including criminalization of insider trading and market manipulation rules required. Clear authority over derivatives and take over bid activity should be granted to the FCSM FCSM staff require legal protection for actions in good faith FCSM should be granted the authority to compel regulated entities to take actions. Fine and penalty levels should be increased. SRO enforcement activities should be increased and closely monitored by the FCSM through inspections and monitoring
Principles for Cooperation in Regulation	Revision of the banking law would be needed to enable the FCSM to obtain all relevant information while discharging its duties, even if the information is protected by bank secrecy provisions. The ability to share information regarding client transactions should be clarified. Domestic cooperation should be enhanced, especially cooperation with the CBR.
Principles for Issuers	Transparency of ownership structures should be enhanced Material event reporting should be shortened Enforcement of requirements requires significant additional attention both from the FCSM and the exchanges The FCSM should be granted full authority to monitor and approve takeover bids and related party transactions and should be granted sufficient resources to adequately monitor this activity Accounting and auditing standards require improvement
Principles for Collective Investment Schemes	The FCSM should be granted full authority over collective investment schemes including the ability to impose administrative penalties and withdraw licenses
Principles for Market Intermediaries	FCSM’s authority to review and approve ownership of market intermediaries should be established; background checks that include criminal and disciplinary records should be carried out Implementation of capital requirements more appropriately adjusted to risks would be helpful. The FCSM should establish an early warning system and contingency plan in place or were empowered to freeze assets, appoint an administrator.
Principles for the Secondary Market	A rigorous oversight program for exchanges should be implemented including inspection and reporting requirements Trade reporting for OTC equity and corporate bond trades should be considered in conjunction with rules regarding off exchange trades of listed securities FCSM should explore incentives for greater transparency in conjunction with the organized exchanges. Market manipulation and insider trade rules should be brought into force and actively enforced by the FCSM and the exchanges

View Table

Table 7.

Recommended Plan of Actions to Improve Observance of the IOSCO Objectives and Principles of Securities Regulation

Reference Principle	Recommended Action
Principles Relating to the Regulator	Clearer demarcation of authority regarding derivatives, take over bids and related party transactions and the securities activities of banks should be established in legislation Improvement to coordination with CBR and Ministry of Anti Monopoly is required, ideally in formal agreements Greater independence from government on day to day basis Greater attention to transparency, including continuous publication of annual reports Development of confidentiality rules for the regulator and rules for handling of insider information
Principles for Self-Regulation	Oversight of SROs requires improvement, including an inspection and reporting plan
Principles for the Enforcement of Securities Regulation	Additional resources for enforcement are required Market abuse laws including criminalization of insider trading and market manipulation rules required. Clear authority over derivatives and take over bid activity should be granted to the FCSM FCSM staff require legal protection for actions in good faith FCSM should be granted the authority to compel regulated entities to take actions. Fine and penalty levels should be increased. SRO enforcement activities should be increased and closely monitored by the FCSM through inspections and monitoring
Principles for Cooperation in Regulation	Revision of the banking law would be needed to enable the FCSM to obtain all relevant information while discharging its duties, even if the information is protected by bank secrecy provisions. The ability to share information regarding client transactions should be clarified. Domestic cooperation should be enhanced, especially cooperation with the CBR.
Principles for Issuers	Transparency of ownership structures should be enhanced Material event reporting should be shortened Enforcement of requirements requires significant additional attention both from the FCSM and the exchanges The FCSM should be granted full authority to monitor and approve takeover bids and related party transactions and should be granted sufficient resources to adequately monitor this activity Accounting and auditing standards require improvement
Principles for Collective Investment Schemes	The FCSM should be granted full authority over collective investment schemes including the ability to impose administrative penalties and withdraw licenses
Principles for Market Intermediaries	FCSM’s authority to review and approve ownership of market intermediaries should be established; background checks that include criminal and disciplinary records should be carried out Implementation of capital requirements more appropriately adjusted to risks would be helpful. The FCSM should establish an early warning system and contingency plan in place or were empowered to freeze assets, appoint an administrator.
Principles for the Secondary Market	A rigorous oversight program for exchanges should be implemented including inspection and reporting requirements Trade reporting for OTC equity and corporate bond trades should be considered in conjunction with rules regarding off exchange trades of listed securities FCSM should explore incentives for greater transparency in conjunction with the organized exchanges. Market manipulation and insider trade rules should be brought into force and actively enforced by the FCSM and the exchanges

General

163. The main objectives of the assessment are to determine the levels of observance with the International Association of Insurance Supervisor (IAIS) Core Principles, and to suggest areas where further development may be appropriate. It focused mainly on the supervisory work of the Insurance Supervision Department of the Ministry of Finance (DIS). The assessment was performed using the Core Principles Methodology report adopted by the IAIS at its meeting in October 2000.

164. DIS does not publish or otherwise make available, statistical information concerning the insurance industry and the companies it supervises. There are no readily accessible sources with information on the asset size of companies operating in the market, their financial strength and their operating performance. Through the All Russia Insurance Association (ARIA) it is possible to obtain information on premiums received and claims paid—both on an aggregate basis and on a by-line of business basis for a selection of the larger companies. However, this information does not provide indication concerning the financial condition. In the absence of such statistics, the assessment has been prepared with considerable reliance on assertions made by the supervisory authorities and the industry officials consulted without being able to confirm all findings through rigorous independent analysis.

Institutional and macroprudential setting—overview

165. There are over 1300 licensed insurance companies in the Russian Federation. However, it is estimated that over 80 percent of all premiums written are collected by the top 100 companies. There are licensed companies in virtually all parts of this very large country but it appears that the actual business written is concentrated in Moscow and the Moscow oblast, where an estimated 75 percent of the premiums were received in the year 2000.

166. Since 1999 foreign investors are permitted to acquire more than 49 percent of a Russian insurance company. Of the 1385 licensed companies, foreign investors have an interest in 50 companies and 7 of these are majority foreign-owned. Major international groups such as AIG and Allianz now have subsidiaries in Russia.

167. In 2000, the insurance market in Russia was estimated to have total premiums of US$6.1 billion. The market is small, in world terms, ranking 30th on the list of 88 countries where these results are monitored, although its aggregate premium income exceeds that of Luxembourg (US$5.3 billion and 31st), Turkey (US$2.8 billion at 37th), and Greece (US$2.3 billion and 39th). Premiums per capita are low at US$42, ranked 61st in the world and 28^th out of the 32 European countries reviewed by Swiss Re for its Sigma statistics. Gross Premiums as a percentage of GDP, commonly referred to as “insurance penetration”, stood at 2.42 percent at the end of 2000, ranking the country 51st in the world on this measure.

168. Russian insurance companies demonstrate a strong preference for holding assets in liquid form. If we exclude reinsurance items, then over 50 percent of total assets are held in cash or in banks. There will be an aversion to government investments as a result of the unfortunate experience during the 1998 crisis. In addition the nature of the insurance business in Russia dictates a short term position. The non-life business is all short term business. The unique feature is that the greater portion of the life insurance premiums collected (estimates as high as 90 percent) is paid under contracts that mature a short time after issue. In such an environment, the insurance industry will not be a major contributor to capital market development.

169. Reforms to the insurance legislation have been prepared and are awaiting presentation to the parliament. An important feature is the proposal to raise minimum capital requirement to US$1 million, a significant increase over the present level.

General preconditions for effective insurance supervision

170. The accounting profession is struggling with the differences between Russian accounting principles and international accounting standards. Some of the insurance companies are audited by “Big Four” firms where others employ representatives of domestic audit firms. There is no requirement for advice to the supervisor or the appointment of an auditor and there is virtually no communication between auditors and supervisors. Audit work on insurance companies is of uncertain quality in some cases.

171. Companies are not required to appoint an actuary and there is no requirement for a report by an actuary to accompany the financial statements. There is a growing number of actuaries in Russia and extensive training programs at the universities. It should be possible to mandate actuarial reports for all companies.

172. The major problem facing the insurance supervisor is the large number of licensed companies. It is simply not possible to maintain a high-quality level of supervision in respect of 1300 companies with a staff of 100 or even 200 persons. The approach to supervision applied by DIS is to focus its attention on those companies with substantial portfolios of business.

Main findings

173. Organization of an Insurance Supervisor. DIS lacks the resources that it requires to carry out the tasks assigned to it. Because of budgetary constraints it is not able to hire sufficient numbers of competent staff for the very technical work it is expected to do. As a department in the Ministry of Finance it lacks the flexibility and independence that an insurance supervisory authority should have.

174. Licensing and Changes in Control. Present licensing rules do not provide the authority to apply “fit and proper” tests to all those persons who would be owners, directors or senior managers of insurance companies. Companies are not obliged to provide advance notice of changes in control to the supervisor and the latter has virtually no influence over such changes.

175. Corporate Governance and Internal Controls. The supervisor does not have the authority to require companies and their Boards of Directors to adopt and maintain good corporate governance practices. There are no established requirements with respect to internal controls and inspection procedures should be amended in order to focus attention in this crucial area.

176. Prudential Rules. The rules for valuation of assets and liabilities and for the measurement of solvency should be reviewed in light of developing international practices. Technical assistance should be arranged to ensure that prudential rules are adequate to provide early warning of companies that are facing financial difficulties. The supervisor should be given specific legislative authority to review all the reinsurance activities of licensed companies and the power to order changes in the treaties or the replacement of a reinsurance company if that seems warranted.

177. Market Conduct. The Supervisor should compile comprehensive statistical information for internal and for public consumption (taking into account confidentiality considerations). This information should include statistics on premiums, benefits, assets, liabilities and solvency of each registered insurer and aggregated for all insurers. Trends should be highlighted and explained. This would be an excellent consumer service and would lead to increased transparency.

178. Monitoring, Inspection and Sanctions. Consideration should be given to adopting a formal early warning process such as that followed in the United States, ensuring that inspections are focused where needed. The supervisor should adopt a risk-based approach to on-site work, focusing only on those companies and those topics that are identified as giving cause for concern.

Table 8.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Table 8.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
i.e., CP 1	Increase resources and independence. Technical assistance to upgrade procedures.
Licensing and Changes in Control
i.e., CPs 2–3	Apply fit and proper tests for all owners, Directors and senior managers of insurance companies. Transfers of ownership or control of an insurance company should be subject to approval.
Corporate Governance and Internal Controls
i.e., CPs 4–5	Promote improvements in corporate governance including particularly internal control practices within insurance companies.
Prudential Rules
i.e., CPs 6–10	Upgrade rules for valuation of assets and liabilities and for the measurement of solvency. Specific legislative authority to review all the reinsurance activities of licensed companies.
Market Conduct
i.e., CP 11	The respective roles of the insurance supervisory authority and the Anti-Monopoly Authority in relation to consumer protection should be reviewed and clarified
Monitoring, Inspection, and Sanctions
i.e., CPs 12–14	Adopt a risk-based approach to on-site work, focusing only on those companies and those topics that are identified as giving cause for concern. The legal environment surrounding insurance companies should be reviewed. In a case of bankruptcy, claims of policyholders should receive a high ranking in the distribution of the estate.
Cross-Border Operations, Supervisory Coordination and Cooperation, and Confidentiality
i.e., CPs 15–17	Authority to enter into Memoranda of Agreement permitting the sharing of confidential information.

View Table

Table 8.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
i.e., CP 1	Increase resources and independence. Technical assistance to upgrade procedures.
Licensing and Changes in Control
i.e., CPs 2–3	Apply fit and proper tests for all owners, Directors and senior managers of insurance companies. Transfers of ownership or control of an insurance company should be subject to approval.
Corporate Governance and Internal Controls
i.e., CPs 4–5	Promote improvements in corporate governance including particularly internal control practices within insurance companies.
Prudential Rules
i.e., CPs 6–10	Upgrade rules for valuation of assets and liabilities and for the measurement of solvency. Specific legislative authority to review all the reinsurance activities of licensed companies.
Market Conduct
i.e., CP 11	The respective roles of the insurance supervisory authority and the Anti-Monopoly Authority in relation to consumer protection should be reviewed and clarified
Monitoring, Inspection, and Sanctions
i.e., CPs 12–14	Adopt a risk-based approach to on-site work, focusing only on those companies and those topics that are identified as giving cause for concern. The legal environment surrounding insurance companies should be reviewed. In a case of bankruptcy, claims of policyholders should receive a high ranking in the distribution of the estate.
Cross-Border Operations, Supervisory Coordination and Cooperation, and Confidentiality
i.e., CPs 15–17	Authority to enter into Memoranda of Agreement permitting the sharing of confidential information.

Authorities’ response

179. The authorities stressed that, as the detailed IAIS assessment had indicated, the DIS duly enforces the functions of an insurance agency across most of the core principles. In this regard, they believed that the summaries at paragraphs 173–178 placed undue emphasis on the need for improvement. As regards the publication of statistical information concerning the insurance industry, they considered supervision to be under the jurisdiction of Goskomstat and not the mandate of DIS.

Main findings

181. The main objectives of monetary policy as specified in the CBR statute are ensuring price and exchange rate stability. Other objectives set for the CBR include the development of the banking system and a smooth functioning payment system. The objectives are publicized on the central bank’s website and are explained through written reports submitted to the State Duma. The CBR statute stipulates that the central bank should fulfill its objectives unencumbered by other bodies of state authority. However, the powers of the National Banking Council to determine the CBR’s budget could compromise this requirement.

182. The monetary policy framework is characterized a multiplicity of policy goals and instruments, which could engender ambiguous policy signals. The CBR has taken measures recently that provide a high degree of transparency in monetary policy.

183. The CBR uses several vehicles for achieving transparency in objectives and implementation of monetary policy, including two annual publications, The Basic Guidelines of State Integrated Monetary Policy and The Central Bank of the Russian Federation Annual Report (the Annual Report). The CBR and the government also jointly draft and publish an annual Declaration of the Economic Policy. The main provisions of these documents are explained in public speeches and interviews to the mass media by the CBR officials. There is also a monthly Bulletin of Banking Statistics and the CBR Bulletin that is published weekly. Frequent press releases are issued as a means of communicating with the public. Extensive use is made of the CBR website in both Russian and English.

184. The roles, responsibilities, and objectives of the CBR are clearly defined in statutes and regulations. In October 2002 the CBR transferred itsshares in the Vneshtorgbank to the Government of the Russian Federation, in exchange for federal bonds. The institutional relationship between monetary and fiscal operations is clearly defined, as are agency roles performed by the CBR on behalf of the government. The CBR has been making additional efforts aimed at enhancing disclosure of equity interest in two domestic banks and in several commercial banks established abroad. Such participation is transparently described in the CBR law while the Annual Report provides additional disclosure on the relationship with domestic and foreign subsidiaries, including a summary of their main activities.

185. With respect to the openness of the process for formulating and reporting monetary policy decisions, the CBR law establishes the basic instruments and methods of monetary policy; specific plans for the year are presented annually in the Basic Guidelines for State Integrated Monetary Policy. Changes in the setting of monetary policy instruments are increasingly being announced publicly and explained through published reports, press releases, and on the website. Additional explanations are provided by officials in appearances before the State Duma and in the CBR’s Annual Report. An advanced schedule for meetings of its Board of Directors (the monetary policy-making body) is not published. While policy changes are always announced immediately after a decision of the Board, an explanation of the main considerations underlying a change in monetary policy is not systematically disclosed. The CBR has in the recent period begun formal consultations, on a regular basis, with the relevant market participants and the public as necessary.

186. With respect to the public availability of information and, as noted above, the CBR has an appropriate range of publications. Senior officials of the CBR also make public appearances before the State Duma, give speeches to financial groups, and give media interviews as a means of explaining CBR policy decisions and actions. The CBR regularly discloses its summary balance sheet and aggregate information on market transactions and the types of transactions on a monthly schedule in the Bulletin of Banking Statistics and posts this information on its web site. Apart from information on international reserves, the presentation and release of data are consistent with Special Data Dissemination Standards (SDDS). Texts of regulations issued by the CBR are readily available to the public and published in the CBR’s weekly Newsletter and also posted on the CBR website.

187. Transparency practices are observed in the area of accountability and assurances of integrity. The CBR is accountable to the State Duma which appoints and can discharge the chairman and members of the Board for specified reasons. The CBR is required to submit its Annual Report, including audited financial statements, to the Duma. Twice a year, the Chairman of the CBR speaks before the State Duma about the operations of the CBR; the State Duma holds parliamentary hearings on the operations of the CBR with the participation of the CBR representatives. The CBR does not disclose a fuller explanation of the internal governance procedures, including the performance of the internal audit systems, and the current standards for the conduct of financial affairs and rules to prevent conflict of interest. Standards for the conduct of the personal financial affairs of officials and staff are established in the CBR law but there are no legal provisions to protect CBR staff in the conduct of their duties.

Table 9.

Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Table 9.

Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
Practice 1.2	Clarify the institutional relationship between debt management operations, the CBR and the Ministry of Finance.
Practice 1.2.2	Disclosure of the terms on which interest is paid on government foreign currency and ruble deposits.
Practice 1.2.3	Provide a more complete description of the procedures for participation of the central bank in secondary markets.
Practice 1.2.4	Disclose the CBR’s equity participation in certain domestic and overseas commercial financial institutions and publish their financial activities on well-recognized principles and procedures. Report the consolidated operations of the CBR and all its subsidiaries and disclose transactions relating lo precious metals and gems
Practice 1.3.2	Further clarification of the principles on which the division of responsibility for secondary market arrangements between the CBR and MoF are based
II. Open Process for Formulating and Reporting Monetary Policy Decisions
Practice 2.1	Improve the timeliness and regularity of explanation of changes in monetary policy and the underlying considerations that led to them. Consider announcing an advanced schedule for monthly meetings of the Board of Directors.
Practice 2.3	Make more systematic and time bound the disclosure of the “main considerations” underlying a policy change.
Practice 2.4.1	A higher frequency of the presentation (e.g., Quarterly) of monetary policy operations and its underlying assumptions would be desirable.
III. Public Availability of Information on Monetary Policy

View Table

Table 9.

Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
Practice 1.2	Clarify the institutional relationship between debt management operations, the CBR and the Ministry of Finance.
Practice 1.2.2	Disclosure of the terms on which interest is paid on government foreign currency and ruble deposits.
Practice 1.2.3	Provide a more complete description of the procedures for participation of the central bank in secondary markets.
Practice 1.2.4	Disclose the CBR’s equity participation in certain domestic and overseas commercial financial institutions and publish their financial activities on well-recognized principles and procedures. Report the consolidated operations of the CBR and all its subsidiaries and disclose transactions relating lo precious metals and gems
Practice 1.3.2	Further clarification of the principles on which the division of responsibility for secondary market arrangements between the CBR and MoF are based
II. Open Process for Formulating and Reporting Monetary Policy Decisions
Practice 2.1	Improve the timeliness and regularity of explanation of changes in monetary policy and the underlying considerations that led to them. Consider announcing an advanced schedule for monthly meetings of the Board of Directors.
Practice 2.3	Make more systematic and time bound the disclosure of the “main considerations” underlying a policy change.
Practice 2.4.1	A higher frequency of the presentation (e.g., Quarterly) of monetary policy operations and its underlying assumptions would be desirable.
III. Public Availability of Information on Monetary Policy

Authorities’ response

188. The authorities felt that the cases in which they did not fully disclose information to the market were covered by the Code’s recognition of circumstances in which such disclosures could have adverse effects on the policy environment (e.g., foreign exchange reserves and intervention). This also applies to interest rates at which the CBR accepts deposits from the Ministry of Finance. They noted that these interest rates are specified in bilateral agreements, which are confidential and therefore not subject to disclosure. The authorities’ response to recommendations 1.2.3 and 1.3.2 was that the rules and procedures governing the relationship between the CBR and its counterparts in the course of monetary operations are governed by the CBR regulatory documents published in the Bulletin. Regarding recommendation 1.2.4, the CBR argued that the language concerning the disclosure of transactions in precious metals and stones should be removed from the text since the CBR has not conducted any sizable operations of this nature in recent years. The CBR’s response to the recommendation that the objectives, rationale, quantitative targets and key underlying assumptions be presented on a higher frequency was that the CBR publishes such information regularly and that timing and periodicity are not precisely defined in the code. Moreover, they disagreed with the Fund staff assessment that a higher frequency of release of information to the market would enhance transparency.

Main findings

189. The assessment found the CBR to be in broad conformity with the transparency code requirements in the implementation of banking supervision policies. The summary below provides details of the findings of the assessment. The CBR is the sole agency responsible for banking regulation and supervision.

190. The CBR’s main responsibilities comprise: conduct of monetary policy; lender of last resort for lending institutions; formulation and implementation of policies for the conduct of the operations of credit institutions; registration of credit organizations and licensing of banking activities; supervision of the activities of credit institutions; regulation of credit institutions’ participation in securities markets; and coordination of the payment system.

191. With respect to clarity of roles, responsibilities, and objectives, the broad objectives and institutional framework for the regulation and supervision of the banking system are clearly defined in the law, and are also disclosed and publicly explained through various publications. However, additional steps should be taken to clarify, publicly disclose, and explain the functional relationships among the banking, securities, and insurance regulators, including through public disclosure arrangements between the agencies.

192. As regards the openness of formulating and reporting of financial policies, the CBR law clearly specifies the framework under which banking supervision and regulation shall be conducted, and mandates that all normative acts be published. The CBR periodically issues its analysis of the state of the banking system in its Annual Report and in its other publications. Key changes in the regulatory framework are published and disclosed through official publications and also on the CBR’s website. The CBR law was recently amended to allow for information sharing between the CBR and foreign supervisory agencies instead of relying on bilateral agreements as in the past. Domestic financial agencies still rely on bilateral agreements many of which are unspecified and not publicly explained.

193. There is a need to introduce changes in the legislation for information sharing among domestic supervisors and to allow for the exchange of customer specific information to enhance the home/host relationship of the CBR with foreign supervisory agencies.

194. The description covering public availability of information for monetary policy (as detailed under 1.1.1) applies equally for banking supervision. The CBR has a high level of accountability in the discharge of its responsibilities. Article 57 specifically provides for the publication of consolidated statistical information on the banking system of the Russian Federation. However, to enhance assurances of integrity, there is a need for periodic explanations to the public of guidelines in place, including procedures for ensuring internal good governance in credit organizations.

195. CBR personnel charged with supervision responsibilities of credit organizations, especially examination work, are not explicitly legally protected in the execution of duties. Consideration should be given to changing the law to protect the CBR’s staff in their supervisory responsibilities for possible lawsuits against actions taken in good faith.

196. Financial reporting covered in the Bulletin of Banking Statistics is compiled on the basis of the RAS, which are quite different in disclosure and transparency requirements from the IAS. The planned implementation of the IAS by 2007 is expected to improve the quality of data released by banks.

197. Improvements are required in the areas of coordination of activities of agencies responsible for the supervision of the banking sector and securities and insurance markets. The CBR law was recently amended to provide for the exchange of non-data-specific information on the operations of the credit institutions and of their customers.

Table 10.

Recommended Action Plan for Improving Observance of the MFP Transparency Code of the International Monetary Fund—Banking Supervision

Table 10.

Recommended Action Plan for Improving Observance of the MFP Transparency Code of the International Monetary Fund—Banking Supervision

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The CBR should inform the public about the signing of formal procedures for information sharing with other domestic financial supervisory agencies.
VI. Open Process for Formulating and Reporting of Financial Policies	The CBR should inform the public about signing of formal procedures for information sharing and consultation between financial agencies and about the content of the agreements.
VIII. Accountability and Assurances of Integrity by Financial Agencies	Changes should be made in the legislation to prevent possible lawsuits against staff for their good-faith actions in the performance of their official duties. Changes to regulations in support of accounting reform and compilation of financial reports in accordance with international standards—including preparations for switching lending institutions to IAS in 2007—should be continued.

View Table

Table 10.

Recommended Action Plan for Improving Observance of the MFP Transparency Code of the International Monetary Fund—Banking Supervision

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The CBR should inform the public about the signing of formal procedures for information sharing with other domestic financial supervisory agencies.
VI. Open Process for Formulating and Reporting of Financial Policies	The CBR should inform the public about signing of formal procedures for information sharing and consultation between financial agencies and about the content of the agreements.
VIII. Accountability and Assurances of Integrity by Financial Agencies	Changes should be made in the legislation to prevent possible lawsuits against staff for their good-faith actions in the performance of their official duties. Changes to regulations in support of accounting reform and compilation of financial reports in accordance with international standards—including preparations for switching lending institutions to IAS in 2007—should be continued.

Authorities’ response

198. The authorities were in general agreement with the assessment. Subsequent to the mission, the assessors were furnished with information confirming the disclosure of agreements on cooperation with other supervisory authorities. The authorities indicated that they would continue to progressively work toward addressing the areas identified as requiring action in the table above.

Main findings

199. The CBR has sole regulatory responsibility for payment systems and for non-cash settlements generally. The Department of Payment Systems and Settlements is responsible for payment system oversight. As regards the CBR payment system, which has a very decentralized structure, the principal oversight tool is the framework of CBR regulations that has been developed to govern the system’s (and its regional components’) operating procedures. As regards private payment systems and networks, there are also CBR regulations that lay down certain operating principles. But in addition, and because only licensed credit organizations can provide funds transfer services, private systems/networks fall within the ambit of the banking supervisors.

200. Besides publishing all the relevant regulations as required by law, the CBR has also established a procedure for formally consulting the banking sector on technical and policy matters relating to payment systems. It is also involved in more widespread public disclosure of payment systems information, via articles in the press and on its website and through speeches, seminars etc. Since the fourth quarter of 2002, the CBR bulletin has included a section containing detailed statistics on the CBR payment system and private payment systems. However, the delineation of institutional responsibilities relating to overlapping issues among the various financial agencies, including payment systems overseers is neither clear nor publicly explained.

Table 11.

Recommended Actions to Improve Observance of IMF’s Monetary and Financial Policies Transparency Code Practices—Payment System Oversight

Table 11.

Recommended Actions to Improve Observance of IMF’s Monetary and Financial Policies Transparency Code Practices—Payment System Oversight

Reference Practice	Recommended Action
V. Clarity of roles, responsibilities, and objectives (5.2)	Clarify and publicly explain the delineation of institutional responsibilities relating to overlapping issues among the various financial agencies, including payment systems overseers.
VI. Open process for formulating and reporting of financial policies (6.1.5)	Establish formal procedures for information-sharing and consultation between financial agencies, domestic and international and explain them publicly.
VII. Public availability of information (7.2)	Publish detailed payment systems statistics.

View Table

Table 11.

Recommended Actions to Improve Observance of IMF’s Monetary and Financial Policies Transparency Code Practices—Payment System Oversight

Reference Practice	Recommended Action
V. Clarity of roles, responsibilities, and objectives (5.2)	Clarify and publicly explain the delineation of institutional responsibilities relating to overlapping issues among the various financial agencies, including payment systems overseers.
VI. Open process for formulating and reporting of financial policies (6.1.5)	Establish formal procedures for information-sharing and consultation between financial agencies, domestic and international and explain them publicly.
VII. Public availability of information (7.2)	Publish detailed payment systems statistics.

Authorities’ response

201. The authorities expressed general agreement with the assessment and recommendations. They added that CBR policy on payment system oversight is aimed at achieving maximum transparency and that in this context, they plan to release in 2003, jointly with the BIS, a detailed description of all aspects of the CBR payment system and private payment systems.

Main findings

202. The FCSM is the supervisory agency responsible for implementing the government policy on the securities market, regulating professional participants of the securities markets, and protecting the rights of investors and shareholders. The FCSM has clear responsibility in the law for the regulation and supervision of market intermediaries, markets and issuers. However, the practice of the supervision of securities activities of banks and the responsibility for regulating trading in derivative products are not clear. Maximum advantage is not being taken of the scope to enhance transparency through consistent publication of annual reports.

203. The FCSM is accountable to the government through a number of reporting mechanisms, including the Chairman’s inclusion in Cabinet and a rule approval mechanism. Rules are published on the website as is the licensing status of regulated entities and general information regarding regulatory standards.

204. The role, responsibilities, and objectives and most aspects of the institutional framework of the FCSM are clearly defined and described in the law, presidential decree, and regulations and orders issued by the FCSM. A need exists, however, to provide greater clarity regarding the formal mechanisms of the FCSM’s accountability, and some steps have been recently been taken to enhance its public accountability. Since the FCSM has some overlapping responsibilities with the CBR, there is also a need for a clear, publicly announced demarcation of roles and responsibilities between the two institutions.

205. In order to establish a clearer and well-defined relationship with the ministries and departments, the FCSM has concluded a number of agreements with relevant agencies. These agreements constitute an important step toward enhancing transparency and accountability.

206. The conduct of financial policy emphasizes confidentiality considerations. There is an established process for public consultation for proposed substantive technical changes in the structure of financial regulations. Several formal council and consultative committees with various industry groups have been established and information relating to meetings of these councils and consultative groups is posted on the website. The constitution and the scope of activities of the Expert Council of the FCSM have been modified to further enhance the role of market participants in the policy-making functions of the FCSM.

207. Formal procedures for information sharing and consultative arrangements with international securities regulators have been entered into and are disclosed publicly. The goal of these agreements is to protect the rights of investors, maintain the integrity of the securities market via the exchange of information, and provide technical assistance in the course of carrying out regulatory functions. The Government of Russia has approved the Code of Corporate Governance developed by the FCSM.

208. Information is generally available to the public. The law requires that FCSM resolutions and regulations be published. In addition, the FCSM publishes in its monthly Bulletin information on the termination of licenses, administrative penalties, and court decisions against professional securities market makers and their self-regulatory organizations. A periodic report on how overall policy objectives are being pursued and a review of developments and operations in the securities market is provided in the Annual Report (although this is published infrequently).

209. Effective use is made of the FCSM website (http://www.fedcom.ru), which is available in both Russian and English. Officials make frequent public appearances to discuss securities market developments and FCSM initiatives. An important challenge confronting the FCSM relates to improving the quality and reliability of financial and nonfinancial information of listed enterprises. Higher standards of disclosure need to be introduced with adequate powers and regulatory and supervisory capacity to prevent material omissions or misstatements.

210. To ensure accountability and assurances of integrity, the FCSM reports to the government. The chairman, when requested, appears before the State Duma to report on the FCSM’s areas of responsibility. The Annual Report provides information on revenues and expenditures, although no balance sheet information is provided. The Accounting Chamber of the Russian Federation audits the financial activities of the FCSM. Standards of conduct for the financial affairs of officials and staff are governed by the Law on State Employees. Apart from audit arrangements, internal governance procedures are not disclosed. Officials and staff do not receive special legal protection in the discharge of their duties, except insofar as they receive the usual protections accorded to government employees.

Table 12.

Recommended Actions to Improve Observance of the IMF’s MFP Transparency Code Practices—Securities Regulation and Supervision

Table 12.

Recommended Actions to Improve Observance of the IMF’s MFP Transparency Code Practices—Securities Regulation and Supervision

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
Practice 5.1.1, 5.1.2, 5.1.3, 6.1, 6.3, 7.1	Require and regularly publish comprehensive annual reports, including detailed description of FCSM’s policies and priorities of its regulatory activity.
Practice 6.1.5	Trie respective roles and responsibilities as well as the means and methods of the cooperation between the FCSM and the CBR should be publicly disclosed and comprehensibly explained.
Practice 6.4	Broaden the scope of the public consultation process beyond the statutorily prescribed manner and to disclose the drafts of proposed technical changes to the public.
III. Public availability of information
Practice 7.1,7.2, and 74.1	In order to strengthen public awareness and understanding of the functioning of the capital market and its regulatory agency it is essential for the FCSM to publish periodic reports in the form of annual reports.
Practice 8.1	Base the appearances of FCSM officials before policy makers on an adequately regular schedule described by the law or regulation.
Practice 8.2.2	The FCSM, should disclose those internal governance procedures that apply to its operations.
Practice 8.4	Formulate and implement specific rules that adequately address the conflict of interest situations that the FCSM’s head and staff may face.

View Table

Table 12.

Recommended Actions to Improve Observance of the IMF’s MFP Transparency Code Practices—Securities Regulation and Supervision

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
Practice 5.1.1, 5.1.2, 5.1.3, 6.1, 6.3, 7.1	Require and regularly publish comprehensive annual reports, including detailed description of FCSM’s policies and priorities of its regulatory activity.
Practice 6.1.5	Trie respective roles and responsibilities as well as the means and methods of the cooperation between the FCSM and the CBR should be publicly disclosed and comprehensibly explained.
Practice 6.4	Broaden the scope of the public consultation process beyond the statutorily prescribed manner and to disclose the drafts of proposed technical changes to the public.
III. Public availability of information
Practice 7.1,7.2, and 74.1	In order to strengthen public awareness and understanding of the functioning of the capital market and its regulatory agency it is essential for the FCSM to publish periodic reports in the form of annual reports.
Practice 8.1	Base the appearances of FCSM officials before policy makers on an adequately regular schedule described by the law or regulation.
Practice 8.2.2	The FCSM, should disclose those internal governance procedures that apply to its operations.
Practice 8.4	Formulate and implement specific rules that adequately address the conflict of interest situations that the FCSM’s head and staff may face.

Authorities’ response

211. The authorities had no comments to this section of the report.

Main findings

212. The regulation and supervision of the insurance industry is the responsibility of DIS/MoF. The work with respect to transparency in the insurance industry somewhat lags behind the progress attained in other financial sectors. Practices need to be strengthened in the areas of open process for formulating and reporting of insurance policy framework, public availability of information, and accountability and assurances of integrity of insurance supervision.

213. The roles, responsibilities, and objectives of the DIS/MoF are defined in the statutes and in regulations. The roles, responsibilities, and objectives are publicly disclosed and explained through written reports to the legislature and through public appearances by senior officials of the MoF. A major shortcoming of the framework is that the Insurance Law does not recognize the possible jurisdictional overlaps among the insurance, securities, and banking regulators and supervisors. Greater clarity and a simplified public explanation would greatly facilitate in defining the existing institutional framework. There is also a need for periodic and more formal consultations among the agencies responsible for the oversight of the financial sector with periodic public disclosure of their activities.

214. With respect to transparency in the area of formulating and reporting of insurance supervisory policies, the authority to conduct insurance supervisory policies, including enforcement powers and the right to carry out audits of insurance providers, is publicly explained in the laws and regulations. Normative legal acts regulating insurance activities (and elucidations thereof), lists of licensed participants in the insurance market, and letters of review and other information for insurance services market entities are published in the mass media. A State Register of Insurers (Reinsurers) is published annually. In case of violations, there is a reported mechanism for mutual exchange of information between oversight bodies for taking appropriate action. Procedures for compiling and submitting various types of financial reports to the MoF are published in professional publications. There is a need to strengthen public consultations on policy changes and not rely on ad hoc mechanisms.

215. The MoF publishes monthly data on the issuance and withdrawal of insurer licenses. The State Register of Insurers is a public document. In addition, a survey is also published in cooperation with the State Statistics Committee, providing consolidated data on the activities of the insurers. The MoF’s website is used for providing public information on the policies and operations of the insurance market. On occasion, officials of the MoF speak to the press and make public statements relating to insurance regulatory policies.

216. The Insurance Law does not explicitly provide any formal mechanisms for accountability and assurances of integrity relating to insurance supervision. For its insurance sector activities, the MoF operates like any other government department. A mechanism is, being worked out to account for insurance-related expenses and revenues and to show them separately.

Table 13.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Insurance Supervision

Table 13.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Insurance Supervision

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies
Practice 5.1.4.	Greater independence would be achieved if the appointment of the head, its duration and terms were disclosed.
VII. Public Availability of Information on Financial Policies
Practice 7.2	Provide information on the asset holdings of insurance companies; on their profitability and their financial strength.
Practice 7.4	The insurance supervisor should perhaps establish a website and a visitor’s area where it can distribute its publications and any important documents.
VIII. Accountability and Assurance of Integrity by Financial Agencies
Practice 8.4.1	The legal protection of staff members should be clarified in legislation.

View Table

Table 13.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Insurance Supervision

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies
Practice 5.1.4.	Greater independence would be achieved if the appointment of the head, its duration and terms were disclosed.
VII. Public Availability of Information on Financial Policies
Practice 7.2	Provide information on the asset holdings of insurance companies; on their profitability and their financial strength.
Practice 7.4	The insurance supervisor should perhaps establish a website and a visitor’s area where it can distribute its publications and any important documents.
VIII. Accountability and Assurance of Integrity by Financial Agencies
Practice 8.4.1	The legal protection of staff members should be clarified in legislation.

Authorities’ response

217. The authorities had no comments to this section of the report.

Background

219. For the purposes of the OECD Principles, corporate governance is “that structure of relationships and corresponding responsibilities among a core group consisting of shareholders, board members and managers designed to best foster the competitive performance required to achieve the corporation’s primary objective.” (A Report to the OECD by the Business Sector Advisory Group on Corporate Governance, April 1998)

220. Note that the corporate governance assessment attempts to review three key components to corporate governance: (1) laws and ordinances that constitute the legal framework, (2) regulatory institutions responsible for enforcing the legal framework, and (3) common business practices that in some countries are as important as the legal and regulatory institutions.

Summary of main findings

221. Market capitalization in Russia is highly concentrated. The top ten “blue chips” represent 85 percent to total market capitalization, with Gazprom (which is 40 percent state-owned) accounting for 16 percent alone. In 2001, 26 percent of all trading was conducted on MICEX and 12 percent on RTS. However, it is estimated that almost two-thirds of trades were conducted outside the organized stock exchanges in the over-the-counter market. Although MICEX and RTS dominate trading on the Russian capital markets, there are an additional nine stock exchanges throughout Russia, including the Moscow, St. Petersburg, Urals and Ekaterinburg Stock Exchanges.

222. On MICEX, the four companies of RAO UES, LUKoil, Mosenergo and Sberbank represent 90 percent of all share trading, with RAO UES representing a full half of all share trading. However, even for RTS, 85 percent of all share trading relates to just seven companies: RAO UES, Mosenergo, LUKoil, Surgutneftegaz, Yukos, and MMC Norilsk Nickel. RTS has the capability to settle contracts in both rubles and U.S. dollars, while MICEX has settle only in rubles. Russian companies also access the international markets. More than 50 companies had ADR issues on the New York Stock Exchange, although only three companies met the high-disclosure requirements of Level III for ADRs. Eight companies also have GDRs issued on the European bourses. Although the shares of over 250 companies are traded on RTS, only 7 meet the 25 percent free float requirement for Tier I qualification. For most companies, the percentage of shares not held by controlling shareholders or company managers is well under 15 percent and often under 5 percent.

223. In the years following the financial crisis of August 1998, the legislation framework for corporate governance has improved dramatically. The most recent amendments in 2001-02 to the Joint Stock Company Law and the Securities Law were particularly helpful in addressing the issues of: (1) maintaining the preemptive rights of existing shareholders in new shares issues and (2) requiring approval of the shareholders’ meeting for the sale or transfer of assets representing a large portion of a company’s balance sheet or where such assets were sold or transferred to parties related to the company’s management. In addition the FCSM has drafted legislation that would mandate disclosure of indirect ownership and control positions and related party transactions and would establish insider trading as a criminal offense. Since the changes went into effect only in January 2002, it may take some time before their effect can be measured. However, the common corporate governance issues in transition economies—asset-stripping, transfer pricing and share dilution—often require more than changes to the legislation.

224. In April 2002, the FCSM released the Code of Corporate Conduct, a corporate governance code that had been more than a year in preparation and for which funding for international and domestic legal advice was provided by the Japanese Government (through the European Bank for Reconstruction and Development). Unlike most codes and legislation drafted in Russia, the Code of Corporate Conduct was reviewed and discussed extensively with all major sections of the Russian and foreign capital markets participants. While the Code is intended as a voluntary code, its main purpose is to influence common business-place practices and set a industry bench-mark against which actions by the corporate sector could be measured. While the Code has some weaknesses, it nevertheless represents the result of an extensive consultative process on corporate governance in Russia. It is interesting to note that even before the Code had been formally adopted, market participants saw improvements in common practices and the reduction of former abuses.

225. At the same time, efforts in the private sector have also been helpful. The US-based rating company, Standard & Poor’s, has established a corporate governance scoring service, which has allowed them to give public comment on weak corporate governance practices, such as failing to disclose material changes in beneficial owners of the Russian airline company, Aeroflot. In addition the Institute of Corporate Law and Governance has published a set of ratings that rank about 30 Russian companies on corporate governance. According to market participants, the primary competition among major Russian companies is not to stand at the top of the list as the best corporate governance firm in Russia, but to ensure that they are not ranked last. The result has been seen, for example, in the increase in the number of non-executive members of the (supervisory) board of directors. To some degree, such improvements may be temporary since they result from voluntary actions by Russian companies but such improvements are nevertheless to be welcomed.

226. However, weaknesses in the regulatory framework have increased in the last year as the FCSM (and many Russian supervisory authorities) has limited authority to impose fines for infractions of the securities and joint stock company legislation. As of July 2002, the maximum penalty for any violation (including insider trading and market manipulation) was limited to Rub 150,000 or about $5,000. In addition the FCSM lacks specific authority to regulate the stock exchanges. Other issues are also covered in the assessment against IOSCO principles, notably the need to establish the FCSM as a fully independent regulatory body with a stable source of funding. At the same time, the decisions of the FCSM, notably those made in the regional offices of the FCSM, lack sufficient transparency to build the necessary investor confidence in the Russian securities markets.

227. Other corporate governance issues remain with regard to the lack of a centralized securities depository, unreliable financial reporting, and a weak and inefficient court system that hinders the effective implementation of a sound system of corporate governance. The issues are fully discussed in other reports submitted as part of the Financial Sector Assessment Program for Russia.

Key recommendations

1. Increase transparency of ultimate ownership and control structures.

• Duma should approve amendments to draft legislation to require disclosure of direct and indirect ownership at international standards (draft amendments to Law on Securities).

2. Strengthen market for corporate control.

• Duma should approve draft legislation requiring disclosure of related party transactions (draft Law on affiliated persons).

• Duma should approve draft legislation to halt insider trading (draft Law on Insider Trading, draft amendments to the Administrative Code and Criminal Code).

3. Increase accessibility to corporate internal legal documents.

• Government should designate (and provide sufficient funding for) a competent agency to establish centralized enterprise register (“companies’ house).

• Make copies of resolutions of shareholders’ meetings publicly available for publicly traded joint stock companies.

• Make information available on the internet.

4. Strengthen financial reporting.

• Require that publicly traded joint stock companies prepare financial statements in accordance with IAS.

5. Establish a centralized securities depository.

• Government should provide sufficient funding to establish centralized depository. FCSM to implement.

6. Strengthen the effectiveness of the FCSM.

• Government should identify measures to ensure the self-financing of the FCSM.

• FCSM to propose increases in maximum fines (and modifications to procedures) sufficient to encourage compliance with legal requirements.

• FCSM to issue regulations on the conduct of shareholders’ meetings.

• Increase the authority of FCSM to supervise stock exchanges.

• Build investor confidence in transparency of FCSM decisions.

7. Improve the quality of court decisions.

• FCSM should publish decisions on court cases where FCSM (including the FCSM Regional Offices) have been a litigant.

Authorities’ response

228. The FCSM of the Russian Federation informally commented on the draft corporate governance ROSC, and the Commission’s comments and suggestions were incorporated into the revised draft. The government authorities provided no additional comment on the final version of the report.