|                                                                                                                                                             |  | USING RUSSIAN PROMISSORY NOTES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              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|**BISNISHome PageSearchBISNISEmbassyReportsCountryReportsIndustryReportsPublicationsSourcesof FinanceLeadsand EventsExchangeRatesState ExportsOtherSources** |  | December 1997/January 1998by Padraic J. SweeneyOne of the most common forms of commercial credit in Russia is the promissory note, or
"veksel."  Russian companies of all sizes, Russian banks, and many local and regional
governments use promissory notes in lieu of cash in an economy where commercial credit is still
hard to obtain.  While promissory notes do carry significant risk, knowledge and common sense
can serve U.S. companies well when they encounter this ubiquitous financial instrument(editor's note: "veksel" is the Russian word for "promissory note": the two terms are used
interchangeably in the Russian banking sector and in this article).Originally a means of addressing the chronic payments problems faced by many Russian private-
and public-sector organizations, promissory notes are issued by banks, enterprises, and
government entities.  Russian companies "are highly illiquid and use veksels as a form of non-cash
payment," observes Michael Workman of Renaissance Capital, a leading Russian investment
bank.  The secondary market for "veksels" has become one of the most dynamic securities
markets in Russia, since  yields on commonly traded promissory notes often  far exceed those of
other types of domestic debt securities. "The yields [reaching as high as 60 to 70 percent in ruble
terms per annum] are reflective of the liquidity of the companies...and their transparency," says
Workman.As Commercial Credit
While the secondary market for veksels is quite risky and best suited only for experienced traders,
its existence makes it possible--with plenty of careful planning in advance--for a seller of goods or
services to convert quickly into cash a note it has received from a buyer.  The third-party broker
or bank that buys the note--at a sharp discount--assumes the risk of collecting.  The cost of
financing, then, is simply the amount the note is discounted for resale to a broker or bank. This
cost is calculated into the amount of the note and is borne by the issuer, namely the company
which bought goods or services in exchange for the note in the original transaction.Under Russian law, veksels are negotiable and unconditional debt obligations, and are considered
securities.  However, since they do not fit the definition of an "emissive security," they are not
registered with the Federal Commission on the Securities Market.  By law, notes may be
transferable from one legal person to another, must comply with a statutory form, and need not be
supported by other forms of security.  Terms vary widely, with maturities extending for days or
years and payment designated in rubles or in kind.  Russian banks can issue dollar-denominated
notes, but non-bank companies--whose paper U.S. exporters are more likely to encounter--can
only issue ruble notes at present.The lack of registration requirements means that there is no reliable estimate of the size of the
veksel market, but the Central Bank of Russia (CBR) puts the size at 30 trillion rubles, or 23
percent of the cash in circulation.  CBR Deputy Chairman Andrei Kozlov, who is also chairman of
the Association of Veksel Market Participants, recently announced the establishment of
standards governing the issue, redemption, and transfer of veksels, as well as the disclosure of
information about them.  These measures, and the gradual emergence of a corporate bond market,
are all likely to lower the risk and increase the transparancy of the secondary market--and
eventually reduce the cost of this type of financing.Many Uses
U.S. exporters are likely to encounter veksels in a variety of commercial situations.  One of the
most well-established is forfaiting, a technique for financing medium-sized exports of capital
goods to many countries, including Russia (see BISNIS Bulletin, June 1997, Page 7).  In a
forfaiting transaction, a bank or specialized forfaiting house issues an aval, or guarantee, on the
note and pays the seller for their goods.  The bank or forfaiting house then either keeps the note
or resells it, with the final owner assuming responsibility for collection.The Export-Import Bank of the United States (Ex-Im Bank) uses promissory notes as a
standard form of documentation for medium-sized and large transactions in Russia.  Ex-Im Bank
will guarantee a promissory note as the principal form of security for transactions of less than $10
million.  For transactions larger than $10 million, a credit agreement is also required.  Ex-Im Bank
attorney David Chavern observes that for tax purposes, promissory notes used by Ex-Im in
transactions in Russia are structured as "debt instruments" under Russian law.  These instruments,
according to Chavern, "are offshoots of our standard documentation" based on forms enforceable
in the state of New York--a feature common to most international financial transactions involving
U.S. banks.The United States Department of Agriculture is considering whether to extend to Russia its
"Supplier Credit Guarantee Program," which uses promissory notes as the basis for guaranteeing
exports of U.S. agricultural commodities.  A decision has not yet been made, pending final review
of Russian legislation and business practices regarding promissory notes.  The program already
supports U.S. agricultural exports to 30 countries around the world.
Promissory notes have a variety of other uses, as well.  Larger Russian companies and their banks
use notes as an instrument for structured corporate finance.  Very large entities, like Gazprom and
the state railways, will often issue notes redeemable in goods or services to pay their domestic
creditors.  Notes such as these, which are used to structure debt between large Russian
corporations, are what fuel the secondary market, but will rarely be encountered by U.S.
exporters.Risks
Managing the legal and commercial risk inherent in promissory notes is the key to using them
safely and successfully in Russia.  Perhaps the most basic problem, says Oleg Popov of
International Moscow Bank (IMB), is that "you have companies with no credit record at all"
issuing veksels.  The use of an experienced bank with extensive domestic correspondent
relationships is important in evaluating an unfamiliar issuer.  "First tier [Russian] banks can act as
an intermediary," with a prospective issuer's bank, according to Popov, in the frequent cases
where little reliable information is publicly available.Reputable commercial banks doing business in Russia will often guarantee promissory notes once
they're satisfied with the risk.  A well-structured veksel transaction results in the exporter getting
paid promptly for its goods, with a bank or veksel broker assuming responsibility for collecting on
the note.  "Every time we issue a guarantee on a promissory note, we have a discount house lined
up" in advance, says Alfa Bank Vice President Yuri Hitrov.As with other types of financial documentation, it is important that a note be filled out precisely
and in accordance with Russian law.  Failure to do so can provide the issuer of a note with
grounds to refuse payment.  When considering a note-based transaction, an exporter should
obtain competent legal advice from the start.  A knowledgeable U.S. financial expert advises U.S.
companies to "have a good lawyer make sure [a promissory note is] in the proper form," since
Russian companies can be quite meticulous about such details.  Otherwise, he adds, "if there's a
technical problem, and they don't want to pay, they won't pay."Despite the risks, veksels are a common feature of commercial finance in Russia and methods
exist to mitigate these risks.  As a seasoned observer notes, "these instruments were prevalent
before the [October 1917] Revolution; to the extent that there is a financial commercial tradition
in Russia, this is part of it." For a list of Russian banks, visit BISNIS Online at
www.mac.doc.gov/bisnis/country/rusbanks.htm.Padraic J. Sweeney, Managing Editor of BISNIS Bulletin, also covers banks and banking for
BISNIS.This report is provided courtesy of the Business Information Service for the Newly
Independent States (BISNIS)