Recent changes to the legislation on investment funds will finally provide the much needed basis for the formation of exchange-traded funds (ETFs) under Russian law. Until recently, all investment funds in Russia were either open-, closed-ended or blended type, and investors were bound by a rigid agreement with an investment manager, thus limiting the investors’ ability to promptly react to changing market conditions. The new amendments to the Russian Federal Law “On Investment Funds” set forth in Federal Law No. 145-FZ “On Amendments to Certain Legislative Acts of the Russian Federation,” dated July 28, 2012, introduce the concept of an ETF and outline the principal rules that will apply to trading in ETFs.

The amendments, which became effective on September 1, 2012, delineate four categories of persons dealing with ETFs in Russia: owners of shares (units) in an ETF; persons authorized by an ETF manager (the Authorized Person, whose functions are discussed below); designated stock exchanges; and market makers.

The principal difference between an ETF and a traditional Russian unit investment fund is that the owner of a share in the ETF has the right to demand that an Authorized Person buy all or a portion of the owner’s shares in an ETF, as well as the right to sell the shares on a designated stock exchange on the terms set out in the ETF management rules (the Rules), which must be registered with the Russian securities regulator, the Federal Service for Financial Markets. An Authorized Person who is also the owner of the shares in an ETF has the right to demand that the ETF manager buy out either all of the Authorized Person’s shares in the ETF on the terms set out in the Rules, thereby terminating the agreement between the Authorized Person and the ETF manager, or a portion of the ETF’s shares held by the Authorized Person.

Authorized Persons, who may either act as intermediaries between the owner of shares in an ETF and the buyer/seller of the shares, or may themselves be the owners of the shares in an ETF, must be specifically named in the Rules. The Rules must also name the Russian stock exchanges where shares in an ETF are admitted to trade and where the market makers are obliged to maintain the price, supply, demand and the volume of shares in the ETF. The same entity can act as an Authorized Person and a market maker for a particular ETF. Prior to the state registration of the Rules and the admission of the ETF shares to trade, a stock exchange must enter into an agreement with the persons who will act as market makers for a particular ETF. Russian ETFs can be traded on a foreign stock exchange, subject to the rules of such foreign stock exchange.

In order to maintain the price level for a particular ETF, the Rules provide that the price for which a market maker may purchase/sell the shares in an ETF cannot deviate by more than 5% from the estimated price of these shares, which must be stated in the Rules.

It remains to be seen how popular ETFs will become with investors, particularly those based outside of Russia who already have access to Russia-focused ETFs, such as, for example, the Market Vectors® Russia ETF and the Market Vectors® Russia Small- Cap ETF. However, analysts cautiously expect that the new legislation will increase investment in the Russian securities market, as well as provide greater protection to investors due to the greater transparency of ETFs as compared to traditional funds currently present in the Russian market.