Central Asia Spring 2003

Law in transition

page

1 ForewordArthur Mitchell, General Counsel, Asian Development Bank

2 Introducing international standards to central and eastern Europe: the role of model international trade contractsJean-François Bourque, Senior Legal Adviser, International Trade CentreUNCTAD/WTO (ITC) and Jean-Sébastien Roure, Associate Legal Expert, InternationalTrade Centre UNCTAD/WTO (ITC)

9 Lending in roubles – a look at the EBRD’s first local currency loans in RussiaDiana Michaliova, Associate, Office of the General Counsel, EBRD

14 Focus on Central Asia

15 Private sector development and the EBRD in Central Asia – lessons from the past ten yearsMasaru Honma, Central Asia Director, EBRD and Martin Raiser, Director for Country Strategy and Analysis, EBRD with Levent Aydinoglu, Associate Banker,EBRD and Toshiaki Sakatsume, Economist, EBRD

24 Legal and policy aspects of the EBRD’s activities in post-Soviet Central AsiaAlexei Zverev, Counsel, EBRD

31 Reflecting on change in Central AsiaJean Lemierre, President, EBRD and Sergei Mironov, Chairman,Commonwealth of Independent States Inter-Parliamentary Assembly

35 Concessions in Central Asia: a licence for progressZhaniya B. Ussen, Gulnara A. Kalikova, Rustem Guldarbogov, Wim A. Timmermans,Jamol A. Askarov and Alexander V. Voronin

48 Legislative evolution in Uzbekistan (1991-2003)James Campbell and Jenny Afia, Jones Day Gouldens, London and Ilkhom Azizov, Azizov and Partners, Tashkent

54 Reform of the Bar system in UzbekistanKazutaka Sugiura, Director, Centre for Asian Legal Exchange, Nagoya University

60 Current status and future of arbitration in UzbekistanYasunobu Sato, Professor, Nagoya University and Akobir Rashidov, Master Student,Graduate School of International Development, Nagoya University

65 Legal transition developments

70 Legal transition events

General Counsel of the EBRDEmmanuel Maurice

Co-Editors-in-Chief Gerard Sanders, Michel Nussbaumer

Focus EditorAlexei Zverev

Contributing EditorsMartin Raiser, Yasunobu Sato

Production EditorTabitha Sutcliffe

SupportRichard Bate, Irena Dajkovic, Angela Hill,Masaru Honma, Amanda Lillywhite,Anthony Martin, Jon Page, Anna Sidorowicz

Law in transitionSpring 2003

The EBRD Office of the General Counselgratefully acknowledges the generoussupport of the Government of Japan forfunding the production of this issueof Law in transition.

Although lying at the trading crossroads of Europeand south-east Asia, being endowed with valuablephysical and human resources and having a rich,common cultural and political heritage, CentralAsia has yet to attract its share of private andforeign investments. Nor has it been able to fostereconomic alliances and unleash its comparativeadvantage or exploit effectively the gains ofinternational trade. Nonetheless, the Asian Development Bank (ADB) and the European Bankfor Reconstruction and Development (EBRD) havebeen development partners in Kazakhstan, theKyrgyz Republic, Tajikistan, Turkmenistan andUzbekistan for the past decade. Together theyhave helped improve the lives of the region’speople by strengthening governance, economicmanagement and transformation and introducingmarket orientation and competition.

The ADB’s primary goal is to reduce povertythrough socially and economically sustainabledevelopment strategies and high standards ofcorporate governance. The ADB has providedloans and technical assistance for a broad rangeof development activities and instigated policy,legal and regulatory reform to create a favourableinvestment climate for the private sector.

Among other things, the ADB has launched acomprehensive regional economic cooperationprogramme aimed at (i) developing effective transport corridors, (ii) encouraging rationaluse of vital resources, particularly energy, and(iii) promoting market integration both withinthe region and with the outside world.

The EBRD, which facilitates transition to openmarket-oriented economies and promotes privateand entrepreneurial initiatives, has employedsimilar methods of operations, although itsfocus has primarily been on the private sector.

For both the ADB and the EBRD, promoting legalreform and ensuring its effective enforcement isan important element of their activities. Overthe past decade, Central Asia has emerged asa natural zone of collaboration for these two inter-national financial institutions. Cooperation betweenthe ADB and the EBRD has taken many differentforms, from financing joint investment projects,such as the Almaty-Bishkek road, to participating incomplementary technical assistance efforts, suchas the proposed reform of the telecommunicationssector in Uzbekistan. In a number of other areas,such as microfinance and small and medium-sizedenterprise development, both institutions areworking side by side. The two have been proactivein financial and enterprise restructuring and havepaved the way for equity investments from foreigninvestors and the private sector.

However, the countries themselves need tomake greater strides in attracting private sectorinvestment from abroad and stimulating entre-preneurial activity within. Key to this will be ademonstrated and sustained commitment toopen markets and governmental accountability.In addition, high standards of state conduct willbe imperative to instil confidence in current andpotential investors and ensure the contracts thatthey enter into are upheld and enforced by inde-pendent courts, particularly against publicly ownedparties. The countries of Central Asia must striveto build on their best legal traditions and discardwhat is no longer useful for a modern economy andprogressive society, thereby entrenching respectfor the rule of law.

As legal reform is pursued in the countries ofCentral Asia, it is important to learn from pastexperiences. Law reform must be part of largersector policies and complement other sectorreforms. The ADB’s experience in east Asia

has shown that market-oriented laws can laydormant for years until economic reformscreate incentive for their use and producefurther demand for improvements.1

Institutional capacity must also go hand-in-handwith law reform and take account of the broadergovernance setting in which new laws and policiesmust operate. If the process of law making is notinclusive and new laws are implemented by theexecutive without citizens’ recourse to independentjudicial institutions, the very objectives of lawreform will fail. Linkage of law reforms to broadergovernance reforms, such as the law makingprocess and judicial reform, cannot be ignored.

This issue of Law in transition highlights theeconomic progress in Central Asia, identifieschallenges as well as opportunities, and seeks toencourage further reform, particularly in the legalsphere. It should be of particular interest to allthose who make or influence sound legal reformpolicy, which is key to sustainable and equitableeconomic growth and a core component of viabledemocratic institutions.

Law in transition – Foreword 1

Arthur Mitchell, General Counsel, Asian Development Bank

Fostering legal reform in Central Asia

1 Pistor and Wellons, “Role of Law and Asian Legal Institutions”, in Asian Economic Development 1960-1995, p. 41 (1998).

Introducing internationalstandards to central and eastern Europe: the role of model internationaltrade contractsThe emergence of universal standard contractsis a recent trend facilitating cross-bordertrade for the benefit of small and medium-sized enterprises (SMEs). Legal practice in thetransition countries of central and easternEurope can directly benefit from this process.The International Trade Centre’s new modelsfor joint venture contracts are a good exampleof harmonisation in trade practices.

Jean-François Bourque, Senior Legal Adviser, International Trade Centre UNCTAD/WTO (ITC) andJean-Sébastien Roure, Associate Legal Expert, International Trade Centre UNCTAD/WTO (ITC)*

2 Law in transition

The use of model contracts by small andmedium-sized enterprises in central and easternEurope is relatively widespread.

Law in transition 3

1 The International Trade Centre (ITC) isthe technical cooperation agency of theUnited Nations Conference on Tradeand Development (UNCTAD) and theWorld Trade Organization (WTO), foroperational, enterprise-orientatedaspects of trade.

2 See The Office of Trade and EconomicAnalysis, Export America, “Small andmedium-sized enterprises play an import-ant role”, p. 26 (September 2001).

3 See Small and Medium Business Admin-istration, “The status of Korean SMEs”,12 December 2002, www.smba.gov.kr.

4 See Agnes, R. Yaptenco, “SME financingin eastern Europe”, World Bank Group,November 2002.

5 For the purpose of the survey thefollowing countries were included in thecategory “Central and eastern Europe”:Bosnia and Herzegovina, Cyprus, Croatia,Czech Republic, Estonia, Hungary, Latvia,Lithuania, Malta, FYR Macedonia,Moldova, Romania, Russian Federation,Serbia and Montenegro, Slovakia,Slovenia, Turkey, Ukraine.

A new generation of international model contractsis setting standards for contractual relations. Forthe past five years, the International Trade Centre(ITC)1 has been developing model contracts forSMEs. The first part of this article analyses theemerging trends in international contracts. Thesecond part describes the development of newITC models for joint venture contracts, due forrelease in 2003.

Model international contracts, dealing with a largespectrum of activities, often go unnoticed by SMEs.This is unfortunate, considering that SMEs con-stitute the more dynamic sector of economies.There is no universal definition of an SME, but theyare often referred to as having fewer than 250full time employees. SMEs comprise generallyyounger and faster growing firms and are a sourceof employment and innovation. In the UnitedStates, nearly 97 per cent of all exporting com-panies are small and medium-sized.2 Theyrepresent 99.2 per cent of all Korean manufac-turing companies3 and a similar percentage in theEuropean Union. Less thorough data for easternEurope shows that these firms represent asignificant sector of the economy.4

Model contracts may be less vital for large com-panies able to pay in-house legal counsel oroutsource required legal assistance. Yet largerfirms do use models too (if not their own).

The need for standard contracts in central and eastern Europe: an ITC survey

In 1998, the ITC conducted a survey on why com-panies needed and used standard contracts.Respondents to the survey comprised 247 tradepromotion organisations, such as exporters’associations, industry associations and chambersof commerce from 115 countries belonging todeveloping economies or economies in transition.

The extent of the survey provided a truly globalpicture. The first question was whether participat-ing organisations, or their members (in particularSMEs), already used model contracts in the courseof international commercial dealings. Only 31.6per cent of respondents answered this questionpositively. More than two-thirds of all enterpriseswere entering into international commerce withouthaving access to model contract forms. Thisconfirms the fact that in their contractual dealings,SMEs are at a disadvantage. The legal basis oftheir international business dealings often consistof contracts that have either been drafted withoutany professional legal support, or that have beenimposed by the other party.

Concerning the types of contracts requested,the highest demand was observed for sales andpurchase contracts (88.3 per cent of all respon-dents) followed by joint venture agreements (78.1per cent). Contracts with intermediaries (76.1per cent) and contracts for representation (71.3per cent) were also in high demand. Results forcountries from central and eastern Europe5 wereall within a 5 per cent range of these figures.

Central and eastern Europe rank among thoseregions where the use of model contracts bySMEs is relatively widespread. However, still61.8 per cent of all respondents stated that theydo not use model contracts. Those who do usethem named sales/purchase contracts, as wellas agency and distribution contracts, as theirlegal tools. Furthermore, various InternationalChamber of Commerce (ICC) model contractsand leasing contracts issued by different universityfaculties are part of the existing legal supportfor SMEs in central and eastern Europe.

The overwhelming majority of all central andeastern European enterprises demanded guide-lines on drafting international contracts (94.1per cent). The request for legal support – modelcontracts, guides or training – was significantlyabove the global average.

I. Contract standardisation: an empirical process

Model contracts are part of a much larger processof harmonising international trade rules andpractices, a process that is still evolving andgaining momentum. What is striking, and seem-ingly paradoxical, is the diversity of channelsthrough which this harmonisation is taking placeand the links between trade usage, modelcontracts, treaties, model laws and regional har-monisation of laws. An important feature of thisharmonisation process is its non-systematic andrather empirical character. Although the lengthof this article is not suited for detailed analysis,the links that have a bearing on the content ofa new generation of standardised contracts arementioned briefly.

From “laws” to “rules”

Consistent with the gradual evolution of inter-national thinking on this subject, internationalcontracts tend to incorporate, or refer to, a numberof internationally recognised trade rules and tradeusage. They also tend to lean, to a much lesserextent, on national law.

The landmark Article 17 (1) of the 1998 ICCArbitration Rules6 reflects this by stating that inthe absence of any agreement, the arbitral tribunalshall apply “the rules of law” which it determinesto be appropriate. This provision is interpretedas meaning first, that arbitrators, when decidingon the merits of a case, are not required to applynational legal rules to determine the applicablelaw. Second, the arbitral tribunal is authorised tochoose rules pertaining to transnational law.

Most model international sales contracts referto two important trade rule codifications: theIncoterms (International Commercial Terms) andthe Uniform Customs and Practice for DocumentaryCredits (UCP). Both of these codes have beendeveloped by the International Chamber of Com-merce. First published in 1936, the Incoterms setout what is included in the sales price, by allocatingtransport costs and risks, as well as determiningresponsibility for insurance and customs. Thecurrent valid version for the 13 existing Incoterms(such as free on board and cost, insurance, freight)

is Incoterms 2000. The next revision will probablynot appear before 2010. Concerning paymentterms, international letters of credit are standard-ised through the UCP. The current valid versionwas released in 1993 (UCP 500).

The 1991 Uniform Rules for Demand Guarantees(URDG), also issued by the ICC, is yet anotherset of rules widely referred to in model forms.This applies to demand guarantees and counter-guarantees and was developed to bridge culturalgaps in practice.

Less specialised transnational commercialrules were justifiably defined as uncertain oreven mythical until the UNIDROIT Principles ofInternational Commercial Contracts7 were intro-duced in 1994. There is now evidence that theUNIDROIT Principles are increasingly used ininternational contracts.8

The present authors do not wish to imply thatcontracting parties should refer to an elusivetransnational law. Current practice seems toindicate that parties still refer to a single nationallaw in their contracts. However, because they arenot dependent on any peculiarity of national law,the appeal of transnational principles is certain.This is especially true when these principles arecodified, such as the UNIDROIT Principles, andwhen they can be articulated with national law.

For example, the ITC Model Contract for the Inter-national Sale of Perishable Goods (1999) hasthe following “Applicable Rules of Law” provisionin Article 14:

“In so far as any matters are not covered bythe foregoing provisions, this Contract isgoverned by the following, in descending orderof precedence:

■ The United Nations Convention on Contractsfor the International Sale of Goods,

■ The UNIDROIT Principles of InternationalCommercial Contracts, and

■ For matters not dealt with in the above-mentioned texts, the national law applicableor, in the absence of a choice of law, the lawapplicable at the Seller’s place of businessthrough which this Contract is to beperformed.”

As can be seen in Article 14, the contractualprovision specifies the rules which govern theparties’ agreement and their order of precedence.The national law fades in last position and isreferred to only if the preceding rules do notprovide an answer.

The provision refers, in first position, to an inter-national treaty, which is also a feature of somemodel contracts. Treaties provide a substantivecommon ground. It is not uncommon to see refer-ences to their provisions in standard contracts.

Influence of regional laws on model contracts

Another significant factor shaping model inter-national contracts is the regional integration ofbusiness law, as witnessed in the EuropeanUnion and more recently in west Africa among16 member countries of OHADA (Organisationfor the Harmonisation in Africa of InternationalBusiness Law).

An example is the International Union of Commer-cial Agents and Brokers (IUCAB), an organisationconsisting of 17 national associations of inde-pendent commercial agents throughout theEuropean Union and the United States, whichoffers a short-form model agency contract.9 Thecontract incorporates an EEC-Council Directiveof 18 December 1986 related to self-employedagents. Agency firms typically handle a portfolioof products under a contractual arrangementwithin a defined geographic territory and on anexclusive basis.

For agents working in Europe who are looking fora model agency contract, the IUCAB contractprobably fits their needs best. For agents workingon an inter-continental basis, the ICC’s ModelAgency Contract is better suited to them. This isbecause it represents “uniform contractual rules”which are not based on any specific national lawbut which incorporate the prevailing practice in inter-national trade, as well as the principles generallyrecognised by the domestic laws on agency.

4 Law in transition

Model contracts are part of a much largerprocess of harmonising international traderules and practices, a process that is stillevolving and gaining momentum.

Law in transition 5

Trend-setters in model contracts drafting

The classic generation

From the early 1900s until 1990 most modelcontracts have had a rather limited focus.

The first group of standard contracts were pro-duced in relation to specific sectors of the econ-omy. These sector-specific contracts exist todayin all the main branches of commodities (coffee,cocoa, cereals, sugar, etc.). Among them, therenowned Grain and Feed Trade Association(GAFTA) contracts – some 90 different standardcontracts for the sale of wheat, rice, soybeans,pulses, peas and fish dishes – stand out as someof the most widely used.

The second group of contracts produced wereintended for specific categories of users (e.g.buyers, agents, distributors, manufacturers).Their use requires special care, as they tend toprovide the best possible contractual solutionsfor the party for which they are drafted. A greatnumber of such organisations have createdcontractual standards in their own specificsector and will continue to do so. ITC’s JurisInternational database (www.jurisint.org)contains many such model contracts.

There is perhaps one notable exception in theengineering and construction sector with theFIDIC (International Federation of ConsultingEngineers) producing standard forms of contractfor use between employers and contractors oninternational construction projects. The 1999new set of four standard forms of contract rangingfrom the Construction for Building and EngineeringWorks to Engineering, Procurement and Construc-tion Turnkey Projects are just the latest of a longseries of carefully balanced specialised construc-tion contracts developed by this organisationdating back to 1913.

The East-West generation

Political barriers between the East and West,and the difficulty of achieving significant harmon-isation of business laws, produced very fruitfulresults on the contractual side, especially between1950 and 1980, under the influence of the UnitedNations Economic Community of Europe. Startingin 1953, a series of model contracts for the supplyor erection of plant and machinery were success-fully developed by a multicultural team of lawyers.

These included General Conditions for the Supplyof Plant and Machinery for Export (1953); GeneralConditions for the Supply and Erection of Plantand Machinery for Import and Export (1957);General Conditions for the Erection of Plant andMachinery Abroad (1963); General Conditions ofthe Sale for the Import and Export of DurableConsumer Goods and of other Engineering StockArticles (1961).10 These contracts were widelycirculated and had considerable impact on tradepractices, including in the countries of centraland eastern Europe.

The Council for Mutual Economic Assistance(CMEA) published general conditions for the supplyof goods between organisations of the CMEAmember countries. The CMEA also drew up generalconditions for the erection and performance ofother technical services related to the supply ofmachinery and equipment between organisationsof the member countries of the CMEA.

When envisaging more complex contracts in thefields of intellectual property or joint cooperationprojects between companies, the divergence ofviews has impeded the drafting of standardcontracts. Between 1972 and 1980, draftingguides were developed by the EEC Commission.The following were published: Guide for Drawingup Contracts for Large Industrial Works; Guidefor Drawing up International Contracts on IndustrialCooperation; Guide for Drawing up InternationalContracts between Parties Associated for thePurpose of Executing a Specific Project; andGuide for Use in Drawing up Contracts Relatingto the International Transfer of Know-how in theEngineering Industry.11

These contracts generally provided for longer andmore diversified relations than the usual contractsfor the supply of plant and machinery. The guideslisted the various contractual procedures that couldbe used for such works, indicating the problemsand consequences of their adoption. However, theguides did not provide advice on which proceduresto adopt or which contractual provisions to apply.Their purpose was essentially descriptive. Withregard to the clauses commonly used for thesupply and erection of industrial plant and forthe construction of buildings or civil engineeringwork, it merely referred to the above-mentionedexisting forms.

6 Y. Derains and E. Schwartz, A guide tothe new ICC rules of arbitration, pp. 217et seq. (1998)

7 See UNIDROIT website www.unidroit.org,in particular M. J. Bonell, “The UNIDROITPrinciples and transnational law”, postedon 29 August 2000; see also the UNILEXdatabase, www.unilex.info, containingover 70 court and arbitration decisionson the UNIDROIT principles.

8 Two issues of the ICC International courtof arbitration bulletin quote contractsreferring to the UNIDROIT principles.See F. Marrella & F. Gélinas “TheUNIDROIT principles of internationalcommercial contracts”, ICC Arbitration,Vol. 10 (2), p. 26 (1999); idem, Vol. 12(2), p. 49 (2001).

9 The IUCAB Agency Contract can befound on ITC’s Juris Internationalwebsite: www.jurisint.org

10 Full text of these contracts can befound on the Juris International website www.jurisint.org

11 Full text of these guides can be found on the Juris Internationalwebsite: www.jurisint.org.

12 F. Bortolotti, “ICC Model Contracts forInternational Distribution”, InternationalTrade Centre Forum, Vol. 4, (2002).

13 Full text of these contracts can befound on the Juris Internationalwebsite www.jurisint.org

14 ICC Publication No. 556.15 Full text and users’ guide can be

accessed at www.jurisint.org.16 Eurostudy Centre, International joint

ventures: the legal and tax issues, p. 267(1991); United Nations Conference onTrade and Development Secretariat(UNCTAD), The role of international collaboration arrangements in developingcountries’ export of manufacturers, p. 41 (1990); United Nations EconomicCommission for Europe (UNECE), East-West joint venture contracts, p. 224(1989); International Chamber of Com-merce, Guide to joint ventures in theUSSR, p. 279 (1989); International TradeCentre, export-oriented joint ventures,selected issues and perspectives fordeveloping countries, p.133 (1989);Centre for the Development of Industry,ACP/EU Guide to partnerships in industry,p. 23 (1988); United Nations Centre onTransnational Corporations (UNCTC),Joint ventures as a form of internationaleconomic cooperation, p. 210 (1988);UNCTC, Arrangements between jointventure partners in developing countries,p. 43 (1987); United Nations IndustrialDevelopment Organisation (UNIDO),Guidelines for the establishment ofindustrial joint ventures in developingcountries, p. 280 (1982); UNIDO,Manual on the establishment of industrialjoint-venture agreements in developingcountries, p. 78 (1971)

6 Law in transition

The new generation

From the 1990s more and more standard formsof general and universal use have been developed,under the initiative of the ICC, followed by the WorldBank, ITC and a few other institutions. One of theinitiators of the new generation of model contractsdeveloped by the ICC, Fabio Bortolotti, has recentlydescribed the thinking and challenges in draftingthese contracts:

“The International Chamber of Commerce hasa different approach as it represents all thoseinvolved in trade: principals and agents, suppliersand distributors, sellers and buyers. Consequently,a model contract issued by the ICC must takeinto account the interests of all parties involved,without favouring any of them. Naturally, it is noteasy to decide which solutions will be consideredfair to both parties. Parties tend to consider asfair the solutions that are more favourable forthem (and which they would like to incorporateinto their contracts) and to forget the clausesthey may have been forced to accept whentheir position was weaker. This is why a really“balanced” contract will often be criticised byeach party as favouring the other.”12

These contracts should nevertheless reflect currenttrade usage, or else they are bound to fall intodisuse. This requirement creates a natural limitto harmonisation. When the ITC devised modelcontractual agreements at the request of thepublishing and printing industries,13 it was facedwith major differences of approach in the civil lawand common law countries regarding the rightsand duties of publishers vis-à-vis authors. For themodel publisher-author agreement only (and notfor the other seven harmonised model agreementsbetween publishers-suppliers and joint-publishers),the drafters finally decided to offer a civil lawmodel and a common law model, although everyeffort has been made to narrow the gap betweenthe two versions. The World Bank, in certaininstances, also issues civil law and common lawstandard forms in the procurement sector.

Business people, and even their legal counsel, areoften not fully informed of the extent and meaningof the new generation of model contracts. Forinternational sales, the ICC published in 1997 its

Model International Sale Contract for Manufac-tured Goods intended for Resale.14 The ITC pub-lished on its part in 1999 a Model Contract forthe International Commercial Sale of PerishableGoods.15 Concerning contracts with intermediaries,the ICC’s role has been extensive. Model contractsachieved until now in the field of distribution are:

■ ICC Model Commercial Agency Contract, 2nd edition, ICC Publication No. 644;

■ ICC Model Distributorship Contract, 2nd edition, ICC Publication No. 646;

■ ICC Model Occasional Intermediary Contract(Non-circumvention and non-disclosureagreement), ICC Publication No. 619;

■ ICC Model International Franchising Contract,ICC Publication No. 557; and

■ ICC Short Form Model Contracts InternationalCommercial Agency and International Distrib-utorship, ICC Publication No. 634.

At present, several working parties establishedwithin the Commission on International Commer-cial Practice of the ICC are drafting new modelforms. These include a model international mergerand acquisition agreement; two models of turnkeycontracts: one for the sale of a plant or productionline to be erected within an existing factory andthe other for larger turnkey projects; and a modelselective distribution contract.

II. ITC’s recent experience in draftingmodel joint venture agreements

As previously mentioned, an ITC survey concludedthat joint venture agreements are the second mostpopular category of model contracts worldwide.On this basis, the ITC decided to coordinate thepreparation of model contracts for internationaljoint ventures. In the past, no attempt had beenmade to draft universal standard joint ventureagreements. Several organisations have, however,published guides highlighting some of the primaryelements that should be included in a joint ventureagreement or presented examples of joint venturecontracts that can be used in a specific nationallegal framework.16

Law in transition 7

This section will focus on the basic options thatwere chosen for the preparation of the modeljoint venture agreements. The model agreements,together with users’ guides, are scheduled forpublication in June 2003.

Taking into consideration economies in transition

The first decisions that were made related tohow the drafting exercise would be organised.Because the models are intended for universaluse, and in light of long-standing complaintsmade by representatives from emerging economiesand economies in transition that their views arenot adequately represented, the ITC chose to setas a priority the principle of legal, cultural andeconomic neutrality.

This was reflected in the organisational aspectsof the drafting exercise. As a result, a culturallyand geographically diversified pro-bono commit-tee,17 composed of selected experienced lawyersand legal experts, was set up. All continents wererepresented. Several international institutions alsoparticipated actively, including the African Develop-ment Bank, the Organisation of the Black SeaEconomic Cooperation (BSEC), the CommonMarket for Eastern and Southern Africa (COMESA),the Commonwealth Secretariat, the EuropeanBank for Reconstruction and Development(EBRD), the International Federation of ConsultingEngineers (FIDIC), the Association of EuropeanDevelopment Finance Institutions (EDFI), andthe Union Economique et Monétaire OuestAfricaine (UEMOA).

Additionally before each working session, asteering committee, composed of the draftingteam,18 ITC personnel and experts from Algeria,Cameroon, Colombia, Estonia, India, Tunisia andthe Philippines, ensured that all issues of concernwould be given full consideration in the agendaof the pro-bono committee sessions.

Two sessions of the pro-bono committee wereheld in January and September 2002. During thefirst, the main options and principles that thedrafting team ought to retain were defined, andthe aim of making the models acceptable undereach national legal framework was confirmed.

During the second meeting, discussions wereconcerned with the wording or basic principlesof particular provisions. A further more restrictedfine-tuning session was held to draft a limitednumber of clauses.

Scope of the model contracts

Decisions as to the objective, scope and poten-tial users of the contracts were important ones,as they subsequently influenced the wholedrafting process.

As to the objective of the models, it was agreedthat they should be used to establish internationaljoint ventures in which parties wish to establishlong-term cooperation. Joint ventures for one-off,single contracts were not considered. It was alsoagreed that the model contracts would need tosuit a wide spectrum of commercial, as well asindustrial, activities where joint venture contractsare used in practice. SMEs were identified asthe main potential users of these models. Nolimitation was envisaged concerning their geo-graphical scope.

Two basic model contracts

At the outset, a distinction derived from practicewas made concerning the legal nature ofcooperation between the parties. This led to thepreparation of two types of joint venture contracts:

■ Incorporated joint venture contract: defined asa joint venture contract for the creation of oneor more joint venture companies, which arelegal entities established to carry out a commonactivity. The joint venture agreement is a prepar-atory vehicle leading to its incorporation into acompany of a specific country. In addition tothe joint venture agreement, the cooperationof the parties requires further legal instruments,usually articles of incorporation of the company,by-laws and a shareholders’ agreement.

■ Contractual joint venture contract: defined asa joint venture contract regulating the coopera-tion of the parties. A legal entity is not created.Therefore, only one legal instrument is usuallynecessary: the joint venture agreement.

17 Olten Abreu (Brazil), Koffi DenisAkhandauh (Union Economique etMonétaire Ouest Africaine), Eva-MarieAndersson (Association of EuropeanDevelopment Finance Institutions),Homayoon Arfazadeh (Iran), BenBeaumont (China), James Bertram(China), Anthony Borgese (Australia),Klaus Brisch (Germany), José MarioBunag (Philippines), Geoffrey P. Burgess(USA), Trevor Carmichael (Barbados),Carlos Carrera (Switzerland), MohammedChemloul (Algeria), Nayla Comair-Obeid(Lebanon), Seward Cooper (AfricanDevelopment Bank), Andrew Corlett(British Isles), Felipe Cuberos (Columbia),Irma Cué Sarquís (Mexico), Kofi Date-Bah (Commonwealth Secretariat),Gaston Kenfack Douajni (Cameroon),Olivier Philippe Dunant (Switzerland),Abdelwahab El Bahi (Tunisia), Hani elSharkawi (Egypt), Alexander Guy Facey(UK), Alon Galili (Israel), Michael Greene(Ireland), Mr. Gueye (Senegal), CharlesB. Gustafson (Switzerland), Ian Hewitt(UK), Tajeldin Idris Babekir (Qatar),Daniel Ivarsonn (International Federationof Consulting Engineers), Sami Kallel(Tunisia), Stephen Karangizi (CommonMarket for Eastern and Southern Africa),Alexander Kemball (Switzerland), DuncanMwenda Kiara (African DevelopmentBank), Jeong Han Lee (South Korea),Thomas Krummel (Germany), EduardoMagallon (Mexico), Moussa K. Mitry(Syria), Rodrigo Muzzi (Brazil), MichelNussbaumer (European Bank forReconstruction and Development),Ahmed Omer (Qatar), Raino Paron(Estonia), Georges Racine (Canada),Jan Ravelingien (Belgium), Ana Scitar(Croatia), Duli Chand Singhania (India),Steven Stern (Australia), Ioannis Stribis(Organisation of the Black Sea EconomicCooperation), Miguel Torres Blanquez(Spain), Francis Walschot (Belgium),Xenios Xenopoulos (Cyprus).

18 Michael E. Schneider, Jean-Paul Vulliety,Carolyn Olsburgh, Arthur Appleton,Rabab Yasseen from Lalive & Partners,Switzerland.

* Jean-François BourqueSenior Legal Adviser and Jean-Sébastien RoureAssociate Legal ExpertInternational Trade CentreUNCTAD/WTO (ITC) 54, rue de Montbrillant1211 Geneva 10SwitzerlandTel: +41 22 730 0303Fax: +41 22 730 0576Email: bourque@intracen.org androure@intracen.org

This fundamental distinction was unanimouslyagreed during the discussions at the committeesessions. Discussions pertaining to local practicesled to the conclusion that establishing jointventures cannot be categorised by the classiccommon law/civil law divisions.

For instance, in South America and India jointventures are often regulated first by a contractualagreement between the parties, whereas in othercountries or regions like the United Kingdom,Russia, eastern Europe, China or Kenya, it iscommon practice to embody the joint venturein an incorporated company.

Some important drafting options

■ Both contracts are accompanied by a users’guide. The purpose of the users’ guide has adual function. The first is to provide guidelines,comments and warnings in order to help SMEsput the models to better use. The secondpurpose is to limit the contents of each contractto what is essential for a joint venture to standby itself. A distinction was thus drawn betweenthe “preferred” options (i.e. the minimum provi-sions/wording required to suit all joint ventures)that should be included in all contracts and theother options (or “what would be nice to have”options), which would be included in the users’guide. The number of options should neverthe-less be limited since the more options, the morecomplicated the use of the model contractswill be.

Even though specific provisions relating to theorganisation and establishment of a joint ven-ture company are, in some countries, alreadycovered by national supplementary rules, theyshould still be included in the contracts since

parties often speak and write differentlanguages. In addition, those establishing ajoint venture company will not always be in aposition to check the local foreign applicablelaw, codes or practices to understand theirrespective rights. Therefore, the contractsneed to be relatively comprehensive.

Further, the principle of liability for a breachin obligation to legally contribute property isincluded in the body of the contracts. Examplesof consequences/problems that may arise fromsuch breaches are included in the users’ guide.

■ Another balance that the model contractsneeded to reflect is that the provisions mustcomply with different legal systems, such ascommon law, civil law and other systems. Toillustrate this point a number of areas need tobe considered: the incorporation of a generalclause of good faith in the contracts; choice ofa suitable decision-making process (unanimityor majority); the issue of whether any legalsystems require a specific voting cast for theadoption of specific decisions; the non use ofthe common law concept “partnership” becauseof its implied legal consequences; and therepartition of prerogatives between the Meetingof the Shareholders and the Board of Directors(for an incorporated joint venture).

■ The draft models were developed simultane-ously in English and French with the intentionof having stand-alone versions in several lan-guages in the future. The idea of having a meretranslation of the contracts with a prevailingversion was rejected. In practice, parties willrarely use two official versions but will rely onthe one they understand. As a result, it wasdecided to ensure that in all languages, thecorresponding concepts are used. This issuearose in particular as regards terminology foridentifying the managing/operating bodies ofthe joint ventures.

■ Contracts ought to preserve the friendly natureof joint ventures. Some of the issues consideredwere the necessity to include a general clauseof good faith or a clause imposing penalties tothe party in breach of its obligations; and theoption to leave the issue of protection of min-ority shareholders in the users’ guide and notin the body of the contract. Also consideredwere provisions dealing with changes in thecomposition of a joint venture and changes inthe control of the parties; the exclusion of a partyfollowing a breach of its obligations and thechoice of a smooth deadlock-breaking procedure.

Conclusion

With the expansion of cross-border trade, the needfor more standard contracts which are universallyacceptable will continue to grow. The emergenceof a body of contractual standards is a welcomedevelopment. The law profession itself is movingquite rapidly, in business sectors, from courtspecialists to contracts specialists. However,because there cannot be a lawyer behind everycontract, the availability of reliable standardmodels can be regarded as a reasonable expec-tation on the part of business people. In centraland eastern Europe, a culture of using modelcontracts has existed for decades and theemergence of new internationally-acceptedmodel contracts can be expected to have asignificant impact.

8 Law in transition

With the expansion of cross-border trade, theneed for more standard contracts which areuniversally acceptable will continue to grow.

Lending in roubles – a look at the EBRD’s first local currency loans in RussiaIn November 2001, the EBRD made itsfirst Russian rouble-denominated loan,followed in June 2002 by a second roublefinancing. This article examines thebackground to these transactions andexplains how they were structured.

Diana Michaliova, Associate, Office of the General Counsel, EBRD*

Law in transition 9

10 Law in transition

Demand for long-term rouble financing

Recent years have seen an increasing demandfor long-term local currency financing fromboth Russian public and private sector entities.Currently, however, this demand cannot besatisfied from domestic sources because ofthe limitations of the emerging Russian financialmarkets. Russian borrowers are, therefore, lookingto international financial institutions (IFIs) to fillthis gap. It is in this context that the EBRD isnow seeking to develop long-term rouble-denominated loans for its Russian clients.

The primary causes of the increased demand forlong-term rouble financing lie, first, in the changesto the regulations governing the borrowing capacityof Russian state and municipal entities and,second, in the nascent state of the Russiancapital markets.

In the 1990s, Russian state and municipal entitieswere permitted to borrow in foreign currencies and,during this period, IFIs and Western governmentsgranted hard currency loans to such entities.However, in 2000, amendments to the RussianBudget Code1 prohibited Russian municipalitiesfrom incurring debt in foreign currency, therebyrestricting them to borrowing in roubles. In addi-tion, the amended Budget Code limited the abilityof sub-federal level entities, the so-called “subjectsof the Russian Federation”, to borrow in hardcurrency. Thus, although the republics, territories,regions, federal cities, autonomous regions andautonomous areas2 are still authorised to takehard currency loans, this is only permitted in orderto refinance existing hard currency debt whichthese bodies had on their books in August 2000.3

As a result of these changes, financing which stateentities might previously have secured by way offoreign currency loans now must be denominatedin roubles.

Parallel to the legal developments describedabove, the practical limitations of the evolvingRussian capital markets have made the demandfor new sources of long-term rouble financingeven more acute.

Decades of under-investment have resulted in aneed for substantial capital expenditure in boththe Russian public and private sectors. Publicinfrastructure and utilities are in urgent need ofrepair or upgrading and the industrial plant alsorequires renewal. To meet this need, activity inthe Russian capital markets has increaseddramatically in recent years. In April 2002, INGreported that during the past two years the sizeof the Russian corporate bond market had grownfrom RUR 20 billion to RUR 76 billion and monthlyturnover had increased from RUR 60 million toRUR 4.2 billion.4 As of August 2002, the out-standing volume of the corporate bond marketwas at RUR 83.8 billion and monthly turnoverreached RUR 5.7 billion.5

Although the development of the Russian bondmarket has been impressive, the financing optionsavailable to borrowers (both in the public andprivate sectors) are still limited to short-termdebt, since short-term issues (with three to six-month maturities) are the most popular on thebond market.6 The maximum maturity of bondsissued to date is three years. Most of suchbonds, however, have embedded annual putoptions (bondholder’s right to redeem a bondbefore maturity),7 which effectively make them12-month paper. In turn, banks are reluctant tolend long-term since they are themselves dep-endent on the short-term markets to fund theirlending operations and would face a refinancingrisk if they were to make longer-term loans.Additionally, most banks have insufficientcustomer deposits to back long-term lending.

In the medium to longer-term, it is expected thata decline in investment risk, more predictableexchange rates and emerging institutionalinvestors, such as insurance companies andnon-governmental pension funds, will lead to thedevelopment of a domestic market for longerterm finance.8 However, at present the Russianpublic and corporate sectors have no access tolong-term financing in roubles.

1 The Budget Code of the RussianFederation No. 145-FZ of 31 July 1998,in force from 1 January 2000, amendedon 31 December 1999, 5 August 2000,27 December 2000, 8 August 2001,30 December 2001, 29 May 2002,10 July 2002 and 24 July 2002.

2 Under Article 5 of the Constitution ofthe Russian Federation of 12 December1993, all these entities have the statusof “subject of the Russian Federation”.

3 Article 2 of the Law No. 116-F3 of theRussian Federation on amendments tothe budget code of the Russian Feder-ation of 5 August 2000 provides thatany such entities which had hard currencydebt on the date of entry into force ofthis federal law may continue to borrowhard currency provided that the amountof such debt during the then currentfinancial year does not exceed theprincipal amount of existing hardcurrency debt repayable by such entitiesduring that financial year. Further,according to Article 2, the abovelimitation on the amount of new hardcurrency debt shall not apply if debt isincurred to reduce the total outstandingamount of hard currency debt, reducethe cost of servicing of such debt orpostpone its repayment terms.

4 “Russian Local Corporate Bonds.Sustained Boom?”, ING, 18 April 2002,www.ing.ru.

5 “New Local Corporate/Municipal BondIssues. Credit Quality Matters”, ING, 26September 2002, www.ing.ru.

6 “Russian Local Corporate Bonds.Sustained Boom?”, ING, 18 April 2002,www.ing.ru.

7 “New Local Corporate/Municipal BondIssues. Credit Quality Matters”, ING, 26 September 2002, www.ing.ru.

8 “Russian Local Corporate Bonds.Sustained Boom?”, ING, 18 April 2002,www.ing.ru.

Law in transition 11

EBRD initiatives

In the absence of a developed local capital marketin Russia, IFIs have been reluctant to step in toprovide long-term rouble-denominated loans, sincethese institutions would face the same refinancingrisk that deters local banks from making long-term rouble commitments. However, in responseto demand from local clients for long-term roubleloans, and in light of its special mandate topromote transition in the countries where itoperates, including to assist in the developmentof capital markets, the EBRD has taken the lead inproviding long-term rouble financing.

The EBRD’s first rouble-denominated loan was tothe City of St Petersburg in November 2001. Thistransaction was a US$ 16 million rouble equivalentpartial conversion of the City’s outstanding USdollar debt, due to mature at the end of 2003. InJune 2002, a second rouble loan agreement wassigned, this time with the City of Surgut, providinga ten-year loan of €45 million rouble equivalent,with a three-year availability period9 and a seven-year repayment schedule.

The funding mechanism

One method for an IFI to secure funds to on-lendto borrowers is to use its high credit rating to raisefunds on local bond markets. In the case ofRussia, however, this option is not yet availableto IFIs since the current regulatory regime govern-ing the securities market has been establishedmainly with domestic bond issuers in mind anddoes not adequately address the particularcircumstances of foreign issuers. The Bank iscurrently working closely with the Federal Com-mission for the Securities Market of the RussianFederation (FCSM) to reform Russian securitieslaws.10 Legislation on this subject is expected tocome into force in early 2003. Pending the adoptionof such legislation and development of detailedimplementing regulations, however, an alternativeway of raising rouble funds had to be found.

For the purposes of the EBRD’s first rouble loanto the City of St Petersburg, the necessary fundswere raised through the utilisation of short-termpromissory notes, veksels. Although, as discussedbelow, this funding mechanism has its drawbacks(and is intended only as a provisional measureuntil other funding sources are available), the useof the promissory notes to raise rouble funds hasenabled the EBRD to begin granting rouble loansto its clients while awaiting completion of thesecurities law reform referred to above.

The legal regime applicable to promissory notesin Russia was established by the Geneva Conven-tion of 1930 (the “Convention”)11 to which theRussian Federation succeeded after the collapseof the USSR.12 The Convention defines a promis-sory note as an instrument under which the issuerundertakes, unconditionally, to pay a specifiedparty a given sum of money at a pre-determinedtime and place.13 As a general rule, veksels (prom-issory notes) do not bear interest – instead, toprovide a return to investors, veksels are issuedat a discount to their face value.

All veksels issued by the Bank to date have had amaturity of three months (since short-term maturi-ties are most in demand by investors). Accordingly,new veksels are issued every three months. Tomitigate the risk caused by the need to issuepromissory notes at such frequent intervals, theEBRD has also put in place arrangements for itto access alternative sources of rouble fundingwhen appropriate, for example, where the Bankis unable to secure funding through the vekselmarket, either because of difficult market con-ditions (i.e., circumstances in which new vekselscannot be issued to replace maturing ones) ordue to a mismatch between the borrower’spayment date under the loan agreement and thematurity date of the Bank’s veksels. Besides therefinancing risk, such arrangements also enablethe Bank to avoid a foreign exchange risk. If newveksels cannot be sold to redeem maturing ones,in the absence of any alternative arrangementssecuring access to rouble funds the Bank wouldbe obliged to borrow in hard currency and exchange

9 The period during which the borrowercan draw on the loan.

10 The EBRD’s legal transition projectaimed at Russian securities law reformis discussed below. See p. 13 of thisedition of Law in Transition.

11 Convention Providing a Uniform Law forBills of Exchange and Promissory Notes(Geneva, 1930), League of Nations,Treaty Series, Vol. 143, p. 257. Countriesthat have acceded to the Conventioninclude all the members of the EuropeanUnion (except the UK and Ireland),Switzerland, Norway, Turkey, Japan,Brazil, Columbia, Ecuador, Peru, Poland,and Hungary.

12 In the USSR the Convention wasimplemented by the Decision of theCentral Executive Committee and theCouncil of People’s Commissars ofthe USSR No. 104/1341 “On Puttinginto Operation the Provisions on Billsof Exchange and Promissory Notes”, 7 August 1937. The validity of thisdecision in the Russian Federation wasconfirmed by the Federal Law No. 48-FZ“On Bills of Exchange and PromissoryNotes”, 11 March 1997.

13 Article 75 of the Geneva Convention.

Although the development of the Russian bond market has been impressive,the financing options available to borrowers (both in the public and privatesectors) are still limited to short-term debt, since short-term issues (withthree to six-month maturities) are the most popular on the bond market.

it for roubles to repay its rouble debt. Under thisscenario, the Bank would incur a hard currencyliability to fund its rouble-denominated assetsand would therefore be subject to a foreignexchange risk.14 With such alternative arrange-ments in place, however, the Bank is in a positionto continue funding its rouble loans in roubles,thereby avoiding such risk. In most cases, theBank’s borrowing from such alternative sourceswould be for short-term maturity periods (theprecise maturity periods would depend on theBank’s funding needs at the time and marketcircumstances).

Specific features of rouble-denominated loan agreements

The special funding mechanism used by the Bankto finance its rouble loans has made it necessaryto incorporate specific provisions for rouble lendingwithin the loan agreements. Most of these areneeded to minimise exposure to risk arising fromhaving to refinance rouble loans on a three-monthbasis (using the promissory note mechanismdescribed above). The provisions in question(which could be adapted for use by other lendersutilising a similar funding mechanism) aresummarised below.

In the near future, however, new sources of roublecapital may become available to foreign lenders. Inparticular, it is expected that the pending changesto current securities legislation will, once imple-mented, make it viable for foreign institutions,including the EBRD, to issue rouble-denominatedbonds. Once such new, potentially longer-term,sources of rouble funding are available, theyshould supplement or gradually replace the use ofveksels as a funding mechanism. In this event,certain provisions described below would either nolonger be relevant or require amendment.

All-in-Cost

There is no established rouble benchmark interestrate comparable, for example, to LIBOR.15 Insteadof being defined by reference to the relevantinterbank offered rate,16 the cost to the Bank offunding the rouble loan during a given interestperiod is calculated on the basis of the totality of

the Bank’s actual costs (determined by the Bankand expressed as an annual rate) incurred in fund-ing the loan during the relevant interest period (the“All-in-Cost”). The All-in-Cost, to which the Bank’smargin is added, is used as the basis for calcu-lating interest payments due from the borrower.

When new rouble funding instruments becomeavailable to the Bank and/or the Bank’s roubleloan portfolio expands, the method of calculatingthe All-in-Cost might change. Instead of beingfunded “back-to-back”,17 the Bank’s rouble loanswill most likely be financed from rouble fundspooled by the Bank from a variety of sources,such as bond and veksel issues, arrangementswith other rouble fund providers and derivativesmarket (the “currency pool” funding approach).In contrast to a typical loan funded on a back-to-back basis, where the All-in-Cost precisely mirrorsthe actual cost of funding the particular loan,the All-in-Cost of a rouble loan financed out of acurrency pool would reflect the blended cost ofthe Bank’s rouble funds as a whole.

Interest period and interest determination date

As noted above, to date the Bank has sold vekselswith a maturity of three months. To match thematurities of the Bank’s funding and lendingarrangements, the Bank’s rouble loan agreementscurrently provide for a three-month interest period.In the event that investor demand with respect tothe maturity period of veksels changes, the Bankcould consider issuing veksels with differentmaturities. Any resultant saving in funding costcould be passed on to the borrower. To addressthis issue, the Bank’s rouble loan agreementsprovide for the possibility of altering the durationof the interest period and for a correspondingrescheduling of loan repayment dates. These canbe applied in the event that investor demandchanges on the veksel market.

In contrast to market practice for floating rateloans, where the interest determination datein respect of the majority of currencies is twobusiness days prior to the first day of each interestperiod, the interest rate for rouble loans can usuallybe determined (and notified to the borrower) onlyon the first day of the interest period.

Market disruption risk

To guard against liquidity shortfalls affecting theBank’s ability to fund its rouble loans via the vekselmarket, the Bank has incorporated a “fall-back”mechanism within its rouble loan agreementsthat will operate in circumstances where theBank is unable to raise funds through veksels.

In the event that rouble liquidity on the market islimited such that veksels cannot be rolled over(circumstances of market disruption), the EBRDcould borrow from the pre-arranged alternativesources of rouble funding referred to above. In anextreme scenario, where the maturity of suchborrowings is as short as one day, the EBRD’sloans would effectively be funded on an overnightbasis at an overnight rate, which would most likelyresult in an increased All-in-Cost to be borne bythe borrower. In these circumstances, the EBRD’srouble loan agreements provide for the possibil-ity of adjusting the length of the interest periodby bringing it closer to the maturity of the Bank’sfunding arrangements at the times of liquidity crisis.

An additional element of such “fall-back” arrange-ment is that the borrower has the right to cancelor pre-pay any part of the loan when, accordingto the estimates of the Bank, the All-in-Cost offunding such part of the loan during the succeed-ing interest period would exceed a certain pre-agreed level.

Timing of payments

Since veksels issued by the Bank mature on thesame date as the borrower’s payment to the Bankis due (every interest payment date), for the EBRDto meet its own payment obligations in time itshould receive the borrower’s payment reasonablyearly in the day. Accordingly, the EBRD’s roubleloan agreements provide that the amount payableby the borrower shall reach the Bank no later thannoon Moscow time on the due date. If the amountpayable is received on the due date but later thannoon Moscow time, the borrower is liable to payto the EBRD the All-in-Cost of funding such anamount overnight.

12 Law in transition

The EBRD, through its Legal Transition Programme, is undertaking a legal andregulatory reform project aimed at assisting the FCSM establish a clearregulatory regime under which foreign issuers with sound financial standingwould be able to issue rouble-denominated bonds in a cost-efficient way.

14 For example, if the rouble depreciatesagainst the hard currency in which theBank borrowed to fund its rouble com-mitments, the amount repayable by theborrower in roubles would be insufficientto cover the Bank’s hard currencyobligations.

15 London Interbank Offered Rate.16 As in the case of hard currency loans.17 “Back-to-back” funding involves match-

ing the amount and maturity of a bank’sfunding arrangements to the amount ofa loan outstanding during a specificinterest period and the duration of suchinterest period respectively. The Bankcurrently uses this method while fundingits rouble loans through veksel issues.

18 The Federal Law on the SecuritiesMarket No. 39-FZ of 22 April 1996with amendments of 26 November1998, 8 July 1999, 7 August 2001and 29 November 2002.

19 Privileged status of the IFIs as the issuersof securities is not unusual. The EBRDlike many other IFIs enjoys such statusin several countries, including the US,the UK, Japan and Luxembourg.

* Diana MichaliovaAssociateOffice of the General CounselEBRDOne Exchange SquareLondon EC2A 2JNTel: +44 20 7338 7521Fax: +44 20 7338 6150Email: michalid@ebrd.com

The author would like to thank Norbert Seiler, Rüdiger Woggon,Hsianmin Chen, Alexei Zverev and Aude Pacatte for their contribution to this article.

Law in transition 13

The future – securities market reform

As previously discussed, there are significantdisadvantages to the use of veksels as a mechan-ism to fund rouble-denominated loans, particularlythe need to continuously re-finance on a short-term basis. Ideally, rather than issuing vekselsforeign lenders would be able to tap the Russianbond market to raise rouble capital by issuinglonger-term rouble-denominated securities. Asnoted, however, the present Russian securitieslaw regime is not designed with the particularneeds of foreign issuers in mind.

For this reason, the EBRD, through its LegalTransition Programme, is undertaking a legal andregulatory reform project aimed at assisting theFCSM to establish a clear regulatory regime underwhich foreign issuers with sound financial standingwould be able to issue rouble-denominated bondsin a cost-efficient way. It is intended that thisreform be implemented principally through amend-ments to the existing Law on the Securities Market(the “Law”)18 and adoption of supplemental reg-ulations. The amended Law would allow theFCSM to establish a specific legal regime appli-cable to non-Russian institutions by issuingregulations under the aegis of the Law. The legalregime to be established would particularly takeinto account the special needs of IFIs.19 At thetime of writing this article, the amendments tothe Law are expected to come into force in early2003. The preparation of regulations to be issuedunder the amended Law is underway.

The successful conclusion of these reforms couldpotentially provide foreign issuers, including theEBRD, with access to longer-term financing instru-ments, which would allow the Bank to expand itsrouble financing operations and encourage otherforeign institutions to start lending in roubles.Further, if foreign issuers are able to issue bondson the Russian capital market their active presenceon the bond market should enhance the develop-ment of the market itself.

Conclusion

The EBRD’s ability to offer long-term rouble-denominated loans seeks to help fill a criticalgap in the market for Russian borrowers. Atpresent, the EBRD is the only IFI providing long-termrouble finance. Whilst other IFIs continue to lendonly in hard currency and Russian banks andsecurities markets, at least at present, can onlyprovide short-term finance, the EBRD is able tooffer Russian state entities and private com-panies long-term financing free from foreignexchange risk. At the same time, the EBRD’spromotion of reforms to the Russian securitieslaws regime aims to create the conditions underwhich other potential providers of long-term roublefinance will become active in the market forrouble lending.

14 Law in transition – Focus on Central Asia

Focus on Central Asia

Following many years of relative isolation under Sovietcentral planning, the five independent states of CentralAsia (Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistanand Uzbekistan) have found themselves back “on the map”over the past decade. The region’s rich natural resourcesand its strategic position at the crossroads of major tradingroutes from East to West and from north to south, as wellas its rich cultural history, have re-ignited the interest ofthe outside world. Yet, despite renewed attention, CentralAsia lags behind the countries of eastern Europe and manyother parts of the Commonwealth of Independent States(CIS) in its willingness to adopt open markets and embracepluralist democracy. In all countries of the region, thestate retains a comparatively larger role in production thanelsewhere and foreign direct investment outside the naturalresources sector remains low. Central Asia will only realiseits aspirations of economic development and strengthenedindependence if it expands the foundations for private sectordevelopment. The increasing international attention andassistance that the region is receiving provide a uniqueopportunity for the countries of Central Asia to demonstratetheir commitment to economic and political reform. Moreover,by adopting a common position of openness and increasingregional cooperation, the five republics have an opportunityto greatly enhance their attractiveness to both indigenousand foreign investors and traders.

The focus section of this issue of Law in transition drawstogether views and experiences from a number of perspec-tives on law and policy issues affecting Central Asia. Thefirst article, co-written by Martin Raiser and Masaru Honmaof the EBRD, explores the development of the private sectorin Central Asia over the past decade and looks closely atthe progress in privatisation, capital flows and foreigndirect investment. The authors argue that the main chal-lenges for private sector development are the improvementof business environment awareness, better access tofinance for small and medium-sized enterprises (SMEs),enforcement of the rule of law and the fostering of regionaltrade development. The article proposes how internationalfinancial institutions can best contribute to the transitionprocess in Central Asia.

In the second article, Alexei Zverev, EBRD Counsel, explainshow laws and supporting institutions as well as the legalculture have evolved since the countries of Central Asiaachieved their independence. Drawing on the EBRD’s surveyof lawyers working in or familiar with the region, he identifiesthe areas where legal reform efforts need to be targeted. Thelegal assistance provided by the EBRD is also described.

Sergei Mironov, Chairman of the CIS Inter-ParliamentaryAssembly and EBRD President, Jean Lemierre are inter-viewed in this issue. Both individuals address the mainpolitical, economic and legal aspects of the relationshipbetween the Central Asian countries and their respectiveorganisations. Together they call for the countries tostrengthen their efforts to integrate their economies moreclosely with those of their CIS neighbours and the widerworld. The next article takes a comparative look at publicprivate partnerships, based on contributions from law firmsin the countries of Central Asia. They discuss the status andlegal framework of public private partnerships, placingparticular emphasis on the concession law regime andimpediments in the law and the way in which it is imple-mented. The article also shares lessons learnt frommaking use of concessions in Central Asia and offerssuggestions for potential improvements.

The last three articles take a close look at Uzbekistan. First,James Campbell and Jenny Afia of Jones Day Gouldens andIlkhom Azizov of the Azizov Partnership provide an overviewof recent developments in law and legal institutions inUzbekistan. This is followed by an article written by ProfessorKazutaka Sugiura of Nagoya University which describes therecent reform of the Uzbek law on the legal profession,including the status of lawyers, the organisation of the localbar and provision of legal services. Finally, ProfessorYasunobu Sato and Akobir Rashidov of Nagoya Universityhave co-authored an article dealing with arbitration inUzbekistan, which considers the influence of the formerSoviet system, Islamic culture and UNCITRAL models on theevolution of arbitration law and practice in the country.

Private sector development and the EBRD in Central Asia – lessons from the past ten yearsThe five republics of Central Asia haveexperienced three years of solid economicgrowth since 1999. Nevertheless, private sectordevelopment in the region is still laggingbehind other countries in eastern Europe andthe Commonwealth of Independent States(CIS).This article charts the progress made ineconomic reform and private sector develop-ment in Central Asia since these countriesgained independence more than a decade agoin 1991. It also examines the main obstaclesand challenges and highlights the role ofthe international community in assistingCentral Asia in building the foundationsfor sustainable investment and growth in theprivate sector.

Masaru Honma, Central Asia Director, EBRD and Martin Raiser, Director for Country Strategy and Analysis, EBRD with Levent Aydinoglu, Associate Banker, EBRD and Toshiaki Sakatsume, Economist, EBRD*

Focus on Central Asia – Law in transition 15

Central Asia: from transition to development

In 1991, the five Central Asian republics were illprepared for independence and the break-up ofthe Soviet Union. For decades, the region hadbeen treated as a Soviet outpost, providing cheapraw materials in exchange for generous fiscaltransfers. With the start of transition, CentralAsia’s political elite were faced with the triplechallenge of learning to live without transfersfrom Moscow, building new nation states withinterritorial boundaries little related to ethnic settle-ments, and reforming the economy as the centralplan withered away.1 Whilst the Soviet Union didinvest heavily in the region’s infrastructure, CentralAsia is geographically isolated from establishedmarket economies and thus remained closelytied to Russia for several years after the break-up of the Council for Mutual Economic Assistance(CMEA). Against these enormous tasks stood anumber of important assets, such as rich energyand mineral resources, a highly-educated labourforce and an important geo-strategic position.

The initial years of transition were characterisedby great macroeconomic instability, significantreduction in output and relatively limited progressin economic reform. Since the mid-1990s,economic reforms have progressed more rapidly,although with significant variation across countries.Kazakhstan and the Kyrgyz Republic have beenamong the front-runners in reform in the CIS,whilst Turkmenistan and Uzbekistan are amongthe region’s slowest reformers. Tajikistan startedlate due to its civil war, but has made goodprogress in recent years. Since the Russiancrisis of 1998, economic performance hasalso recovered. However, three of the region’seconomies – the Kyrgyz Republic, Tajikistan andUzbekistan – are still among the poorest in theworld with per capita incomes below US$ 700.After a decade of transition, the reform agendaremains long and difficult. It is no longer simply aquestion of transition but is also increasinglybecoming a question of economic development.

The key area linking transition and developmentis the development of the private sector. A vibrantprivate sector is the key to a successful marketeconomy. It distinguishes success cases so far,such as Estonia, Hungary or Poland, from thosecountries still struggling to achieve sustainablegrowth. The private sector is also the engine ofgrowth in developing countries such as India,Mexico, Mauritius and in China and Vietnam.2

The key objective of the EBRD is the creation ofmarket economies based on private investment.It has pursued this objective since 1991, andin Central Asia since the five republics becamemembers of the Bank during 1992-93. TheEBRD signed its first private sector operation inCentral Asia in 1993 and opened its first residentoffice in the region in the same year. Through itsinvestments, the EBRD promotes competition,privatisation, entrepreneurship, stronger financialinstitutions and legal systems, as well as thedevelopment of the infrastructure needed tosupport the private sector. This article reviews theprogress made with private sector developmentin Central Asia since independence, identifiesthe main policy challenges to improving theinvestment climate, and outlines the strategicorientations of the EBRD for the coming yearsagainst this background.

Private sector development: progress to date

Size of the private sector

At the start of transition, virtually all economicresources were concentrated in the hands ofthe state. A summary indicator of private sectordevelopment is, therefore, the extent to which theprivate sector has increased its claim on economicresources, which can be approximated by theprivate sector’s share of GDP. Chart 1 showsthat the process of resource reallocation fromthe state to the private sector has led to anincrease in the average private sector share in GDPfor transition economies from 11 per cent in 1990to 62 per cent in 2001. Yet, this progress hasbeen highly uneven across countries, with CentralAsia lagging behind all other regions by comparison.

The state currently retains a dominant share ineconomic activities in Tajikistan, Turkmenistanand Uzbekistan and the average private share inGDP in Central Asia is still just below 50 per cent.

There are two related reasons for the slow paceof resource reallocation. The first is the slow paceof privatisation of state-owned assets. The secondis the low level of private sector investment dueto a weak business climate and difficult accessto finance. Privatisation and private investmentare of course related, as privatisation may directlyinvolve additional investment commitments,restructuring, or the unbundling of assets, withnon-core activities and assets becoming avail-able to private entrepreneurs.

Progress in privatisation

Privatisation was the main vehicle for increasingthe role of the private sector during the initial stageof transition. It is useful to distinguish the transferof small-scale units largely to individual entre-preneurs (small-scale privatisation) and theprivatisation of large enterprises, for which a varietyof methods are available. Chart 2a shows theprogress made in both dimensions as measuredby the EBRD index.3 As in most transition econ-omies, small-scale privatisation was largelycomplete in the Kyrgyz Republic, Kazakhstanand Tajikistan by the end of 2000. However, inTurkmenistan and to some extent also inUzbekistan a significant number of small-scaleestablishments remain state-owned. Large-scaleprivatisation and the sale of strategic enterprisesand public utilities has progressed less in CentralAsia than elsewhere in the region, as revealed in

16 Law in transition – Focus on Central Asia

1990

Per c

ent

01995 2000 2001

80

70

60

50

40

30

20

10

Chart 1: Private sector share in GDP, 1990–2001

Central Europe and the Baltic states

Commonwealth ofIndependent States

Central Asia

Transition economiesaverage

Source: EBRD

1 W. Buiter and S. Fries, “What shouldthe multilateral development banks do?”Working Paper No. 74, June 2001,www.ebrd.com.

2 This is not to deny the importance ofwell-functioning state and market support-ing institutions. Laying the foundationsfor private sector development encom-passes policies directed at improvingeconomic governance and strengtheningthe capacity of the state.

3 The EBRD transition indicator rangesfrom 1 to 4+, with 1 indicating little orno progress and 4+ indicating a standardsimilar to advanced market economies(see EBRD Transition Report, variousissues, for more details).

4 H. P. Lankes and A. Venables, “Foreigndirect investment in economic transition:the changing pattern of investment”,Economics in Transition, Vol 4:2 pp 331-348, Bevan, A.A. and Estrin, S. (2000)‘The Determinants of Foreign DirectInvestment in Transition Economies’,Centre for Economic Policy Research Discussion Paper DP2638, WilliamDavidson Institute Working Paper No. 342, University of Michigan, andCentre for New and Emerging MarketsDiscussion Paper No. 9, LondonBusiness School.

Focus on Central Asia – Law in transition 17

Chart 2b. Voucher privatisation led to relativelyrapid early progress in the Kyrgyz Republic, butthe sale of strategic enterprises has lagged behind.In Kazakhstan, there were numerous early salesof large enterprises in the mineral and metallur-gical sectors to foreign investors, but the stateretained minority stakes, which it has so farcontinued to hold. Moreover, several strategicenterprises, including the state-owned oil andgas company, are not likely to be sold in thenear future. In Tajikistan large scale privatisationhas made steady but slow progress in recentyears, whilst privatisation has largely stagnatedin Turkmenistan and Uzbekistan. In the lattercountry, plans to revitalise the process exist,but their implementation will depend in largemeasure on the achievement of currency convert-ibility, an essential precondition for attractingoutside investors.

Capital flows and attraction of foreign direct investment

Foreign investment plays a significant role inprivate sector development in most transitioneconomies. Since domestic savings are typicallylow, foreign investment is often the only potentialsource of new capital, as well as managementknow-how and modern technologies. There arenumerous determinants of foreign direct invest-ment (FDI), including market potential, geographic(or cultural) proximity to the investor’s homecountry, competitive costs, availability of naturalresources, a well-qualified labour force and agenerally stable, predictable and transparentbusiness environment.4 In transition, progress inlarge-scale privatisation is also often associatedwith significant inflow of FDI. As with privatisation,Central Asia has under-performed in attracting

1990

Aver

age

trans

ition

indi

cato

r sco

re

01995 2000 2002

4

3

2

1

Central Europe and the Baltic states

Commonwealth ofIndependent States

Central Asia

Transition economies average

Note: The EBRD transitionindicator ranges from 1 to 4+, with 1 indicat-ing little or no progressand 4+ indicating asimilar standard toadvanced marketeconomies (see EBRDTransition Report 2002for more details).

Source: EBRD

Chart 2b: Progress in large-scale privatisation, 1990–2002

1990

Aver

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trans

ition

indi

cato

r sco

re

01995 2000 2002

4

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Central Europe and the Baltic states

Commonwealth ofIndependent States

Central Asia

Transition economies average

Note: The EBRD transitionindicator ranges from 1 to 4+, with 1 indicating little or no progress and 4+indicating a similarstandard to advancedmarket economies(see EBRD TransitionReport 2002 for more details).

Source: EBRD

Chart 2a: Progress in small-scale privatisation, 1990–2002

FDI relative to other regions. While the per capitacumulative inflow of FDI into Kazakhstan is impres-sive (US$ 741 billion cumulative from 1989 to2001), FDI to other Central Asian countries hasbeen disappointing. Tajikistan, the Kyrgyz Republicand Uzbekistan are among the least attractive FDIdestinations in the transition economies, with percapita cumulative inflows of just US$ 24 billion,US$ 101 billion and US$ 30 billion respectively.However, despite the impressive amount of FDIflowing into Kazakhstan, it has mainly beenconcentrated in the natural resources sector,particularly oil and gas. In the Kyrgyz Republicand Uzbekistan, FDI has been used to developgold mining.

Investment in Central Asia has seen a significantupturn in recent years, however, with total FDIincreasing to US$ 3.6 billion in 2001 up fromUS$ 1.5 billion in 2000. Moreover, as officialflows have been diminishing in recent years, therelative importance of FDI inflow has increased(see Chart 3). These developments are largelydue to increasing investment in the Caspianenergy developments in Kazakhstan andTurkmenistan rather than a general upturn inthe region’s attractiveness to private foreigninvestment. In the Kyrgyz Republic, Tajikistanand Uzbekistan, the dependence on officialfinancing remains very high, whilst foreign debthas reached critical levels. For all five countries,the challenge is to attract private investment intoareas of the economy such as manufacturing, thefinancial sector, construction services and utilities.

To achieve this, significant improvements in thebusiness climate are necessary, as explained inmore detail on the following pages. It is importantto note at the outset that the required policymeasures apply not just to foreign investors butwould benefit domestic enterprises as well. CentralAsia is lagging in private sector development notmerely because foreign investors have stayedaway from the region. In many ways, domesticprivate investment holds an even greater promisefor the region, as does investment from companiesin neighbouring countries because they will typi-cally be better attuned to its social norms andthus face lower transactional costs. But for allinvestors it is essential that there is: transparentand predictable legislation and regulations;access to finance and a functioning paymentsystem; and open and competitive marketaccess. The resulting challenges affecting policyare highlighted in the following section.

Main challenges for private sectordevelopment in Central Asia

Improving the business environment

The business environment is a broad and poten-tially unwieldy notion. To make it more precise andhighlight key policy challenges in relation to improv-ing the business environment in each country, theEBRD and the World Bank have jointly commis-sioned two successive Business Environmentand Enterprise Performance Surveys (BEEPS).The first survey was conducted in 1999, thesecond in 2002.5 The surveys were designed tohighlight the main obstacles facing domesticand foreign enterprises doing business in thecountries surveyed.

Although there are significant differences amongcountries, some common themes emerge. Thebiggest obstacles to business in the transitioneconomies are the access and cost of financingprojects as well as tax rates, tax administration,and macroeconomic instability, and Central Asiais no exception in this regard (see TransitionReport, 2002, Annex 2.3).6 The importance ofsound legal institutions and the impact of therule of law have also been highlighted as decisivefactors. Compared to 1999, the business environ-ment has improved in Central Asia as elsewhere,particularly in reducing corruption, suggestingthat the economic revival since the Russian crisismay have somewhat reduced the burden ofdiscretionary interventions on enterprises (seeChart 4a).7 The practice remains widespread

nonetheless, as BEEPS data on the frequency ofbribe payments suggest. Approximately 32 percent of Central Asian firms report that they paybribes frequently, compared with 21 per cent incentral Europe and the Baltic states (CEB) and30 per cent in the remainder of the CIS.

The differences across the Central Asian republicsare also revealing. As Chart 4b illustrates,Kazakhstan records the lowest obstacles inaccess to financing, which in turn are highest inTajikistan. Tax rates and tax administration area problem common to all countries. The KyrgyzRepublic and Tajikistan face the biggest obstaclesin the rule of law and the functioning of the judi-ciary, whilst corruption is perceived as a largerobstacle by Kyrgyz businesses than by the com-petitors in other Central Asian countries.

The BEEPS provides no more than an indicationof where priorities may lie for each country withrespect to improving the business environment.A few conclusions can, however, safely be drawn.First, in Uzbekistan the macroeconomic environ-ment remains a key constraint on businesses.Without exchange rate convertibility and a clearpolicy signal that a market-based system forallocating foreign exchange will be maintained inthe future, investment will remain lacklustre andthe country will fall further behind Kazakhstan,Russia and other leading CIS economies. At thesame time, the BEEPS reveals that businesseshold the government’s administration in relatively

18 Law in transition – Focus on Central Asia

1995M

illio

n US

$

5,000

4,000

3,000

2,000

1,000

0

-1,000

-2,0001996 1997 1998 1999 2000 2001

Official flows, net

Other private flows, net

Foreign Direct Investment, net

Source: World EconomicOutlook (September 2002)

Chart 3: Net private and official flows to Central Asia, 1995–2001

5 For details see the EBRD’s TransitionReport 1999 and 2002, as well as the EBRD’s and World Bank’s websites (www.ebrd.com andhttp://info.worldbank.org/governance/beeps/).

6 The cross-country comparison of businessobstacles needs to be handled withsome care, as it appears that the generalmacroeconomic environment has asignificant impact on enterprise percep-tions of obstacles to business. In theTransition Report 2002, businessenvironment scores are presentedwhich are corrected for the influence ofsuch “business cycle” effects. In thisarticle, we present the raw data, in partbecause the macroeconomic policyenvironment is a key distinguishingfeature between Turkmenistan andUzbekistan on the one hand, andKazakhstan on the other. Moreover, thebusiness cycle has pointed generally inthe same direction across the region,with significant recovery since 1999 inall five countries, making direct compari-sons easier. The reader should be aware,however, that controls on macroeconomicperformance could change the relativeranking on some of the dimensionspresented in Charts 4a and 4b.

7 Turkmenistan is excluded from theregional average. Whilst the countrywas included in the survey, duringimplementation evidence of politicalinterference emerged and the surveywas therefore halted.

Focus on Central Asia – Law in transition 19

high regard in most other areas – an advantagethat Uzbekistan should be able to capitalise on ifit were to move towards more market orientatedpolicies. Second, the Kyrgyz Republic and Tajikistanface major challenges to strengthen state capa-city and reduce corruption including in the judicialsystem, in public administration and in the taxsystem. Third, Kazakhstan is a good exampleof how reforms work to improve the businessenvironment. Kazakhstan is the CIS front-runnerin financial sector reform and consequently thisarea is rated relatively high by Kazakh businesses,as is the macroeconomic environment – anotherstrong-point of Kazakhstani policy making.

Access to finance and development of SMEs

One of the critical obstacles for domestic enter-prises, as identified by the BEEPS, is access tofinance. Market-based finance was non-existentat the start of transition, and those commercialbanks that emerged after the start of reform wereusually either tied to old state-owned enterprisesor private-related parties. Small and medium-sized enterprises (SMEs) have continued to belargely excluded from bank loans, except for those

loans provided under the credit lines of interna-tional financial institutions. Chart 5 documentsthe difficulties that businesses in Central Asiaface in accessing long-term banking finance forinvestment purposes, drawing again on the 2002results of the BEEPS. Notably, both small, mediumand large-scale businesses report significantdifficulties in accessing bank loans in CentralAsia, whereas the market seems far more seg-mented in favour of larger scale businesses inCEB. The differences across Central Asia arealso large, with around two thirds of enterprisesreporting difficulties in accessing bank loans inKazakhstan, but more than 90 per cent facingsuch difficulties in Tajikistan.

Given the underdeveloped nature of financial inter-mediation, most businesses rely predominantlyon retained earnings for investment. Bank loansare prominent only among larger firms, althoughevidence from the BEEPS suggests that Kazakhfirms rely on bank loans about as much as Polishfirms in the same size category. Equity is virtuallynon-existent as a source of financing in CentralAsia. The high reliance on internally generatedresources has potential negative implications forthe efficiency of capital allocation and the vulner-ability of economic activity to fluctuations in

20021999Worst case

4

3

2

1

0

Finance

Infrastructure

Tax

RegulationsCorruption

Crime

Judiciary

Note: The average of Kazakhstan, the Kyrgyz Republicand Uzbekistan is shown. Data for Tajikistanand Turkmenistan were not available. The com-bined measures of qualitative assessments ofthe business environment are calculated as anunweighted average across the seven dim-ensions. The values range from 1 to 4, with 1indicating no obstacles to business growth andoperation and 4 indicating major obstacles. Afuller circle indicates a more challenging busi-ness environment.

Source: BEEPS (1999, 2002)

Chart