Driven by the increasing volatility of the hryvnia exchange rate and encouraged by the approval of major international creditors of Ukraine, the National Bank of Ukraine has been gradually toughening the regime of currency operations, a process started back in late 2013. This, predictively, affected those major Ukrainian companies whose business operations have a significant cross-border component. As usual, the regulator's attention was focused on limiting the mechanisms of transferring foreign currency abroad.
Mandatory sale of foreign currency proceeds
The first step came with mandatory sale of foreign currency proceeds in October 2013. With certain exemptions (e.g., made for transactions involving international financial institutions, of which Ukraine is a member) this requirement applies to any foreign currency proceeds belonging to Ukrainian companies. Starting with 50%, the amount subject to mandatory sale reached 100% in mid-2014 and decreased to 75% in September 2014. In cross-border financing transactions, the aforementioned mandatory sale requirement has resulted in additional conversion costs for local recipients using the foreign currency proceeds for payments under other cross-border contracts.
Currency regulations affecting foreign investments
By its Resolution No.540, effective from 2 September 2014 until 2 December 2014 (inclusive), as amended by Resolution No.591, the NBU introduced a number of new regulations affecting foreign investments, in particular:
— the prohibition of cross-border repatriation of proceeds received by foreign investors from the sale of Ukrainian issuers' securities outside the stock exchanges, except for sovereign bonds of Ukraine;
— the prohibition of cross-border repatriation of proceeds received by foreign investors from the sale of their corporate rights in legal entities, which are not documented as shares;
— the prohibition of repatriation of dividends to foreign investors (except for the repatriation of dividends under the securities traded on stock exchanges);
— the prohibition of making payments on the basis of NBU individual licenses (except for transactions on the basis of NBU individual licenses issued to legal entities in relation to crediting funds to accounts opened abroad), including investing outside of Ukraine.
Given that the majority of Ukrainian companies are incorporated as limited liability companies rather than joint-stock companies and the shares of the majority of Ukrainian joint-stock companies are not traded on stock exchanges, the aforementioned prohibitions may have a substantial freezing effect on the activity of foreign investors in Ukraine throughout the whole term of their validity. Furthermore, as a matter of practice, the existence of such prohibitions would in fact squeeze out the majority of the transactions involving transfer of corporate rights in Ukrainian companies abroad, to jurisdictions which have less restrictive currency regimes. On the other hand, it may be difficult to find a foreign entity prepared to invest in Ukraine while having no possibility to receive dividends from the profits of the companies they control. Therefore, until the aforementioned prohibitions are terminated, cross-border transactions with corporate rights in Ukraine would most likely be limited to intra-group transfers.
Prohibition of prepayment of cross-border loans
By its Resolution No.49, effective as of 6 February 2014, the NBU prohibited the purchase of foreign currency for early repayment of loans. This prohibition, however, did not preclude Ukrainian borrowers from prepayment of loans and interest from their own funds in foreign currency. Slightly later, by NBU Resolution No.172, effective as of 28 March 2014, the said limitation was enhanced by a requirement that payment of principal and interest under cross-border loans be made on the terms envisaged by the relevant loan agreements. This measure eventually introduced a general early repayment prohibition also applicable to the prepayment of loans with borrowers' own funds in foreign currency (the Prepayment Prohibition). Currently, the Prepayment Prohibition applies pursuant to NBU Resolution No.540.
Under the applicable rules, a loan agreement contemplating a cross-border loan must be registered with the NBU before any funds can be obtained or paid by a Ukrainian borrower. Based on the Prepayment Prohibition, the NBU shall not register amendments to loan agreements with non-resident lenders reducing the term of fulfillment of the local borrowers' obligations under such loan agreements or providing for early fulfillment of obligations there under. Furthermore, as certain local banks have stated on condition of anonymity, the NBU may punish banks for processing any interim payments under loan agreements if such payments are made ahead of the schedule of payments submitted for NBU registration, although such schedule had never been mandatory until the Prepayment Prohibition was introduced. In practice, this may affect Ukrainian borrowers' regular settlements with foreign lenders under loan agreements concluded before and after 6 February 2014.
It can be argued that the Prepayment Prohibition applies solely to Ukrainian borrowers and should not prevent foreign lenders from declaring the loan principal and all charges there under immediately due and payable upon occurrence of certain events envisaged by the loan agreement (such as change of control provisions, underperformance in business, event of default provisions and similar). However, the risk exists that the Ukrainian banks servicing payments under cross-border loan agreements, may interpret the Prepayment Prohibition restrictively by treating it as a ground to refuse to purchase and transfer foreign currency for the purposes of loan prepayment made both voluntarily and upon acceleration by lenders.
The Prepayment Prohibition has been in force for eight months now and has proved to substantially affect the foreign creditors' willingness to provide financing to Ukrainian businesses. Notably, the Prepayment Prohibition affects not only loans as a money borrowing instrument but also the corporate loans frequently used as a cash channeling tool within the groups involving foreign entities.
Previously, early repayment of loans was prohibited by the On Amendment of Certain Acts of Ukraine with the Purpose of Overcoming Adverse Consequences of the Financial Crisis Act of Ukraine of 23 June 2009. However, it was later amended to cancel the early repayment prohibition in full. The introduction of the Prepayment Prohibition by an NBU resolution may be treated as an unlawful interference by the NBU with business operations, on whose basis the Prepayment Prohibition can be challenged in court by the affected party. The NBU can, however, claim that it has statutory powers to regulate the currency market.
The political factors beyond the Ukrainian government's control, along with the aforementioned restrictions, have resulted in a standstill in the activities of Ukrainian companies on international capital markets and cooled the interest of foreign investors in Ukraine. The encouraging news is that the protective measures introduced by the NBU are temporary, which preserves expectations towards their prompt cancellation across the market.