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Riding the Roller-Coaster: Capital Markets in 2010
Good News and Bad News
Domestic capital markets in Ukraine continue to be rather weak and Ukrainian companies seeking significant debt or equity investment must still look to international markets. The entry of Ukrainian issuers and borrowers to these markets at the height of the global crisis in late 2008 and 2009 was quite limited and the most significant capital markets transactions in 2009 were debt restructuring.
This situation started to improve in 2010. Access to international markets is once again a possibility for the strongest Ukrainian issuers. These markets, however, experienced what can only be described as a dramatic roller-coaster ride in 2010. The first quarter of 2010 was rather optimistic with nearly a dozen Ukrainian companies expressing their interest in an IPO in 2010 and 2011.
In the first quarter of 2010, as Ukraine’s export-oriented economy grew rapidly and as the political situation in the country reached the current period of relative calm, the Eurobond market for Ukrainian companies saw a revival. Ukreximbank and the DTEK steel holding tapped the market for a total of USD 1 billion in April 2010.
In April 2010, a major poultry producer, Avangard, had an IPO on the London Stock Exchange and a major sunflower oil producer, Kernel, had a secondary public offering in Warsaw.
This wave of optimism abated at the end of the spring when the debt crisis in Greece triggered fears of a global “double-dip” recession. Given these conditions, amazingly the summer of 2010 did see the first IPO by a Ukrainian IT sector company. In late June 2010 EasyDate, a company with a Ukrainian co-founder and all operational facilities located in Ukraine, successfully entered the Alternative Investment Market of the London Stock Exchange, attracting the interest of major institutional investors.
Since the markets remained volatile for most of the year, syndicated loans and loans from international financial institutions were an apparent route to reliable large-scale financing. The largest financing transaction in Ukraine not only in 2010 but, in general, since the beginning of the world financial crisis of 2008, came with Metinvest arranging for syndicated pre-export financing of USD 700 million in July 2010.
Currently, international investors appear to be more attracted by Ukrainian debt than equities. There are good reasons for this, because the overall debt standing of Ukraine improved dramatically in the second half of 2010, especially, since the government renewed cooperation with the International Monetary Fund. In late July 2010, Ukraine received the first USD 1.9 billion tranche from the IMF as part of a stand-by arrangement worth more than USD 15 billion. Renewed cooperation with the IMF led to the upward revisions of the Ukrainian sovereign debt rating by the major rating agencies. September also saw a successful Ukrainian sovereign Eurobond placement.
PrivatBank followed closely, placing USD 200 million five-year Eurobonds on the London Stock Exchange. The GDP numbers for the 8 months of 2010 are encouraging, with more than 10% industrial sector growth registered according to official reports. All of this helps Ukrainian corporate debt, at least that of the most attractive and solid issuers, on international markets. In this climate two Ukrainian companies, Agroton and Milkiland, managed to tap the Warsaw market in November 2010 but a third, GeoAliance, had to postpone its IPO there. In other words, the equities of non-agricultural Ukrainian issuers are, unfortunately, still a hard sell abroad, even on the Warsaw market.
Legal Developments in 2010
The two major legal developments directly affecting the capital markets in 2010 were the abolition of most
crisis-related restrictions on foreign investment. Another important change came in the domestic debt markets, where the Act of 8 October 2010 made it easier for the issuers of domestic Ukrainian bonds to avoid default.
The Act of 27 April 2010 abolished most restrictions on foreign investment introduced by the On Amendments to Certain Laws to Overcome the Negative Impact of the Financial Crisis Act of Ukraine of 23 June 2009. In particular, the Act of 27 April 2010 abolished the limitations on modifications and early repayment of foreign loans and made registration of foreign investment optional. It also removed the requirement to open investment accounts with Ukrainian banks, which were necessary for investment operations in Ukraine, in particular, for the acquisition of shares in Ukrainian companies. Foreign investors no longer have to convert their investments into Ukrainian currency. In a relatively minor but important change, 2010 also saw the abolition of the mandatory contribution to the Pension Fund which used to be required for currency conversion operations.
On 8 October 2010, the Ukrainian Parliament adopted the act, which permitted bond issuers to prolong the terms for bond circulation and payback, and toughened requirements on the issue of promissory bonds for which property is used as collateral.
The Act of 8 October allows the issuers of Ukrainian domestic bonds to prolong the term of circulation and postpone the maturity date of the bonds, if the issuer buys back the whole bond issue (apparently, reissuing the bonds for a new term), or obtains the agreement of all bondholders to the prolongation of the terms. The price of such buyback cannot be lower than the nominal value of bonds. The period — for which the terms of bond circulation can be prolonged — cannot exceed the term defined in the original prospectus. In addition, the repeated prolongation of bond circulation terms is not allowed. The law also retroactively applies to bonds issued before the law took effect. The law is obviously rather unconventional and raises a number of questions as to the procedure for its implementation. The implementing regulations are to be promulgated by the State Commission for Securities and the Stock Market (the SEC).
In its letter of September 2009 the Ukrainian SEC, in order to facilitate the restructuring of Naftogaz Ukraine's obligations, took a revolutionary and quite encouraging position that the placement of foreign securities by Ukrainian issuers does not require a special permit from the SEC. The notes issued by Naftogaz Ukraine in November 2009, relying on this imprimatur from the SEC, were issued directly by Naftogaz, a Ukrainian company. Unfortunately, no regulatory action followed from this liberal interpretation from the SEC. However, in 2010 the SEC officials again reiterated the SEC's intention to relax restrictions on issuances of securities abroad by Ukrainian companies and the hope remains that the SEC will finally follow up on this promise. Even regulatory action by the SEC, however, may not clear all the hurdles for Ukrainian issuers since certain provisions of Ukrainian law can be interpreted as not allowing Ukrainian entities to issue securities abroad.
This means that Ukrainian businesses seeking to tap international capital markets must use various strategies to avoid the various regulatory limitations on the issuance of Ukrainian securities abroad. All Ukrainian Eurobond issuances prior to the 2009 Naftogaz transaction involved a non-Ukrainian special purpose vehicle (SPV), or an existing company connected with the Ukrainian fund raiser or lead managers or established as an orphan SPV through trust arrangements.
The proceeds raised on the international capital market were then lent to the Ukrainian companies of the issuing Ukrainian group. In many such arrangements, Ukrainian operational companies act as sureties for the obligations of the non-resident issuer. Even these circuitous arrangements cannot completely exempt parties to capital markets transactions from the uncertainties of Ukrainian law. For example, the proceeds of these transactions are often channeled to the Ukrainian recipients under loan agreements. These loans customarily contain the so-called gross-up provisions, which require the borrower to compensate the lender for any withholding or other taxes, which can be associated with the payment of interest to a nonresident.
However, such provisions contradict Ukraine's Tax Code and the National Bank of Ukraine (the NBU) refuses registration of loans containing such provisions.
Another potential thorn in the side of Ukrainian issuers is the currency control restrictions on payments by Ukrainian sureties indemnifying the obligations of the non-Ukrainian issuer. Some believe that such payments are subject to mandatory price evaluation under NBU Resolution 597 of 30 December 2003. In a letter of 1 October 2010 issued upon a clarification request by Asters, the NBU explained that no such price evaluation was necessary for payments under surety contracts.
What the NBU gives, however, the NBU takes away. After clearing one minor uncertainty, the NBU erected another major barrier in the way of Ukrainian companies seeking capital abroad. On 15 November 2010 the NBU issued an official clarification letter to commercial banks explaining that in order to make a payment to a foreign creditor a Ukrainian surety must obtain an individual license from the NBU unless the surety is an authorized bank or financial institution. This is a major event given that sureties were part of all recent Eurobond issuances originating from the Ukrainian non-banking corporate sector including those of DTEK, Metinvest, MHP, and Avangard. New structures would have to be sought for future debt issuances.