Argument (#3 March 2020)

A Case For Setting Up Ukraine International Financial Centre

by Syed Mujtaba Hussain

Every nation has guaranteed its people the basic right to economic development, sustainable growth and a better life. Developed nations can fulfil this promise, whereas developing nations struggle hard to achieve these objectives. It is the availability of finance that ultimately paves the way for economic growth and development.

Developed nations can tap the global funds with ease because they have robust legal systems, with effective enforcement mechanisms that guarantee much-needed protection to international investors. Developing nations lack such a system and are not able to tap global funds with great ease. They seem to rely heavily on aid from international donor agencies that follow very stringent guidelines and may not be amenable to finance most development projects. Due to the sheer paucity of available finance,  developing nations take longer than usual to fulfil their part of the promise.

Tapping global funds

The nations that succeed in effectively tapping the global funds are bound to achieve rapid economic growth. Rapid economic growth is needed in the context of developing nations, including Ukraine. Such growth could be achieved if developing nations adopt dual and mixed legal systems, akin to the common law system, providing a sense of guarantee and comfort to international investors.

In the context of Ukraine, we need to adopt a common set of financial rules and regulations, enforced by independent common law courts, with a mix of local and foreign judges. The judgments shall be enforced by local courts all over Ukraine. This shall motivate institutional investors as well as ultra-high net-worth individuals to invest their funds in development projects that are crucial to economic growth and the development of Ukraine.

Dubai’s success story

Dubai followed this approach and is today regarded as the global hub for international trade and investment. In 2004, the Government of Dubai formed the Dubai International Financial Centre, which is an offshore financial center situated in mainland Dubai, UAE. It is governed by its own laws and regulations, founded essentially on common law principles. The DIFC has its own courts, with a mix of local and foreign judges. Its decisions are enforced in the UAE by local courts, without any challenge.

The English courts of the DIFC and local Arabic courts in Dubai operate side-by-side. Both are courts of competent jurisdiction and can enforce each other’s decisions in their respective jurisdictions. The DIFC is regarded as an independent jurisdiction, distinct and separate from mainland Dubai. Thus, in Dubai, foreign investors have the option to choose between an English legal system and/or a local Arabic legal system. This has given huge impetus to economic growth and development in Dubai.

There is no compromise in respect of national sovereignty, as all laws and all judgements of the English courts of DIFC are subject to the UAE’s Constitution. Investors have generally made investments subject to the laws of the DIFC. The success of the DIFC can be measured from the available statistics, which shows that in 2018 Dubai recorded a 41% year-on-year growth in FDI amounting to USD 10.5 billion, as opposed to an inflow of USD 4.5 billion in 2011. In 2019, the inflow of FDI reached close to USD 18.5 billion. The DIFC and independent common law courts were established in 2004.

Ever since then investors have flocked Dubai, deployed their investments in various infrastructure and development projects, thereby participating in the growth and development of the UAE. Today, the DIFC has grown as a leading global financial center catering not only to the UAE, but also to the Middle East, South Asia and South-East Asia.

Abu Dhabi follows the Dubai story

Following the success of the DIFC, the government of Abu Dhabi in 2013 established the Abu Dhabi Global Market, which is an offshore financial center, founded on the basis of the DIFC. It has an independent judiciary comprising of English judges. The judgments of the ADGM Courts may be enforced anywhere in Abu Dhabi, as well as in the UAE, along the lines of the DIFC. Local courts do not have the power to set aside any judgment of common law courts, either in Dubai or in Abu Dhabi.

Kazakhstan follows the UAE

Inspired by the success stories of Dubai and Abu Dhabi, Kazakhstan in 2018 established the Astana International Financial Centre based on the Dubai model. The AIFC has its own laws and regulations based on the English common law, very similar to the laws of the DIFC. It has its own common law courts, comprising essentially of all judges drawn from the United Kingdom. The judgments of the AIFC Courts can be enforced anywhere in mainland Kazakhstan, and local courts do not have the power to set aside its judgment. Like Dubai, the enforcement of the AIFC Court judgments is done by the local courts, as per the applicable local laws of mainland Kazakhstan. The AIFC was established in 2018 and has attracted 330 companies, including leading foreign banks, investment companies, other financial service firms and law firms.

The most impressive part about the AIFC is that the Government of Kazakhstan is open to subject itself to the AIFC Laws in respect of contracts to be carried out by foreign investors. The implication of Government subjecting itself to AIFC laws is that it is bound by its decisions. The decision of AIFC Courts is final and binding on all parties, subject to the process of appeal embodied in the AIFC Court Law. This has made Kazakhstan the most attractive place for foreign investment in the Central Asian region, comparable to Dubai and Abu Dhabi.

The story of Ukraine

The lessons that can be learnt from the success stories of Dubai, Abu Dhabi and Kazakhstan are that the tapping of global funds could be more effectively achieved by establishing an offshore financial center, with an effective court system based on common law principles, which is generally preferred by foreign investors.

A dual or a mixed legal system that incorporates requirements of the local laws and addresses the needs and requirements of foreign investors is the need of the hour. Adopting such a system does not mean surrendering a nation’s sovereignty, as the new legal system only addresses financial transactions, whereas all other civil and criminal matters are addressed by applicable local laws. Apparently, there is no conflict, and experience suggests that mixed legal systems have promoted growth and development, even in the context of Europe. The European Union itself is a mixed legal system.

The choice that Ukraine needs to make is to do away with its reliance for development funds on donor agencies and instead focus on creating a new financial institution, affording foreign institutional and private investors a platform to co-invest and pool in their funds. These funds would ultimately be utilized towards achieving economic growth and development.

Current FDI figures in the context of Ukraine do not reveal a promising story. In 2014, FDI inflow of USD 300 million (equivalent to 0.2% of GDP) was attracted on a net basis, which is a multi-year low. The inward stock of FDI declined by about USD 15 billion to USD 63.8 billion (48.4% of GDP) over the year. From 2017 until the middle of 2019, the FDI inflow in Ukraine did not even pass USD 1 billion. It was only towards the end of October 2019 that an FDI inflow of USD 1.4 billion was recorded.

Significant amounts of private capital as well as long-term oriented FDI inflows are needed to achieve external stabilization in Ukraine. Unless external financing increases, domestic investments will not benefit, as the borrowing and funding costs will be very high. As such, reconstruction of the Ukrainian economy shall largely depend on how rapidly it’s to attract foreign capital.

Now’s the time for change

Ukraine has, all these years, relied on investment from European markets, largely ignoring the critical fact that a little over USD 1 trillion is held in the Gulf Cooperation Council Region by institutional and private investors. The current fragile institutional environment that exists in Ukraine needs to be supplemented by a more robust financial and legal infrastructure to improve the availability of finance that would ultimately pave the way for rapid economic development. The idea is to supplement regional liquidity and create a more efficient allocation of capital and investment that would benefit the state and foreign investors alike.

Ukraine needs to shift its focus towards GCC countries. The only way to motivate and convince private and institutional investors in the GCC region is to highlight investment opportunities and develop a legal structure that supports a more efficient and sophisticated form of financing.

It is in this context that a case for setting up an offshore Ukraine International Financial Center needs to be examined by lawmakers, and with a sense of urgency. The external stabilization of Ukraine can be successfully achieved by reducing external debt, and such reduction is only possible when there is a large inflow of FDI into the country.

Ukraine needs to come out of the financial turbulence created by the external headwinds and the only way it can do so is by setting up its own financial center based on the Dubai model, with independent common law courts, comprising a mix of local and foreign judges that would provide the much needed confidence to the potential investors seeking investment opportunities in the region.

Setting-up the Ukraine International Financial Centre

Traditionally, a country should think of setting up an International Financial Centre if it faces the following four problems, namely: (a) its private finances are minimal; (b) financial systems are underdeveloped; (c) there is low level of private credit on deposit; and (d) the cost of borrowing is very high. In the case of Ukraine it appears that all four problems are prevalent and in large measure. Private finance is needed to finance the public infrastructure and build up the private sector.

So as to tap this private finance, International Financial Centres play an important role by providing investors with secure jurisdictions, financing structures and tax neutrality. This is particularly true in the context of Ukraine, where financing difficulties are the most acute and the need for risk mitigation is the highest. If Ukraine succeeds in providing investors with a safe and a secure investment regime that meets international requirements, with an effective enforcement mechanism, there will be a huge inflow of FDI. As a reference point, the level of finance channeled through International Financial Centresto developed nations reached an estimated USD 1.6 trillion between 2007 and 2014. This led to an increase of USD 400 billion in GDP and USD 100 billion in tax revenue of developing countries during the period (IFC and Developmental Finance Report 2019: Judith Tyson).

This goal can be attained if weak domestic institutions are replaced by strong institutions like IFCs, following the universally accepted standards for investment that are prevalent in developed countries. By setting up such an International Financial Centre,Ukraine will be able to achieve significant GDP growth, as well as job creation. This is because sectors such as infrastructure and financial services contribute significantly to GDP growth, while the agricultural and manufacturing sectors are important for creating jobs. UIFC will be able to meet these objectives by tapping into global funds needed for achieving economic growth and development.

As such, Ukraine needs to create an offshore financial center in Kyiv (UIFC), with its own laws and regulations modelled on the rules and regulations applicable in the DIFC (Dubai). The UIFC should have its own common law courts with foreign judges, who will work alongside local judges, as in Dubai, without disturbing the existing legal system.

The proposed common law legal system shall be specific to foreign investments and shall be subject to the Constitution of Ukraine. All other aspects relating to civil and criminal laws shall be governed by  local laws. In this way Ukraine, without affecting its present legal system, would be able to create a new financial system governed by its own laws and regulations, incorporating all international provisions and practices proposed by global regulatory bodies. This new system will restore the confidence of investors and provide for an effective investment regime, providing the necessary development capital needed to rebuild Ukraine.

Two choices lie with the people of Ukraine: (a) either to seek development finance from international donors, subject to their terms and conditions; and/or (b) create a strong domestic institution, namely the UIFC, which would foster economic growth and act as an effective tool in tapping global funds.

If, Dubai, Abu Dhabi, Kazakhstan, Singapore, Hong Kong and Japan were able to succeed in achieving economic growth and development using International Financial Centres, there is little reason for us to doubt the success of Ukraine, especially when it has huge natural resources and a wealth of human capital.

The time to act is now.

Syed Mujtaba Hussain  is the Managing Partner of Emirates Legal

 

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