Eurobonds from Ukraine: a Decade in Review
Andriy S. Nikiforov
Debt issuance by Ukrainian companies in the global capital markets dried up in the third quarter of 2013 primarily due to the deterioration of the country’s external liquidity position. Currently, the Ukrainian economy remains fragile and the sovereign ratings assigned by all three major credit agencies hover on the edge grade C. While access to capital markets by Ukrainian issuers, other than the State of Ukraine in some instances, is yet to be regained, now seems like a good time to take a look back at what has happened since the first Eurobond issuance by the government of Ukraine in 1999.
Direct issuances
Since August 1999, the State of Ukraine has been issuing bonds in the international markets directly, without using any conduits. The direct sovereign issuances were formalized in the Securities and Stock Exchange Act of Ukraine of 18 June 1991, No.1201-XII that, with effect from 1 July 1999, was supplemented with provisions expressly allowing direct bond issuances by the State of Ukraine outside Ukraine.
For quite a while it was believed that Ukrainian legislation permitted only sovereign direct Eurobond issuances while other Ukrainian issuers were subject to onerous regulatory restrictions under securities and currency control legislation. This analysis of the legal environment prompted the first Ukrainian corporate issuers (such as Kyivstar) to choose a loan participation notes (LPN) structure, as discussed below.
However, history showed that where there is a will, there is a way. In 2009 — 2011, NJSC Naftogas and the State Enterprise Financing of Infrastructural Projects (Fininpro) directly issued bonds in the international markets relying on guidance papers of the National Securities and Stock Market Commission of Ukraine (NSSMCU) and the National Bank of Ukraine (NBU) that were specifically adopted in relation to these issuances. The NBU took the view that payments by these quasi-sovereign entities under the notes and the related transaction documents do not require an individual license of the NBU. The NSSMCU resolved that, because these Eurobond issues by Naftogas and Fininpro were issued outside Ukraine, they were not subject to Ukrainian securities legislation, in particular the regulations related to registration of securities in Ukraine and obtaining the permission of the NSSMCU to place securities abroad. From the marketing perspective, investors’ concerns about these unconventional positions of the regulators seemed to have been balanced by the fact that the Naftogas and Fininpro bonds in question had the benefit of guarantees issued by the Cabinet of Ministers of Ukraine (CMU).
Loan participation notes
21 November 2014 was the 12th anniversary of the first ever corporate bond from Ukraine, the Kyivstar USD 100 million LPNs due 2005. At that time the choice in favor of an LPN structure was an easy one. The LPN structure had already been tested in Russia, so the lead managers were quite positive about the prospects of selling a similar deal from Ukraine. Furthermore, from the perspective of then effective Ukrainian legislation, direct issuance by a Ukrainian company would raise plenty of legal concerns, as follows.
Under the Securities and Stock Exchange Act in effect at the time of the Kyivstar debut issuance, corporate bonds had to be denominated in hryvnia and could be issued by a joint stock company in an amount not exceeding 25% of its charter capital. In addition, payments by a Ukrainian issuer (whether as principal or coupon) under its securities issued outside Ukraine to the holder of such securities would require an individual license of the NBU, under Decree of the CMU On Currency Regulation and Currency Control of 19 February 1992, No. 15-93.
The list of pieces of Ukrainian legislation that ruled out a direct issuance by Kyivstar in 2002 was completed by the Regulation on the Procedure for Approval of Circulation of Shares and Corporate Bonds of Ukrainian Issuers outside Ukraine, approved by Decision of the NSSMCU of 17 October 1997, No.36. This regulation established a few further cumbersome requirements that Ukrainian issuers eventually chose to avoid by structuring their issuances. Under Regulation No.36, (1) the issuance for which approval was sought must have constituted a tranche of bonds subsequent to a tranche that had been listed on a Ukrainian stock exchange or electronic trading platform, (2) the issuance had to be placed at a price no lower than the current price at which these bonds traded in Ukraine, and (3) the title to the bonds must have been recorded within the Ukrainian depositary system.
If an offering document of an issuer were to be registered by the NSSMCU in accordance with Regulation No.36, an issuer would also need to pay a state duty of 0.1% of the face value of the issued securities in accordance with Decree of the CMU On State Duty of 21 January 1992, No.7-93.
Now the Securities and Stock Exchange Act has been replaced by the Securities and Stock Market Act of Ukraine of 23 February 2006, No.3480-IV, and Regulation No.36 — by the Regulation On the Procedure for Approval of Placement and/or Circulation of Securities of Ukrainian Issuers outside Ukraine, approved by Decision of the NSSMCU of 20 June 2013, No.1105. As a result, at present, corporate bond may be denominated in foreign currency, may be issued in a much larger quantity than before, and its placement price does not need to be no lower than the current price at which the bond is traded in Ukraine. Nevertheless, the individual licensing requirement remains in place and, even more importantly from a marketing perspective, it would be much easier for a lead manager to sell a conventional LPN deal rather than to convince the market to invest in a complicated untested structure. It is, therefore, unlikely that those Ukrainian issuers that do not have offshore vehicles will fall out of love with LPNs in the near future.
Historically, in an LPN transaction the notes would be issued either by, but without recourse to, a non-Ukrainian bank (in Ukraine, most commonly by Credit Suisse, Dresdner Bank or Standard Bank) or by a special purpose vehicle. If a bank was acting as legal issuer of the notes, the responsibility for the prospectus would be split so that the bank would be responsible only for the information related to it, and the economic issuer, i.e., the Ukrainian entity, would be responsible for the larger part of the disclosure.
Foreign bank acting as issuer
In the 2002 Kyivstar deal, the loan participation notes were issued by Dresdner Bank acting as conduit. This option was preferred by the bank as a manager because it would embed the bank in the transaction, and could allow the bank to sell its other services. From the Ukrainian borrower’s perspective, this option helped to avoid the practical difficulties that the borrower would have faced in obtaining an individual license of the NBU, as well as establishing an offshore subsidiary and maintaining it. Also, for such issuers as Ukrainian banks and the City of Kiev some further regulatory considerations had to be taken care of.
Until 23 October 2007, in accordance with the Regulation On the Procedure for Residents Obtaining Foreign Currency Loans from Non-Residents and Residents Granting Foreign Currency Loans to Non-Residents, approved by Resolution of the Management Board of the NBU of 17 June 2004, No.270, Ukrainian banks were allowed to borrow only from non-resident banks and non-resident non-banking financial institutions. Similarly, until 27 July 2012, various legislation applicable to municipal borrowing inconsistently required that such borrowing be made only under loan agreements to which a financial institution was a party. Ukrainian banks and the City of Kiev, therefore, could effortlessly take a loan from a non-resident bank, including one funded by LPN issuance proceeds, while for any other lender they would need to take the risk of such lender entity not being able to satisfy the financial institution test.
On 4 November 2003, the European Parliament and the Council of the EU adopted Directive 2003/71/EC On the Prospectus to be Published when Securities are Offered to the Public or Admitted to Trading (commonly referred to as the Prospectus Directive). According to Article 29 (Transposition) of the Prospectus Directive, member states were required to bring into force laws, regulations and administrative provisions necessary to comply with this directive not later than 1 July 2005.In particular, the member states had to ensure that responsibility for the information given in a prospectus attaches at least to the issuer, the offeror, the person asking for the admission to trading on a regulated market or the guarantor, as the case may be, as required by Article 6 of the Prospectus Directive.
Since the banks would under no circumstances accept responsibility for the entire prospectus, it appeared that this responsibility rule of the Prospectus Directive would kill-off LPN structures in which banks acted as issuers. In practice, however, there was initially some difference in the way the national regulators of some of the EU member states applied the Prospectus Directive. In particular, although the Prospectus Directive was implemented in Luxembourg on 12 July 2005, the Luxembourg regulator (Commission de Surveillance du Secteur Financier) for quite a while continued to accept “split responsibility” statements in prospectuses for LPN transactions whereby bank issuers only accepted responsibility for information relating to themselves. By way of example, the prospectus for the UkrSibbank USD 200 million 7.375% LPNs due 2010, of 16 July 2007, was approved by the CSSF in Luxembourg on this basis.
Also in 2006 — 2007 listings of Ukrainian LPNs for which banks acted as issuers gained momentum on the SWX Swiss Exchange (now, the SIX Swiss Exchange). This became possible due to Switzerland not being an EU member state and, consequently, not subject to the Prospectus Directive. For quite some time after the Prospectus Directive was adopted, the SWX Swiss Exchange allowed split responsibility statements. It then fell into line with EU regulators relying on their best practices. Before this happened, the SWX Swiss Exchange admitted to listing, inter alia, the City of Kiev USD 250 million 8.25% LPNs due 2012, on 26 Novem- ber 2007.
At present, the same approach is followed by all major securities exchanges in the European Economic Area (EEA) in relation to securities admitted to trading on an “unregulated” (or “exchange regulated”) markets such as the General Exchange Market in Ireland, which has recently become quite popular among Ukrainian issuers.
SPV acting as issuer
Once the CSSF and the SWX Swiss Exchange aligned themselves with the other EU regulators on split responsibility for a prospectus, Ukrainian issuers switched from structures that envisaged an LPN issuance by foreign banks to issuances by offshore special purpose vehicles. Most EEA regulators accept for listing purposes not only structures in which an issuing SPV is a finance subsidiary of the borrower but also a so-called “orphan SPV” that is not owned or controlled by the borrower or any member of its group. In the context of Ukrainian issuances, however, a Ukrainian business that had an offshore finance subsidiary would never opt for an LPN structure but rather make a direct issuance having the benefit of a guarantee by Ukrainian operating companies.
Typically, an orphan SPV will be established and managed by a corporate service provider unrelated to the borrower, and its shares will be held on trust for charitable purposes. In addition, such an SPV will normally have no assets and it will charge its rights to the proceeds of the loan and the segregated bank account through which the proceeds are paid to the trustee. The orphan SPV has become popular among Ukrainian issuers as a convenience vehicle to avoid withholding tax and other practical difficulties that Ukrainian issuers would otherwise face to establish the necessary offshore finance subsidiary.
Deposit linked notes
At various times, international lenders explored different options for financing Ukrainian borrowers in UAH. As Ukrainian legislation never permitted foreign entities to make loans to local entities in hryvnia (with the exception of international finance organizations), the options available to international lenders were limited to UAH deposits with Ukrainian banks. While small hedge funds were happy earning high interest on straightforward bank deposits, major investment banks were also considering structures for issuing Ukrainian bonds on international markets linked to a deposit with a Ukrainian bank.
These deliberations were interfered by the NBU that, reportedly being concerned by the upward pressure on hryvnia, in August 2005 adopted Resolution On Regulation of Foreign Investment into Ukraine of 10 August 2005, No.280. This Resolution restricted non-resident investors’ ability to make deposits in UAH with Ukrainian banks until April 2009. A foreign currency deposit, as opposed to a foreign currency loan, would expose international investors to larger risks arising from its stricter legal regime, in particular the risk of not being able to receive any payments of principal owing to them until after the first anniversary of the deposit, in accordance with the foregoing Resolution No.280. Therefore, debt issuances featuring deposits with Ukrainian banks were not in investors’ thoughts for quite a while, until in February 2011 Ukreximbank issued UAH 2,385,050,000 11.00% Deposit Linked Notes (DLNs) due 2014, the first “euro clearable” international hryvnia bond. In essence, Ukreximbank’s DLN was economically identical to conventional Ukrainian LPNs.
Once the dust settles and the international capital markets reopen for Ukrainian issuers, it is not likely that investors will risk taking a punt on the hryvnia rising, but foreign currency DLNs may turn out to be a viable option. This may happen due to foreign currency cross-border deposits (unlike loans) not being subject to any interest rate limitations administered by the NBU. To illustrate, in favourable market conditions a Ukrainian bank would be able to issue a 3-year DLN (but not an LPN) priced at a rate above 11% which is the current maximum interest rate ceiling for 3-year foreign loans envisaged by Resolution of the Management Board of the NBU On Establishing Interest Rates for Residents’ External Borrowing of 3 August 2004, No.363.
Issuances by non-Ukrainian holding companies
At some point major Ukrainian businesses, such as Metinvest, DTEK and MHP, were restructured in such a way that their Ukrainian operating companies became controlled by a holding company established in a jurisdiction convenient from a tax and regulatory perspective. It allowed these Ukrainian issuers not to bother with LPNs but to issue bonds directly. Because their holding entities most often would not be generating any operational income and would rely on dividend distributions from the Ukrainian subsidiaries, a typical bond of an offshore Ukrainian holding company would have the benefit of sureties (corporate guarantees) issued by the operating entities.
Previously, the major investor concern about these direct structures, from the legal standpoint, was the need for the operating companies to obtain an individual license of the NBU for the payments under the surety, in case of the holding company’s default under the notes. However, recent pressure on the hryvnia made the NBU introduce extraordinary currency control measures, in effect from 23 September and currently until 3 March 2015, that affected direct holding company issuances. Namely, the NBU restricted (i) payments by the sureties on the basis of individual cross-border payment licenses issued by the NBU and (ii) distribution of dividends by Ukrainian legal entities other than joint stock companies whose shares are listed/ traded on a Ukrainian stock exchange. At present, the holders of the outstanding notes issued under these structures have reason not just to worry about the general financial condition of the relevant Ukrainian businesses but also whether the management of those groups that remain financially sound would be able to use any other avenues for remitting cash from the operating subsidiaries to the issuer holding company to fund payments under the notes falling due while the contingency measures of the NBU are in effect.
Notes programmes
Programmes for issuance of notes in international markets (commonly referred as Medium Term Note (MTN) Programmes) allow issuers, subject to a minor increase in expenses as compared to a one-off Eurobond deal, to make multiple issuances of notes up to the aggregate amount of the programme on the basis of the same principal documentation. The prevailing view is that an MTN programme is a sensible option when an issuer plans to issue more than once per year. Once a base prospectus has been approved, it is valid for 12 months and securities can be issued relatively quickly using “final terms and conditions” that do not require approval each time, provided that the base prospectus remains complete and accurate at the time of issue. If there has been a material development (e.g., interim accounts have been published), the base prospectus will not be viewed as complete and accurate and the issuer would need to prepare a supplement to the base prospectus and have it approved. Further, a Rule 144 A offering must generally close within 135 days of the date of the audited or reviewed financial statements included in the prospectus which also puts a practical limit on the “shelf life” of the base prospectus.
In 2007 — 2011, four Ukrainian issuers, TAS-Kommerzbank, Alfa-Bank, UkrSibbank and Metinvest set up MTN programmes for an aggregate amount of USD 6.5 billion. To date, only Alfa-Bank and Metinvest made second drawdowns under their programmes. However, because of the time gap between the two issuances, neither Alfa-Bank nor Metinvest was able to take full advantage of its MTN Programme.
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As the flow of new deals from Ukraine has shrunk due to market conditions, issuers, together with their financial and legal advisers, are currently busy restructuring outstanding Eurobonds. Once the economic situation in Ukraine improves and Ukrainian issuers regain access to international capital markets there is no doubt that the conventional DCM deals discussed in this article will be done again. Perhaps, we will also see other transactions in Ukraine from the rich cornucopia of international financial instruments, in particular issuances of euro-commercial paper.
