Capital, or equity, markets in Ukraine have grown considerably over the last few years, increasingly becoming one of the main spheres for (foreign) investment in financial instruments. Over the last three years, the capitalization of the equity markets in Ukraine increased from 10% of Ukraine's gross domestic product in 2003 to 42% of Ukraine's GDP in 2006. The volume of securities transactions in 2006 amounted to more than Hrn492 billion ($97 billion).

The attractiveness and development of the Ukrainian capital markets is reflected by the increasing of number of professional participants investing and circulating private equity from domestic and foreign sources. At the beginning of 2007, 805 companies were registered as securities trading companies, 354 as securities registrars, 157 as securities custodians and 10 as organizers of trade in securities (among which eight were stock exchanges).

Despite these indicators of a buoyant market, transactions on the capital markets in Ukraine remain polarized. The main areas of investment through the capital markets remain the manufacturing industry, wholesale and retail trade, transport services and agriculture, while the preferred means of attracting financial and capital resources is the issuance of shares, investment certificates and bonds of legal entities. But changes in these trends are expected, especially in the light of Ukraine's aim to further attract domestic and foreign investments to its capital markets.

Legislative framework

An act on securities and the stockmarket was adopted in 1996, but it is not satisfactorily comprehensive. Consequently, a diverse and wide-ranging set of legislative and regulative acts constitute and govern the field of capital markets and securities in Ukraine, the most important of which are:

• The Civil and Commercial Codes of Ukraine.
• The Act on Securities and the Stockmarket, Act 3480-IV, adopted on February 23 2006, which entered into force on May 12 2006.
• The Act on the State Regulation of the Stockmarket, Act 448/96, adopted on October 30 1996, which entered into force on November 26 1996.
• The Act on the National Depositary System and Specifics of the Electronic Circulation of Securities in Ukraine, Act 710/97-IV, adopted on December 10 1997, which entered into force on January 6 1998.
• The Act on Companies, Act 1576-XII, adopted on September 19 1991, which entered into force on October 1 1991.
• The Act on the Circulation of Promissory Notes, Act 2374-14, adopted on April 5 2001, which entered into force on May 4 2001.
• The Act on Mortgage, Act 898-IV, adopted on June 5 2003, which entered into force on January 1 2004.
• The Act on Mortgage lending, Transactions with Consolidated Mortgage debts and Mortgage-backed Certificates, Act 979-IV, adopted on June 19 2003, which entered into force on January 1 2004.
• the Act on Mortgage-backed Bonds, Act 3273-15, adopted on December 22 2005, which entered into force on January 24 2006.

The field of private equity in Ukraine remains underdeveloped. The first and only legislative act was adopted in 2001: the Act on Instruments of Joint Investment, Act 2299-III, adopted on March 15 2001.

Various special regulations adopted by executive bodies and administrations, as well as the National Bank of Ukraine and the Ukrainian State Commission on Securities and the Stockmarket, apply in the issuance and subscription of securities, licensing of issuers and traders of securities, and the registration of securities.

The SCSSM

The main state authority that governs and controls capital markets in Ukraine is the Ukrainian State Commission on Securities and the Stockmarket (the SCSSM). The SCSSM reports to the president of Ukraine and is accountable to the parliament of Ukraine.

The SCSSM stands independent from the National Bank of Ukraine, but also performs registration and licensing tasks. For instance, all shares of a joint stock company established under the Ukrainian law must be registered with the SCSSM. The SCSSM performs, among others, the following functions:

• Issuing licences for professional activities in the capital markets, such as securities trading, asset management of investment funds, depository activity, activity on the organization of securities trading on the stockmarket.
• Registration of issues of investment certificates of capital venture funds.
• Registration and control of professional traders and participants on the stockmarket.
• Establishing orders and rules for the issuance and circulation of securities.
• Issuing permits and licences for the circulation of securities.
• Imposing fines for the violation of the rules governing the capital markets and securities.
• Annulment of permits and licences in response to violations of the rules governing the capital markets and securities.

The SCSSM also cooperates and coordinates with the National Bank of Ukraine with regard to adopting special rules on the issuance of securities by banks, as well as monitoring the compliance of domestic and foreign entities and individuals operating on the stock and equity markets with the legal requirements governing securities and stockmarket operations in Ukraine.

The SCSSM participates in the International Organization of the Commissions on Securities that unites stockmarket regulators from more than 80 countries worldwide. By having access to the information and normative basis of the state regulation bodies of stockmarkets around the world, the Ukrainian SCSSM can enhance the modernization and harmonization of stockmarket rules and practices in Ukraine. In the framework of its international profiling, the SCSSM has signed three memoranda on mutual agreement and cooperation with the State Commission on Securities of Moldova, the Supervising Commission on Securities of the People's Republic of China and the Federal Commission on Stockmarkets of Russia.

Private equity

Private equity is a new phenomenon in Ukraine, recognized only in 2001 with the adoption of the Act on Instruments of Joint Investment. Instruments of joint investment are corporate investment funds or share investment funds that collect, invest and manage private equity of investors into securities on the capital markets, with the aim of generating profits for the funds and redistributing those profits to the initial investors. At the beginning of 2007, 130 instruments of joint investment were operational throughout Ukraine, 54 of which were in Kyiv.

Three main types of (corporate or share) joint investment funds can be distinguished in Ukraine:

• Open joint investment funds. The private equity fund manager commits to redeem the securities issued by the joint investment fund upon the first demand of the investors.
• Interval joint investment funds. The private equity fund manager commits to redeem the securities issued by the joint investment fund during the term stipulated in the offering memorandum, but at least once a year.
• Closed joint investment funds. The private equity fund manager commits to redeem the securities issued by the joint investment fund only at the moment of the reorganization or liquidation of the fund.

Joint investment funds may be established for a fixed term, upon the expiry of which the fund will be liquidated or reorganized, or without a fixed term, so created for an indefinite term. Joint investment funds may be diversified or non-diversified. Subject to certain establishment and formal conditions, a joint investment fund would be deemed diversified if:

• The amount of securities of one issuer in the fund does not exceed 10% of the total volume of the securities issue.
• The total cost of the securities in the fund that exceed 5% of the total volume of the securities issue does not exceed 40% of the total net asset value of the fund at the moment of its establishment or acquisition.
• At least 80% of the total net asset value of the fund is constituted of monetary assets, savings certificates, corporate bonds and municipal and state bonds, as well as other securities that are admitted to auctions on a stock exchange or on the PFTS.

Only diversified joint investment funds may be open or interval joint investment funds, while both diversified and non-diversified joint investment funds may be closed joint investment funds.

A closed non-diversified joint investment fund that undertakes placement of private equity in securities of which more than 50% consist of corporate rights and securities that cannot be traded at stock exchanges or on the PFTS is considered a venture fund. Only legal entities may participate in a venture fund.

Corporate investment funds

A corporate investment fund assumes the nature of an open joint stock company that exclusively performs joint investment activities and is managed by its general meeting of founders and a supervisory council. (Other bodies may not be created.) Although the corporate investment fund is, in principle, established as any other open joint stock company, it may not be founded by legal entities in which the state or municipal authorities hold a participation in the registered capital that exceeds 25%.

A corporate investment fund may not unlimitedly undertake commercial activities. So a corporate investment fund may not: (i) issue and place securities other than the simple shares it issues itself and which cannot be placed at a cost lower than their nominal value; (ii) obtain credits or loans the amount of which exceeds 10% of its assets; (iii) give assets as pledge on behalf of third persons; or (iv) create special or reserve funds.

Share investment funds

Contrary to a corporate investment fund, a share investment fund is not a legal entity. A share investment fund is a joint property fund of assets contributed by investors and managed by an asset management company. A share investment fund is founded by an asset management company by way of subscription of its shares by investors, who receive investment certificates attesting their investment contributions in the fund. Investors in a non-diversified share investment fund may only be legal entities (whether Ukrainian or foreign), whereas investors in diversified share investment funds may be also natural persons. Foreign contributions and investments in a share investment fund may not exceed 20% of the total nominal value of the fund's assets.

An asset management company is a legal entity performing exclusively professional asset and equity management activities on the capital markets and stock exchanges, on the basis of a special licence issued by the SCSSM for a term of five years and at a cost of Hrn2000. However, an asset management company may manage several share investment funds simultaneously.

All asset management companies in Ukraine must be members of a self-regulating organization, the registered capital of which may not be less than €300,000 and the participation in which by state or municipal authorities may not exceed 10%.

As is the case for corporate investment funds, the rights and operations of an asset management company that holds the assets of a share investment fund are not unlimited. An asset management company, while operating with assets of a share investment fund, may not: (i) buy shares issued by the share investment fund or sell its own shares to the share investment fund; (ii) alienate private equity assets of the share investment fund on a non-payable basis; (iii) provide loans from the assets of the share investment fund; (iv) purchase real estate from the share investment fund; or (v) sell assets of one share investment fund that it manages to another share investment fund that it simultaneously manages. In other words, the asset management company cannot undertake commercial transactions between itself and the share investment funds it manages.

In the exercise of its private equity asset management activities, the asset management company bears responsibility for damages incurred to the share investment fund and must reimburse damages incurred to the share investment fund that provided open subscription of its securities if, within a year, the price of the securities of the share investment fund drops to less than 80% of the securities' nominal value as a result of the asset management company's violation of legislative and regulative prescriptions.

Securities

A security is defined in Ukrainian legislation as a properly established and legalized document containing the appropriate requisites that confirms the property or other rights over the security and establishes the relations between the issuer of the security and its owner. A security also makes provision for the fulfilment of obligations it encompasses, as well as the transfer of rights that emanates from the security.

The Ukrainian legislation recognizes and governs most common types of securities, including equity securities (among others: shares of capital stock and investment certificates), debt securities (such as deposit certificates, promissory notes, bills of exchange, treasury bills, municipal bonds, state bonds and corporate bonds), mortgage-backed securities (such as mortgage-backed bonds and certificates, mortgage receipts and certificates of funds of real estate operations), derivative securities, commodity-linked securities and privatization securities. However, equity and debt securities remain the predominant forms of securities issued and traded in Ukraine and on the Ukrainian stockmarkets.

Equity securities

Equity securities are securities that confirm the participation of the owner of the security in the registered capital of legal entities and entitle its owner to the proceeds and income generated on the security.

Ukrainian equity securities may be subdivided into two distinct categories: shares in the registered capital and investment certificates.

Shares in the registered capital

A share is defined as a security that certifies the property rights of its owner over a part of the registered capital of a joint stock company. So only joint stock companies may issue shares, which are, upon its establishment, divided between its founding members (in the case of a closed joint stock company) or publicly subscribed (in the case of an open joint stock company). Owning a share in a joint stock company entails the right to enjoy a part of the profits of the joint stock company in the form of dividends, to obtain a part of the company's property in the event of its liquidation, and to contribute to the management of the company.

The Ukrainian Act on Securities and the Stockmarket distinguishes between simple and preferential shares, all of which must obligatorily be issued in nominative form. Preferential shares imply the prevailing rights of its owner over the owners of simple shares with respect to obtaining a share in the profits of the company or in the property of the company in case of its liquidation. The amount of preferential shares in the registered capital of a Ukrainian joint stock company may not exceed 25% of its registered capital.

The nominal value of a share may not be less than Hrn0.01.

Investment certificates

Investment certificates are defined as securities that are distributed by venture funds, investment companies or asset management companies of the venture funds and certify the investor's property rights in the respective company or fund. Investment certificates may be distributed among a limited number of investors or publicly distributed depending on the type of venture fund. Similarly to shares of joint stock companies, investment certificates entail the right of their owners to enjoy a part of the profits of the investment fund.

Due to the growing number of joint stock companies being registered in Ukraine, including by foreign investors, the importance of shares, and in particular shares in open (that is, public) joint stock companies, cannot be underestimated as an instrument on the equity markets in Ukraine. Investment strategies of foreign investors might differ considerably from one to another, but the acquisition and trading of equity securities in the form of shares in open joint stock companies enables foreign investors to balance risks against the opportunities on the highly dynamic and fluid equity markets in Ukraine.

Debt securities in Ukraine

Debt securities are securities that certify the obligation of the issuer of the security to pay a given capital to the owner or bearer of the security, under the terms and conditions pertaining to the security.

Ukrainian debts securities can be subdivided into state debt securities (primarily municipal and state bonds, but also exchequer securities) which are issued by the self-government administrations, the parliament of the Autonomous Republic of Crimea and other state authorities on behalf of Ukraine, and other debt securities (such as deposit certificates, promissory notes, bills of exchange, treasury bills and corporate bonds), which are issued by private legal entities.

State debt securities

State bonds retain an important role in the Ukrainian capital markets, due to the lingering involvement of the state in the domestic economy and its participation in the Ukrainian capital markets.

Several types of state (discount) bonds exist: (i) bonds of interior state loans offered on the interior stockmarket and certifying the obligations of Ukraine to pay to its bearers the nominal value of these securities and the profit from these securities according the conditions of offering; (ii) special purpose bonds of interior state loans, the issue of which constitutes a source of refinancing the state budget deficit; (iii) bonds of exterior state loans issued, serviced and repaid by the Ukrainian Ministry of Finance and offered and traded on the international stockmarkets (usually Eurobonds).

Exchequer (or treasury) securities are state bonds that are offered merely to natural persons and legal entities that have the right to obtain profit from them. The issuer of exchequer securities is the Ministry of Finance, whereas the general agent performing the distribution, deliverance, circulation and repayment is the Savings Bank of Ukraine. Exchequer securities are issued in documentary or non-documentary forms, nominative or to bearer. The capitalization of the exchequer securities is performed on the basis of the state budget profits or by means of reimbursement of the holder's debts to the state budget.

Non-resident natural persons or legal entities may purchase state debt securities in a restricted amount, determined case-by-case by a special commission formed jointly by the National Bank of Ukraine and the Ukrainian Ministry of Finance. The purchase of state debt securities by foreign natural persons or legal entities is considered foreign investment in Ukraine. Also, non-resident investors may only acquire state debt securities at authorized commercial banks, the list of which must be adopted by the same special commission. The commercial banks act on behalf of the non-resident investors on the basis of agreements and buy the state bonds at an auction that is organized and undertaken by the National Bank of Ukraine. However, the National Bank of Ukraine may directly allocate state bonds to non-resident investors if they acquire state bonds in an aggregate amount exceeding $100.

Municipal bonds may be issued by the parliament of the Autonomous Republic of Crimea or the municipalities and confirm the obligation of the respective issuer to pay to the security bearers the nominal value of these securities and the profit from them according to the conditions of offering, on the account of the local budget.

Other debt securities

Deposit certificates are defined as securities that testify the right of their owner to obtain the sum deposited on a bank deposit and interests stipulated in the deposit certificate. Deposit certificates are distributed for a certain period of time, after which the owner has the right to obtain the sum of the deposit and the total sum of calculated interests. In the event of the pre-timely submittal of the deposit certificate to the bank, the sum of calculated interests will be decreased.

Promissory notes are securities testifying the single bond of the issuer, while bills of exchange testify the issuer's instruction (command) given to a third person to pay the defined sum to the holder of the promissory note after a certain period of time. Promissory notes and bills of exchange may only be issued in documentary form. As Ukraine is a party to the 1930 Geneva Convention on the unification and harmonization of the Act on promissory notes and bills of exchange, the rules stipulated in the Convention apply in Ukraine.

Corporate bonds are securities that confirm the obligation of the issuer to return the nominal value of the bond to the owner of the corporate bonds within a certain period of time and to pay out the related profit, if this is stipulated in the terms of issuance of the given corporate bond. Corporate bonds may be issued only if the registered capital of the respective legal entity is paid up in full. The aggregate value of the issued corporate bonds may not exceed the treble amount of the available equity of the legal entity. Corporate bonds must be registered at the SCSSM.

Transfer of securities rights

Securities in Ukraine may be issued in nominative (registered) form, in order form or in bearer (anonymous) form (although securities and shares issued by joint stock companies may only take the bearer form). Also, securities may take a documentary (certificated) or non-documentary (book-entry or electronic) form. Ownership titles of documentary securities must be registered at a registrar of securities.

The ownership titles and rights to documentary securities are transferred by way of full endorsement of the securities, as confirmed by the securities' certificates.

The ownership title and rights to documentary bearer securities are transferred by physical delivery of the securities by the former owner to the new owner, as attested by the securities' certificates.

The ownership title and rights to non-documentary securities occurs by crediting the owner's account kept at the securities custodian, and evidenced by the extract from the custodian's register.

Depository system

The depository system in Ukraine consists of the National Depository of Ukraine and other depositories on the one hand, and the registrars of owners of securities and the custodians of securities on the other hand.

National Depository of Ukraine

The National Depository of Ukraine is an open joint stock company in which the Ukrainian state is the majority shareholder on a statutory basis. The Ukrainian state holds 82% of the shares of the National Depository of Ukraine. The National Depository of Ukraine maintains accounts on securities of all depositories in Ukraine, strives towards a standardization and unification of securities circulation, and regulates and supervises stockmarket operations and activities.

Depositories are licensed open joint stock companies that are founded by at least 10 custodians, the share of each not exceeding 25% of the registered capital of the company. They may only be involved in depository activities with securities, such as the registering and maintaining universal certificates pertaining to the issuance of securities by Ukrainian issuers, maintaining accounts for custodians of securities or issuers of securities, and undertaking clearing and settlement activities regarding securities transactions. Accounts are maintained for custodians or issuers of securities on the basis of an agreement on the servicing of securities between the custodian or issuer of securities and the depository.

Depositories must be licensed by the SCSSM to carry out depository activities. This licence is generally valid for 10 years. The cost per licence is Hrn10,000.

Securities registrars

The registrar of documentary securities is the issuer of the registered securities. The issuer of securities may only register the securities on condition that it has obtained a licence from the SCSSM to maintain a register of the owners of documentary nominative securities. The issuer of securities may only receive the licence if the total number of owners of securities does not exceed 500.

Alternatively, if the issuer of the securities does not register the documentary nominative securities or if the number of owners of securities exceeds 500, a licensed special purpose legal entity may act as an independent registrar of the securities. State bodies and administrations may not be founders or members of the independent registrar legal entity. In addition, any issuer of securities may not hold more than a 10% participation in the registered capital of an independent registrar.

Securities custodians

Ownership titles and rights held by foreign legal entities over securities issued by Ukrainian issuers must be registered at and accounted by the relevant securities custodians. Custodians must be either commercial banks licensed by the National Bank of Ukraine and holding a special custody licence obtained from the SCSSM, or traders of securities that have acquired a custody licence from the SCSSM to preserve and service the turnover of the securities on the securities accounts. A custodian may not at the same time be a registrar of owners of securities with which it transacts. The custody and servicing of securities is undertaken on the basis of an agreement on the opening of an account in securities between the owner of the securities and the custodian.

Securities trading

Securities trading in Ukraine is subject to a securities trading licence. Only joint stock companies with registered capital that consists entirely of registered securities, or any other legal entity, such as a limited liability company, whose sole activity consists in trading securities on the capital markets, may receive a securities trading licence from the SCSSM, subject to the fulfilment of all licensing conditions.

These licensing conditions are:

• The licensee must take part in at least one self-regulating organization of professional participants on the stockmarket.
• It must be registered in the state register of financial organizations (with the exception of banks).
• Qualification demands for certificated specialists of the licensee must be met.
• Proper technical provision must be present.

The SCSSM makes its decision as to whether or not to allocate a securities trading licence within 30 days from the date of receiving the relevant application and all needed documents. Securities trading licences are valid for five years. Costs vary in regard to the intended securities trading activities: for brokerage and dealer activities the registration fee is Hrn1,700, for underwriting and management of securities it is Hrn2,000.

Upon receiving a securities trading licence, the licensee may undertake the issuance of securities (underwriting), brokerage, dealer activities and management of securities.

Underwriting securities

The subscription or sale of securities, on behalf and on the account of the issuer of the securities, may only be exercised by securities traders whose registered capital is at least Hrn600,000 and has been fully paid up.

Brokerage

Brokerage, that is, acting as an agent for undisclosed principals on the basis of an agency or commission agreement, may only be exercised by securities traders whose registered capital is at least Hrn300,000 and has been fully paid up.

Dealer activities

Dealer activities, that is, the conclusion of civil contracts by the seller of securities on its own behalf and for its own account, with the aim of reselling the securities, may only be exercised by securities traders whose registered capital is at least Hrn120,000 and has been fully paid up.

Securities management

Securities management activities, on the basis of a securities management agreement between the manager and the investor, may only be exercised by securities traders whose registered capital is at least Hrn300,000 and has been fully paid up.

Stock exchanges

Nine stock exchanges operate on the Ukrainian capital equity markets, the oldest and largest of which is the Ukrainian Stock Exchange established in October 1991. The traded volume of the Ukrainian stock exchanges in 2006 was more than Hrn239 million (the stock trade volume in 2005 was about Hrn780 million; this decrease in stock trade volume relates to the decrease of privatization and the slow-down of activities on the derivative securities market).

Stock exchanges may be established as commercial legal entities (either limited liability companies or joint stock companies) or as subsidiary enterprises of associations of securities traders. A stock exchange must have at least 20 founders, all registered as licensed securities traders or associations of securities traders that comprise at least 20 members. The registered capital of a stock exchange that does not perform clearing and settlement services must be not less than Hrn3 million and at least Hrn6 million for a stock exchange that performs clearing and settlement services. Also, the profit generated by a stock exchange through its activities must be reinvested in the stock exchange's development and cannot be distributed between its founders.

Stock exchanges must be state registered in the same order established for commercial legal entities and licensed by the SCSSM. The licence is valid for 10 years, and the cost of the license is Hrn8,500.

Trading on the stock exchanges is governed and regulated by the respective stock exchange's rules of conduct, which must be registered at the SCSSM.

Apart from the traditional low-volume stock exchanges, securities are traded in ever increasing volumes and capitalization values on the fully electronic PFTS stockmarket trading system. The PFTS is a self-regulating, SCSSM-licensed organization. State and corporate bonds remain the most traded securities on the PFTS and accounted for 35.51% of the total market turnover in 2006. Trade on the PFTS is performed through licensed security traders and is possible from 11am until 5pm. The growth of the PFTS stock index in 2006 was 7.73%.

Under the spotlight

Despite the rapidly growing number of traded companies in Ukraine (there are now over 250), the increasing dynamism of the Ukrainian capital markets and the recent modernization of the legislative framework for securities trading, Ukrainian capital markets are still characterized by a number of weaknesses. The Ukrainian capital markets are highly fragmented, exceedingly illiquid, and lack price stability and transparency.

One of the symptoms of the embryonic character and volatility of the Ukrainian stock exchanges are the lasting variations of daily demands and the spreads between bid and offer prices of securities. Further compliance with international standards of transactions with securities is necessary to increase the international competitiveness of Ukrainian stock exchanges and the capital markets.

The rights of minority shareholders should also be further strengthened and received increased regulatory protection, as minority shareholders' interests are often discarded in the process of alienation and acquisition of securities.

However, taking into consideration the recent diversification of the forms of securities encountered on the Ukrainian capital markets, the optimistic growth patterns and increasing capitalization of the capital market (over 42% of the Ukrainian gross domestic product), the diversification of types of securities and the introduction of mortgage securities onto the capital markets, and the growing interest of foreign investors in the Ukrainian capital markets and stock exchanges, the Ukrainian capital markets have come under the foreign investment spotlight. They show promising prospects, particularly for foreign mid-cap private equity investors.