Steady growth

Author: | Published: 29 Sep 2008
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Since 2000, Ukraine's capital markets have been growing at a steady pace and more financial instruments have gradually been added to the market. Capital markets had their start in Ukraine with sovereign bond issuances, followed by municipal and corporate Eurobond offerings and IPOs, and now private placements and converted securities offerings. In fact, Ukrainian capital markets transactions involve offerings of securities of Ukrainian issuers abroad, which are primarily done via special purpose vehicles (SPVs) and foreign holding companies. However, in most cases, the underlying assets are Ukrainian operating companies.

Equity markets

Since its first IPO back in 2005, Ukraine has seen several large corporate groups successfully launching their public offerings on the international capital markets. The range of venues for such listings has included the London Stock Exchange (LSE), both the main market and AIM, the Warsaw Stock Exchange (WSE) and the open market of the Frankfurt Stock Exchange. The issuers have represented various industries, including iron ore production, food production and real estate development. The largest listing was the IPO of Ferrexpo on the main market of the LSE with the total amount raised exceeding £213 million ($351 million).

In November 2007, Kernel Group, the largest Ukrainian vegetable oil producer, completed a very successful IPO on the WSE, raising a total of Hrn400 million ($62.5 million). The Kyiv-based real estate developer KDD Group finished the year amid turmoil on the financial markets by raising $130 million on AIM in December 2007.

In 2008, so far only Myronivsky Hliboproduct (MHP), the leading chicken meat producer in Ukraine, successfully raised another $371 million on the main market of the LSE.

However, starting from late spring 2008, as the effects of the credit crunch continued, the market trend in Ukraine changed from IPOs to private placements and auction sales. As equity investments have continued to be attractive as compared to debt, the leading investment banks on the Ukrainian market have developed a new package, offering to investors shares in a foreign holding company, which are either unlisted or are listed on the open market of the Frankfurt Stock Exchange (which is an unregulated market for purposes of the Prospectus Directive). As an alternative, they have often offered a dual-track setting by allowing investors to choose, in addition to an IPO or a private placement, the alternative route of an auction sale with one or two investors selected as the final bidder(s) for a minority stake in the foreign holding company.

The reasons for having a foreign holding company as the listing vehicle are found in the Ukrainian securities legislation. In particular, Ukrainian law requires that the shares of a Ukrainian issuer must be denominated in Ukrainian hryvnia, which creates an uncomfortable currency exchange risk, given that the hryvnia is not a freely convertible currency. Furthermore, there is a 25% limitation on the amount of its shares that a Ukrainian issuer may issue abroad. To list abroad, the Ukrainian issuer must have also first listed in Ukraine, which requires extensive dealings with the Ukrainian securities regulator.

The last, but not the least, relevant factor is the undeveloped corporate governance standards in Ukraine. The Ukrainian Companies Law has been in effect since 1991 and, despite numerous changes, it does not meet the present day requirements for corporate governance. Attempts to enact a modern Joint Stock Companies Law had been thwarted for more than eight years by the continuing political skirmishes within the Ukrainian parliament and between the parliament and Ukraine's Cabinet of Ministers, until this law was finally adopted by parliament in September 2008. If it is signed by Ukraine's president, it is scheduled to come into effect in spring 2009.

Debt markets

Until early 2007, when the news about the credit crunch hit the market, the debt capital markets were the predominant source of relatively cheap long-term funds for Ukrainian businesses. The six-year history of Ukrainian corporate and municipal Eurobond offerings was launched when Kyivstar, the leading Ukrainian mobile operator, made its debut Eurobond offering back in 2002. The range of venues for the listing of such Eurobond offerings has included the Luxembourg Stock Exchange, the London Stock Exchange, the SWX Swiss Exchange and the Irish Stock Exchange. The issuers have represented various industries including banking, telecoms, metallurgy, oil and gas, food production, real estate development and chemical products.

Because of certain Ukrainian legal restrictions disallowing the direct issuance of Eurobonds by Ukrainian corporate and municipal issuers, in most cases non-sovereign Eurobond offerings from Ukraine have been structured as the issuance of loan participation notes (LPNs) with certain variations. Among the utilised LPN structures have been: (i) a bank-loan structure involving the issuance by an overseas bank of limited recourse loan participation notes and a loan being financed from the issuance proceeds; (ii) a two-tier structure involving an overseas bank as the lender to the Ukrainian borrower and a separate SPV as the issuer of the limited recourse loan participation notes; and (iii) an SPV structure involving the issuance of notes by an overseas SPV, with the payments under the notes being guaranteed by the Ukrainian borrower and a loan being financed from the issuance proceeds. Such structuring variations have mostly been driven by tax considerations, as well as by the legislative restrictions applicable to certain types of Ukrainian issuers.

In particular, under the applicable Ukrainian legislation, municipalities may borrow a loan only from a bank. Until recent changes in the applicable regulations of the National Bank of Ukraine (NBU), a Ukrainian commercial bank was allowed to borrow a loan in a foreign currency only from a foreign bank or financial institution under the laws of its jurisdiction of registration. This requirement is no longer in effect. Nonetheless, a Ukrainian bank-borrower is required to make mandatory provisioning for any loan received from a lender that is not a bank or an international financial institution (such as EBRD and IFC). In addition, the Commercial Code of Ukraine contains a provision that any Ukrainian borrower may borrow from a foreign financial institution. Normally, such a provision is not seen as restrictive and is regarded as declaratory.

The adoption of the Prospectus Directive, which imposed on issuers a higher standard of responsibility for disclosure documentation, affected the earlier-used LPN structures (the bank-loan structure) and resulted in the need for lead managers or arrangers to find new structuring solutions and to move from the traditional venues (London or Luxembourg, for example) to a safe-harbour stock exchange with less restrictive disclosure requirements (the Swiss Stock Exchange, for example).

Following the Ukrainian securities regulator's attempts to reform the regulation of Eurobond issuances by Ukrainian issuers, the new Ukrainian Securities Law, which came info effect on May 13 2006, removed the requirement of the denomination of corporate bonds only in Ukrainian hryvnia, which was one of the primary obstacles for the direct issuance of Eurobonds by Ukrainian issuers. However, a similar restriction still remains in the Commercial Code of Ukraine, leaving some uncertainty as to the permissibility of a direct issuance of Eurobonds by a Ukrainian issuer. Furthermore, a direct issuance of Eurobonds by a Ukrainian corporate issuer is also problematic because of a still effective (though obsolete) regulation of the Ukrainian securities regulator, which provides for certain onerous requirements, including: (i) the prior approval of the Ukrainian securities regulator must be obtained for the placement of Ukrainian corporate bonds outside of Ukraine; (ii) before listing abroad, the Ukrainian issuer must have a listing in Ukraine; (iii) the listing at the foreign stock exchange must be approved by the Ukrainian securities regulator; and (iv) the purchase price of such corporate bonds may not be less than their par value or market value as indicated on the Ukrainian stock exchange or the over-the-counter (OTC) system.

In response to market demand, starting from 2006 new structures of Eurobond borrowings have been developed in order to ensure the continuing interest of investors. Such new Eurobond structures have featured a number of structuring aspects and solutions that were novel for Ukraine. In November 2006, MHP, one of the largest agro-industrial enterprises in Ukraine, completed a $250 million Eurobond offering under Rule 144A and Regulation S, which was listed on the LSE. That offering was remarkable because it was the first issuance of high yield notes in the international markets to fund a loan to Ukrainian borrowers. Furthermore, a new structure was applied whereby the offering was structured as an offering of Eurobonds by MHP's Luxembourg holding company of MHP with upstream guarantees from the principal Ukrainian operating companies of the MHP Group and pledges of the loan proceeds for the benefit of the noteholders, with a multi-borrower loan agreement.

In January 2007, shortly after the MHP Eurobond offering, Privatbank, the largest commercial bank in Ukraine in terms of assets, successfully completed its $500 million five-year Eurobond offering under Rule 144A and Regulation S, which was listed on the Swiss Stock Exchange. The transaction was structured as an offering of guaranteed notes by UK SPV Credit Finance plc, a UK-based SPV, with the obligations under the notes being guaranteed by Privatbank.

In May 2007, when the market first signalled the declining interest of investors in debt, XXI Century, one of Ukraine's leading real estate development companies, managed to raise $175 million through a Eurobond offering of guaranteed secured notes listed on the Luxembourg Stock Exchange's Euro MTF Market. The deal was structured as an offering of guaranteed secured notes by XXI Century Public Limited, the Cyprus holding company of XXI Century, supported by guarantees from XXI Century's Ukrainian operating companies and, among other security arrangements, secured by a pledge of the shares of one of those companies. 2007 also saw the first private convertible bond issuance by one of Ukraine's large gas chains.

So far in 2008, few public debt deals have closed. Notwithstanding the low level of investors' hunger for debt, UkrSibbank, which is the third largest Ukrainian bank in terms of assets, raised $250 million under the established $2 billion Medium Term Note (EMTN) Programme. The offering was structured as an issuance of loan participation notes under Rule 144A and Regulation S, with the listing on the LSE. It was the third EMTN Programme established by Ukrainian issuers since 2007.

Apart from market reasons, the ability of Ukrainian businesses to borrow in foreign currency has been hampered by the relatively heavy NBU regulation of borrowings in foreign currency, including a still quite strict currency control regime. In particular, under the applicable NBU regulations: (i) any loan agreement in respect of a foreign loan to a Ukrainian non-banking borrower; and (ii) any loan agreement in respect of a foreign loan with a Ukrainian borrower that is a bank, where the loan's maturity exceeds one year, must be registered with the NBU before any disbursement of the loan may be made. To be eligible for registration with the NBU, a loan agreement must comply with the applicable maximum interest rate limitation. The NBU regularly announces maximum interest rates for foreign loans, which are limitations on the rate (or the amount) of the cost of borrowing for the borrower (on all payments by the borrower related to the use of the loan, which are deemed to include all of the borrower's payments in respect of the loan, other than the repayment of the principal amount of the loan). However, as a result of the recent developments in international financial markets affected by the credit crunch, the NBU has relaxed foreign borrowing requirements by removing the maximum interest rate limitations for all loans (other than subordinated loans) with a maturity of over one year that have been in place since 2004. The maximum interest rate limitation for loans with a maturity of up to one year has been increased from 9.8% to 11%. A loan agreement must contain certain specific provisions, including a provision that the loan agreement becomes effective from the date of its registration with the NBU, and a provision limiting the amount of all of the payments under the loan agreement (other than principal payments) to the amount resulting from the application of the interest rate, registered by the NBU for that loan agreement, to the principal amount prepaid.

Securities market

In 2006, the new Ukrainian Securities Law came into effect with the purpose of introducing better regulation of the Ukrainian securities market and securities issuances. It also introduced the notions of disclosure and underwriting to the Ukrainian securities market. However, the disclosure requirements embodied in the Securities Law are still far from the detailed disclosure requirements of the Prospectus Directive adopted in the EU. The practice resulting from the application of such disclosure requirements also remains limited, as there have been few public offerings of shares on the Ukrainian securities market since the adoption of the law. The level of required disclosure is quite superficial, and the Ukrainian SEC is only beginning to seriously regulate the market.

An actual listing may be one of two types: a first or second-level listing. For a first-level listing, the issuer must have existed in the Ukrainian market for at least three years, have net assets of at least $20 million, have annual sales of at least $20 million, have no financial losses in its last two financial years, have a market capitalisation of at least $20 million, have a minimum trading of its shares occurring in the last six months and have at least 500 shareholders. There are also some other formal requirements.

For a second-level listing, the issuer must have existed for at least one year, have net assets of at least $10 million, have annual sales of at least $10 million, have no financial losses in its last financial year, have a market capitalisation of at least $20 million, have a minimum trading of its shares occurring in the last six months and have at least 100 shareholders. There are also some other formal requirements.

Nevertheless, the shares of a Ukrainian company may be traded on the stock exchange (such as the PFTS, a leading Ukrainian stock exchange) without a formal listing. Trading without a listing is a very simple but formal procedure that requires the filing of several simple applications, copies of the issuer's constituent documents and the issuer's prospectus registered with the Ukrainian SEC. The trading and listing of shares of non-Ukrainian companies on a Ukrainian stock exchange, including foreign (non-Ukrainian) holding companies of Ukrainian groups, require the special approval of the Ukrainian SEC, which has not been done so far on the Ukrainian market.

Depositary receipts

A new financial instrument that is being actively considered and evaluated by investment banks and lawyers is the direct issuance of depositary receipts (DRs) by Ukrainian companies.

Formally, there is nothing to prevent a Ukrainian company listing its shares in the form of DRs on a foreign stock exchange, whether as primary or secondary securities. However, there are several restrictive factors involved with this instrument. First, there is the outdated Ukrainian corporate legislation, which does not offer potential investors adequate protection in the area of corporate governance. Second, while the Ukrainian issuer may announce its intention to comply with the UK Combined Code and to put in place those corporate governance structures commonly expected by international investors (such as independent, non-executive directors and board committees), such undertakings would be of a contractual nature only (not supported by the existing Ukrainian corporate legislation) and their enforcement in the Ukrainian courts would be uncertain.

If a primary offering is considered in addition to a secondary offering, then the Ukrainian issuer will need to go through the lengthy and complicated procedure of registering the issuance of the new shares with the Ukrainian securities regulator. This process is likely to involve a significant time gap between the payment for the DRs by the investors and their receiving title to the securities, which may further serve as a negative factor for many investors.

In the case of the offering of secondary DRs, there may arise potential negative capital gains tax consequences for the selling shareholder if the offering comprises the sale of DRs representing the shares of a Ukrainian company.

Author biographies

Mykola Stetsenko

Baker & McKenzie

Mykola Stetsenko is a partner at the Kyiv office of Baker & McKenzie. His primary focus is on the areas of capital markets, mergers and acquisitions and corporate law. He advises numerous Ukrainian and international clients in connection with their IPOs, private placements and acquisitions.

Mykola holds a degree with honours in international law from the Institute of International Relations of the Taras Shevchenko Kyiv National University. He spent one year studying at the Georgetown University Law Center (Washington DC) as a Muskie fellow under the Edmund S Muskie Program and received an LLM with distinction in 2004. His areas of specialisation at Georgetown included corporate law and finance. Before joining Baker & McKenzie in February 2000, Mykola worked as a junior attorney at several Ukrainian law firms.

The 2008 edition of Legal 500 regards Mykola highly and recommends him for both corporate and equity capital markets in Ukraine. The most recent edition of the Ukrainian Legal Market Research Programme names him among the top ten Young Hopefuls among Ukrainian Lawyers.

Among recent IPO projects for Ukrainian companies on which Mykola was the key attorney of the Kyiv office team are the following: an IPO of GDRs on the London Stock Exchange for MHP SA, the AIM admission of XXI Century Investments Public Limited, listings on the Warsaw Stock Exchange of two big Ukrainian agribusiness participants (Astarta and Kernel) and the IPO of KDD Group on AIM.

Glib Bondar

Baker & McKenzie

Glib Bondar is a partner in Baker & McKenzie's banking and finance practice group based in Kyiv, with a main specialisation in capital markets, securitisation and structured finance, general banking and finance and bank and corporate lending. Since joining the Kyiv office of Baker & McKenzie, Glib has worked on nearly all Eurobond offerings from Ukraine, including sovereign, municipal and corporate debt offering transactions. He also has extensive experience in advising borrowers and lenders on various types of credit facilities, securitisation transactions and structured finance.

Glib joined Baker & McKenzie in October 2001. Before that, he worked for the Kyiv office of another international law firm. He graduated from the law department of the Kyiv National Taras Shevchenko University in 2000 (diploma with honours). In 2001, he received an LLM from the Columbia School of Law.

The 2008 edition of Legal 500 recommends Glib as a leading specialist in Ukraine. According to the research held by the Ukrainian Law Firms Handbook, he is ranked among the top-tier practitioners in Ukraine for international finance.

Glib has developed a proven expertise in advising both foreign and domestic financial institutions and corporate clients on various aspects of Ukrainian banking and finance legislation, as well as representing issuers and lenders in a number of capital markets transactions. Recent capital markets projects in which Glib was heavily involved include the issuance of loan participation notes of JSC Bank UkrSibbank under an MTN programme, the Eurobond issuance by the City of Kyiv, the MTN programme of TAS-Kommersbank and the debut Eurobond offering of XXI Century Investments.