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Frishberg & Partners Kiev

Last year ING threatened to hold Ukraine in default, declaring the 8-year-old nation to be insolvent. At the time, ING's threat appeared to have have finally forced Ukraine into an interesting series of economic reforms, leading to a renewed effort in the privatization of its enterprises.

On July 21 1999 the Ukrainian Cabinet of Ministers approved the procedure for selling state-owned shares in open joint stock companies on international markets, allowing foreign investors to assemble their portfolios by simply buying shares of a Ukrainian enterprise on international stock exchanges without investing the considerable time and energy required in finding Ukrainian partners. Sounds good, but is it now possible to follow the stock exchange rates of Ukrainian enterprises and freely buy and sell Ukrainian stocks as the market rises and falls? Yes, if one blindly believes in the effectuation of Resolution 1320 of the Cabinet of Ministers of Ukraine (On the Procedure for the Sale of Packets of Shares of Open Joint Stock Companies, Created in the Process of Privatization, Which Belong to the State, in the Form of Depository Receipts on International Stock Exchanges, dated July 21 1999).

In an effort to boost the state budget with funds earned from privatization, the Cabinet of Ministers passed the Resolution, making it possible for investors to buy packets of shares from specific open joint stock companies on international markets in the form of depository receipts. As a side effect, this creates jobs for those who work in the securities markets in Ukraine (ie, traders, underwriters, banks, brokers, custodians, etc).

Ultimately, the success of the depository receipt procedure will depend on how the international securities traders and banks perceive the potential profits of buying and selling Ukrainian securities. In other words, someone will need to make Ukraine a sellable product on international markets. Among other things, this means that the valuation of the shares of Ukrainian open joint stock companies will have to be both attractive and comprehensible to foreign securities traders and banks.

Procedurally, the State Property Fund (SPF) must first make a formal decision to sell shares of an open joint stock company in the form of depository receipts on international stock exchanges. A depository receipt is the security which confirms the right of an investor to securities located in a specific depository institution, and gives the receiver the right to own the securities for which they hold the receipt. After rendering its final decision to sell shares in the form of depository receipts, the SPF must appoint a so-called advisor to organize the sale of such shares. The advisor is chosen by a tender held by the SPF and concludes an agreement with the SPF, which contains the specific obligations of such advisor. The advisor must be a legal entity which will determine the scheme of distributing the depository receipts onto the international market. The advisor is responsible for such matters as advertising the block of shares to potential investors, substantiating the best market and form of depository receipts for the sale of shares, estimating the price ratio between the actual shares and the depository receipts, and approximating the expenses related to effectuating the final sale of shares.

Upon performing its obligations under the contract with the SPF, the advisor presents its conclusions to the SPF for approval of the program for issuing the depository receipts and the minimum price of the block of shares to be sold. Thereafter, the SPF chooses an international depository institution on the basis of either the advisor's work product and suggestions or the proposal of the open joint stock company whose shares will be sold. The SPF then must choose a share distribution agent based on the advisor's conclusions. The function of the agent, similar to the function of an underwriter in the West, is to find a buyer for the shares offered for sale according to a program set forth by the advisor. The agent can be a physical or legal entity (group of legal entities) and a resident or non-resident of Ukraine. The chosen agent must conclude an agreement with the SPF for the sale of shares of the specific enterprise targeted for share distribution on international stock exchanges.

Before the sale of the shares begins the SPF and the foreign depository institution must select a custodian of the shares. A custodian is appointed for each regional department of the SPF to hold securities until the final sale procedure is complete. Custodians can be commercial banks or duly-licensed securities traders. All shares to be sold must be in the possession of the custodian before the actual commencement of the procedure for sale of the shares on international stock exchanges. If the shares are in documentary (paper) form, the actual shares must be deposited by the SPF with the custodian, where the shares are kept under lock and key. For this purpose, the SPF and the foreign depository institution must open securities accounts with the custodian.

At this point the agent may begin to search for any interested buyers of the targeted shares. The agent must finalize the execution of sale-purchase agreements with any interested investors. If an investor decides to buy a Ukrainian open joint stock company's shares, it must also open an account with the custodian. Thereafter, the investor transfers the sale price to the account of the SPF with the custodian and the custodian transfers the funds to the SPF's authorized bank in Ukraine.

Upon receipt of the notice of transfer to the SPF's account with the custodian, the SPF instructs the custodian to transfer the shares from its securities account with the custodian to the investor's securities account with the custodian. Finally, the investor instructs the custodian to transfer the shares to the foreign depository institution's securities account with the custodian. Once the custodian gives notice to the foreign depository institution that the transfer of shares to its securities account from the investor's securities account has occurred, the foreign depository institution must issue the depository receipts evidencing ownership rights of the investors to the block of shares and transfer them to the investor.

Once an adequate infrastructure has been set up and the stock acquisition procedure has been tested, the foreign investor may actually begin to freely purchase Ukrainian securities, and the state will begin to receive the foreign investment into its budget. In concept, the Resolution is beneficial to all parties, assuming the attractiveness of the state-owned shares offered to the investor. The procedure also allows Ukrainian open joint stock companies to be exposed to and advertised in western financial markets.

Despite the enthusiasm, several important caveats exist. First, the Cabinet of Ministers has yet to set up the necessary infrastructure to accomplish the noble goals passed in the Resolution. For instance, there is no approved list of open joint stock companies and the size of each company's state-owned packets of shares which will be sold on international stock exchanges has yet to be stated. Therefore, based on the historical record of failure to implement key reform legislative acts, a reasonable investor is justified in wondering whether the aforementioned procedure will function in his or her lifetime and, if so, whether the SPF will put up shares of attractive companies for sale. Scott Brown

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