Diversification of Financial Instruments legal Aspects and Challenges

1
Diversification of Financial Instruments legal
Aspects and Challenges
2
INTERNATIONAL FINANCE / CAPITAL MARKETS
INSTRUMENTS

• Debt
• - EUROBONDS - SYNDICATED LOANS
• Equity
• - IPO
• Structured Finance
• - SECURITISATION OF ASSETS- PROJECT FINANCE

3
EUROBONDS ISSUES IN UKRAINE
EUROBONDS 2005/2006
4

• Eurobonds
• DEFINITION Securities (i) denominated in
  currency other than that of issuer, (ii) placed
  publicly (through listing at a stock exchange) or
  privately by a syndicate of underwriters among
  foreign investors to whom this currency is also
  foreign, and (iii) establishing a debt obligation
  of the issuer to pay a par value amount plus
  interest to the bondholders
• AMOUNT from USD 100 mln.
• STRUCTURE
• A. - offering in the US to qualified
  institutional buyers in reliance on Rule 144 A
  under US Securities Act of 1933, and/or
• - offering outside the United States in
  reliance on Regulation S under US Securities Act
  of 1933
• B. - Direct issue
• - Indirect Issue

5
EUROBONDS STRUCTURE DIRECT ISSUE

• The issuer is an immediate and final funds
  recipient
• Possible only in sovereign Eurobond issues
• Issue whether corporates may issue bonds
  denominated in foreign currency makes it
  unclear whether direct corporate Eurobonds are
  possible (Commercial Code, Art.165, Securities
  Law, Art.7)
• Circulation of corporate bonds outside Ukraine is
  heavily and restrictively regulated by State
  Commission on Securities and Stock Market of
  Ukraine (the SEC) (Infamous Regulation 36 of
  17.10.1997, as amended)
• charter capital of at least UAH 5 mln.
• purchase price may not be less than par value or
  market value, as indicated at a Ukrainian stock
  exchange or OTC system
• listing at a foreign stock exchange or OTC system
  must be approved by the SEC after domestic
  registration of the issue
• issuer must submit to the SEC an audited
  placement report and copies of transaction
  documents, annual report and statement of
  interest paid to bondholders
• amount may not exceed stock companys capital
  fund (Civil Code, Art. 158) vs. three fold
  capital of an issuer (Securities Law, Art.8).

6
EUROBONDSINDIRECT ISSUE LIMITED RECOURSE LPN
STRUCTURE
Proceeds of Notes
Loan
Lender / Issuer
Borrower
Noteholders
repayment of principal and interest on the Notes
repayment of principal and interest on the Loan
trust
trust
Trustee
Paying agent
pledged rights under the Loan
Transfer agent
7
EUROBONDSLPN STRUCTURE PRINCIPAL DOCUMENTS

• Preliminary Offering Circular
• Offering Circular
• Subscription Agreement
• Loan Agreement
• Trust Deed
• Trustee Indemnification and Compensation
  Agreement
• Agency Agreement (payment and transfer)
• Agency Indemnification and Compensation Agreement
• Listing Documentation
• Legal Opinions
• Auditors Letters

8
EUROBONDS LPN STRUCTURE LOAN AGREEMENT

• LENDER/ISSUER Borrowers SPV or an arms length
  intermediary
• SPV Individual license of the National Bank of
  Ukraine (NBU) to conduct investment abroad (NBU
  Instruction ? 122 dated 16.03.1999) (onerous
  requirement of a contract between parent and its
  foreign partner and documentary evidence of
  registration of SPV)
• INTERMIDIARY bank, financial institution or not
  (Commercial Code, Art. 388).
• LOAN vs. BORROWING a by-pass surgery
• - Civil Code, Art. 1046 allows borrowing from a
  non-financial lender
• - Corporate Tax Law includes borrowings into
  financial loans
• - Banks and municipalities may borrow only from
  foreign banks and financial
  institutions.
• REGISTRATIN OF THE LOAN with the NBU
  (notification, if the borrower is a bank).
• PRICE EVALUATION ACT is required for a payment
  for services in excess of EUR 100,000 to a
  non-resident, except for payment, inter alia,
  under loans registered by NBU, payments to EBRD
  or IBRD, or for financial services (when the
  borrower is properly licensed to carry out such
  business).
• STATEMENT OF PURPOSE, TERM AND INTEREST

9
EUROBONDSLPN STRUCTURE LOAN AGREEMENT
(continued)

• INTEREST RATE Capped and Combined (NBU
  Regulation 270, dated 17.06.2004)
• - fixed rates are capped at 9.8 for loans of
  up to 1 year
• 10 for loans from 1 to 3 years
• 11 for loans of more than 3 years.
• - floating rates are capped at 3-month USD LIBOR
  plus 750 bp. (floating interest
• challenges)
• - loans of strategic importance to Ukrainian
  economy, commercial (deferred payment)
• loans and loans guaranteed by the government
  are not subject to a cap
• - interest includes the lenders fees, default
  interest, and other charges under the loan
• agreement
• - prepayment is subject to interest cap
  effective on the prepayment date (uncertain
• amount and interpretation)
• - registration of loan amendment may be denied
  by the NBU, if at the time of
• amendment interest rate under the loan
  exceeds the then effective cap

10
INTEREST RATES APPLICABLE UNDER DOUBLE TAX
TREATIES OF UKRAINE

11
EUROBONDS LPN STRUCTURE TAX ISSUES

• BENEFICIAL OWNERSHIP as a condition of a reduced
  interest rate
• TAX RESIDENCY CERTIFICATE
• NON-APPLICABILITY OF A DOUBLE-TAX TREATY in case
  of assignment of the loan to the Trustee
• GROSS-UP AND TAX INDEMNITY may be challenged as
  providing for payment of tax on behalf of the
  other party (Corporate Tax Law, Art.16.14 and
  18.2)
• ACTS OF ACCEPTANCE OF SERVICES
• TAX RULES IN THE LENDERS JURISDICTION

12
SYNDICATED LOANS 2006
13
SYNDICATED LOANS

• LOAN PROVIDED JOINTLY BY SEVERAL BANKS
  OFTEN FROM DIFFERENT JURISDICTIONS WITH THE
  BORROWER
• ARRANGER(S)/LEAD MANAGER(S), MANAGER(S),
  CO-MANAGER(S), PARTICIPANTS
• ASSIGNMENT (SUBPARTICIPATION) vs. SYNDICATION

14
SYNDICATED LOANSSUBPARTICIPATION

• Risk Subparticipation
• Indemnity
• Risk
• Subparticipation
• (default deposit)

• Funded Subparticipation
• Commitment
• Risk
• Subparticipation
• (scheduled deposit)

15
SYNDICATED LOANSFEATURES

• BORROWERS sovereigns and large banks/corporates
• AMOUNT USD 10-50 mln. (average), larger amounts
  than under bilateral loans
• SECURITY unsecured (often) or secured
• CURRENCY mostly USD
• TERM 1 to 5 years
• INTEREST RATE floating (libor 2.75-3.95)
• COST participation fees and commission, cheaper
  facility than Eurobonds (cost is under 7 PA)
• PRE-CONDITIONS does not require borrowers
  audited financials and rating
• TIMING shorter period for arrangement
• DIVERSIFIED RISKS FOR THE LENDERS

16
IPOBENEFITS/CHALLENGES

• Access to equity capital markets to fund future
  growth
• Attractive valuation and liquidity for
  shareholders
• Operational and management control
• High international profile and publicity
• Reputational benefits for marketing and
  regulatory review
• Higher share value
• Development of internal accounting and reporting
  standards

• Dependency on capital market condition
• High degree of finance transparency and
  disclosure
• Established corporate governance policies and
  protection of minority rights
• Compliance with listing rules
• Offering size of at least USD 100 mln.
• 3-year internationally audited accounts
• Restructuring of business operations
• Long preparation period

17
IPOTypes

• Direct
• - Same restrictions as for direct Eurobonds
  issue
• Indirect
• - SPV controlling the Issuer (Ukrproduct
  Group)
• - SPV controlled by the Issuer
• - Jurisdiction
• ADR (New York, NASDAQ, PORTAL)/GDR (London,
  Frankfurt, Berlin, Luxemburg, USA)
• - Negotiable certificates representing
  ownership of shares in a foreign corporation for
  US and/or international investors
• - Main Market vs. Alternative Investment Market
  at SE (London, Luxemburg)
• - Sponsored and unsponsored programs
• - 4 levels for sponsored programs
• I existing shares, OTC, release from
  data disclosure, not expensive private placement
  (37 issues for Ukrainian
  companies Ukrneft, Styrol, Dneproenergo,
  Azovstal, Centroenergo, etc)
• II - existing shares, listing at SE
• III public placement of new and
  existing shares at SE
• Unregistered underwritten private
  placement (Rule 144A/Res S) among QIB qualified
  institutional buyers (USD 100mln.) data
  disclosure is not required

18
IPOGDR / ADR STRUCTURE
GDR / ADR
shares / dividends
dividends
Depositary
Issuer
Investors
purchase price
purchase price
Custodian
Broker
19
IPOGDR/ADR STAGES
20
IPOLegal issues

• ACQUISITION OF SHARES brokers and investment
  accounts
• NON-DOCUMENTARY SHARES
• ANTIMONOPOLY FILING
• BENEFICIARY HOLDING OF SHARES under the
  depository agreement vs. true ownership under
  Ukrainian corporate law
• SPLIT VOTING RIGHT and other corporate rights
• DISCRETIONARY PROXY PROVISION in the depository
  agreement (management voting rights)
• ADR/GDR HOLDERS may seek protection in
  international dispute resolution forums
• TAX ON DIVIDENDS

21
IPO
22
IPOCOST/TIMING

• Ukrprodukt IPO
• GBP 6 mln. Placement
• total cost GBP 700,000
• timing 1 year

23
STRUCTURED FINANCE Financing structured to
free the provider of funds from concerns over
credit-worthiness of the recipient of funds. The
financier relies for payment on assets that are
legally isolated from the funds recipient
resulting in elimination of bankruptcy risk of
the latter. Securitization of assets
Project Finance
24
STRUCTURED FINANCEFeatures

• Limited recourse or Non-Recourse Financing
• Target limit or remove liability of a true
  recipient of funds (sponsor in project
  finance or originator in securitization)
• reduce or eliminate risk of financier
  (investor or lender) related to performance or
  bankruptcy of the originator (sponsor)
• Method True Sale of Assets
  (Securitization)
• Establishment of a Project SPV

25
STRUCTURED FINANCEFeatures

• Credit Enhancement
• A. In Securitization All asset-backed securities
  are credit enhanced to provide greater investors
  protection against losses (defaults by the
  obligors), reducing the credit risks of the
  underlying pool of assets and increasing
  securities rating. Credit enhancement may be
  provided by the originator or a third party in
  the form of a guarantee (by the originator, bank
  or insurance company), reserve fund or cash
  collateral (by the SPV), overcollaterization, a
  revolving facility (bank or the originator),
  and/or senior/subordinated structures (by the
  SVP).
• B. In Project Finance Sponsors or third
  partys security in the form of pledge, mortgage,
  guarantee, including performance guarantee,
  letter of credit, and/or a contingent equity
  commitment.

26
STRUCTURED FINANCEPROJECT FINANCE

• Financing (loan) to an SPV created (sponsored)
  by one or several business enterprises for the
  purpose of building and operating a large-scale,
  long-term, revenue-generating infrastructure
  project
• Loan is repaid from receivables generated by
  the project under off-take contracts with
  customers (clients) rather than from assets of
  sponsors
• Typical examples include power plants, oil and
  gas systems, ports, and telecommunications
  networks. Examples of Ukrainian project finance
  include
• - EBRDs Euro 75 mln. financing of
  reconstruction of highway Chop-Striy (2000) and
  anticipated Euro 100 mln. financing of
  reconstruction of MO 6 highway Kyiv-Chop
• - EBRDs USD 10 mln. financing of Energy
  Alliance (sponsored by Western N IS Enterprise
  Fund) to develop independent energy generating
  facilities
• - USD 171.75 mln. loan from the Government of
  Japan to the Government of Ukraine to
  reconstruct Boryspil airport
• - Deutsche Banks USD 700 mln. and USD 480 mln.
  loans to the Ukrainian Railroad Agency and the
  State Road Service of Ukraine under the guarantee
  of Ukrainian Government for construction of the
  bridge and highway Kyiv- Odessa.

27
PROJECT FINANCE
guarantee
Financial consultant
Sponsor(s)
equity
Law Firms
repayment
receivables
Clients / customers
loan
Project SPV
Lender
sales / lease
mortgage and pledge of project assets
payments
services
Insurance company
Suppliers / contractors
28
STRUCTURED FINANCE SECURITIZATION OF ASSETS

• Developed embrionically in the 1970s it now
  represents one of the dominant means of capital
  formation in the United States and increasingly
  throughout the world.
• Conversion of assets, such as bank loans and
  credit receivables, into marketable securities
  for sale to investors by means of sale of such
  assets by a bank (originator) to an SPV (issuer)
  on a non-recourse basis
• Assets transfers where the buyer has recourse
  against the selling institution are financing,
  e.g., borrowing secured by assets
• A bank appealing instrument securitized
  assets may include residential mortgages, auto
  loans, leases, credit card receivables

29
SECURITIZATION OF ASSETS
Lead Manager
Law Firms
Credit agency
Credit enhancer(s)

credit rating
enhancement
assets (receivables)
assets-backed securities (bonds)
sale of asset
SPV
Originator / Servicer
Investors
Obligors
purchase price (assets)
credit
Administrator
purchase price (securities)
agency to service receivable accounts
Trustee
pledge of receivable account
Listing Agent
Paying Agent
Enhancement (overcollaterization, guarantee, loan)
30
SECURITIZATION OF ASSETS A. Benefits for
Originators Attractive financing alternative at
reduced cost of funds as a result of segregation
of the assets from the credit risk and higher
credit rating of the securities issues by the
SPV Effective Management tool based on
non-recourse financing Ideal way to tap the
capital markets on an anymous basis for unrated
companies facing difficulty in issuing debt in
their own name As an off-balance sheet funding
technique, it reduces debt to equity ratio by
selling assets and using the proceeds to repay
more expensive long-term debt (e.g., releasing
credit lines for future business) If Originator
is a bank Greater liquidity Diversification
of finance sources and risks Improvement of
capital indicators (reserve fund, debt ratios) B.
Benefits for Investors Diversification of
investments within an investment
portfolio Spreading risk between different
sectors of economy by reference to assets
generated in such sectors Comfort from the
highest level of structural and legal review
Transparency of the securitization
risks Supply of highly rated instruments
31
SECURITIZATION OF ASSETSLEGAL ISSUES
The concept of factoring under Ukrainian law and
general theory of obligations (contacts) appear
to accommodate securitization structure. ?.
Origination of Assets Asset is not void or
unenforceable, but there are remedies against the
Originator in the event of the Originators
breach under an asset underlying
contract Originators liability is not
transferred to the SPV (financier) Standard
asset documentation permit securitization without
obligors consent Assets include present and
future receivables (Civil Code, Art. 1078) -
right of future claim is assigned when it arises
32
SECURITIZATION OF ASSETSLEGAL ISSUES (CONTINUED)

• B. Currency Control
• Receivables under contracts with non-residents
  obligors (export factoring) are subject to
  currency control limitations, e.g., requirement
  of a 90-day payment by the Obligor to the
  Originators bank account, and therefore may not
  be eligible for securitization.
• Receivables payable by Obligors in local
  currency must be converted to foreign currency by
  the Servicer for the subsequent transfer to the
  SPV. However, Ukrainian law currently does not
  allow such conversion. The solution may be in
  amending applicable regulation or modification of
  the transactional structure, e.g. by combining an
  LPN structure with assignment of assets by the
  Originator to the borrower (SPV)

33
SECURITIZATION OF ASSETS LEGAL ISSUES (continued)

• C. Bankruptcy
• Recognition of legal separateness of the SPV
  from the Originator, even if the SPV is part of
  the same group of companies
• Sale of assets to the SPV is not subject to
  adjustment or unwinding in case if Originators
  bankruptcy, except if conducted (Art. 81 of the
  Banking law)
• - within 6 months before appointment of a
  bankruptcy officer to benefit certain creditors
  of the Originator
• - within 1 year of appointment of a bankruptcy
  officer and SPV is Originators affiliate and
  the sale does not comply with legal requirements
  or threatens interests of Originators
  creditors
• - within 3 years before appointment of a
  bankruptcy officer and the purchase price
  significantly exceeded the market value of assets
  or the sale was aimed at keeping assets from the
  creditors
• Servicers bank account pledge. Cash held on
  pledged accounts will fall into the assets of the
  Originator in bankruptcy, but will be a priority
  payment to the SVP as secured creditor
• No disposal of assets following the start of
  bankruptcy proceedings
• If Originator is a leasing company, its
  bankruptcy may disrupt obligors payments. This
  requires a scrutinized disclosure of Originators
  business in early stage.

34
SECURITIZATION OF ASSETS LEGAL ISSUES

• D. Banking data secrecy laws
• Disclosure of clients information to a third
  party is allowed only upon consent of the
  Obligor, except for requests of law enforcers
• A solution may be to enforce law/regulation
  expressly excepting assets-backed financing
  from the scope of regulatory limitation (as in
  the US data protection law).

35
SECURITIZATION OF ASSETSCOST APPROXIMATION FOR
USD 150 MLN. PROJECT

• Lead-manager up to 3 (USD 3-4.5 mln.)
• Underwriters up to 0.05 (USD 15,000)
• Trustee up to 0.03 (USD 45,000)
• Service Agent up to 0.005 - 0.008 (USD
  1,500-USD 12,000)
• Auditors up to 0.033 - 0.01 (USD 50,000-USD
  150,000)
• Rating Agencies up to 0.033 - 0.07 (USD
  50,000-USD 100,000)
• Law Firms 0.2 - 0.33 (USD 300,000-500,000)
  
• Total 3.6 (USD 5.382 mln)
• Information of Business (Ukraine)