by Iryna V. Pokanay, partner, Asters, tel. +38 044 230 6000

Gabriel P. Aslanian, associate, Asters, tel. +38 044 230 6000

Following the financial downturn of the late 2008 and 2009, 2010 has proved the viability of the Ukrainian economy significantly affected by the global economic crisis and, backed by the increasing demand for metal and agricultural products, has relaxed the relevant export-oriented Ukrainian producers in raising capital in the world's finance markets. Although the impact of the Global Recession, which profoundly hit Ukrainian businesses in the previous couple of years, has turned out non-recoverable within one year, the growing presence of Ukrainian players in the world's financial markets may be an encouraging factor turning the eye of investors to Ukraine.

 International markets backing major domestic players 

The warming on the foreign markets has slightly melted the domestic market frozen by the global financial crisis, whose aftermath still makes the raising of capital difficult and comparatively expensive for the maintenance of sustainable growth of Ukrainian market players. According to the World Economic Forum Global Competitiveness Report, Ukraine's domestic financial market was almost in the bottom of the list of 139 countries under the following criteria: soundness of banks (138th position); ease of access to loans (130th position); regulation of securities exchanges (127th position); restriction on capital flows (125th position); affordability of financial services (122nd position). According the National Bank of Ukraine (the NBU) analytical report, the volume of bonds issues on the domestic capital market over the period of January through September of 2010 increased sixfold against the relevant period in 2009. However, pursuant to the same statistics, such progress has been made due to the over than 18-fold growth in government bonds issued to cover the state budget deficit, while the issue of corporate stock and bonds for the same period has decreased by 1.2% and 1.3%, respectively. The mentioned slump may be explained by the fact that during the first 9 months of 2009 there were approximately 40 technical defaults. As a result, corporate bonds turned out to bear real risk, keeping the potential Ukrainian investors cold-minded. Limited access to long-term financing with dominant outstanding debts restructurings, which were the determining factors in 2009, prevailed till mid-2010. The current situation on Ukrainian capital markets can be defined as a standstill period expected to continue till the end of 2010. According to banking and finance experts, if no deterioration in the investment climate takes place and stability in the finance market is sustained, some noticeable revival should be expected in 2011.

In view of the continuing weakness and standstill of the domestic capital markets, Ukrainian companies in the growing sectors seeking significant debt or equity investment have acceded or increased their presence on international markets. In April 2010, as Ukraine's political life reached relative stability, Ukreximbank and DTEK steel holding re-launched Ukrainian companies' pace on the Eurobonds market with a total of USD 1 billion placements. In April 2010, Ukraine's largest egg producer, Avangard, raised USD 187.5 million in an initial public offering of shares in the London Stock Exchange and Kernel, a major sunflower oil producer, conducted a secondary public offering in Warsaw. The mentioned success stories have encouraged other major agricultural producers, such as Sintal and a number of other market players, which are either working on IPOs and SPOs or targeting raising capital in international markets at the end of 2010.

Recent developments in legislation

The manual handling of the capital markets, which was the dominant trend in 2009 helping Ukraine to survive at the height of the financial turmoil, has made way for some deregulation in 2010 resulting in the abolition of certain crisis-related restrictions on foreign investment. However, not all regulators have proved consistency with such a deregulatory trend.

Most restrictions introduced by the On Amendments to Certain Ukrainian Laws for the Purpose of Overcoming Negative Consequences of the Financial Crisis Act of Ukraine adopted by the Parliament in the end of October 2009 were abolished on 27 April 2010. The abolished law provided for limitations on amendments and early repayment of foreign loans and made registration of foreign investment mandatory. It also required opening of investment accounts with Ukrainian banks which were a condition for investment operations in Ukraine, in particular for the acquisition of shares in Ukrainian companies. Foreign investors no longer have to convert their investments into Ukrainian currency. The abolition was welcomed by both Ukrainian market players and foreign investors.

Another important change came in the domestic debt markets where the On Amendments to the Act of Ukraine On Securities and Stock Market in Connection with Creating Conditions for Proper Circulation of Corporate Bonds Act of Ukraine of 8 October 2010 (the Act of 8 October) helped the issuers of domestic Ukrainian bonds to avoid default. On 8 October 2010 Ukrainian Parliament passed this Act which permitted bond issuers to extend the terms for bond circulation and payback, and toughened requirements on the issue of bonds for which property is used as collateral. The Act of 8 October allows the issuers of Ukrainian bonds to extend the term of circulation and postpone the maturity date of the bonds if the issuer redeems the whole issue of the bonds (apparently reissuing the bonds for a new term) or obtains consent of all bondholders for the extension of the terms. The redemption price cannot be lower than the nominal value of bonds. The period for which the terms of bond circulation can be extended cannot exceed the term defined in the original prospectus. In addition, the repeated extension of bond circulation terms is not allowed. The Act also retroactively applies to bonds issued before the Act took effect. The Act is obviously rather unconventional and raises a number of questions as to the procedure of its implementation. The implementing regulations are to be promulgated by the State Commission for Securities and the Stock Market (the SEC).

Issues to tackle and alternative solutions

One of the significant regulatory initiatives in 2009 was the separate SEC resolution allowing the state-owned company Naftogaz to issue foreign debt securities governed by foreign law outside of Ukraine. Prior to this only the Government was entitled to issue securities outside of Ukraine. Based on SEC's consent to Naftogaz' issue of debt securities abroad there was a hope that all Ukrainian companies may soon obtain the right of direct access to foreign capital markets. However, no further regulatory action followed in 2010 from this liberal interpretation from the SEC. Although the On Securities and Stock Market Act of Ukraine (effective as of 3 May 2006) removed the requirement of denomination of corporate bonds only in Ukrainian currency, certain provisions of the Commercial Code of Ukraine can be interpreted as not allowing Ukrainian entities to issue securities abroad.

The circulation of Ukrainian corporate bonds abroad is restrictively regulated by the SEC's Regulation No. 36 of 17 October 1997, as amended, which provides, inter alia, for the following onerous requirements for the potential issuers:

-    charter capital of at least UAH 5 mln.;

-    purchase price may not be less than par value or market value, as indicated on Ukrainian stock exchange or OTC system;

-    listing on 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.

The substitution of Regulation No. 36 with the new set of rules is a regulatory step long-awaited from the SEC. Otherwise, the above legislative shortcomings urge Ukrainian businesses acceding international capital markets to use various strategies to avoid the regulatory limitations on the issuance of Ukrainian securities abroad.

The public offerings of Ukrainian companies on international markets are carried out through existing or specially founded foreign holding companies or intermediate foreign vehicles by placements of either shares or private depositary receipts backed up by Ukrainian assets. A foreign SPV then injects capital into the Ukrainian company through capital contributions or loans.

The structures contemplating injections through loans remain subject to uncertainties of Ukrainian finance regulations. Due to adverse interpretation of the rule in the Commercial Code of Ukraine, local entities may only draw loans from foreign entities qualifying as financial institutions. As a result, the risk exists of invalidation of a loan received from a lender that is not a bank or a financial institution. At the same time Ukrainian civil law distinguishes between "loans" and "borrowings". Under the Civil Code of Ukraine, a "loan" is provided by a bank or other financial institution, which is consistent with the above-noted restriction under the Commercial Code, while a "borrowing" is not subject to such restriction. Thus, it can be argued that Ukrainian legislation allows Ukrainian entities (except for municipalities, which are subject to special regulations) to receive funds from lenders that are non-financial institutions pursuant to agreements on borrowing.

Syndicated and bilateral loans have remained in 2010 an alternative to Eurobonds. The largest financing transaction in Ukraine not only in 2010 but in general since the beginning of the world financial crisis of 2008 came with Metinvest arranging for syndicated pre-export financing of USD 700 in July 2010. Positive trends in world's markets also helped a major agricultural holding Mriya to receive a secured $75 loan facility from the International Finance Corporation, which investment program in Ukraine is expanding with a focus inter alia on the rapidly developing agribusiness. USD 50 million pre-export facility has recently been extended by ING Bank N.V. to Myronivsky Hliboproduct Group (MHP).

Project finance continues to be used by large international banks and financial institutions (such as European Bank for Reconstruction and Development or International Finance Corporation) as a well-developed finance technique mitigating common risks by sharing them with foreign and local sponsors of the borrower and repaying loan from the project proceeds. One of the legislative hurdles limiting the operations of the mentioned international financial institutions in Ukraine is the still effective prohibition to extend loans to Ukrainian entities in the local currency, which preservation has been strongly supported by the NBU until now. However, as reported, IFC's and EBRD's long-lasting efforts in lobbying the abolition of the mentioned limitations have been a success in 2010 with the relevant regulatory action to follow.

The young Ukrainian economy appears to have passed the survival test and overcome the volatility in the finance sector. However, it is still taking a test for maturity, which may identify its potential for growth. While 2009 proved the vulnerability of the whole Ukrainian economy against fluctuations in foreign markets, 2010 has proved the readiness of only a minor part of Ukrainian businesses to quickly adjust to the new market environment and sustain their growth. Deregulation trends and initiatives in corporate securities regulation were favoured by the market, yet requiring legislator's persistence in implementing long-awaited reforms.