Access to Foreign Capital Markets: Stumbling Blocks of Currency Regulation
Nazar A. Chernyavsky, Andriy S. Finogin
This article focuses on issues of currency regulation that arise when Ukrainian borrowers take loans from foreign lenders. The conclusion of loan agreements with foreign lenders takes place not only within the traditional bank lending.
The foreign loan transaction is also employed, for example, in cases where Ukrainian businesses wish to issue debt securities (notes, bonds, etc.) in foreign capital markets. Since a direct issuance in foreign markets by Ukrainian companies is subject to cumbersome regulation, securities are issued in practice by a foreign holding company or an SPV. The proceeds of such issue may be further on-lent by such foreign issuer to the operating companies in Ukraine.
However, attracting foreign borrowings, albeit important for the Ukrainian economy, is hampered by imperfections in the tight Ukrainian currency controls.
Individual licensing regime
One of the main concerns to be taken into account in that regard is the licensing regime generally applicable to all outbound payments and poorly drafted exemptions available for payments under cross-border loan agreements. Failure to obtain an individual licence from the National Bank of Ukraine (NBU) for making certain payments exposes the person in breach to a fine in the full amount of such payment. The severity of the penalty is, unfortunately, not matched by the clarity of rules.
Among the exemptions from the requirement to obtain a foreign payment licence, the Decree of the Cabinet of Ministers of Ukraine On the System of Currency Regulation and Currency Control of 19 February 1993, No.15-93 (the Currency Decree), lists “foreign currency payments made [from Ukraine] abroad in the form of interest payments on a loan extended to the resident by a foreign lender”. Although, as a matter of law, this exemption is limited to interest payments under a loan, as a matter of practice, repayment of principal actually received by a borrower is subject to the same treatment. The omission of any specific exemption in the Currency Decree for the repayment of the principal is regarded as a result of poor drafting.
At the same time, the currently existing statutory exemptions from the licensing regime of the NBU do not expressly cover other payments which may have to be made by a borrower from Ukraine abroad under a loan agreement including, for example, additional amounts (gross-up), tax indemnity, currency indemnity, costs, charges, expenses reimbursement and other payments. As a result, it can be argued that any such payment may legally be made by the borrower only after an individual licence has been obtained for such payment. As a matter of practice, such licence cannot be obtained in advance given that the borrower would not know the exact amount of any contingency payment and the term for its making.
In addition, foreign borrowings have been recently more and more often secured by suretyship from Ukrainian companies (members of the borrower’s corporate group, etc.). In particular, where debt is attracted by a foreign holding company, the structure almost invariably involves Ukrainian operating companies providing suretyship to creditors (or a trustee acting on their behalf) in respect of the foreign entity’s obligations. Until recently, an argument could be made that payments under such suretyship should fall under another exemption from the licensing requirement, namely “foreign currency payments to perform obligations to non-residents to pay for […] property rights”. While in the past the NBU seemed to concur, such interpretation was rejected in the NBU’s Letter of 15 November 2010. In this Letter the NBU clarified that payments abroad by Ukrainian sureties (except for Ukrainian banks having a general NBU permit for currency operations) do require an individual licence, which had a positive effect by introducing clarity to the issue.
Purchasing foreign currency
Performance of obligations under cross-border loans and suretyships requires the availability of foreign currency funds to the obligors. Regulation approved by NBU Resolution No.281 of 10 August 2005 (Regulation No.281) provides for an exhaustive list of grounds for the purchase of foreign currency in Ukraine and documents which must be submitted if any available ground is used. In particular, in order to purchase foreign currency for making payments under a loan agreement, the borrower must present, among other documents, the NBU registration certificate with respect to such agreement. In turn, this creates problems with purchasing foreign currency for performing payment obligations not specified in the registration certificate (increased costs, indemnities, reimbursements, etc.). In such case, foreign currency may be purchased only if the borrower manages to persuade its servicing bank that it is a payment for services (e.g. in case of reimbursement of expenses or losses of the lender) or other payment required under the agreement with a non-resident. Therefore, it is advisable to have this in mind while drafting the application for the registration of the loan agreement in the first instance, so that various prospective payments are referred to in the NBU registration certificate.
Regulation No.281 expressly prohibits purchasing foreign currency to make payments under suretyships or guarantees issued to secure obligations of a non-resident borrower. However, in January 2011 amendments to Regulation No.281 came into effect, according to which an individual licence for making a payment abroad can serve as a basis for purchasing currency for such payment. Accordingly, despite the conflicting provisions that remained in place, it may be argued that a surety should be able to purchase foreign currency on the basis of the individual licence issued to it for a cross-border payment. At the same time, guarantor banks would still be restricted from purchasing currency for making payments under their guarantees securing the obligations of a non-resident, since such payments by banks are not subject to the individual licensing regime.
The maximum interest rate for cross-border loans Ukrainian legislation establishes the maximum permitted rate of interest under a loan agreement between a Ukrainian borrower and a foreign lender (the Interest Ceiling). At present, the Interest Ceiling for loans in freely convertible currencies is at USD 3 month LIBOR plus 7.5% per annum for floating interest rate loans and at 11% per annum for fixed rate loans if the term of the loan is more than three years. Under the Regulation approved by Resolution No.270 of the NBU of 17 June 2004 (Regulation No.270), any loan agreement subject to registration with the NBU must provide that the amount of payments for the use of the loan (based on the interest rate set by the agreement and taking into account fees, penalties and other payments provided by the agreement, including sanctions for the improper performance of the terms of the agreement) (the Loan Payments) for the whole term of the loan agreement cannot exceed in the aggregate per annum the amount determined based on the Interest Ceiling specified at the time of registration of the loan agreement with the NBU (the NBU Cap). In the event of payment of any amounts (e.g. fees) under the loan agreement prior to or on the date of disbursement of the loan, all such amounts shall be taken into account for the purposes of calculation of the amount of the Loan Payments in the first year of the loan. Therefore, the amount of payments by borrowers under or in connection with foreign loans are limited with the NBU Cap to the extent that such payments can be attributed to the Loan Payments.
The NBU has the authority to regularly review and alter the Interest Ceiling. If the borrower is required to register a change related to the loan agreement with the NBU (e.g. in connection with the change of a lender), the NBU may refuse to register such change if, at the time of such registration, the Loan Payments in the aggregate per annum exceed the NBU Cap existing at the time of such registration. Furthermore, in view of the fact that under Regulation No.270 parties to a cross-border loan agreement have to provide that effectiveness of any change which has to be registered with the NBU is conditional upon such registration, the change would not become effective in the absence of the registration with the NBU. Accordingly, any decrease in the NBU’s Interest Ceiling may adversely affect all debt restructurings which occur after such change and where the amount of payments was close to the NBU Cap by then.
The maximum interest rate limitations should also be taken into account in the structuring of prepayment provisions of the loan agreement. The agreement may provide for the borrower’s right to prepay all outstanding amounts prior to maturity, or for its obligation to do so on the occurrence of an event of default. The effect of such provisions may be distorted by the rule of Regulation No.270 which provides that in the event of prepayment the Loan Payments may not exceed, in the aggregate per annum, the amount determined based on the applicable Interest Ceiling (taking into account only the period during which the loan was actually utilised by the borrower).
At present, the shortage that the lender may fail to receive as a result of this prepayment limitation may reach up to 1.2% of total payments (excluding repayment of principal), which results from the difference between 9.8% per annum being the Interest Ceiling for loans for the term less than one year and 11% per annum being the Interest Ceiling for loans with the term over three years. Should the NBU set a more drastic difference in the caps depending on their term, this could alter the patterns of lending, including the willingness of lenders to allow voluntary prepayment of loans by the borrowers. This would be an unfortunate development, since the successful refinancing of a borrower may depend on its ability to prepay the existing loans. For example, where existing loans contain restrictions on incurring further indebtedness, the only way for the borrower to get the existing lenders around to waive such restrictions may be to promise prepayment to such lenders.
Making reserves out of non-existent funds
Severity of the Ukrainian currency control rules may be illustrated by another example. Starting from 1 October 2010, according to Resolution No.171 of 18 June 2008 of the NBU (Resolution No.171), Ukrainian banks again have to keep at a non-interest-bearing reserve account with the NBU 20% of the amount of their short-term (i.e., not exceeding 183 calendar days) foreign currency loans for the whole term of such loans.
The most important issue, however, is that Resolution No.171 actually provides for post factum reservation in case of prepayment of long-term loans. Even where the contractual maturity of a loan exceeds 183 days from the date of disbursement, Resolution No.171 nonetheless requires reservation of funds if the actual period of using the loan did not exceed 183 days. As a result, the borrower would be required to direct to the account with the NBU an amount equal to 20% of the loan after the borrower has already prepaid it, and to keep it on such account for the period equal to the term during which the loan was actually used.
Firstly, this requirement may come as an unpleasant surprise in case when a lender accelerates a long term-loan upon default of the borrower. The necessity to procure and set aside large amounts in foreign currency when the loan has already been repaid can make an already burdensome acceleration even more drastic for the borrowing bank. Secondly, this requirement would definitely complicate liquidity management as banks would try by all means to abstain from prepaying long- and medium-term loans in order to avoid the onerous 20% “levy”.
To aggravate the matter further, this post factum requirement is camouflaged in the text of the regulation which generally deals with reservation during the term of the loan, but not after repayment.
We hope that illustration of some of the currency control issues above would help both Ukrainian borrowers and their foreign counterparties to structure their transactions more efficiently. However, until Ukrainian currency control regulation is substantially revised to make it clearer, more liberal and in line with Western standards, any cross-border finance transaction would require in-depth legal analysis to avoid all those pitfalls which are hidden in the wilds of legislation issued by various Ukrainian regulators and authorities.
