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The New Capital Markets Law — What Should We Expect?
On June 19, 2020, the Ukrainian Parliament adopted the Law of Ukraine On Amendments to Certain Legislative Acts Related to the Simplification of Attracting Investments and Introducing New Financial Instruments (Capital Markets Law).
The Capital Markets Law is based on the practices and standards of the European Union, including those set out in MiFID II, MiFIR, EMIR, FCAD, SFD and MAR.
Most of the provisions of the Capital Markets Law are set to come into full force and effect on 1 July 2021.
In this article, we will focus on certain novelties introduced by the Capital Markets Law which, in our view, will have a significant impact on international financial transactions with Ukrainian counterparties.
Infrastructure of Organized Capital Markets
The market infrastructure is undergoing significant changes. Instead of trading taking place on stock exchanges, such activities will be carried out on organized capital markets, which include:
1) Regulated markets — where securities, derivatives and foreign exchange assets are traded. Given its nature, a regulated market should serve as a trading platform for major businesses.
2) Multilateral Trading Facilities (MTF) — trading in securities and derivatives; MTF should serve as a trading platform for small and medium-sized businesses.
3) Organized Trading Facilities (OTF) — where non-equity securities are traded, specifically bonds and derivative contracts.
The Capital Markets Law introduces the concept of “investment firms”. On the basis of the relevant license, investment firms may carry out professional activities related to trading in financial instruments, the list of which has been expanded to include sub-brokerage activities and investment consulting.
Subject to certain exceptions, all transactions with Ukrainian financial instruments, inter alia derivatives and securities, should be carried out with the mediation of an investment firm.
The Capital Markets Law introduced the institution of a trade repository.
The trade repository should consolidate information on derivative transactions and keep records as to concluded derivative contracts, which are executed both in the organized market and the over-the-counter (OTC) market.
Central Counterparty and Clearing Institutions
Among the novelties introduced by the new law is an updated clearing model for capital markets, whereby clearing activities are divided into:
- Clearing activities related to determining liabilities; and
- Clearing activities of the central counterparty.
Clearing activities are carried out with respect to transactions involving securities, derivative contracts and money market instruments, which are concluded both in and outside the regulated market, except for the instances when the clearing of these transactions should be carried out exclusively through the central counterparty.
Foreign legal entities will be able to carry out clearing activities in accordance with requirements which will be further developed by the NSSMC.
A separate category of investors in the capital markets — qualified investors — is established. The qualified investor shall assess risks independently and adopt decisions related to transactions with financial instruments. The advantages of qualified investors include, in particular, the ability to invest in securities without restrictions imposed with respect to non-qualified investors, concluding OTC transactions related to financial instruments without the mediation of an investment firm, etc.
Qualified investors include:
- International financial organizations;
- Foreign countries and their central banks;
- The State of Ukraine represented by the Ministry of Finance of Ukraine and the National Bank of Ukraine;
- Professional participants in capital markets and organized commodity markets, banks and insurance companies;
- Foreign financial institutions that meet the criteria set by the Stock Market Commission (NSSMC); and
- Legal entities, including those established under the laws of another state, if they meet at least two of the following criteria: (i) the balance sheet total is at least the equivalent of UAH 20 million; (ii) the annual net income for the last financial year is at least the equivalent of UAH 40 million, with the entity’s own funds being at least the equivalent of UAH 2 million.
Other entities which meet a number of criteria established by legislation may also be recognized as a qualified investor by investment firms.
Securities and New Financial Instruments
The list of securities is expanding; in particular, option certificates, stock warrants, credit notes, and depository receipts have been added to the list of securities.
New types of securities such as interest-bearing bonds for environmental investments (green bonds) and infrastructure bonds have been introduced. It is expected that in Ukraine such securities will contribute to the further development of renewable energy sources and infrastructure projects, including by obtaining funding for such projects from foreign creditors.
Market for Derivative Contracts
The Capital Markets Law created the legislative basis for the development of derivative transactions the underlying assets of which are production, securities, currencies, rates, yields, exchange rates etc.
Derivative contracts are divided into:
- Delivery contracts (which provide for delivery of the underlying asset);
- Settlement contracts (which provide for settlements between the parties depending on the value of the benchmark); and
- Mixed contracts (which provide for the possibility of settlements both via delivery of the underlying asset and settlements, subject to the choice of the parties).
Derivative contracts may be concluded both inside and outside organized capital markets.
It is expected that the Capital Markets Law will provide for the possibility to use standardized ISDA documentation as well as other standardized documentation, in particular GMRA and GMSLA, when concluding derivative contracts, in particular with non-residents of Ukraine.
An important innovation consists in the introduction of the concept and mechanism for close-out netting.
Close-out netting should also be applicable in respect of agreements concluded with the aim of securing the performance of undertakings under transactions to which close-out netting applies.
At the same time, we see a number of risks in general bankruptcy rules that might affect the enforceability of close-out netting in bankruptcy proceedings.
However, there are a number of mitigators introduced under the concept of close-out netting in the Capital Markets Law which, presumably, should address such risks. The law provides:
- That the close-out netting is carried out in “out-of-court” order. This may be interpreted in a creditor-friendly manner, namely by implying that close-out netting is beyond the scope of bankruptcy procedures and which, therefore, there is no requirement to submit creditor claims for inclusion in the creditors’ claims registry, or use the priority ranking rules and other limitations for satisfaction of creditors’ claims set out by the Bankruptcy Code;
- The rule whereby provisions of the Bankruptcy Code on close-out netting prevail over any other provisions of the Bankruptcy Code;
- The rule whereby instructions in relation to the derivative contract or the commodity transaction served by the party before commencement of bankruptcy proceedings are valid, legal, irrevocable and enforceable and cannot be invalidated by a court.
We note that the close-out netting concept is new in Ukraine and at this stage it is difficult to estimate how close-out netting will work in practice.
On top of that, there are Ukrainian currency controls and company liquidation rules that may create practical issues in the course of close-out netting enforcement. At the same time, certain fundamental concepts for the functioning of the derivatives market which are used in international derivative transactions, such as the “single agreement principle” and the concept of “outright transfer” of collateral (i.e. transfer of title to collateral), are not specifically addressed in Ukrainian law.
Combating Abuses in Capital Markets
Improving the procedure for combating abuses in capital markets is among the key changes in the Capital Markets Law. In particular, this includes:
- Regulating the definition of insider information and establishing a list of actions that persons who possess such information are prohibited from taking;
- Enabling capital market participants to test the capital markets — to transfer information to the investor(s) in order to determine the investor’s (investors’) interest in a possible transaction, until information about entering into such a transaction is announced; and
- Expanding the list of actions qualifying as manipulation of capital markets.
It is expected that the new law would allow market participants to elaborate new structures and use new instruments in cross-border finance and capital market transactions. At the same time, there are a number of uncertainties/gaps in the new law which should be clarified by additional regulation, formal clarifications by the Ukrainian authorities, or further amendments to the law (as the case may be). The development of respective court practice is also important.