Pending Revocation of Inbound Loan Registration – Legal and Policy Considerations

The National Bank of Ukraine announced^[1] its intention to cancel requirement for registration of inbound loans, in place since 1999. As a temporary measure, the registration duty might shift from the National Bank (the responsible personnel have been notified of pending firing) to Ukrainian commercial banks. Another option might be replacing the registration with disclosure requirement (publication on site).

The Ukrainian registration procedure for lending to Ukraine has a murky history. Leonid Kuchma, then the President of Ukraine, decreed the measure^[2] on the last day when he could do so under the transitional provisions of the Constitution of Ukraine. The document was not published on time and, despite the existing requirement, no bill addressing the matter was submitted to Ukrainian Parliament for consideration. It is also unclear whether the Decree was approved by the Cabinet of Ministers of Ukraine and countersigned by the Prime Minister, in line with the Constitution. In 2012-2014 the courts and even the tax authority of Ukraine even declared some provisions of this Decree being contrary to the Constitution and other laws of Ukraine on control of foreign exchange^[3].

The authority of the National Bank (the “NBU”) to regulate the loans denominated in foreign currency was limited to the instances where such loans “exceeded thresholds established by the laws of Ukraine”. Since no limits were introduced by legislation, the effectiveness of the registration requirment was doubtful. Over 15 years, the registration procedure had been amended numerous times; whatever was the shape of the regulation, no one dared to challenge it in the court. The key aspects of the cross-border loans registration are:

• discrimination of Ukrainian corporate lenders, which have no right to grant interest bearing loans, against foreign lenders to whom such right was granted;
• cap on interest and other payments to a foreign lender under a loan agreement, which prevents adequate pricing of the loans and discriminates foreign lenders for the benefit of Ukrainian banks, not subject to the cap requirements;
• issue of a registration certificate by the NBU as a condition to agreements becoming binding upon the parties. This brings uncertainty into the deal: the borrower is unsure whether the lender will have money, while the lender is not sure when fees and interest can start accruing;
• requirement to transfer principal of the loan in Ukraine before most payments can start accruing, including prohibition of offsets;
• rigid application forms limiting standard lending practices,e.g. disbursement to more than one borrower / or from more than one lender, use of varying interest rate or drawdown in different currencies;
• requirement by the NBU to incorporate in a contract a number of provisions barely compatible with international financial practices, leave alone with expertise or authority of the NBU;
• devaluation of Hryvnia / loan currency pair exchange could not be shared with the lender; and
• reporting requirements on the status of settlements under loan agreements.

Legal and policy considerations

Cancellation of the cross-border loan registration raises collateral issues, some of which were probably considered by the regulator and can be compared to the thesis of this article.

1. Revocation procedure

Cancelation or significant modification of the registration procedure (the NBU Resolution no.270) requires changes to the original Presidential Decree. One must expect this being done through the parliamentary act – fundamentals of the entrepreneurship and penalties thereunder must be established only be the law^[4]. However, the initial idea of the regulator was for the President to repeal the Decree^[5], which would be, first, an excess of the authority – the President cannot regulate economic affairs in 2015, even if the result is deregulation; second, this would again legitimise the Decree 734/99.

2. The scope of the National Bank’s authority to regulate cross-border lending

The National Bank has significant authority to regulate cross-border transactions and currency operations. However, the scope of the NBU powers does not include licensing of the loans, including registration, because the Decree on the Currency Regulation and Currency Control System requires licensing only if the loans denominated in the foreign currency exceed term (maturity) and amounts established by the legislation. Similarly, the NBU had doubtful legal grounds for introducing a cap on payments (maximum interest rate) in the past; such interference into the commercial activity of the business entities was not justifiable neither under the Constitution nor under the Decree on the Currency Regulation and Currency Control System (see above), nor does it have such authority now.

Accordingly, with the Presidential Decree in place, the NBU is bound to keep the registration and issuance of registration certificate, within the limits set by the Decree, but could change the procedure:

• make it electronic versus paper based,
• reduce number of documents to zero or to completion of the online form,
• introduce a filing principle instead of licencing (pre-approval);
• take out the schedule for disbursements and repayments in the application forms, which appears confusing and insignificant;
• take out unnecessary details on the payments: either principle of the cap stays (in this case, the servicing bank is responsible to supervise the compliance) or the maximum rate is cancelled, with the NBU having the right produce second opinion on the contractual terms that appear unusual / unfair to Ukrainian party;
• introduce additional options to fill in the fields in the registration certificate;
• replace monthly statistics of performance of the loan with the annual or even report data in the contract, i.e., in the beginning and the end of the loan only.

Two further intervention strategies that appear relevant under the laws in effect are:

• establishing limits in size and amounts of the loans pursuant to the Decree. We would expect that amounts below USD 50,000 should not be regulated; and/or
• limitation of the loans as regulated financial services in Ukraine. Article 388 of the Commercial Code of Ukraine should be corrected: either the loans can be received from “credit institutions” and the EU legislation can be used to define this concept further or, if the NBU so wishes, the foreign loans can be limited to Ukrainian banks. This approach, if adopted, must distinguish between the counterparties from EU and other countries. That is, credit institutions from EU until 2019 should be granted the national regime of credit services in Ukraine in accordance with Ukraine’s covenant under the Association Agreement with the EU^[6].

In all cases, the NBU will retain the right to intervene with the bank on the unusual terms of transaction or limit the payments as a part of rescue package for trade balance, being thus adequately equipped for its authority to regulate the export and import of capital^[7].

3. Retention of cap on payments (maximum interest rate) and reporting

Payments cap, which is set at 3m USD Libor + 7.5% p.a. for floating rate loans and 12% p.a. for 3-year loans with the fixed rate, is usually referred to in Ukraine as the “maximum interest rate”. The term is a bit misleading, as the amounts include also fees, penalties and any and all other amounts; equivalent concept widely used in many jurisdictions is called “effective interest rate”. The NBU did not express intention to drop this requirement^[8].

The NBU makes two principal arguments in support of the limitations. First, it is a job of the NBU under the Constitution to control exchange rate of Ukrainian currency – cross-border lending and, apparently, cross-border services is the area of expertise for the NBU to establish pricing. Second, the NBU is entitled to overview the balance of payments, in particular, timely settlements to prevent the draining of the capital before the assets will be out of reach of Ukrainian authorities, including judiciary.

Helpful temporary measure, though, is hardly a tool to be used in a long run or to replace the institutions such as effective judiciary and a web of international treaties to deal with the diverted assets.

The above policy considerations are countered by many, include the following:

• the NBU has no authority to introduce or keep the cap in the first place (see above); if indeed such measure is necessary, it should be decreed by the Ukrainian Parliament, not the National Bank;
• intervention into private contractual relations is easily abused – evidenced by the history of Regulation No.270 and its application, particularly, opinion letters by the NBU;
• the pricing for the loans and services are regulated, while pricing for the letters of credit, investment deposits, guarantees, leasing or commercial credit are not, let alone dividends or sale contracts. Thus, all non-regulated operations can be used as a vehicle to export the capital outside the country;
• maximum interest rate is simply irrelevant instrument to fight the tax base eroding and illegal asset stripping. Substantive rules addressing such issues can be found in taxation tools and justice, such as thin-capitalization rules (limitations on the amount of debt a company may hold), transfer pricing (dealing with related parties). In the proper tax regime, the effective interest rate discourages law obedient lenders;
• the maximum interest is discriminatory in economic sense: relatively low interest rate on the loan is available to the banks and large corporations, to the company within international groups (in the form of intercompany loans), at the same time, small and mid-size borrowers are cut off from the international capital markets. Perhaps, this was the real purpose of the threshold applicable since 2004 but this practice should stop. The low rate also gives competitive edge to Ukrainian banks that do not have to comply and, therefore, can claim greater margin than the foreign financial institutions;
• the maximum interest rate is the most complicated to administer, supervise and report; keeping it defeats the purpose of revoking the requirement in the first place (i.e. administrative cost savings), especially if the primary supervision is delegated from the National Bank to the banks of account;
• the bank’s of account responsibility to control compliance with the maximum interest rate excludes other banks, where the borrower may also hold assets, from entering into security arrangements with the lender: such other Ukrainian banks cannot control the maximum interest rate; thus, with less security, fewer loans are possible.
• the rate also indirectly discourages equity contributions, whereas the investor understands inability to achieve proper ratio of the debt and equity; and, finally.

Notes