Exchange Control Implications for Cross-Border Finance 

October, 2003 - Michael V. Kharenko

Ukrainian Exchange Controls Have Always Been, if Anything, Overprotective. As More Ukrainian Companies Are Seeking Finance Abroad, Ukraine Has to Consider Adding Clarity and Certainty to its Exchange Controls in Order to FacilitateCross-Border Finance Regulatory imperfections. The system of Ukrainian exchange controls is based on the Decree of the Cabinet of Ministers of Ukraine On the System of Currency Regulation and Currency Control (the “Decree”) adopted back in 1993. A relic of the first steps of Ukrainian lawmakers, the Decree itself appears to be the root of many unresolved issues in cross-border finance. Under the Decree any transactions with foreign currency by Ukrainian residents are subject to licensing by the National Bank of Ukraine (the “NBU”) with certain exemptions. Unfortunately, these exemptions are worded in such a way that leave a lot of room for various interpretations and, hence, discretion of the controlling authorities. To mention but one, it is not clear why the Decree exempts interest payments to foreign lenders from licensing but forgets to specifically exempt the return of the principal. While no NBU license has been required in practice for re-payment of loans, this is not good enough to remove the legal uncertainty surrounding the status of such payments. It is worth noting that some exchange control instruments have been devised by the NBU outside of the relevant powers vested in the central bank by Ukrainian law. The most controversial example of such rulemaking is the present procedure for the evaluation of service fees payable to non-residents. Furthermore, additional problems are created by application of exchange controls by the tax authorities which go contrary to legal rationale and market needs. The most topical issue in this respect is the refusal by the tax authorities to recognize cross-border set-offs as being in compliance with the so-called “90-day” rule on the receipt of hard currency earnings by Ukrainian companies. Having outlined the general weaknesses of Ukrainian exchange controls, let us turn to the particular currency regulation provisions which complicate foreign financing of Ukrainian companies. NBU registration of loans Any loans received by Ukrainian companies are subject to NBU registration with the sole exemption made for the short-term (up to one year) loans received by Ukrainian commercial banks authorized to operate in international capital markets. Presently, the NBU registers foreign loan facilities subject to their compliance with the following two requirements: (a) interest rate cap and (b) purpose of the loan. Interest rate cap The main task of the loan registration procedure appears to be the enforcement of compliance of the interest rate on foreign-sourced loans with a cap on interest rates. This regulatory interest rate cap is calculated by the NBU based on the so-called average weighted interest rate at which Ukrainian commercial banks lend foreign currency to Ukrainian companies. Considering the high risk profile of any lending to Ukrainian companies, it is generally questionable whether the interest cap should be based on the interest rates offered by Ukrainian commercial banks. (Presently, the NBU-published average weighted interest rate is equal to 11 % per annum.) Unfortunately, the NBU Regulation on registration of foreignsourced loans does not specify certain details of application of the interest rate cap, in particular its application to floating rates. As a practical matter, the NBU is registering such loans with a fixed interest rate or with a floating interest rate based on the recognized financial indicators (e.g. LIBOR), which is clearly below the interest rate cap at the time of registration of the loan. The situation is less certain with the floating interest rates based on other than such recognized financial indicators. Curiously, the loans with the floating interest rates are in many cases registered by the NBU without any reservation regarding the cap. It would appear, however, that even in the absence of such reservation the borrower should not be able to pay the interest in excess of the cap existing at the time of registration of the loan. It is also not entirely clear whether the interest rate limitation applies to loans for a term of up to one year received by authorized Ukrainian banks, as such loans are not subject to registration by the NBU. Purpose of the loan requirement Although the new Civil Code does not expressly require that all loans be provided for a certain purpose defined in the loan agreement, this requirement is retained in another legislative novelty — the Commercial Code of Ukraine. In the past, the “forpurpose” requirement led to the close scrutiny of the appropriate terms of the loan agreements both by the NBU and the tax authorities. These authorities were especially suspicious of any broad indications of the use of borrowed funds (e.g. “to be used for current needs of the company”) and even refused to register the respective loan agreements or grant them favorable tax treatment. We expect that Ukrainian borrowers will face the same attitude in the future and will have to be quite specific as to the purpose of their borrowings. Price evaluation More than a year has passed since the NBU introduced the price evaluation procedure for service payments transferred by Ukrainian companies to non-residents. The procedure provides for state review of service fees under contracts with payments in excess of EUR 50,000. To pay for nonresident’s services a Ukrainian company has to receive a price evaluation act confirming that the service fee is in line with prices in international markets. The NBU Regulation No.597 of 30 December 2003 attempted to plug some gaps in the application of price evaluation rules and close certain loopholes. For example, contracts for the same type of services concluded by a Ukrainian company with the same non-resident are now treated as one contract for price evaluation purposes. At the same time, the new regulation expanded the list of exemptions from the price evaluation requirement available to Ukrainian companies. In particular, it specifically exempted payments of borrowers under the loan agreements registered with the NBU, as well as payments for financial, tourist, transportation and communication services by the Ukrainian companies licensed to provide such services. The scope of application of these exemptions, however, is far from being finalized. Thus, the Ukrainian law definition of financial services is not specific enough to provide clear guidance as to which service fees would fall under the exemption. In particular, the application of this exemption is not entirely clear for complex financial services, e.g. fees for underwriting services, as well as management and supervision services. To be continued… Clearly, as Ukrainian companies gain credibility on the international debt markets, the need for improvements in existing regulation becomes apparent. Furthermore, increased complexity of finance transactions involving Ukrainian borrowers is urging regulators to develop more sophisticated and reliable set of exchange control rules.


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