Modern Banking Technologies in Ukraine: the Developing Potential of Commodity Financing

By Aleksandr ALEKSYEYENKO
Volkov & Partners

The purchase of Ukrainian banks by major Western players and smaller European banks has become a long-standing trend in Ukraine. Plenty of banks were acquired in 2006-2007 and more will follow. This logically brings modern technologies of international financing to the Ukrainian market and provides new instruments for both banks and industrial companies.

This article is devoted to outlining certain tools - commodity financing and certain ways to secure such transactions — which were introduced to the Ukrainian market and which are now frequently used by Ukrainian businessmen and bankers.

Loans granted by Western banks to Ukrainian companies against commodities, such as grain or sugar, have expanded rapidly in recent years. Viewed broadly, commodity financing is considered to be an efficient instrument for providing producers and traders with working capital on attractive terms. Western banks offer financing both directly to Ukrainian producers or traders and to their foreign subsidiaries/parent companies.

Generally, commodity financing is provided in line with the following procedure. A finance facility is given to a producer or trader who directs the received funds to the purchase of commodities or raw materials for the manufacture of certain goods, or delivery of the already manufactured commodities to foreign or domestic purchasers (offtakers). The repayment of the loan and interest is made by the borrower from the proceeds under the commodity contracts.

The classic structure for commodity financing in Western countries is usually based on a combination of:

• taking security over the physical commodities in the form of a local law pledge;

• assigning the receivables under the export and/or domestic contracts for the commodities;

• establishing a collection account in a suitable jurisdiction to which purchasers of the commodity are to pay the assigned export receivables.

Other legal tools may also supplement the traditional Western structure depending on the type of commodity, participants of the transaction, etc. For example, facility may be secured by a guarantee (suretyship) by the parent company or beneficiary of the Ukrainian borrower; the lender may be indicated as a loss payee in the commodity insurance policies.

Therefore, it is common practice for Western banks to have complete control over the commodities and connected cash flow at any stage of the transaction (purchase of raw materials, manufacturing, transporting, storing, delivering, etc.).

In fact, a pledge is usually the principal security in commodity financing. There are usually no legal problems in Ukraine with regard to the execution and further enforcement of the pledge of commodities in circulation (inventory pledge), the immovable property pledge (mortgage), pledge over moveable property and pledge over shares. It is usually recommended to foreign lenders that pledges be registered with respective state registries, as this allows them to have their pledges in most cases as first-ranking priority claims to the borrower.

At the same time, due to valid Ukrainian legislation certain traditional Western legal tools do not work properly in Ukraine. In particular, in order to open a collection account at a foreign bank, Ukrainian companies should receive a license from the National Bank of Ukraine. Even so, the transfer of the proceeds of export contracts to a foreign bank collection account may be considered by Ukrainian tax authorities as a violation of currency regulations (the “90 day rule” stipulates that income in foreign currency under export contracts shall be paid to the exporter’s bank account in Ukraine in terms set out in the export contracts but later than 901 days from the day of customs clearance of the exported commodities). After all, the traditional approach provides that the Ukrainian loan servicing bank should transfer the funds for repayment of the loan and accrued interest.

In Ukraine, collection accounts are opened by borrowers with Ukrainian banks (under a standard account service agreement) with simultaneous conclusion of the tripartite account pledge agreement between the borrower, lender and servicing bank. Existing and future commodity contracts of the borrower should as a matter of obligation indicate the mentioned account in the payment details. Such a pledge agreement provides for the pledge of receivables to be credited to the borrower’s account.

The parties to the account pledge agreement may agree to the amount of average periodic turnover on the collection account or the amount of irreducible deposit on the account to be maintained throughout the term of the facility.

Should a default, as prescribed by the loan agreement, occur, the lender may enforce the account pledge agreement under the procedure provided by valid Ukrainian legislation. The general rule under valid Ukrainian legislation provides for enforcement of the pledge on the basis of a court order. Another legal tool commonly used in commodity financing along with the account pledge is an assignment of the receivables under export and/or domestic commodity contracts. With respect to export contracts, there is still uncertainty regarding the so-called “90 day rule”. The chances are high that the Ukrainian tax authorities will consider direct payment of the proceeds by the offtaker under the export contracts to the lender in avoidance of the Ukrainian bank which services the loan, as a violation of the “90 day rule” and, as a result, a fine will be imposed as provided by valid Ukrainian legislation.

With respect to the assignment of domestic contracts, the borrower should notify his domestic offtakers as to the assignment, and even so the lender may face a problem with conversion of the proceeds under commodity contracts. The proceeds under domestic contracts are received in Ukrainian currency, and the lender, without any collaboration with the borrower, will not have grounds directly stipulated by valid Ukrainian legislation to purchase foreign currency on the Ukrainian interbank foreign exchange market.

One of the most commonly used types of additional security is a guarantee by a Ukrainian parent/subsidiary or beneficiary of the borrower. From a Ukrainian legal perspective, it is recommended to use the term “suretyship” in the texts of facility documents as valid Ukrai nian legislation provides that only financial institutions are able to issue guarantees.

The lender may still face the problem of currency regulation, as under valid Ukrainian legislation, Ukrainian surety is not able to purchase foreign currency in Ukraine for performance of the principal obligation (repayment of the loan and accrued interest). Ukrainian surety will be able to perform its obligation under the suretyship agreement only from its own foreign currency reserves. Notwithstanding a number of uncertainties in working out and implementing Ukrainian commodity financing transactions, they are considered very attractive and beneficial for foreign lenders and Ukrainian borrowers alike.

In many cases traditional Western legal financing techniques may not be applied in Ukraine and, therefore, they must be adapted and modified for implementation in Ukraine. Foreign banks are usually advised by their Ukrainian legal counsels on the problems they may face in the course of enforcing certain traditional Western legal tools (account pledges, assignments, etc.); however, they still prefer to have them contemplated in commodity financing documents, with unification of business practice being the main reason for such an approach.

With the role of Western capital in the Ukrainian economy set to increase in the future, we shall witness a wider use and perfection of domestic banking and business practice, including a variety of complex financial structures.