The fate of up to $4 billion of Ukrainian money in Cyprus remains unclear after the island’s legislature this week failed to approve a $13 billion bailout plan for its crippled banks that entails a one-off bank deposit tax for almost every type of account holder.
The island nation’s troubles were initially thought to have little immediate impact on Ukraine, but the deteriorating prospects of Cyprus as a transaction center for post-Soviet clientele could have a lasting effect on business in the region.
An incorporation hotspot for many domestic companies and foreign entities doing business in Ukraine, Cyprus on March 15 brokered a bailout deal with the European Union and the International Monetary Fund.
Still under negotiation, the deal as of late March 21 envisions nationalizing pension funds and an emergency sale of bonds to help raise $7.5 billion. Controversially, the revised plan also contains a bank tax to shave 2 percent from deposits with less than 100,000 euros. Accounts above the threshold would get a one-time haircut of 5 percent.
Cyprus President Nicos Anastasiades said account holders – including personal and corporate, current and fixed deposits with positive balances – would be compensated with bank shares.
On March 21, Jeroen Dijsselbleom, who chairs meetings of euro zone finance ministers, told the European Parliament that “it’s probably inevitable there will be some kind of levy (on bank deposits) in the final package that we will agree upon.”
Cyprus banks have been closed since March 16 and aren’t rescheduled to re-open until March 26 to prevent a run and let Cyprus officials hammer out a deal by March 25, the deadline set by the European Central Bank. Automated bank machines have been ordered to stay filled with cash as long as bank doors remain shut.
If no rescue plan surfaces, Cyprus could default and exit the 17-nation euro zone.
But there’s been little respite for Ukrainian banks and businesses that use Cyprus as a transactions hub and an offshore source of financial services.
A double taxation avoidance treaty between Ukraine in Cyprus is in place that allows for the island to be used as an advantageous and low-tax financial conduit.
Cyprus has a 10 percent corporate tax. But the real advantages with the double tax treaty with Cyprus means that dividends, interest and royalties from Ukrainian companies to Cyprus residents are not taxed at all in Ukraine. These payments are only subject to tax in Cyprus, which doesn’t tax those items.
Elena Redko, a Moody’s analyst, told the Kyiv Post that the direct exposure of Ukraine’s banking sector in Cyprus corporations and banks is up to $100 million.
Timothy Ash, head of emerging market research at Standard Bank, suggested that “Ukrainian banking deposits are likely around $2-$4 billion, but a bigger exposure is through the use of Cyprus as an offshore conduit for tax ‘efficient’ mergers and acquisition activity, and perhaps stress individual corporates at the margin.”
Some experts believe $4 billion of Ukrainian money to be a conservative estimate because many multinational companies doing business in Ukraine also use Cyprus as a transaction center.
“The hit to the Ukrainian economy would be much more because (many) foreign and international companies choose Cyprus as a good special purpose vehicle,” said Oleg Zagnitko, partner at Beiten Burkhardt law firm in Ukraine.
Meanwhile, one of Ukraine’s largest conglomerates, System Capital Management owned by multi-billionaire Rinat Akhmetov, on March 21 reiterated a previous statement that the measure won’t “affect the financial standing of the SCM group in any way.”
Yet Ash wrote that while Ukraine could readily absorb the one-off deposit tax, “the longer the Cypriot banking sector remains closed, a more important factor could be to complicate/disrupt imminent M&A activity, and perhaps stress individual corporates at the margin.
“A bigger worry in Ukraine perhaps is the risk of the tax on corporates in Cyprus causing some knock-on effect to depositors in Ukraine itself, where broader confidence in the economy and policy elite is lacking, while the banking sector still appears fragile.”
Some 74 percent of foreign direct investments into Ukraine last year, or $3.37 billion came from Cyprus, generally presumed to be repatriated money.
The ripple effect already appears to be reaching the wider financial services industry.
“Already risk managers in London are sending internal mails quietly suspending Cypriot counterparties from acceptable trading lists. As the deposits and the trading entities go, so go the jobs in law and accountancy,” wrote Pawel Morski, a respected financial blogger.
As an offshore center, Cyprus has often been alleged to be the recipient of proceeds from tax evasion and money laundering around the globe, especially from Ukraine and Russia, charges the island strenuously denies.
Russia stands to lose much more than Ukraine as it is more exposed. Ratings agency Moody’s estimates that Russian banks had placed $12 billion in Cypriot banks at the end of 2012, with corporate deposits at $19 billion.
The measure sparked the ire of Russia’s leadership.
Russian Prime Minister Dmitry Medvedev criticized the Cypriot and EU deal: “So far actions of the European Union, the European Commission together with the Cypriot government regretfully resemble a bull in a china shop to me.”
Kyiv Post editor Mark Rachkevych can be reached at [email protected]. Editor Jakub Parusinski contributed to this story
