New policy requires foreign investments be made in hryvnya

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Nov. 18, 2004, 1:34 a.m. | Business — by Roman Olearchyk

Roman Olearchyk

Kyiv Post Staff Writer

New central bank currency policies have proved unpopular with the nation's business community n entities to be carried out in national currency have proved unpopular with the nation’s business community.

Explanatory notes accompanying the National Bank of Ukraine’s resolution No. 482, introduced on Nov. 11, say the rules are intended to regulate foreign investments into Ukraine and the repatriation of investments. Businesses, however, claim the regulation will negatively impact foreign entities that make direct investments into Ukrainian companies, sell local interests and repatriate profits from local businesses.

Before the implementation of resolution 482, foreign investors were allowed to pump foreign cash investments into Ukrainian entities; but the contested resolution requires that all cash investments be made in Ukrainian hryvnya through accounts at a resident commercial bank.

Under the new rules, cash settlements of shares in Ukrainian companies between non-resident sellers and non-resident buyers can only take place through the parties’ hryvnya bank accounts. In cases when the buyer of shares in a Ukrainian company is a Ukrainian resident or citizen and the seller is a foreigner, the buyer is required to make payments through a local hryvnya bank account. In cases when foreign entities desire to partially or fully get out of local investments, independent evaluators will set the value of their holdings to establish the amount of money that could be repatriated.

Andrew Mac, a senior attorney at the Kyiv offices of PricewaterhouseCoopers, expects the new NBU regulations to negatively impact the Ukrainian investment climate.

“This regulation adds cumbersome requirements for foreign investors seeking to enter the Ukrainian market or expand their activities in the Ukrainian market,” Mac said. “Forcing non-residents to convert hard currency into hryvnya raises the issue of currency exposure. At the very least, the cost of conversion will make investors think twice before investing in Ukraine.”

Ihor Olekhov, an associate at the Kyiv law offices of Baker & McKenzie, expressed similar sentiments. “The resolution unnecessarily complicates the procedure of investing in Ukrainian companies and selling existing shareholdings in such Ukrainian companies...Obviously [the regulation] will create additional complications for foreign investors to make cash charter capital contributions to Ukrainian companies.”

Volodymyr Kotenko, senior manager at Ernst & Young’s offices in Kyiv, described the resolution as an “unpleasant document.”

More bad news

The resolution poses other damaging consequences, too.

“In addition to setting forth stringent currency control measures, the resolution actually imposes the function of tax control agents on the banks,” Kotenko said. In particular, the banks are only allowed to transfer abroad the income/profit derived by non-residents after receiving proof that the non-resident had paid Ukrainian taxes, duties and fees, he added.

According to Olekhov, most new businesses with foreign investments will be impacted by the NBU’s policies. The use of hryvnya accounts by foreign investors could also make them more vulnerable to taxation, he added. The sale of Ukrainian securities by foreign investors could result in the required payments of capital gains taxes on each transaction, Olekhov continued.

The resolution may also stunt the growth of the country’s growing, yet vulnerable, stock market.

Dmytro Tarabakin, director of Dragon Capital, said volumes on Ukraine’s securities market have started picking up after stalling in connection with the elections, but the NBU regulation threatens to impose significant barriers on acquisitions of Ukrainian securities by foreign entities. More than 85 percent of market activity involves foreign investors.

“This is one of the worst administrative control tactics employed by the national bank,” Tarabakin said, adding that the timing of the resolution is especially harmful.

Unanswered questions

Some wonder why the policies were adopted in the first place; were they implemented to quell growing currency concerns in the country? Other sources believe the resolution was intended to prevent capital outflow on the eve of presidential elections.

“Hopefully the regulation is only a temporary measure introduced by the NBU in order to stabilize the situation in the foreign currency market,” Baker & McKenzie’s Olekhov said. The new rules were likely imposed to increase the supply of foreign currency [on the local market] and to collect increased amounts of capital gains tax on the sale of Ukrainian equities by foreign investors, he added.

Uncertainty connected with the presidential elections diminished trust in Ukraine’s national currency, triggering citizens and companies to exchange their hryvnya into foreign currency. The phenomena has resulted in a shortage of available foreign currency on the market, inducing the national bank to sell off more than $1 billion of its $12 billion in foreign currency reserves in effort to calm fears.

The NBU did not respond to inquiries by the time the Post went to press.

Ernst & Young’s Kotenko said the resolution “testifies to the desire of its authors to complicate cash outflow from Ukraine, in an honest and economically sound way or in an unfair and discriminatory way.”

A trivial “fiscal greed” should not be disregarded as one of the possible motives for the new rules, he added.

“Under the new rules, the investors would inevitably have to receive the majority of their investment-related incomes in hryvnya, including dividends, proceeds from share sales, etc.

“Logically, this hryvnya income would have to be converted into a foreign currency, but Ukraine levies a Pension Fund duty – now set at 1.5 percent – on foreign currency conversions. Although it is debatable whether non-resident entities would have to pay this duty, I have no doubt that there will be attempts to force them to pay it,” Kotenko added.PricewaterhouseCooper’s Mac doubts the new regulations will remain in place for long. “In addition to its devastating affect on the investment climate,” he said, “almost every large Ukrainian business group is structured primarily through off-shore companies, and consequently, the regulations are contrary to their interests.”
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