Legal Considerations with Respect to Emerging Market Finance and Investment: An Overview Brian W....

Legal Considerations withRespect to Emerging MarketFinance and Investment: An Overview

Brian W. Tang*Senior AssociateSullivan & Cromwell LLPNovember 20, 2003

*Views expressed are personal and not those of Sullivan & Cromwell LLP

Yale School of Management: Emerging Market Finance (MGT 647)

Emerging Market Finance - Legal Considerations

2Emerging Market Finance - Legal Considerations

Ever-improving opportunities for emerging markets finance and investment . . .

EQUITY 1-Year Returns*

Eastern Europe 54.37%Emerging Asia 36.24%Latin America 59.26%U.S. 17.95%

DEBT the number of recent completed emerging

markets (EM) quasi-sovereign and sovereign bond issuances indicate growing market confidence in those economies and new benchmarks for future corporate bond issuances from those countries . . .

* As of Oct. 28, 2003 Data: MSCI and Business Week

. . . such as Mexico’s Pemex and Venezuela issuing €500M and $700M of bonds respectively in August and September . . .

3


. . . and United Mexican States and China each issuing $1B of bonds in October . . .


. . . yet substantial risks remain for investors in emerging markets:

See e.g., headings in the “Investment Considerations” disclosure in Bolivarian Republic of Venezuela September 16, 2003 offering circular:

Recent Political Developments 2002 Economic Results New Exchange Control Regime 2003 Year-to-Date Results The Financial System Oil Dependency Dependence on Major Trading Partner Emerging Markets Limited Trading Market for the Notes


Main roles of the lawyer in emerging markets finance and investment transactions

Navigate multi-jurisdictional regulatory hurdles, complicated by different levels of development and national priorities

Advise on structuring and negotiating cross-border transactions to capture opportunity and maximize profit

Risk management and re-allocation Four main components from a foreign investor’s

perspective: Market entry Obtain bargain Retain benefit of bargain Exit strategy (profit and proceeds)


Outline

1. Categories and participants of emerging market finance and investment

2. Main risk considerations

3. Risk management and re-allocation techniques

4. Other strategic considerations

5. Recent developments


(a) Foreign direct investment

Five main categories Traditional foreign direct investment (FDI)

Greenfield physical asset development (e.g., set up factory)

In past – countries often required local partner Query – degree of foreign investor control

Project financing Greenfield or brownfield (esp. resources (mining and

O&G) and infrastructure) Considerations include:

Equity - Joint ventures, consortia Debt – private and public financiers; commercial banks and

capital markets Government - concessions/build-operate-transfer (BOT),

build-own-operate-transfer (BOOT) and production sharing contracts/licenses


(a) Foreign direct investment

Five main categories Mergers and acquisitions (M&A), privatizations

Strategic purchase of existing companies and/or assets

Query – level of corporate law development Query – level of permitted foreign control and

ownership Private equity (financial buyers; later stage

financing) Query - exit strategy: IPO or trade sale

Venture capital (seed/early stage financing) Query - exit strategy: IPO or trade sale

continued


(b) Foreign indirect investment

Direct investment in local stock market Query — quality of listing standards (corporate

governance; accounting standards)

Dual/cross-listings via e.g., American Depositary Receipts (ADRs) — sponsored or unsponsored

Subject to host country listing and securities requirements

ADRs often sell at premium to home market (esp. Taiwan and India (e.g. Infosys on NASDAQ often trades at a 30% premium to Mumbai SE))

NYSE’s “global shares” since DaimlerChrysler in 1998, only issued by Deutsche

Bank, UBS and Celanese


(b) Foreign indirect investment

Portfolio investment Broad product range – equity, debt, convertibles

Emerging markets sovereign and corporate bonds

Mainly institutional investors Holders have less leverage compared to bank

lenders

continued


(c) Main EM participants include:

Equity investor — opportunity/profit maximization and risk management = long-term (trader = may be short-term) and bundle of rights and obligations

EM investee — capital-raising; market liquidity EM host country (central and provincial) — foreign

capital inflow for economic development Home country government Debt financings

e.g., syndicate banks; underwriters; financial advisors e.g., multilateral agencies (MLAs) such as World Bank, IFC e.g., export credit agencies (ECAs) such as US EXIM, JBIC


Outline

1. Categories and participants of emergingmarket finance and investment






Five levels of analysis for framework of project debt rating analysis (2002)

Project-level risk Contractual foundation benchmarks

Commercial and collateral contracts Technology, construction and operations benchmarks

Preconstruction –v- postconstruction Competitive market risk benchmarks

Industry fundamentals, supply, demand, competitive advantage

Legal risk benchmarks SPE bankruptcy remoteness, financing jurisdiction, collateral

Counterparty benchmarks Sponsors, EPC contractors, suppliers and offtakers

Financial risk benchmarks Debt-service coverage ratios, amortizing –v- bullet payments


Five levels of analysis for framework of project debt rating analysis (2002)

Sovereign risk (“sovereign ceiling”) Foreign currency rating, exchange controls,

expropriation Business and legal institutional development

Legal system, enforcement culture, transparency Force majeure risk

Floods, earthquakes, civil disturbances, strikes, law change

Credit enhancements Political risk insurance (PRI), sponsor support,

monoline insurance wrappers

continued

Analysis assists with conclusions regardingbankability of non/limited recourse projects


Outline







(a) Foreign investment orconcession agreement framework

Concessions/BOT, BOOT and production sharing contracts/licenses

Statutory/constitutional basis Government guarantees and foreign

investment contracts Contractually stabilized legal and tax regime


(a) Foreign investment or concession agreement framework

Chile widely recognized for successfully

attracting FDI between 1974-2001, attracted FDI

totaling $57.9 billion DL 600 is one of oldest foreign

investment statutes in Latin America Peru

protection mainly constitutional and statutory, but augmented by execution of legal stability agreements with each investor

between 1993-2001, entered into 336 legal stability agreements

continued



Main features (e.g. Chile and Peru) Type of regime – constitutional; statutory;

contractual Restrictions to investment in certain sectors

(e.g. media, “strategic areas”) Non-discrimination principle Right to repatriate capital Right to remit profits Availability and convertibility of foreign currency

(e.g. Peru requires registration with Comision Nacional de Inversiones y Technologieas Extranjeras (CONITE))

Off-shore account maintenance and payments

continued



Main features (e.g. Chile and Peru) (con’t) Legal and fiscal stability (regime matters whether

constitutional, statutory or contractual) Freeze at time of execution of agreement (Peru) Stability with respect to e.g., tax, environmental

protection, labor, export promotion systems One time waiver of tax stability

continued


(b) Treaties

Bilateral and regional tax and investment treaties

Bilateral tax treaties — e.g., double taxation and tax-non-discrimination clauses

Bilateral investment treaties — e.g., MFN and non-discrimination clauses

Regional conventions — e.g., NAFTA

Multilateral investment treaties Dispute resolution — e.g., 1965 International Center for

Settlement of Investment Disputes (ICSID) Convention Cross-jurisdictional recognition and enforcement —

e.g., New York Convention on Recognition and Enforcement of Foreign Arbitral Awards

Breach gives rise to inter-governmental claim


(c) Some tools for risk allocation inproject financings

Completion undertakings/ construction bonds Take-or-pay or other offtake arrangements Price support Political risk insurance

e.g., Multilateral Investment Guarantee Agency (MIGA) Convention: PRI covering debt and equity against

convertibility/transfer risk expropriation political violence arbitrary non-enforcement of breach of contract

Casualty insurance Legal opinions Engineering reports Off-shore accounts

Reserve accounts in USD


(d) Some non-legal protections inproject financings

Composition of lender group(e.g., MLA/ECA participation)

Local political support publicly expressed Local economic stake in outcome of

investment


Outline







Rule of Law/ Enforceability of contract

“So what if you have great representations and warranties?”

Default risk especially in contracts with sovereign and sovereign debt

Fear lack of impartiality of local judiciary Choice of law and forum Litigation, arbitration and restructuring Enforceability of foreign judgment


Choice of jurisdiction ofspecial purpose entity (SPE)

e.g., according to Conyers Dill & Pearman, Bermuda companies constitutes more than 50% of approx. 750 HKSE listed companies

Tax considerations — absence of income, profit or capital gains taxes; absence of withholding tax

Geographical location — proximity to New York and London

Legal system based on UK, with final appeal to Privy Council

Corporate law flexible and based on UK corporate law

“Light regulation” Takeover defense tools permitted — e.g., blank

check preferred stock, staggered board, poison pill


Equity investment

Choice of investment vehicle — corporate; contractual JV

Corporate governance under corporate law and listing requirements

liability of management; minority shareholder protection; private securities litigation rights; regulatory oversight

Shareholder agreements Accounting and reporting requirements Bankruptcy rules Antitrust/competition regulation Project operation: environmental laws; labor

regulation; industry-specific regulations; local content requirements; permits, consents and approvals; penalties, etc.


Debt investment

Piercing “sovereign ceiling” set by rating agencies

Require e.g., strategic importance, U.S. dollar revenues, irrevocable account structures, export product (esp. O&G projects)

Requirements in addition to financial covenants e.g., environmental and social requirements of MLAs

and ECAs Creation and perfection of security interests for

collateral Guarantees (parent or subsidiary) and structural

subordination


“Exit strategy”

Capital/currency controls — taking profit and proceeds out of country

Trade sale — esp. for foreign direct investment and M&A

Initial public offering (IPO) — domestic and/or international

Choice of overseas listing market (e.g., NYSE, NASDAQ, LSE, HKSE) – often for deeper markets and richer valuations

Local regulatory issues (e.g., political acceptability) Carl E. Walter & Fraser J.T. Howie in

Privatizing China (2003) outline five methods of corporate restructuring for international listings of Chinese enterprises:


1. Basic indirect overseaslisting structure

Holding companyincorporated in

tax-efficient jurisdiction

Public investors of foreign listed

shares

Offshore Chinainvestment company

Onshore Sino-foreignjoint venture

company

Chinese jointventure partner

Issues Shares

Cash

100%

>50%

<50%

Source: Walter & Howie, Privatizing China (2003)


2. Back door listing with share offer

Step 1 Step 2

Publicly listedcompany

Publicly listedcompany

Publicinvestors

Unlisted company Parent company

Cash Sellsassets

Issuesshares

Acquireslisted company



3. Typical listed infrastructure“company”

Publicinvestors

ProvincialCommunications

Bureau

Listed company

HighwaySegment # 2

HighwaySegment # 1

Highway Segment # 3

Tariff structure

CashCashIssues Shares



4. Red chip listed company

A B C D E

Chinese municipalgovernment

Hong Kongregistered company

Public investors

Listedcompany

Issues Shares

Cash

onshore

offshore

Cash



5. Whole industry repackaging

Parent companiesMinistry

HoldingCompany Co. Ltd.

New Company/

ListCo



Outline







EM sovereign debt restructuring

Debt restructurings that require e.g., change of payment terms generally require unanimous bondholders’ approval, leading to holdover risk

1. Statutory approach embodied in the IMF’s proposal for a Sovereign Debt Restructuring Mechanism (SDRM)

2. Market-based contractual approach — collective action clauses (CACs) Majority action to amend and waive key bond terms (including

payment terms, governing law, submission to jurisdiction, waiver of sovereign immunity)

Appointment of bondholders committee upon Event of Default Initiation of acceleration by 25% bondholder vote In 2003, sovereigns that used CACs include Brazil, South

Africa, United Mexican States; Uraquay Query - use for EM corporate issuers under US law


Equator Principles

Launched in June 2003 by certain commercial lenders

(i.e. non-MLAs and ECAs) who agree to manage social and environmental issues surrounding project financing based on World Bank and International Financial Corporation (IFC) policies

current signatories include18 banks which, according to Dealogic, arranged $43 billion in project loans in 2002 (74% of the project loan market volume), including Citibank, ABN Amro, Barclays, WestLB, Mizuho, HSBC and Dresdner

require environmental assessments and environmental management plans

principles incorporated onto loan covenants justified as prudent risk management to address NGO

criticism


International investment treaty

Extension of bilateral investment treaties (BITs)

Negotiations to establish a Multilateral Agreement on Investment (MAI) discontinued by OECD countries in 1998

Multilateral Investment Agreement (MIA) on agenda of WTO ministerial conference in Cancun in September 2003, but trade talks collapsed


International capital markets andcorporate governance developments

Numerous corporate governance rule changes in light of Enron, WorldCom and other corporate scandals worldwide

e.g., US Sarbanes-Oxley Act, UK Combined Code Competition for capital

e.g., EU Prospectus Directive and proposed HK Stock Exchange listing rules

Harmonization of accounting standards e.g., all listed EU and Australian companies to

prepare and publish their financial statements in accordance with International Accounting Standards (IAS) by 2005

U.S. Financial Accounting Standards Board (FASB) to work with IASB to remove differences between US GAAP and IAS


Asian bond market initiative

Lack of domestic bond markets increasingly blamed as a cause of the Asian financial crisis

Recent promotion of Asian bond market initiative, especially by Thailand

e.g., APEC Regional Bond Market Initiative, ASEAN+3 Asian Bond Market Initiative

e.g., June 2003 - $1B Asian Bond Fund established to invest in a basket of dollar denominated bonds issued by Asian sovereign and quasi-sovereign issuers

Date post:	31-Mar-2015
Category:	Documents
Upload:	lexus-ellens
View:	214 times
Download:	2 times

Legal Considerations with Respect to Emerging Market Finance and Investment: An Overview Brian W....

Documents