Core provisions of the new Capital Markets Law became effective in Ukraine.

On 01 July 2021 has been taken into force the core provisions of the Law of Ukraine “On Amendments to Certain Legislative Acts Related to the Simplification of Attracting Investments and Introducing New Financial Instruments” (hereinafter referred to as the “Capital Markets Law”).

The Capital Markets Law is aimed at improving regulation of the existing, and creating new, financial instruments, introducing the derivatives market in Ukraine, upgrading infrastructure of the capital markets and bringing their regulation closer to the practices and standards of the European Union, including those set out in MiFID II, MiFIR, EMIR, FCAD, SFD and MAR.

The Capital Markets Law amends a number of the Ukrainian regulations, in particular, the Code of Bankruptcy Procedures, the Civil Code; in addition, the Law of Ukraine “On Commodity Exchange” is thereby re-stated.?

The Law introduces the concept of a capital market, which includes the stock market, as well as the derivatives market (including commodity derivatives) and the money market (in relation to the money market instruments and currency assets). Among the key novelties of the Capital Markets Law are the following:

·????????Updated capital market infrastructure model;

·????????Introduction of procedure for algorithmic trading of financial instruments;

·????????Introduction of new types of securities;

·????????Introduction of the regulatory field for operation of derivative contracts;

·????????Introduction of the concept of close-out netting;

·????????Introduction of the institute of investment firms;

·????????Introduction of the concept of the systemically important market participant on the capital markets and commodity markets;

·????????Scoring of investors, in particular, the concept of qualified and institutional investors was introduced;

·????????Improvement of the requirements for combating abuses on the capital markets, prevention of market manipulation and misuse of insider information.

Below, we provide a brief analysis of the above novelties.

Infrastructure of the organized capital markets

The market infrastructure and the professional participants’ operations in the capital markets are undergoing significant changes. Instead of the trading, which is currently taking place at the stock exchanges, upon entry into full force and effect of the Capital Markets Law, such activities will be carried out in the organized capital markets, which include:?

1)???Regulated markets, which are operated by the regulated market operator on the basis of the relevant license of the regulated market operator. In a regulated market (analogue of the existing stock exchanges), securities, derivatives and foreign exchange assets are traded pursuant to non-discretionary rules, which, in turn, do not provide for the possibility of the regulated market operator’s affecting (by adjustment, rejection, etc.) the bids and quotations submitted by bidders. Given its nature, a regulated market should serve as a trading platform for major business.

2)???Multilateral Trading Facilities (hereinafter referred to as “MTF”) are operated by the MTF operator on the basis of the relevant license. At MTF, trading in securities and derivatives pursuant to MTF’s discretionary rules is taking place; in contradistinction to the regulated market, MTF should serve as a trading platform for middle-seized and small businesses.

3)???Organized Trading Facilities (hereinafter referred to as “OTF”) are operated by the OTF operator on the basis of the relevant license; at OTF, non-equity securities are traded, specifically - bonds and derivative contracts – pursuant to OTF’s discretionary rules; in contradistinction to non-discretionary rules, they enable the OTF operator to affect bids and quotations submitted by the bidders.

It should be noted that the structure of the organized market proposed by the Capital Markets Law complies with the European practice, which is reflected in the MiFID II/MiFIR.

Commodity Exchanges

The Capital Markets Law, among other things, restates the Law of Ukraine “On Commodity Exchange”. Thus, the Law regulates, in more detail, the operations of commodity exchanges; in particular, from now on, the commodity exchange may operate only on the basis of a license issued by the National Securities and Stock Market Commission (hereinafter referred to as “NSSMC”).

Only spot agreements may be concluded at a commodity exchange.

Trade Repository and reporting in the instances when the derivative contracts are concluded outside the organized market

The Capital Markets Law provides for introduction of the institute of a trade repository. Trade repository operates due to the fact that NSSMC has entered it into the register of trade repositories. Trade repository should consolidate information on derivative transactions and keep records as to the concluded derivative contracts and the agreements, whereby a party to the derivative contract is replaced, which are executed both on organisized market and over-the-counter (hereinafter referred to as “OTC”) market.

If the parties to a transaction fail to submit, delay in submitting, or submit incomplete information on a derivative contract to the trade repository such failure results in imposition of a fine of 10% of a value of the derivative contract, and if such failure occurs again during the year, the fine imposed will be equal to 50% of a value of the derivative contract.

The purpose of introducing the institute of a trade repository is to create conditions ensuring transparency of the derivatives market, to enhance control and prevent abuses as to the derivatives.

Central Counterparty and clearing institutions

Among the novelties introduced by the new law, is an updated clearing model on the capital markets, whereby the clearing activities are divided into:

·????????Clearing activities related to determining liabilities; and

·????????Clearing activities of the central counterparty (hereinafter referred to as “CCP”).

Settlements under agreements concluded at the regulated market and MTF (if such obligation is provided by the MTF’s rules) are made exclusively through the CCP.

In addition to the above, the CCP may perform clearing operations for the financial instruments and derivative contracts, as well as in other instances provided by the NSSMC and effective laws. The CCP is a clearing institution which received the respective license from the NSSMC to carry out the activities of the CCP.

Starting from 01 July 2021 until (at least) 01 January 2023 the Settlement Center would perform functions of the CCP.?

The requirements related to the central counterparty’s capital are set by the NSSMC. Note that in accordance with the practices of the European Union, the CCP is a highly capitalized legal entity possessing such capital that enables it to properly manage the risks when carrying out its activities.

Clearing activities related to determining liabilities may be also conducted by clearing institutions, organized market operators, the National Securities Depository and the National Bank of Ukraine (hereinafter referred to as the “NBU”).

Clearing activities related to determining liabilities are carried out with respect to the transactions with securities, derivative contracts and money market instruments, which are concluded both in and outside the regulated market, except for the instances when clearing of these transactions should be carried out exclusively through the CCP.

Clearing activities should be carried out on the basis of agreements regarding settlements in securities, based on results of clearing with the Central Depository or the NBU.?

The Law stipulates that foreign legal entities will be able to carry out clearing activities in accordance with the requirements that will be further developed by the NSSMC.

Algorithmic trading

Algorithmic trading defines trading in financial instruments, which is carried out through a computer algorithm automatically performing the functions to determine parameters of orders or quotations, determine the time of initiation of orders or quotations, send orders or quotations, determine their price and actions to be taken in relation to orders or quotations.

The algorithmic trading is carried out through the information and telecommunications system, which must meet the requirements set by the NSSMC.

Investment firms

The Capital Markets Law introduces the concept of investment firms. On the basis of the relevant license, the investment firms may carry out professional activities related to trading in financial instruments, the list of which has been expanded in comparison with the one stipulated by the existing laws, and now includes:

1)???Sub-brokerage activities;

2)???Brokerage activities;

3)???Dealer activity;

4)???Financial instruments portfolio management activities;

5)???Investment consulting;

6)???Underwriting and/or placement with issuance of guarantees; and

7)???Placements without issuance of guarantees.

Each type of trading in financial instruments is carried out on the basis of a license issued by the NSSMC.

In addition to the above activities, an investment firm may provide additional services stipulated by the Capital Markets Law, if they are specified in the decision of the NSSMC related to the issuance of a specific license. Such services include, but are not limited to, the safekeeping of the clients’ financial instruments and funds, issuance of credits and loans to clients for the purpose of their entering into derivative contracts with or through such investment firms; and execution of financial instrument transactions, provision of business funding advice, issuance of guarantees for performance of obligations under agreements concluded on behalf of the investment firm’s clients and other services.

Cash, financial instruments and property rights transferred by clients to an investment firm during their professional activities in the capital markets may not be seized and/or are not subject to foreclosure as a result of default under obligations of such investment firm.

At the same time, requirements for the authorized capital of a professional participant - a securities trader – have been enhanced. Thus, according to a general rule, initial capital of an investment firm must be at least in the amount equivalent to 22,000,000.00 hryvnias (please note that prior to 01 January 2024 – would apply more relaxed requirements). In some instances, such amount of the initial capital may be reduced.

Currently, the NSSMC issuing new regulation with regard to activities of investment firms (i.e. regulation on the procedure of re-issuing of licenses for professional securities traders, etc.).

Under the Capital Markets Law under supplementary legislative regulations, requirements to investment firm (previously – securities traders) become much more strict and comprehensive.

Outsourcing and related agents

When carrying out their professional activities in the capital market and organized commodity markets, professional participants of the capital markets may resort to outsourcing services. If the capital market professional participant resorts to such services, he/she/it will be fully responsible for the actions of the person providing the outsourced services. Requirements set with respect to the outsourced services are set on an individual basis by the NSSMC.

In addition to the above, the Capital Markets Law introduces the concept of a related agent, which, acting pursuant to an agency agreement with an investment firm (such agreement may be concluded only with one investment firm), may provide on behalf, and at the expense, of an investment firm, the following services:

·????????Advertising of the stock market and securities in connection with the services rendered by an investment firm;

·????????Accepting orders from clients for entering into derivative contracts and transactions related thereto as well as other financial instruments;

·????????Arrangement for placement of securities, etc.

Related agents shall necessarily be entered into the register of the NSSMC.

An investment firm is fully responsible for any actions taken by the related agent. An investment firm, in its turn, has the right of recourse against a related agent if the former has provided compensation for the damage caused through the fault of such agent.

Provision of informational services in the capital markets

The Capital Markets Law provides for the possibility for individuals to render informational services in the capital markets if they are entered into the relevant register of the NSSMC.

Such informational services include the following:

·????????Disclosure of regulated information on behalf of capital market participants and/or professional participants of the organized commodity markets;

·????????Dissemination of consolidated information in the continuous updating mode; and

·????????Submission of reporting data to the NSSMC.

The requirements set with respect to the persons who intend to provide informational services in the capital markets and organized commodity markets are set by the NSSMC.?

Qualified and institutional investors

The Capital Markets Law establishes a separate category of investors in the capital markets - qualified investors. The qualified investors shall independently assess risks and make decisions related to transactions with financial instruments. Advantages of the qualified investors include, in particular, the ability to invest into securities without restrictions imposed with respect to non-qualified investors, concluding OTC transactions related to financial instruments without mediation of an investment firm, etc.

The qualified investors include:

·????????International financial organizations;

·????????Foreign countries and their central banks;

·????????The State of Ukraine represented by the Ministry of Finance of Ukraine and the National Bank of Ukraine;

·????????Professional participants in capital markets and organized commodity markets, banks and insurance companies;

·????????Foreign financial institutions that meet the criteria set by the NSSMC; and

·????????Legal entities, including those established under the laws of another state, if they meet at least two of the following criteria: (i) the balance sheet total is at least the equivalent of UAH 20 million; (ii) the annual net income for the last financial year is at least the equivalent of UAH 40 million, with the entity’s own funds being at least the equivalent of UAH 2 million.

Other entities which meet a number of criteria established by the effective laws may be also recognized as a qualified investor by the investment firms.

The Law also establishes the concept of institutional investors – entities/persons which carry out transactions with financial assets in the interests of third parties.

The institutional investors include:

·????????Mutual investment institutions;

·????????Investment funds;

·????????Mutual funds of investment companies;

·????????Private pension funds;

·????????Banking management funds;

·????????Insurance companies; and

·????????Other financial institutions.

Securities, financial instruments and money market instruments

In contradistinction to the current law, the Capital Markets Law introduces a wide range of financial instruments, which now include securities, money market instruments, options, futures, swaps, forwards and other derivative contracts, the underlying assets of which are production, securities, currencies, rates, yields, exchange rates etc.

The Capital Markets Law also introduces the definition of money market instruments, which include treasury obligations of Ukraine, savings and deposit certificates of banks, promissory notes and other instruments that meet the following criteria:

·????????have a value that may be determined at any time;

·????????are not derivative financial instruments; and

·????????have a maturity of 397 days or less at the time of issuance (delivery).

Moreover, the list of securities is expanding; in particular, option certificates, stock warrants, credit notes, and depository receipts have been added to the list of securities.

Such a new type of securities as an interest-bearing bond for environmental investments (green bonds) is envisaged, among other things. It is expected that its introduction in Ukraine will contribute to further development of renewable energy sources, including by obtaining funding for such projects from foreign creditors. In addition, the Capital Markets Law provides for such a type of securities as infrastructure bonds, which should expand the opportunities for borrowing funds intended for development of infrastructure facilities.

These bonds can be issued by persons implementing or funding such projects.

As a general rule, a legal entity may issue bonds in an amount not exceeding three times the amount of its equity or the amount of security provided to such legal entity for this purpose by third parties.

In addition, the Capital Markets Law amended the procedure for issuance of securities, requirements for securities prospectuses, etc.

In particular, it is possible to hold a meeting of bondholders and appoint a bond issue administrator, who, among other things, will coordinate the actions of bondholders and serve notices thereon. The rights of a bond issue administrator are determined by the prospectus (decision regarding the issuance), decisions of the meeting of bondholders and the agreement regarding the administrator’s appointment.

Market for derivative contracts

The Law will regulate not only functioning of the derivative securities, but conclusion of derivative contracts as well.

The derivative contracts are divided into:

·????????Delivery contracts (which provide for delivery of the underlying asset);

·????????Settlement contracts (which provide for settlements between the parties depending on a value of the benchmark); and

·????????Mixed contracts (which provide for the possibility of settlements both via delivery of the underlying asset and settlements, subject to the parties’ choice).

By type of the underlying asset, the following derivative contracts are envisaged:

·????????Money market derivative contracts;

·????????Commodity derivative contracts;

·????????Stock derivative contracts; and

·????????Other derivative contracts.

The Capital Markets Law defines that the list of derivative contracts presented therein is not exhaustive and provides for the possibility of the NSSMC to establish other types of derivative contracts by the criterion of a type of the underlying asset.

The derivative contracts may be concluded both in and outside the organized capital markets. In the regulated market, a derivative contract must be concluded in accordance with the specifications developed by each operator of the regulated market and registered by the NSSMC. OTC Derivative contracts may be concluded on the basis of a general agreement.

It is expected that the Capital Markets Law will provide for a possibility to use standardized ISDA documentation as well as other standardized documentation, in particular, GMRA and GMSLA, when concluding derivative contracts, in particular with non-residents of Ukraine.

An important innovation consists in introduction of the concept and mechanism for close-out netting. Relevant amendments were also introduced into the Bankruptcy Code of Ukraine.

Currently, as of 16 August 2020, the close-out netting mechanism is provided for derivatives [contracts] concluded with participation of a professional securities trader. At the same time, commencing from 1 July 2021, the close-out netting will be working for a wide range of derivative contracts, as it is stipulated by the Capital Markets Law.

The lack of close-out netting mechanism has impeded development of the derivatives contract market in Ukraine, exposing investors to the risks arising out of the counterparty’s insolvency.

It should be noted that due to this novelty and complexity of the concept of netting, Ukrainian courts should develop a consistent and stable position.

Combatting abuses in the capital markets

Improvement of the procedure for combating abuses in the capital markets is among the novelties of the Capital Markets Law. These procedures are close to the provisions contained in the European laws.

In particular, the key changes include:

·????????Regulating the definition of insider information and establishing a list of actions that the persons who possess such information, are prohibited to take;

·????????Enabling capital market participants to test the capital markets (provide market sounding) – to transfer information to the investor(s) in order to determine the investor’s (investors’) interest to a possible transaction, until information about entering into such transaction is announced; and

·????????Expanding the list of actions qualifying as manipulation in the capital markets.

It should be noted that the Capital Markets Law provides for administrative and criminal liability for abuses in the capital market, including manipulation therein.?

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The article aimed at only information purposes and shall not be treated as an official legal advise. For a detailed consultation/advise please feel free to contact me here, or at: [email protected]