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Legal Considerations with Respect to Emerging Market Finance and Investment: An Overview Brian W. Tang* Senior Associate Sullivan & Cromwell LLP November.

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Presentation on theme: "Legal Considerations with Respect to Emerging Market Finance and Investment: An Overview Brian W. Tang* Senior Associate Sullivan & Cromwell LLP November."— Presentation transcript:

1 Legal Considerations with Respect to Emerging Market Finance and Investment: An Overview Brian W. Tang* Senior Associate Sullivan & Cromwell LLP November 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

2 1 Ever-improving opportunities for emerging markets finance and investment... EQUITY 1-Year Returns* Eastern Europe54.37% Emerging Asia36.24% Latin America59.26% 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

3 ... such as Mexico’s Pemex and Venezuela issuing €500M and $700M of bonds respectively in August and September... 2

4 Emerging Market Finance - Legal Considerations 3... and United Mexican States and China each issuing $1B of bonds in October...

5 Emerging Market Finance - Legal Considerations 4... 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

6 Emerging Market Finance - Legal Considerations 5 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)

7 Emerging Market Finance - Legal Considerations 6 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

8 Emerging Market Finance - Legal Considerations 7 (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

9 Emerging Market Finance - Legal Considerations 8 (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

10 Emerging Market Finance - Legal Considerations 9 (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

11 Emerging Market Finance - Legal Considerations 10 (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

12 Emerging Market Finance - Legal Considerations 11 (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

13 Emerging Market Finance - Legal Considerations 12 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

14 Emerging Market Finance - Legal Considerations 13 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

15 Emerging Market Finance - Legal Considerations 14 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 regarding bankability of non/limited recourse projects

16 Emerging Market Finance - Legal Considerations 15 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

17 Emerging Market Finance - Legal Considerations 16 (a)Foreign investment or concession 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

18 Emerging Market Finance - Legal Considerations 17 (a)Foreign investment or concession agreement framework Chile widely recognized for successfully attracting FDI between , 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 , entered into 336 legal stability agreements continued

19 Emerging Market Finance - Legal Considerations 18 (a)Foreign investment or concession agreement framework 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

20 Emerging Market Finance - Legal Considerations 19 (a)Foreign investment or concession agreement framework 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

21 Emerging Market Finance - Legal Considerations 20 (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

22 Emerging Market Finance - Legal Considerations 21 (c) Some tools for risk allocation in project 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

23 Emerging Market Finance - Legal Considerations 22 (d) Some non-legal protections in project financings Composition of lender group (e.g., MLA/ECA participation) Local political support publicly expressed Local economic stake in outcome of investment

24 Emerging Market Finance - Legal Considerations 23 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

25 Emerging Market Finance - Legal Considerations 24 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

26 Emerging Market Finance - Legal Considerations 25 Choice of jurisdiction of special 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

27 Emerging Market Finance - Legal Considerations 26 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.

28 Emerging Market Finance - Legal Considerations 27 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

29 Emerging Market Finance - Legal Considerations 28 “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:

30 Emerging Market Finance - Legal Considerations Basic indirect overseas listing structure Holding company incorporated in tax-efficient jurisdiction Public investors of foreign listed shares Offshore China investment company Onshore Sino-foreign joint venture company Chinese joint venture partner Issues Shares Cash 100% >50% <50% Source: Walter & Howie, Privatizing China (2003)

31 Emerging Market Finance - Legal Considerations Back door listing with share offer Step 1Step 2 Publicly listed company Public investors Unlisted companyParent company CashSells assets Issues shares Acquires listed company Source: Walter & Howie, Privatizing China (2003)

32 Emerging Market Finance - Legal Considerations Typical listed infrastructure “ company ” Public investors Provincial Communications Bureau Listed company Highway Segment # 2 Highway Segment # 1 Highway Segment # 3 Tariff structure Cash Issues Shares Source: Walter & Howie, Privatizing China (2003)

33 Emerging Market Finance - Legal Considerations Red chip listed company ABCDE Chinese municipal government Hong Kong registered company Public investors Listed company Issues Shares Cash onshore offshore Cash Source: Walter & Howie, Privatizing China (2003)

34 Emerging Market Finance - Legal Considerations Whole industry repackaging Parent companies Ministry Holding Company Co. Ltd. New Company/ ListCo Source: Walter & Howie, Privatizing China (2003)

35 Emerging Market Finance - Legal Considerations 34 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

36 Emerging Market Finance - Legal Considerations 35 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

37 Emerging Market Finance - Legal Considerations 36 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

38 Emerging Market Finance - Legal Considerations 37 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

39 Emerging Market Finance - Legal Considerations 38 International capital markets and corporate 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

40 Emerging Market Finance - Legal Considerations 39 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 $1B Asian Bond Fund established to invest in a basket of dollar denominated bonds issued by Asian sovereign and quasi-sovereign issuers


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