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Partner, EVERLEGAL, Head of International Arbitration Practice, Co-Head of Banking and Finance Practice
Raising Finance for Ukrainian Agri Sector through Securitization
The securitization mechanism has not used been widely in Ukraine to date. There are only two transactions which tapped the market and those are RMBS and car-loans securitzations by Privatbank in 2007 and 2008, respectively. Before the credit crunch, securitization was considered not only by Privatbank but also by a number of other Ukrainian banks and the receivables in question were residential mortgages, car loans, credit cards receivables, diversified payment rights and certain trade account receivables of commercial entities.
However, since 2008 the situation with leaders of the Ukrainian economy driving its growth has changed, and Ukrainian banks do not currently originate the considerable loan portfolios of receivables which were traditionally used for securitizations. In 2019, the largest contributor to Ukraine’s GDP was its agri sector, which even outweighed the contribution to GDP from the services sector. Despite that leading role, many Ukrainian agri producers continue to complain about the lack of proper funding, which means that traditional instruments of finance for the agri sector are not coping with the demand either because of the cost or because of volumes.
Many commentators have acknowledged that there is no apparent or irreconcilable difficulty in raising finance through securitization of rural output. The important prerequisite of securitization deals is the presence of a sophisticated financial market with experienced investors. Many may question the existence of a properly sophisticated financial market in Ukraine, while others will answer in the affirmative. While this discussion continues, it is worth noting that a credit enhancement mechanism can still be used to overcome market inefficiency. And this was demonstrated by certain structured finance mechanisms that were already in use in the securitization of agri receivables in other countries, and not only at a private level, but also to foster government support programs.
Securitization in the agricultural sector generally takes in four types of receivables, namely agricultural loan securitization, future agricultural income securitization, securitization based on other agricultural collateral, including with the use of repo transactions or warehouse receipts, and securitization of insurance risks.
Securitization of Agricultural Loans
The originators of securitization of agricultural loans are mostly banks and financial institutions. Securitization effectively allows them to remove the default risk under agricultural loans from their balance sheet and to raise additional funding for the issuing of new loans. The liquidity ratio of the originator is increased and this diversifies the sources of funding. It also increases the profitability of the originator, although the interest is transferred to investors and the originator continues to receive service fees and may charge additional interest on the loans made out of funds raised as a result of securitization.
Securitization of agricultural loans may require that the loans participating in the program be uniform to the maximum extent possible and this may be difficult to achieve within one originator. Therefore, securitization of agricultural loans may be multi-originator and a special purpose vehicle (SPV) will purchase such loans from different banks or financial institutions.
Ukrainian banks and financial institutions have accumulated sufficient amounts of agricultural loans, including those which are sufficiently uniform as to their terms. Such loans include financing which was made available to farmers based on crop receipts. In accordance with the available statistics, by March 2020 Ukrainian farmers had issued crop receipts to the value of approximately UAH 21 billion. Those crop receipts are transferable and are generally available for securitization. Ukrainian crop receipt regulations are currently under review and proposed changes considerably reduce the costs of dealing with them. Once the reform is complete crop receipts are likely to become the most attractive collateral for securitization in the Ukrainian agri sector.
As experience in other countries shows, the role of the government in establishing the infrastructure for securitization of agricultural loans may be important. The government may establish an SPV, which may be buying agricultural loans from the market on the account of proceeds raised through a collagenised bonds issuance. The government, or even international financial institutions, may provide certain credit enhancement for such bonds by, for instance, guaranteeing a certain portion of agricultural loans participating in securitization or providing certain subsidies.
Securitization of Future Agricultural Income
While securitization of agricultural loans is mostly for banks and financial institutions, securitization of future agricultural flows is for agri producers or traders. Securitization of future receivables is very popular in countries in transition and Ukraine can become a member of that club. In the agri sector securitization of future income will normally cover domestic and export sales of agri products. The attractiveness of future income securitization in the agri sector may also be because it can help to pierce the ceiling of the sovereign credit rating and procure financing at a lower interest rate than the sovereign one and for longer.
One good example of credit enhancement tools used for securitization of agri receivables in developing countries like Ukraine is a program offered by the International Finance Corporation (IFC) in Peru. The Peruvian transaction was connected with the issue of USD 25 million worth of bonds to finance the Drokasa Corporation, a leading agri producer and distributor in Peru. The terms of the transactions provided for the transfer to an issuing SPV of existing and future receivables from agri sales by Drokasa Corporation. The SPV was receiving daily proceeds from Drokasa’s sales to non-related parties and used the proceeds to top up a bondholder payment account to ensure that at on any payment day the SPV debt servicing account is 6 times over-collateralized. The IFC also provided additional credit enhancement by agreeing to guarantee 30% of the bonds issue. The IFC’s involvement enabled the issue to achieve an AAA national rating, a substantial increase on the SPV’s stand-alone AA rating. This resulted in Drokasa making considerable savings in interest charges even after paying IFC’s fees for the guarantee.
Securitization Based on Repo Arrangements
Repo agreements are more frequently used in relation of securities, but a repo agreement can also be used in relation to any commodity. A good example of a repo transaction to securitised collateral in the agri sector is the Colombian livestock finance program. That program was essentially developed by the Colombian National Agriculture and Livestock Exchange, and it was aimed at benefiting a number of farmers. In accordance with that program, the National Agriculture and Livestock Exchange established an SPV and that SPV was designed to take ownership over unfattened calves and the pasture land where the livestock is fattened. The SPV and National Agriculture and Livestock Exchange were responsible for selecting farmers to participate in the scheme under a strict set of criteria. Selected farmers received finance from the SPV to purchase animal feed. The farmers fattened the animals for 11 months and after that the calves were sold by the agent to third parties and the raised proceeds were used to pay the liabilities acquired with the investors, with the remaining earnings paid to farmers. To make sure that the finance could be raised at the appropriate rate the scheme used a number of credit enhancement mechanisms. The bond issue was for 75% of the expected value of the cattle, and there was also insurance to cover the risk of theft, and technical supervision to guarantee in the event that the cattle failed to reach the anticipated weight gain.
Repo transactions are well known in Ukraine and are also used by the National Bank of Ukraine to provide private and state-owned banks with stabilisation loans. Repo transactions, apart from in effect being a collateralised loan arrangement, are also treated as encumbrance under Ukrainian law. Ukrainian legislation is however, unclear on who is the holder of that encumbrance. If respective changes are introduced to Ukrainian legislation, the use of repo transactions to securitise Ukrainian agri collateral could become an available option.
Securitization Based on Warehouse Receipts
Securitization based on warehouse receipts is designed to provide post-harvest financing to cover working capital needs. Since warehouse receipts represent goods in storage, the SPV or investors in the securities may enforce and charge receipts created by a warehouse and cover their obligations.
Ukraine has (and continues to develop) modern warehouses for the storing of agricultural products. In many cases, licensed warehouses are affiliated with or constitute an integral part of agricultural holdings. Since the majority of warehouses may not be regarded as public and they are rather, inhouse, the eligibility of such warehouses to participate in securitization arrangements may be limited. In addition, Ukrainian regulations on warehouse receipts have been in existence since 2002-2004 and are embodied in two legislative acts. There are discrepancies in those acts as to how warehouse receipts circulate, and the enforcement mechanism in the event of default is not particularly creditor friendly. These circumstances caused a situation when storage of grain in warehouses is documented mainly by warehouse tickets. The use of single or double warehouse receipts is quite limited for practical reasons, and even when they are not used in the way set out in the applicable legislation. It appears that warehouse regulations need further review to meet the needs of the market, including to be eligible for securitization.
Agri Insurance Securitization
Securitization of insurance proceeds in the agri sector is used to transfer the insurance risk from insurance and reinsurance companies to investors in securitization bonds. The bonds issued in insurance securitization may be called “catastrophe bonds”. Catastrophe bonds belong to the high-yield market, and were designed to raise funding for insurance or reinsurance companies in the event of natural disasters. The issuer of the CAT Bond receives funding only if such events like floods, drought or tornado, occur. If an event protected by the bond activates a payout to the insurance company, the obligation to pay interest and repay the principal sum is deferred, reduced or completely forgiven, depending on the amount of losses caused by a natural disaster.
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Many may express pessimism regarding securitization of receivables originating in the Ukrainian agri sector for the reasons that Ukraine does not have properly developed financial markets, and that it considerably downsized after the 2008 credit crunch. On the other hand, development of the financial market was driven by the needs of other sectors which were leading the economy, and the agricultural sector is one such sector for Ukraine.