Although the economic crisis has significantly slowed down the financial sector’s M&A activity in Ukraine with nearly 90 (of the 180 existing before 2014) commercial banks becoming insolvent or being taken over by the state, several banking cross-border equity transactions closed in recent years are paving the way towards the market’s gradual recovery.
Investors with a risk appetite for geopolitical risks and an unstable banking system recovering from the hryvnia’s significant devaluation are destined to get substantial rewards based on the current distressed pricing of these assets in Ukraine.
The peak of the financial meltdown was arguably reached at the end of 2016, when the largest Ukrainian commercial bank, PrivatBank, was nationalised. The share of the state-owned banks in the banking sector has now exceeded 50% and, in some sectors of the banking market (deposits, domestic payment services, domestic money transfers and a number of others), PrivatBank’s dominant positions have now become state-controlled. The regulators should be concerned that the banking market could be quickly monopolised by state-owned banks, which have previously shown a notable lack of cutting-edge innovation and agility in developing banking services.
From a transaction mechanics standpoint, there has been a variety of transaction types over the last two years, from classic M&A deals to share swaps and debt-to-equity conversions or their combinations. No matter which form the deal takes, the buyers and sellers need to consider some essential rules of thumb to avoid problems during implementation of the equity deals in the financial sector and achieve a smooth and timely completion.
(1) Timely tend to the possible need of bank re-capitalisation
In the market’s currently difficult position, parties to banking M&A deals often face the requirement for the bank’s regulatory capital to be improved during preparation for the deal or after the parties have entered into binding transaction documentation.
The local laws allow a bank to be re-capitalised in many different ways. In particular, the parties need to analyse whether re-capitalisation is possible by means of a regular full-fledged or a fast-track share capital increase procedure. The latter, with its various exemptions from the regular complex process, is only available to those banks which, based on qualified auditors’ stress tests, required being re-capitalised to meet the capital adequacy requirements.
If the private share issue route is chosen, it needs to be fully aligned with the deal timeline. Additionally, before the capital increase kicks off, both the seller and the buyer have to pre-agree who will subscribe for the new shares. Not attending to this matter in advance may frustrate both the deal and the re-capitalisation plan.
The central bank has also recently been allowing the regulatory capital to be replenished using historical cash infusions by means of a shareholder’s forgiveness of bank’s debt based on an ad hoc approval. The terms of this forgiveness need to be structured appropriately so that they satisfy the regulator’s requirements.
(2) Accurately define the terms of the buyer’s pre-acquisition involvement
No buyer wishes to buy "a pig in a poke" or an asset that has lost its value since due diligence. Thus, it is not uncommon for the Ukrainian M&A market to enable the buyer to have a certain degree of involvement in the bank’s affairs prior to the actual sale.
The crucial point here is to preclude such involvement from becoming troublesome in respect of merger control or the banking secrecy regulations. The seller often agrees to allow a buyer’s nominated person to have some degree of oversight, veto and information rights. The scope of these rights should be crafted with extreme care to avoid problems with the regulators, who will see the terms of these arrangements when pre-approving the deal.
When structuring the pre-closing oversight arrangements, we recommend that the parties also thoroughly think about until what point in time they keep the deal undisclosed from the bank’s employees, as this is a very sensitive point that may sometimes lead to staff outflow. This will directly affect the terms of the oversight arrangements.
(3) Motivate incumbent management
Where the deals would result in a change of the controlling shareholder and replacement of management, the parties need to think about how to properly motivate the key personnel, as the cooperation of the target’s personnel during the sale process is vital for the sale to be closed successfully.
Management often becomes the connector between the buyer and the seller in communicating information about the bank and taking various regulatory actions to honour the regulatory requirements.
The seller is interested in keeping both management and the buyer happy with the process, which is not always an easy task to achieve. For example, resigning managers may be concerned with getting new job offers from the outside or with any potential damage to their professional reputation in the event the regulator finds out that their bank is in trouble within one to three years (depending on the violation) after closing the deal. It may be difficult for resigning managers to argue that they should not be held liable for the trouble.
The sellers often use ‘golden parachute’ structures to give incentives to the people steering the bank to stay and cooperate up until its sale. In Ukraine’s volatile market, the sellers tend to opt for variable amounts of bonuses to be tied to the transaction value. Regardless of whether the seller chose fixed or variable bonuses, careful structuring of arrangements should be made to avoid situations where expats’ bonuses would be caught up by the local currency control regulations in Ukraine.
(4) Make a decision as to new management beforehand
Recent amendments to the central bank’s regulations now allow a buyer’s management to be pre-approved in advance of completing the deal.
Previously, the buyer had to retain the incumbent head of the management board and the chief accountant for reporting purposes until the regulator approved the new management appointed at transaction closing. During this transition period, the new head was only given the status of acting chairperson, having a rather nominal role which could not provide enough comfort to the buyer. Now, the pre-approval is issued within one month after such request and remains valid for six months.
Therefore, the parties may want to factor this step into their transaction timeline. Importantly, the filing process requires the full cooperation of the bank’s incumbent management, which may prove to be tricky given that the incumbent management essentially works towards its own replacement.
(5) Carefully plan closing mechanics
Closing in banking M&As is usually tied to the general assembly of the shareholders convoked more than a month in advance to accept resignations from the incumbent supervisory board, appoint the buyer’s supervisory board members, adopt the new articles to match the buyers’ needs and pass other relevant resolutions.
Recent legislative developments, in certain cases, now allow changing certain board members without the general assembly. This route may be particularly attractive in cases where parties, for some reason, need to close urgently while the other matters constituting the exclusive competence of the general meeting are not so urgent to be resolved at closing.
At completion, the selling shareholder can replace the supervisory board members it previously appointed as its representatives by a simple notice to the bank having immediate effect. This option, however, cannot be used to replace the independent members of the bank’s board or to appoint new ones to fill in the positions that are already vacant. When going into the deal, the buyer needs to figure out whether the board will be quorate post-closing, as well as if it has comfort around the issue of independent members.
To conclude, although Ukrainian law is slowly but steadily improving the banking M&A environment, the market continues to remain weak and unstable. Investors should be mindful of the plethora of structuring options, both for those who intend to enter and those who intend to leave the market, which need to be used with great care and with the assistance of experienced consultants.
By Ihor Olekhov, Partner, and Andrii Moskalyk, Senior Associate, Baker McKenzie Kyiv
