As the full-scale war continues into the second year, Ukrainian companies are facing unprecedented difficulties with attracting capital which is desperately needed to restore their day-to-day business operations and production halted by the military aggression. Predictably, international debt capital markets remain inaccessible not only to Ukrainian private borrowers but also to sovereign entities. The unpleasant situation worsens with high costs of borrowing, which have skyrocketed even more for Ukrainian borrowers since the outbreak of the war due to unsustainable country risk. However, this gloomy picture is not without silver linings. A few recent noticeable changes cultivate a positive outlook and expectations for capital inflow next year. Notably, international financial institutions (IFIs) have substantially increased vital financial support for the businesses that suffered the most. Moreover, borrowers may not only expect to receive very generous restructuring terms but can also count on the lenders to inject new money to help a company recover from significant losses resulting from the war. Undoubtedly, IFIs have become more willing to onboard new clients and have made investments in critical infrastructure and new constructions. On the other hand, the Multilateral Investment Guarantee Agency, the Development Finance Corporation, and other export credit agencies are now offering protection for investors and lenders against war risk, although the amount of coverage is still quite limited. Undoubtedly, institutional financial support is vital, but it is not enough. Many companies and projects are still unable to meet the eligibility and bankability criteria typically required by IFIs to extend financing. For this reason, investment funds turned their eyes to private investors which historically invested in real estate assets in Ukraine. A deep crisis in the real estate market, low interest rates on deposits, and a complete ban on making investments abroad have left private investors with no instruments to invest in except, probably, sovereign bonds. Investment funds and companies (especially large retail chains) have grasped such a chance and offered investors covered corporate bonds and lease-revenue bonds backed by real estate assets as more lucrative options compared to sovereign bonds. It is too early to say if the bet succeeds but, hopefully, the issuance of covered corporate bonds may breathe life into the domestic capital market and may allow corporates to attract additional financing. Unsurprisingly, transacting in domestic governmental bonds (so-called “war bonds”) has been growing exponentially after Russia’s invasion of Ukraine. Sovereign bonds remain the least risky but still relatively high-return instrument for investors. Additionally, FX-linked sovereign bonds help investors mitigate FX fluctuation risk, which is very high in the extremely volatile Ukrainian market. The bonds are very popular among foreign investors (individuals and entities) which are allowed to repatriate interest/coupon payments paid on sovereign bonds outside of Ukraine subject to certain conditions. This makes bonds even more attractive for investors considering that, as a rule of thumb, divestments and pay-outs of dividends overseas are expressly prohibited. According to official statistics, the government has raised almost UAH 600 billion (approximately USD 15 billion) through public placement of domestic sovereign bonds denominated in local and foreign currencies since martial law was imposed. Sovereign bonds, especially EUR/USD-denominated bonds, are hugely traded in the secondary market and frequently bought by large exporters of commodities as a safe haven for foreign currency proceeds under export contracts. We expect that international capital markets will unlikely become more accessible to Ukrainian private and public borrowers until the war is over. Again, IFIs may be willing to subscribe to additional sub-sovereign or sovereign debt as part of their continuous efforts to support Ukraine. We also predict an overall increase in direct investments and bilateral financing thanks to the coverage against political violence risk which has become available just recently. At the same time, the domestic capital market may, surprisingly enough, become a significant source of affordable capital for Ukrainian private businesses and a viable alternative to expensive corporate loans from either domestic or international lenders.

Author:
Igor Krasovskiy, Partner
Published on CEE Legal Matters