Hedging risks in times of war: a new financial instrument has appeared on the capital markets

At the beginning of June, the National Securities and Stock Market Commission (hereinafter – the NSSMC) registered the first issue of credit notes. This extraordinary event, especially in times of war, has aroused great interest among market participants. Who and in what cases can this financial instrument be suitable for, what are its features and benefits, and what should companies that want to use it in their business do? Ruslan Magomedov, Chairman of the NSSMC, spoke about this in his column for UBR.ua.

Credit notes: what do you need to know?

By their nature, loan notes represent a symbiosis of two financial instruments: a debt instrument and a credit risk hedge. The holder has the right to receive payments on the debt instrument and to repurchase such securities if the credit risk is realized. In short, a loan note is a derivative security.

Despite the fact that credit notes appeared in the legal field several years ago (on July 1, 2021, when the new version of the Law of Ukraine on Capital Markets and Organized Commodity Markets came into force), the registration of the first trial issue took place recently. The logical question is: why is this?

First, it must be an initiative of the issuer itself, which has identified this instrument as interesting for its activities. In May, we were approached by LLC «MARKET CONSULT PLUS» (the issuer) with a request to consider the possibility of conducting a pilot project to register the issue of credit notes. Since the NSSMC always supports the development and popularization of new financial instruments, we implemented such a project. We have registered the issue of Series A loan notes, which includes 334 thousand registered interest-bearing ordinary loan notes for the total amount of UAH 334 million, with a nominal value of UAH 1 thousand per loan note. The loan notes bear interest at 5% per annum and have a maturity of 5 years.

Secondly, the introduction of a new instrument on the market now should demonstrate to all participants that it is possible and necessary to issue new instruments. Our priority is to attract foreign investors’ funds to Ukraine’s economy, and such instruments are quite commonplace for them. For example, credit notes are often used in synthetic securitization. Therefore, we have to offer our investors a wide range of instruments that will make them interested in coming to our market and will be understandable at all stages of interaction.

The nature of loan notes and their benefits

Credit notes are indeed an interesting and promising financial instrument by their very nature. They deserve special attention when there is uncertainty or certain risks associated with a third party.

The advantage of credit notes, as with any financial instrument, is that they meet the expectations of the parties to which they are intended to be used. If such parties need to hedge credit risk, this mechanism will be effective and useful for them.

The fact that credit notes have a hedging component is the main feature of this instrument. What is common to all derivatives is that the law currently defines a general perimeter for their use, which the NSSMC should then cover in its documents, taking into account the specifics of the current state of development of capital markets.

Since such instruments have emerged in the process of financial engineering of various models, there are many configurations of their use.

What’s next.

The loan note registration pilot project was an important first step in gaining practical experience. Based on its results, we will conduct an internal analysis, which will include the following:

• re-evaluation of all issues that arose within the regulator;
• outlining a typology of models for applying this tool, taking into account the specifics of potential issuers.

After that, we plan to develop a universal document on the procedure for issuing, circulating and redeeming such securities.

At the same time, we are already inviting all potential issuers to contact the NSSMC, as this way we will receive feedback from the market. And we will also be able to help them, at the initial stage of structuring models, to better assess the feasibility of using this particular instrument for their activities.

In addition, I would like to draw your attention to the fact that there are other instruments that are provided for by law, but have never been issued. I hope that everyone will be able to hear about them in the near future.

Other instruments and projects in the pipeline

The NSSMC is constantly working on the development of time-relevant financial instruments. If we are talking about fundraising instruments that may also be of interest to market participants, this is securitization. This is a mechanism for refinancing companies through the issuance of securities of various classes, which are paid out of predetermined assets.

Most often, this mechanism is used by banks to refinance mortgage portfolios, which is very relevant for our country now in the context of increasing mortgage lending.

In addition, we are actively working on the following projects:

• introduction of investment accounts, which will ensure the attraction of long money to the economy;
• building a virtual asset market based on European MiCA standards;
• pension reform – a major social reform for Ukrainian citizens that will provide liquidity in the capital markets;
• Crowdfunding – a mechanism for raising funds for SMEs in Ukraine instead of using traditional sources of financing,
• financial instruments (agricultural receipts, derivative contracts, IPOs, municipal bonds);
• infrastructure – building modern exchange trading and clearing in the capital markets with the participation of key stakeholders and international partners of Ukraine;
• UCITS – expanding the potential of direct investment in the Ukrainian economy;
• commodity market – development of an organized commodity market for transparent pricing of Ukrainian products (wood, gas, oil, grain, etc.),
• European integration (UCITS and AIF, ESG projects, IORP) is a priority and a benchmark in the development of capital markets.

Source: UBR.ua.