LEGAL CONSIDERATIONS WITH RESPE

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					        Yale School of Management:
        Emerging Market Finance (MGT 647)




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



Emerging Market Finance - Legal Considerations
Ever-improving opportunities for emerging
markets finance and investment . . .

   EQUITY                                1-Year Returns*
             Eastern Europe                      54.37%
             Emerging Asia                       36.24%
             Latin America                       59.26%
             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

Emerging Market Finance - Legal Considerations                        1
. . . such as Mexico’s Pemex and Venezuela
issuing €500M and $700M of bonds
respectively in August and September . . .




                                             2
. . . and United Mexican States and China
each issuing $1B of bonds in October . . .




Emerging Market Finance - Legal Considerations   3
. . . 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
Emerging Market Finance - Legal Considerations                           4
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)




Emerging Market Finance - Legal Considerations                         5
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




Emerging Market Finance - Legal Considerations      6
(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

Emerging Market Finance - Legal Considerations                                      7
(a) Foreign direct investment
                                                                       continued

   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




Emerging Market Finance - Legal Considerations                                     8
(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




Emerging Market Finance - Legal Considerations                                   9
(b) Foreign indirect investment
                                                               continued

   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




Emerging Market Finance - Legal Considerations                             10
(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



Emerging Market Finance - Legal Considerations                        11
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




Emerging Market Finance - Legal Considerations    12
                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
Emerging Market Finance - Legal Considerations                                13
               Five levels of analysis for framework
               of project debt rating analysis (2002)
                                                            continued

   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
            Analysis assists with conclusions regarding
            bankability of non/limited recourse
            projects

Emerging Market Finance - Legal Considerations                          14
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




Emerging Market Finance - Legal Considerations    15
(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




Emerging Market Finance - Legal Considerations      16
(a) Foreign investment or
    concession agreement framework
                                                                 continued

                      Chile
                           widely recognized for successfully
                            attracting FDI
                           between 1974-2001, 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 1993-2001, entered into 336 legal
                            stability agreements

Emerging Market Finance - Legal Considerations                               17
(a) Foreign investment or
    concession agreement framework
                                                            continued

   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



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

   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




Emerging Market Finance - Legal Considerations                                   19
(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


Emerging Market Finance - Legal Considerations                           20
(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


Emerging Market Finance - Legal Considerations                   21
(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




Emerging Market Finance - Legal Considerations      22
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




Emerging Market Finance - Legal Considerations    23
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




Emerging Market Finance - Legal Considerations            24
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



Emerging Market Finance - Legal Considerations                          25
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.

Emerging Market Finance - Legal Considerations                        26
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



Emerging Market Finance - Legal Considerations                       27
“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:


Emerging Market Finance - Legal Considerations                         28
1. Basic indirect overseas
   listing structure


                                                                       Issues
                                                                       Shares
                                             Holding company                    Public investors
                                              incorporated in                   of foreign listed
                                          tax-efficient jurisdiction                 shares
                                                                        Cash

                                                         100%

                                                 Offshore China
                                              investment company

                                                        >50%

     Chinese joint            <50%            Onshore Sino-foreign
    venture partner                              joint venture
                                                   company
Source: Walter & Howie, Privatizing China (2003)
Emerging Market Finance - Legal Considerations                                                      29
 2. Back door listing
    with share offer


      Step 1                                           Step 2
                                                                       Issues
                                                                       shares
                                                                                  Public
 Publicly listed                                    Publicly listed
                                                                                investors
   company                                            company




          Acquires                                    Cash            Sells
          listed company                                              assets



      Unlisted company                             Parent company

Source: Walter & Howie, Privatizing China (2003)


  Emerging Market Finance - Legal Considerations                                            30
 3. Typical listed infrastructure
    “company”


            Public                                           Provincial
          investors                                        Communications
                             Cash                             Bureau
      Issues
      Shares
                           Listed company




         Highway                                    Highway                  Highway
        Segment # 1                                Segment # 2              Segment # 3
                          Tariff structure

Source: Walter & Howie, Privatizing China (2003)
  Emerging Market Finance - Legal Considerations                                          31
 4. Red chip listed company


                                               Chinese municipal
                                                  government                Cash



      A                  B                 C                    D       E




                                                                                        onshore
                                                                                         offshore

       Listed                                      Hong Kong        Issues Shares    Public
      company                                  registered company                   investors
                                                                        Cash
Source: Walter & Howie, Privatizing China (2003)
  Emerging Market Finance - Legal Considerations                                                32
 5. Whole industry repackaging



         Parent companies
                                                     Ministry




                                                      Holding
                                                   Company Co. Ltd.
                                                                        New
                                                                      Company/
                                                                       ListCo




Source: Walter & Howie, Privatizing China (2003)


  Emerging Market Finance - Legal Considerations                                 33
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




Emerging Market Finance - Legal Considerations    34
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
Emerging Market Finance - Legal Considerations                              35
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
Emerging Market Finance - Legal Considerations                     36
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




Emerging Market Finance - Legal Considerations              37
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



Emerging Market Finance - Legal Considerations                                38
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 2003 - $1B Asian Bond Fund established to invest
         in a basket of dollar denominated bonds issued by Asian
         sovereign and quasi-sovereign issuers




Emerging Market Finance - Legal Considerations                         39

				
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