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PrivatBank bondholders say BoE bail-in recognition sets dangerous precedent
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Strategic Considerations: The Bank of England's decision to recognize PrivatBank's bail-in of English law-governed bonds has prompted mixed reactions. While AlixPartners, which advised the authorities on the nationalization of the bank, publicly welcomed the decision, several other market participants cautioned that the decision could set an unfortunate precedent and appeared political in nature. A wide variety of concerns over the resolution process through which PrivatBank was nationalized, and how this impacted international investors unrelated to the alleged fraud at the bank, were flagged. The trustee of the bailed-in senior bonds is now investigating challenging the BoE decision in an effort to protect investor rights. 

  • Bank of England recognition a major setback for PrivatBank bondholders pursuing LCIA arbitration against lender
  • Trustee investigating options to challenge the BoE decision, including launching a judicial review
  • BoE decision could set precedent for the bail-in of other English law-governed bank bonds that do not feature loss absorption language
  • Issues of transparency, potential breach of NCWO principle, treatment of bonds as related party and disregard of creditor hierarchy flagged as problematic

The Bank of England’s (BoE)  decision to recognize the National Bank of Ukraine’s (NBU) bail-in of PrivatBank’s USD 595m English law-governed bonds sets a potentially dangerous precedent for other emerging market nationalizations, according to a member of an ad hoc committee of bondholders, an EM buysider and a Ukraine-based analyst. The decision was labelled “political” by the market participants, who pointed to apparent inconsistencies between the Ukrainian nationalization process and the UK’s bank resolution regime.

“The bail-in of the PrivatBank eurobonds was done opaquely and arbitrarily by the Ukrainian authorities and the recognition by the BoE sets a bad precedent in the treatment of international creditors,” said David Nietlispach of Pala Assets, a member of the ad hoc group.

“Should the bail-in […] remain recognized by the BoE, despite the breach of so many rules during the bail-in process in Ukraine, it will invite other foreign banks to also seek BoE backing for arbitrary treatment of debts governed by English law,” said Nietlispach. As reported yesterday, the trustee of PrivatBank’s senior bonds sent notice this week that it is considering applying to the English courts for a judicial review of the BoE’s decision.

This is believed to be the first time the BoE has recognised a non-EU ‘third-country’ resolution. The UK’s ministry of finance, HM Treasury, approved the decision to recognize the bail-in, announced on 14 May.

The NBU applied to the BoE for recognition of the bonds’ bail-in following the nationalization of PrivatBank in December 2016, during which total liabilities of UAH 29.4bn (USD 1.1bn at today’s exchange rate) were bailed in. The government explained the move by announcing a UAH 148bn (USD 5.4bn) black hole in the bank’s books along with evidence of a multibillion-dollar fraud, allegedly at the hands of its former owners Ihor Kolomoisky and Gennadiy Boholyubov.  

While none of those interviewed by this news service doubted that PrivatBank was the victim of a massive fraud, the BoE’s decision to recognize the NBU’s bail-in was described as “political” in light of the significant unresolved questions over the process the Ukrainian authorities followed when nationalizing the bank.

Western institutions, notably the IMF and the World Bank, have publicly shown their support for the “new Ukraine” and its post-Maidan presidents, Petro Poroshenko and Volodymyr Zelensky, said the buysider. Both multilaterals were vocal in their support of PrivatBank’s nationalization in 2016. Developed market institutions, such as the BoE, appear unwilling to take any decisions that could be perceived as supportive of an oligarch such as Ihor Kolomoisky, continued the buysider.

The decision was flagged as a potential area of concern for emerging market investors in a research note produced by hedge fund Gramercy. “The BoE decision in the Privatbank case may serve as yet more proof (not that this was needed) that government intervention may not always be positive for investors in emerging market banks,” the note stated.

“Recognition of Ukraine’s resolution action by the Bank of England may set a precedent for authorities in other countries which are not members of the FSB [Financial Stability Board] seeking recognition of similar actions on securities with no contractual loss absorption language which were issued under English Law. Application of the FSB’s key attributes [of an acceptable resolution process] may be much broader than the board’s member list suggests,” continued the Gramercy note.

However, not everyone was critical of the BoE decision. In a blog post following the recognition, AlixPartners – which was coordinating advisor to the Ukrainian authorities regarding the nationalization – said it was “delighted” to see the formal recognition and alluded to the potential precedent the decision sets for other bank resolution cases, especially in light of the UK’s departure from the EU – meaning European bank resolutions could also pursue this avenue.

“The […] nationalisation of PrivatBank […] has been a key component of the country’s enormous efforts to address corruption in the country and clean up its banking system. Delivered with support from the IMF and the broader international community, it is still seen as a major test for the country’s reform agenda. As such, recognition from Threadneedle Street is significant,” read AlixPartners’ statement.

The BoE and PrivatBank did not reply to requests for comment. The NBU declined to comment, beyond reiterating that “the Bank of England’s decision to recognize the bail-in of the PrivatBank is beyond reasonable doubts for the National Bank of Ukraine”.

Background to the recognition request

Following the nationalization, an ad hoc group of PrivatBank’s bailed-in senior bondholders initiated an arbitration case against the bank in the London Court of International Arbitration (LCIA). In June 2019, the LCIA tribunal conditionally ruled that those senior noteholders who could prove that they were unrelated to the fraud perpetrated against the bank should be repaid.

However, the LCIA ruling also stipulated that PrivatBank would only be required to pay the notes if the bank's ‘bail-in defence’ was unsuccessful. In essence, the ‘bail-in defence’ advanced by PrivatBank was that it should not be obliged to repay the English law-governed bonds if the BoE recognized the bail-in of the notes. 

The ad hoc group, which includes international asset managers Amundi, ICE Canyon and Pala Assets, recently expanded to include JPMorgan, as reported. The noteholder group is advised by law firm Dechert. The note trustee is advised by law firm Boies Schiller Flexner. PrivatBank is advised on the arbitration by law firm Quinn Emanuel.

While arguments around the BoE’s decision will likely still need to be heard by the LCIA tribunal, the recognition is a major blow to noteholders securing repayment – at least through the LCIA arbitration, according to the Ukraine-based analyst.

Bank of England’s decision-making process  

Although PrivatBank is incorporated in Ukraine and does not perform banking activities or have customers in the UK, the NBU sought recognition from the BoE due to the existence of the English-law governed loans from UK SPV Credit Finance Plc, the orphan special purpose vehicle which issued the various bailed-in loan participation notes and subsequently on-lent the funds to PrivatBank.

In order to secure recognition under Section 89H of the Banking Act 2009, the BoE had to determine whether the PrivatBank bail-in was “broadly comparable in its objectives and anticipated results to those of the UK resolution regime. The Bank of England must then also consider whether any of the statutory grounds apply for refusing to recognise the bail-in”, according to a public statement from the BoE following the recognition. The UK central bank ultimately decided that this test was met in the case of PrivatBank.

According to a source with direct knowledge of the BoE’s rationale for the recognition, communicated to bondholders after the decision, the BoE considered the bail-in an action to have been taken “under the law of Ukraine”, given that the NBU – the relevant local authority – itself deemed the bail-in lawful and given there are no outstanding local court judgements to the contrary.

The BoE delayed making its determination until a legal case brought by Theo Worldwide – in which an individual local bondholder was challenging the bail-in in the Ukrainian courts – was withdrawn in February 2021, according to the source with direct knowledge. The BoE specified in its rationale to bondholders that its decision to recognize the bail-in is not, in itself, an endorsement of the nationalization and is not relevant to any challenge against the bail-in brought in the Ukrainian courts, something that a number of other creditors have successfully done, the BoE noted.

The BoE considered three key differences between the Ukrainian nationalization process and theb UK’s resolution regime, according to the source with direct knowledge. Firstly, Ukraine’s resolution process features a related party tier. Secondly, under Ukraine’s resolution procedures only 100 non-shareholder creditors can be bailed in. Lastly, the transparency of the Ukrainian process was considered lower than that expected in a UK resolution process.

On the first two differences, the BoE found that the differences between regimes were not significant enough to deny recognition, while on the transparency issue the central bank decided that sufficient information had been disclosed to allow bondholders to challenge the bail-in – albeit less than would be seen in the UK, according to the source with direct knowledge.

Having decided that the processes were broadly comparable, the BoE then identified five grounds on which it might refuse the recognition, of which only two were particularly relevant in the case of PrivatBank: if UK-based creditors were to receive different treatment to local creditors with similar rights; or if recognition breached the Human Rights Act 1998. 

In regard to the first of these, while the BoE recognized that a higher portion of international creditors were bailed in than local creditors, it reasoned that this was not discrimination on the basis of a creditors’ geographical location or nationality but that any differing creditor treatment was based on policy-based considerations, according to the source with direct knowledge.

On the second point, the BoE argued that the NBU looks to have been pursuing the public interest in nationalizing PrivatBank, and therefore did not breach the Human Rights Act. Differences in resolution regimes, such as the existence in Ukraine of a related party creditor class and the maximum of 100 non-shareholder creditors being bailed in, were acceptable within the context of the Ukrainian authorities’ efforts to stabilise the country’s banking sector.

A flawed process?

With international litigation against the former shareholders yet to yield results, the former owners have allegedly walked away from the bank with potentially billions of dollars in embezzled assets. Meanwhile, while the government spent UAH 155bn (USD 5.49bn) on the recapitalization, it also took ownership of a now-highly profitable bank, noted Pala’s Nietlispach.

“As it stands today, it seems that no other stakeholder apart from the bondholders have to face losses in relation to the nationalization of PrivatBank,” he said. PrivatBank generated a UAH 25.3bn (USD 926m) profit in FY20, according to preliminary results, down from UAH 32.6bn (USD 1.2bn) the year before.

However, alongside any ethical argument regarding the treatment of international investors, the BoE decision is also contested on a variety of legal grounds.

Kyiv confidential

The relative lack of transparency regarding the bail-in was among the issues considered by the BoE. Requests made to the BoE by noteholders’ legal representative for disclosure of the nature of the NBU’s bail-in request were also denied, at the behest of the NBU, according to legal arguments put forward by bondholders to the BoE.

Central to the transparency issue is the fact that a valuation report was never produced by the Ukrainian authorities, according to the legal argumentation. This would have allowed bondholders to both understand whether there was truly a need to bail-in the bonds at all, and to assess what recoveries could be expected under a liquidation. It is argued that the production of such a report is a crucial requirement under the UK’s own resolution regime.

The lack of a valuation report poses fundamental questions for the BoE, according to the legal argumentation. At the heart of the Bank Recovery and Resolution Directive – the EU regulations under which failing lenders can be nationalized, and which the UK implemented – lies the No Creditor Worse Off (NCWO) principle. This stipulates that a bailed-in creditor should not be left worse off through a bank resolution than if the bank were liquidated.

Not only is it impossible to say for sure that the NCWO principle has not been broken as long as no valuation report is available, but there are also good reasons to believe the principle has indeed been broken, according to the bondholders' legal arguments. This is because in a liquidation scenario, creditors would have had a potential claim to pursue Kolomoisky for damages – something bondholders do not currently have.

Given the potential quantum of the damages sought by the bank in UK litigation – a USD 2.6bn worldwide freezing order remains in place against PrivatBank’s former owners – this could amount to a meaningful recovery, to which bondholders have no recourse, according to the legal argumentation. This potential breach of the NCWO principle was a topic not addressed in the rationale the BoE communicated to creditors.

Related in hindsight

The Ukraine-based analyst also highlighted Ukraine’s limit of bailing in just 100 creditors as a topic for concern, potentially leaving many related parties untouched, while wiping out the international bondholders. Some related parties – notably the Kolomoisky-affiliated Surkis brothers, whose deposits were originally bailed-in – have enjoyed some successes in the local courts reversing this decision.

In this context, the Ukrainian authorities’ classification of the international bonds as a related party has come in for particularly pointed criticism from the market participants. This decision appears to have been justified on the basis that UK SPV Credit Finance Plc, through which the bonds were issued, was related to the PrivatBank because the orphan SPV was established by the bank, according to the legal argumentation.

The NBU’s official decision to categorize the bonds as related parties appears to have been confirmed only after the bail-in, according to the legal argumentation. Noteholders were not categorized as such at the time of bond issuance. Instead, the NBU issued a press release on 24 February 2017 which added UK SPV Credit Finance to the list of entities within CB PrivatBank PJSC’s Banking Group – but backdated this decision to 16 December, immediately before the nationalization.

Failure to respect creditor hierarchy

Had the bonds been categorized properly – as senior unsecured obligations of the bank – they would have been protected by the creditor hierarchy in line with a normal insolvency scenario, ranking senior to related party obligations of the bank, according to the legal argumentation. The 100-creditor bail-in limit would have resulted in 100 related parties being bailed in but leaving any senior ranking bondholders unscathed.

For example, another senior unsecured creditor which was initially bailed-in – Cargill, ranking pari passu with the notes – successfully argued that it had been mis-categorized and subsequently had its claim reinstated, according to the legal argumentation. On the face of it, it appears the treatment of pari passu creditors was not equal, making it hard to understand how the BoE can recognize a bail-in that did not respect the proper hierarchy, the argumentation continued.

For its part, the LCIA tribunal did not view the bonds as related parties and instead “looked through” the bond’s Loan Participation Note structure – a commonplace financial structure in the region – to assess the nature of the individual bondholder as the relevant entity, the argumentation added.

The saga continues

With the ad hoc group potentially set to challenge either the BoE decision or to continue the fight in Ukraine, and the LCIA arbitration yet to conclude, the four-and-a-half-year PrivatBank saga appears far from over.

The case will likely continue to provoke divergent views between those who see the nationalization as a necessary step toward Ukraine's banking sector reform, and those who argue that the methods of its implementation – both at home and abroad – disregarded innocent investors’ rights.

As Gramercy summarised in its research note: “With legal remedies still available, it is not yet clear whether bondholders or Privatbank will prevail in the end. Possible implications of the eventual outcome on other emerging markets means the Privatbank case remains one to watch.”

by David Orbay-Graves

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