Ben Aris in Kyiv -

Speaking at the Davos summit earlier this month, Ukrainian Prime Minister Viktor Yanukovych said his administration is going to "pay foremost attention to developing capital markets in Ukraine in order to boost inflows of foreign investment."

These comments are welcome, as even by Eastern Europe's low standards, Ukraine's capital market legislation and infrastructure is in a mess.

Coming from Yanukovych, his comments are more than a little ironic given he was a member of the administration of former president Leonid Kuchma that gave away most of Ukraine's industrial jewels to a group of insiders without raising a peep of protest. But that doesn't mean anyone doubts Yanukovych's sincerity.

Ukraine has seen a political sea change since Kuchma was ousted in 2004 and foreign investment has been flooding in. Over the last year, despite the general political brouhaha the government and the executive have actually been working together well over the last year to shunt through a raft of new legislation that creates much of the missing legal infrastructure needed to develop the domestic capital market.

Prime Minister Viktor Yanukovych

"For a long time, the development of capital markets in Ukraine was overlooked, but my government is determined to make considerable progress in this direction in a short time," Yanukovych said. "We’ll pay close attention to guaranteeing investors’ rights and improving corporate governance standards, including information disclosure."

Yanukovych also announced at Davos that the government would shortly submit to parliament a package of bills intended to further liberalize the domestic business environment and create incentives for companies to invest in new technologies.

Setting the rules…

Symbolically, President Viktor Yushchenko kicked off the current reforms immediately after taking office in 2005 by drawing up a new investment law, which was passed by the Rada on the eve of the crucial March 2006 parliamentary elections. The new law replaced rules that had been in service largely unchanged since 1991, the year Ukraine declared independence.

Analysts hailed the "monumental new stock market law," which improves disclosure requirements, regulates insider trades and sets out the procedure for IPOs.

"The law also introduces more sophisticated financial tools: convertible bonds and real estate certificates. If properly implemented, this will provide a tool for equity investors to get exposure to the booming real estate market, and for corporations to offer more diverse options for those who they borrow from," analysts at Concorde Capital said in a note at the time.

The law also gave the bond market a shot in the arm by increasing the maximum limit on bond issuance from 25% to 100% of a company's statutory fund. Bond issues can now be registered in foreign currencies, and zero-coupon bonds were also introduced.

"Importantly, investment banks are allowed to open cash accounts for their clients. Though according to the draft the number of clients is limited to 150 accounts, this makes a big difference, as currently only commercial banks can accumulate money. The sweeping changes this law brings with it look great on paper, however it will be crucial that the government puts in adequate enforcement to implement them," Concorde said.

…and making them stick

With the basic legislation in place, the next task has been to beef up on the government's ability to enforce the rules - here transparency and accountability are key.

In October, the Ukrainian Securities and Stock Market State Commission (SSMSC) said it would turn the screw on publicly traded companies and require them to report quarterly and, moreover, to report in an electronic form that is accessible to anyone with a connection to the Internet. In the past, companies were required to disclose financial information once a year and then only to the SSMSC.

Among the information the SSMSC is asking for now is: all changes in management, bankruptcy filings, liquidations, mergers and acquisitions, the creation and disbursement of affiliates and sister companies, decreases in share capital, the establishment of credit borrowing in excess of 25% of assets, and changes of ownership that exceed 10% of equity. The Justice Ministry has already registered these changes and the new rules are due to go into effect on March 1.

Other changes made last year have begun to be felt in the marketplace. For example, in November the local stock trading system, the PFTS, introduced market makers for the first time.

The PFTS' qualifications for market makers require two-sided quotations and limit bid-ask spreads to a maximum of 5% for stocks in the PFTS's first tier, 15% for stocks in the PFTS's second tier, and 25% for the stocks in the PFTS's third tier. Eight participating brokers announced they will support 25 stocks.

Likewise, up-and-coming second-tier bank Ukrgazbank says it will be the first to take advantages of changes made last year and issue Ukraine's first mortgage-backed bonds this March. The SSMSC has already registered the issue, which is expected to attract a fixed yield of about 10.5% for the three years of its life.

Still to do…

On the agenda for this year is to significantly expand the size of the capital markets. Ukraine’s central bank deputy governor, Oleksandr Savchenko, said in an interview in November that Ukraine needs to double the size of the domestic capital market from the current $35bn and increase the size of the foreign exchange market from the current $300m turnover a day on the interbank market to at least $1bn within a year.

The SSMSC has also followed up with a proposal in February that pre-emptive rights can be executed by existing shareholders during a new share issue at the time the new shares are sold. The new rules would oblige a company issuing shares to sell the remaining shares (including shares of those shareholders who refused to participate in the additional share issue) on an organized exchange.

"If the regulation is implemented, the incentive for companies to issue additional shares with the sole intention of diluting the stakes of minority shareholders may be practically eliminated," says Vladislav Nosik, an analyst with Renaissance Capital in Kyiv.

The key change made this year will be to rewrite the rules covering the way companies must work in a badly needed joint stock company law. The Cabinet of Ministers approved a draft JSCO law in the middle of February, which now goes to the Rada for debate and approval.

Amongst the more contentious items is a reduction in the quorum for general shareholders meetings from 60% to 50% of shareholders. The legislation also includes a cumulative voting procedure for when the company's governing bodies are elected.

The law is stuffed with measures to protect minority shareholders rights and will phase out the closed joint stock company form – where only insiders are allowed to buy and own a company's shares – completely over the next five years.

"The absence of such a law has been one of the biggest setbacks in developing the Ukrainian stock market," say analysts at Alfa Bank. "Numerous drafts have been submitted to parliament since 2001, only to be rejected. Given that parliament is now working in full cooperation with the government, we believe this time the law stands a much better chance at approval."

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