Much has been written regarding the recent EU and US sanctions targeting the Russian capital markets, military and oil sectors (our own commentary can be found here) and the broad nature of the sanctions has, it would seem, produced some (probably) unintended consequences when applied to the mechanics of day to day capital markets operations. On their face, the capital markets sectoral sanctions are designed to cut off the ability of the sanctioned companies to access funding in the equity and debt markets. Hence, broadly speaking, anybody who must comply with EU or US sanctions cannot participate or deal in any new debt or equity issued by a sanctioned entity once they have been put on the sanctions lists. Existing debt or equity issued prior to the implementation of sanctions is grandfathered.
However, what is an ‘issuance’ of new debt or equity? Clearly a new bond with a new ISIN code raising capital would be an issuance and the same would be true if an SPV were to issue a bond and on lend the monies to a sanctioned entity. But what about a new depositary receipt (DR)? DRs allow investors to invest in the equity of a company without holding the equity of such a company directly and are themselves typically issued by large financial institutions. If a sanctioned entity were to issue new equity, a financial institution would not be able to issue corresponding DRs as that would mean dealing with the new equity in breach of sanctions. But what if a new DR was being issued in respect of the grandfathered equity of a sanctioned entity? Would that be a new ‘issuance’ prohibited by sanctions? After all, no new monies would actually make their way to the sanctioned entity. In the US, OFAC in its FAQs say ‘no’ (see FAQ 391 here) and the issuance of such DRs seems to be allowed. In the UK, H.M. Treasury (and the Financial Conduct Authority) seem to say ‘yes’ (though there is no official interpretation on the point, evidence found here suggests this is the case) and no new DRs can be issued in respect of any and all equity of sanctioned entities. Apart from highlighting the fact that different regulatory authorities can take opposing views on similar topics, it does mean (if we accept that the H.M. Treasury view as correct) that it is not necessary for any new capital to flow to a sanctioned entity for an ‘issuance’ to be prohibited by sanctions.
This principle does however raise interesting questions of interpretation when applied to other areas of capital markets, for instance in respect of Reg S and Rule 144A bonds or DRs. It is common for an issuance for DRs or bonds to include a global Reg S instrument and a global Rule 144A instrument in respect of the same class of bond or DR. This allows an issuance to be marketed to a wider pool of investors and the size of each global instrument at issuance is set to reflect the initial investor base. However, if the instruments are traded in the secondary market that initial allocation sometimes needs to be adjusted depending on the status of an incoming investor. Mechanically this is done by reducing the size of one of the global instruments and increasing the size of the other global instrument by a corresponding amount. If the increase in the size of a global instrument is in respect of an existing grandfathered bond or DR issued by a sanctioned entity is such increase prohibited by sanctions (on the basis that it represents a new issuance)? No new capital actually flows to the sanctioned entity but as we have seen, at least according to H.M. Treasury, that is not a necessary criterion for an action to be prohibited by sanctions. So is such ‘switching’ between different types of global instruments a new issuance of debt or equity or is it merely an investor convenience? All lobbying efforts to H.M. Treasury please.