Recently, the Commercial Court of Uganda in the case of Ham Enterprises Limited & 2 Others vs Diamond Trust Bank (Uganda) Limited & Another, Miscellaneous Application No. 654 of 2020 (the Ruling) held that a foreign bank must obtain a license/approval from the Bank of Uganda (the Ugandan Central Bank) prior to directly lending to a Ugandan borrower and taking security over the borrower’s assets. In the Court’s Ruling, failure by the foreign lending bank to obtain the Central Bank’s approval invalidates the entire transaction on the ground of illegality for conducting financial institutions business in Uganda without a license.
The Ruling has attracted mixed reactions within the banking industry and the general public. Critics are arguing that that the Ruling will impose onerous restrictions on free movement of international capital into Uganda and risks upending the offshore financial investment framework. Proponents are counter-arguing that the Ruling has removed regulatory arbitrage and clarified the legal position on direct cross-border lending and the nature and extent of financial business in Uganda.
This write up is not an analysis of the merits and demerits of the Court’s Ruling but rather a market guide on how foreign/offshore lenders can de-risk their facilities directly advanced to Ugandan borrowers in the manner the transactions were structured in this case.
Generally, there are various gateways on how foreign lending is structured. The most common are direct bi-lateral loans and syndicated lending, which is a type of financing offered by a group of lenders (referred to as a syndicate) who work together to pool and provide funds/credit to a single large borrower. Borrowers of such instruments are usually corporations, large projects, or sovereign governments. One of the lenders acts as the manager (arranging bank), which administers the loan on behalf of the other lenders in the syndicated transaction. The transaction in the Ham vs DTB case was direct lending by the Kenyan parent of Diamond Trust Bank, and DT Bank Uganda was appointed as an agent for purposes of debt recovery since the securities pledged by the Ugandan borrower were situated in Uganda.
The Uganda Financial Institutions Act, 2004 as amended defines financial institutions business in a very broad manner to include acceptance of deposits; issue of deposit substitutes; lending or extending credit held on deposit, including consumer and mortgage credit; factoring with or without recourse; financing of commercial transactions; recovery by foreclosure or other means; foreign exchange business; and issuing and administering means of payment, including credit cards and bank drafts.
A financial institution is defined as a company licensed to carry on or conduct financial institutions business in Uganda and includes a commercial bank, merchant bank, mortgage bank, post office savings bank, credit institution, a building society, an acceptance house, a discount house, a finance house, Islamic financial institution, or any institution which by regulations is classified as a financial institution by the Central Bank.
In light of the new risk involving foreign based/offshore lenders in Uganda, the following could serve as important short, medium and long-term litigation risk management measures for the effected category of transactions;
- One short-term intervention towards de-risking is for active offshore lenders such as banks to obtain authorization/waivers from Bank of Uganda (the Ugandan Central Bank) in order to de-risk unconcluded transactions. This can be done by formally establishing/appointing representative banks in Uganda in order to streamline correspondence banking functions in the Ugandan jurisdiction. Section 117 of the Financial Institutions Act (as amended) gives the Central Bank the mandate to give authorization to foreign banks interested in appointing representative offices in Uganda. However, this may not act retroactively to cover concluded transactions.
- Sale, assignment and/or transfers of existing facilities directly held by foreign lenders to Ugandan financial institutions could also be a possible de-risking intervention. Such disposals would not only transfer the risk, but also create a boom and liquidity in the Ugandan secondary loan market for such de-risked assets. There might be need for prior Central Bank approval for Ugandan supervised financial institutions intending to engage in such transactions with depositor held funds. Tax implications in form of transfer pricing and capital gains tax where gains/profits are made should be factored into such arrangements.
- Portfolio re-alignment/re-balancing in order to create more diversified investment plans and reduce exposure to syndicated facilities with unlicensed offshore entities. This form of de-leveraging ensures optimal re-grouping of risks and assets to inform quick decision making/asset re-allocation strategy required to quickly get rid of potential value destroyers.
- Due to the COVID-19 pandemic, it is anticipated that there will be more defaults in syndicated facility backed projects, and hence will need refinancing. Prospective agents and co-lenders are advised to secure specific and robust warranties and indemnities in the event of loss arising from regulatory and litigation risk to directly structured Ugandan inward bound transactions.
- Increased use of intra-group and inter-group lending for parent entities to lend their Ugandan financial subsidiaries for on-lending purposes for Ugandan based borrowers so that the Ugandan entities can directly foreclose and sale locally based collaterals in event of default as opposed to using the Ugandan subsidiary as the recovery and foreclosure agent. Parent groups may formally appoint their Ugandan subsidiaries/affiliates as their representative offices formally by obtaining authorization from the Central Bank. Other investment houses and funds may also consider entering into such arrangements with their Ugandan banks and/or other licensed financial entities as the Central Bank may designate for purposes of representative capacity and agency in Uganda.
It is anticipated that the affected lender in concert with the Uganda Bankers Association (UBA) will appeal against this Ruling. The Central Bank has also indicated that it will assess the implications of the Ruling and determine an appropriate response to the matter. For now, the position regarding offshore non-bank financial institutions such as private equity, venture funds and hybrid structures such as mezzanine funds investing through debt and debt-like instruments remains unclear. It is hoped that the Central Bank and the Capital Markets Authority (CMA) will clarify the official regulatory position as soon as possible as we wait for the Appeal process against the Ruling to run its course. Offshore pension funds, hedge funds, collective investment schemes, insurers and re-insurers with exposure in Uganda are also advised to study the implications of the Ruling and adjust their risk allocation accordingly.
Some non-judicial interventions such as international relations and lobbying could also be considered by the financial services industry. Regional and international regulators’ guilds will play a key role in capacity building, stakeholder engagements and consensus on financial sector regulation and predictability in regulatory enforcement and supervision. Engagements with the various regional, continental and global Central Bank association bodies and other critical stakeholders such as judicial bodies can enhance uniformity and stability in cross-border lending and facilitation of foreign direct investment opportunities.
By and large, lenders are advised to review their debt portfolio and assess their exposure in Uganda in order to undertake the relevant mitigation measures. Furthermore, it is anticipated that with the increasing cross-border financial activity as a result of globalization and international trade and investment, there will be a correlational increase in regulatory and litigation risk and scrutiny from various stakeholders. Both international and domestic financiers are advised to review their current lending, business and transactional practices in Uganda in order to align them to potential novelties and scenarios in legal and regulatory interpretation and application in order to minimize institutional and market wide disruptions and losses.