New Law of the Republic of Kazakhstan

For foreign investors, creditors and financial institutions, the new Banking Law is not only an updated regulatory framework for banking activities in Kazakhstan – they may need to rethink their approaches to structuring transactions, risk management, contractual protection, etc.
Set out below is a practical overview of the key changes under the new Banking Law.

Two-tier licensing system

One of the key innovations under the new Banking Law is the introduction of two types of banking licences: a universal licence and a basic licence.

The universal licence is intended for large and medium-sized banks and offers comprehensive services (corporate and retail banking services, securities market transactions, cross-border transactions, investment activities, etc.) under robust supervision.

A basic licence differs from a universal licence in terms of a limited scope of permitted operations and a distinct regulatory regime. It is intended for smaller banks and focuses on microbusinesses and SMEs, with simplified requirements. In particular, a bank holding a basic licence may primarily provide services to Kazakhstan residents, may not open branches abroad and invest in foreign entities and is limited in the volume of attracting retail deposits.

Based on the distinction between the two licences, a foreign counterparty when structuring a cross-border transaction, syndicated financing or another international operation with a Kazakh bank, needs to verify whether the Kazakh bank holds the appropriate banking licence.

Islamic window for traditional banks

The new Banking Law for the first time establishes the legal basis for so-called “Islamic window”. Prior to the enactment of the new Banking Law, Islamic finance business in Kazakhstan was limited to Islamic banks. Now a bank holding a universal licence may obtain an additional licence for Islamic banking operations and based thereon carry out Islamic financial services (non-interest bearing demand deposits, investment deposits, trade and partnership financing, as well as Sharia-compliant leasing) within its existing structure.

The new Banking Law provides for mandatory accounting segregation of Islamic banking within the structure of a universal bank. Assets and liabilities related to Islamic banking operations are required to be accounted separately from the bank’s other assets and liabilities and separate accounts must be opened for their servicing. In addition, assets generated through Islamic banking operations may not be used to cover losses and liabilities under standard banking operations and, to the contrary, assets arising from standard banking operations may not be used to cover losses and liabilities under Islamic banking operations.

Islamic banking operations must comply with the principles of Islamic finance, including mandatory establishment of a Shariah supervisory board. Without its positive opinion the relevant internal banking rules may not be approved. Internal rules relating to Islamic banking operations require a positive opinion of the Shariah supervisory board.

For foreign investors and organisations from the Gulf states, Malaysia and other jurisdictions with developed Islamic finance markets, this opens new opportunities to work with Kazakh banks within a familiar legal framework without the need to look for an Islamic bank.

The objective of these changes is to develop Islamic banking and to expand Islamic banking operations within the existing banking system.

Branches of foreign banks: facilitation, new requirements and creditor protection mechanisms

Under the new Banking Law, some requirements for a foreign bank (US$10 billion threshold for its total assets, a valid licence in its country of residence, and the required minimum credit rating) remain as in the previous banking law.

The new Banking Law extends the enhanced supervision and financial soundness recovery regimes to branches of foreign banks. So now the authorised body (the regulator) may impose restrictions and special regulatory measures on a branch without revoking its licence.

A foreign bank is required to form in Kazakhstan reserve assets of the branch. It can do so by placing funds in the correspondent account opened with the National Bank of the Republic of Kazakhstan for the branch and/or acquiring certain financial instruments. The list of such financial instruments and the minimum amount and composition of the assets are determined by the regulator.

Upon compulsory termination of activities of a branch, the reserve assets constitute the primary source to satisfy creditors’ claims against the branch. If such assets are insufficient to satisfy the creditors’ claims, the foreign parent bank becomes liable to do so pursuant to its mandatory written undertaking submitted to the authorised body at the licensing stage. Thus, the new Banking Law provides for a two-tier creditor protection mechanism for a foreign bank branch: local reserve assets as the first tier and an unconditional undertaking by the parent bank as the second tier.

Bank insolvency resolution: modernised mechanisms

The most significant change introduced by the new Banking Law is the creation of a fully-fledged resolution regime for insolvent banks. Under the previous banking law, an insolvent bank was subject to compulsory liquidation. The new Banking Law provides for a more sophisticated mechanism for bank insolvency, aimed at stabilising an insolvent bank without its liquidation. In this regard, the new Banking Law contemplates a three-tier intervention model to address bank insolvency: enhanced supervision, financial recovery, and bank insolvency resolution. The tier to be applied to an insolvent bank is based on its viability assessment by the authorised body (regulator) and the assessment costs are borne by the bank.

The new Banking Law sets out the principal resolution tools for an insovlent bank: compulsory sale of its shares to a new investor, bail-in, transfer of its assets and liabilities to another bank, and the establishment of a bridge bank. The tools may be applied individually or in combination, without the consent of shareholders or creditors.

The new Banking Law establishes that the application of the resolution regime may not serve as a ground for the early performance of the bank’s obligations at the initiative of a counterparty, the occurrence of a contractual default, or the satisfaction of the creditors’ claims from the collateral. In other words, standard acceleration and cross-default provisions in a loan agreement and other financial documentation may become unenforceable in certain circumstances in Kazakhstani context when the resolution regime applies. This should be taken into account when preparing financial documentation and assessing the enforceability of a standard protection clause.

Bail-in and creditor priority

The bail-in mechanism involves compulsory restructuring of a bank’s liabilities. As against the creditor priority in liquidation, bank losses are absorbed in the following order of priority:

1. perpetual financial instruments;
2. subordinated debt;
3. TLAC instruments;
4. other unsecured liabilities.

At the same time, the new Banking Law requires that, prior to the application of bail-in, the bank’s own capital must be reduced by the amount of actual and expected losses in accordance with International Financial Reporting Standards, which means that shareholders bear losses first.

The new regime also establishes a list of liabilities that in no circumstances may be subject to bail-in, including salary claims from employees, claims by certain protected categories of depositors, budget-related claims, as well as certain other protected claims.

An important safeguard is the NCWO principle (no creditor worse off), under which as a result of bail-in a creditor must not suffer greater losses than it would have suffered in the event of the bank’s ordinary liquidation. Compliance with this principle may be confirmed through a special valuation of the bank’s assets and liabilities, which the authorised body may carry out under the law, including with the involvement of independent valuers and auditors at the bank’s expense. If such valuation shows that a creditor has suffered losses beyond the permitted level, the creditor may claim compensation for the difference.

For foreign holders of subordinated instruments and other vulnerable categories of debt, this means that the relevant instrument in the loss-absorption hierarchy must be assessed with particular care.

Compulsory squeeze-out of minority shareholders

As the resolution regime for a systemically significant bank where the state acquires participation in a systemically significant bank as part of the resolution regime, the law provides for a compulsory share squeeze-out: if as a result of the applied resolution regime the Government of Kazakhstan or a national managing holding acquires 95% or more of the voting shares in a systemically significant bank, it may require the compulsory acquisition of the remaining shares from all persons who were the shareholders of the bank on the date the decision to apply certain resolution regime was made. This distinction is important: the shareholders acquiring the shares after that date are not covered by this provision.

Compulsory acquisition does not require the shareholder consent and is implemented by sending the relevant decision of the Government of Kazakhstan or the national managing holding to the bank. Upon receipt of the decision, the bank must publish it on the website of the depository of financial statements within three business days and notify the central securities depository, as well as the stock exchange if the shares are listed.

For foreign shareholders of Kazakh banks, this mechanism creates a significant practical risk for two reasons:

First, disputing the very fact of the application of the resolution regime is extremely difficult. The law provides that when considering such dispute, the court is expected to give significant weight to the bank’s viability assessment. As mentioned above, the assessment is made by the regulator. It is also the regulator who based on the assessment makes the decision as to which resolution regime to apply, and the court, in fact, treats such assessment as the starting point.

Second, and perhaps more importantly from a practical perspective, even if a foreign shareholder files a claim challenging the decision, this will not stop the compulsory acquisition of its shares. The law expressly provides that appeals against decisions of the authorised body on the application of the resolution regime and resolution tools do not suspend their execution.

Liquidation waterfall and protection under master financial agreements

The new Banking Law establishes a 12-level ranking of creditors’ claims in the liquidation of a bank. Secured creditors are satisfied from the collateral in the 3rd ranking whilst claims exceeding the value of the collateral move to the 8th ranking. Unsecured foreign creditors will, as a rule, also rank in the 8th class. Subordinated debt and perpetual financial instruments rank even lower, confirming their elevated risk both in bail-in and in liquidation.

At the same time, the new Banking Law provides important protection for transactions entered into under a master financial agreement, including an ISDA Master Agreement. The law expressly permits close-out netting and excludes the application to such netting of certain restrictions relating to attachment of assets, ranking of claims and certain supervisory measures. This is particularly important for international financial institutions dealing with Kazakh banks in derivatives transactions.

However, netting protection is not absolute. Under the new Banking Law, certain transactions may be invalidated, in particular if they were entered into in the period preceding resolution or liquidation and the counterparty was an affiliated person of the bank or knew or should have known of signs of the bank’s financial instability. This evaluative standard may create a material legal risk for professional market participants.

Participation of Kazakh banks in international financing

An important practical innovation is the express recognition of the ability of a Kazakh bank to act as the facility agent and the security agent under a loan agreement governed by foreign law. Previously, this function lacked a clear legislative basis and this complicated the use of standard syndicated and project finance structures. The new Banking Law removes this gap and facilitates the application of international financing documentation in transactions involving a Kazakh element.

Expanded regulatory discretion

Another systemic change is the expanded power of the authorised body to apply supervisory measures based upon reasoned assessment rather than upon establishment of a formal breach of a rule. This increases regulatory flexibility on the one hand but reduces predictability in supervisory practice on the other hand.

For foreign shareholders and creditors of Kazakh banks, this means increased regulatory risk: certain decisions might be based on a qualitative assessment of the circumstances, and the prospects of their successful challenging in court might be limited because the court will give significant weight to the professional assessment by the regulator.

Conclusion

The new Banking Law significantly reshapes the regulatory architecture of the banking sector. The changes introduced by the new Banking Law are crucial. By aligning regulations to global standards, the banking sector is expected to become more competitive, stable, and supportive of economic growth, which may enhance the attractiveness of Kazakhstan’s banking sector for investors.