The Fine Print: Legal & Tax insight

The Fine Print: Legal Tax insight

By Alessio Polastri and Sebastian Pawlita   |   Monday, 17 March 2014

Investors have asked us whether convertible loans are feasible in Myanmar, as they have proved to be in other emerging markets. A convertible loan entitles the lender to swap it, partially or entirely, for equity (stocks, ordinary shares, preference shares, etc) of the borrower by a certain deadline and at a pre-agreed conversion rate.

A convertible loan has two purposes. The first is financing. If the borrower then defaults, it can pay the lender back using its own shares. This is the worst-case scenario for both lender and borrower, but has some appeal as long as the question of debt security in Myanmar is still complicated and enforceability is questionable. However, shareholders in locally owned companies cannot transfer shares to foreigners, and it is uncertain such a company would be allowed to increase its capital to allow foreigners in.

The second purpose is when international investors try to penetrate industries that are currently off-limits to foreigners. The investor lends to a company active in a certain sector in the hope that the sector will be liberalised in the future. The loan agreement allows the investor to recover the loan in shares of the local company instead of cash once foreign ownership restrictions have been lifted. Interest payments on the loan by the local company could be made dependent on profits. Such convertible loans have been used in other emerging markets as an interim step to foreign ownership while market access was

restricted.

One of the problems in this scenario is the conversion mechanism. If a lender cannot convert the loan from a debt position to equity, it is nothing more than an unsecured loan. For example, an inter-bank convertible loan does not make sense as foreigners cannot own or operate banks in Myanmar. A foreign bank (the lender) therefore cannot switch the debt (the loan) into an equity stock of the local bank (the borrower). Microfinance institutions may be penalised as well, since it is a common practice in this industry. This has indirect consequences, as local banks are not in a position to inject large amounts of capital into the economy.

As to the second scenario, a foreign investor wishing to invest through a convertible loan may have difficulty finding local businesspeople familiar with the concept. Furthermore, it is unknown whether Central Bank approval could be obtained.

Alessio Polastri is managing partner and Sebastian Pawlita is a partner at Polastri Wint Partners

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