There are several reasons for considering some countries'
programs as models for Bulgaria. First of all, Bulgaria is a late
comer to the family of countries with such programs and it is an
obligation and a privilege to learn the lessons of its
predecessors. Secondly, some of the programs are reflecting
accumulated experience or have specific features that are
attractive to Bulgaria from legal, economic or other point of view.
However, there still remains place for subjective choices. But
nobody can argue against the programs of the following countries:
Argentina, Brazil, Chile, and Mexico.
The formal debt conversion scheme based on the restructuring
agreement of August 1987 consisted of a debt-to-equity investment
program and a capitalization mechanism for onlending funds. A third
element was added later - the purchase of shares of existing
companies if a Central Bank rediscount was canceled in the process.
These three instruments resulted in the conversion of .5 bn in
one year, with the debt equity conversions accounting for more than
50 % and the rediscount mechanism for 34 %.
The Argentine debt equity conversion program is relatively more
structured and well-defined program, particularly, with regard to
investment aspects (like Mexico and the Philippines). In order to
set a ceiling for the conversions, a system of quotas has been set
up through a public auction process rather than administrative
decision to assign conversion quotas. There was a clear intention
to adapt the swap scheme to the country's economic policies.
An important aspect is that all foreign direct investments
associated with debt-for-equity conversions are regulated
explicitly by the existing legislation. It did not impose any major
restriction on foreign direct investment except in the real estate
and finance sector. Argentina used the conversion program as a
leverage to promote investment projects beyond the program
parameters. Investments benefiting from it were ineligible for
industrial promotion schemes, as well as tax or other special
benefits. Invested resources could not be repatriated for ten
years, they were immobilized for three years and profits cannot be
remitted during the first four years.
Following the authorization of the investment by the Ministry of
the Economy, the Central Bank puts the pre-set quota up for tender
and redeems the debt instruments in Australes at the free exchange
rate, less a conversion commission (discount). The exchange rate
less the commission sets the effective cost of the swap. It is the
public auction where only the discount offered by the investor in
order to obtain a portion of the quota is formally taken into
account. (In the course of the 5 public auctions the discount rose
from 36 % nominal value of debt to about 72%).
In those cases where the holder of the paper (generally the
foreign bank) becomes the investor in the Argentine company, there
is no price attached to the debt instrument to be swapped. It will
then have to make a fair valuation of the project to determine at
what value it will be incorporated as an asset in its accounts.
With respect to the requirement for additional funds, 70% of an
investment project may be financed by a swap deal, while the
remaining 30% should be covered by fresh money. But the cost of
imported equipment, the VAT and a percentage of the working capital
or real estate are excluded from the capitalization program. From
the point of view of the investor, the need for additional funds
increases the cost of the project. Such additional funds may be
paid up in foreign currency or Australes and contributed as a
capital participation or a loan. The level of risks and the return
on the investment will depend to a large extent on how this mix is
There is a mechanism which slightly favors the development of
small and medium enterprises. The program is also concentrating in
agro-industry, tourism and the automotive sector. This might point
to substituting normal foreign direct investment, but it has been
quality investment that has created new productive capacity.
If the investor is the original holder of Argentine paper, the
swap is tax free as it will be treated as a redemption of the debt
instrument before maturity at less than nominal value. The investor
becomes shareholder in Argentine company. However, if the investor
purchased the paper in the market, income tax may be due on the
difference between the purchase price and the Australes received
from the Central Bank. Here are some taxes levied under the
An important aspect of the Argentine program is the Foreign
Investment Law (FIL) Application. If the investor is foreign, the
project falls under the terms of the FIL, which restricts the
repatriation of investments and the remittance of profits. In the
case of investments made under the Debt-for-equity swap program,
the converted funds cannot be repatriated for a period of ten years
and dividends may not be paid during the first four years.
Argentine's program is highly regulated one, where the Central
bank controls the supply and demand by establishing quotas and
discount rates. The financial and tax regulations in Argentina and
abroad are critical factors to be taken into account.
The quota system sets a ceiling on the investments necessary for
the restructuring of production.
If the component of imported equipment, working capital and real
estate is significant, then the requirement for additional fund
would be larger and consequently the project will have a lower rate
of return. The real cost of the project will be lowered and the
expected rate of return after taxes can be improved through a good
combination of discounts, fresh funds and fiscal planning. Projects
with better short term profitability are in the best position.
Resolution No 1460 of February 1, 1988 with respect to public
debts is considered here because it is most relevant to our
Debt for equity swap may cover all types of financing registered
with the Central Bank including medium and long term loans and
foreign currency deposits of matured installments of principal and
of interest with the central bank covered by the Brazilian foreign
debt restructuring agreements.
The assignment of loans and financing to third parties is
expressly accepted. However, the proceeds of swaps must be applied
in risk investments and cannot be used for operations that could be
interpreted as credit transactions or for projects that guarantee a
return of repurchase, directly or indirectly covered by public
Public sector debt is exempted from the auction process and
ceilings but investment must be made in public sector companies or
used to liquidate their debt. Such investments must have the prior
approval of the Special secretariat for the Control of State
Companies and the Secretariat of the national Treasury. Investments
may also be made in foreign capital conversion funds which may hold
in their portfolio more than 5% of the voting capital or 20% of the
total capital of any company. The Securities and Exchange
Commission (SEC) may establish provisions for their transfer
Funds invested in Brazil must remain in the country for a period
of 12 years from the date of capitalization and the remittance of
profits and dividends is as defined for foreign investment under
Law No 4131.
Swaps that result, directly or indirectly, in the transfer of
control from Brazilian to foreign ownership are not permitted.
Proceeds may not be invested in the total or partial acquisition of
foreign owned company unless the product of the sale is reinvested
in Brazil, by the foreign seller.
Swaps are not permitted where repatriation of capital with or
without capital gains have been made in the preceding 36 months
unless these funds are brought back. Any remittance abroad of
capital repatriation with or without capital gains by companies
that already have a foreign capital registration is subject to a
deposit with the central bank, for a period of 12 years in an
amount equivalent to the funds swapped. Proposals for swaps are
examined and decided by the Central bank.
The Brazilian Securities and Exchange Commission has authorized
the creation of several Debt/Equity Swap funds:
- FCCE 0 million conversion fund set up by
- Bozano Simonsen de Investimento, managed by Morgan
Grenfell of the UK;
- The Safra conversion fund, managed by Banco
- The million Factor conversion fund, by Factor
- The Boston/Sodril Conversion Fund by Bank of Boston and the
Sodril brokerage house;
- The Chase Conversion fund by Chase Manhattan group.
Debt conversion in Chile is governed by Chapter XVIII and XIX of
the Compendium of Rules on International Exchange. Short term
maturities, official and multinational loans have been excluded
from the program.
3.3.1. Chapter XIX rules for foreign
This regulation authorizes natural and juridical persons,
Chileans or foreigners, with residence and domicile abroad, to
invest in Chile using eligible external debt instruments.
Prospective investors must apply for authorization to the
International Directorate of the central bank. If the investor is
other than the original creditor, the application must also include
a request to change the instrument's creditor.
If the Central Bank (CB) is the debtor, local currency
redemption will be made indexed or dollar denominated financial
instruments to be exchanged for the external debt at the debt
instrument's face value as follows:
- A dollar denominated promissory note to be paid in
pesos, with maturity of principal as of ten years from date of
substitution of the debt instrument and semi-annual interest
payment in pesos at an interest rate based on LIBOR, fixed by the
CB, from time to time.
- An indexed peso denominated promissory note issued
in Unidades de Fomento (inflation indexed development units), with
maturity of principal as of fifteen years from the date of
substitution and semi-annual interest payments in pesos at an
average rate based on local market conditions fixed by the CB, from
time to time.
- The holders of the dollar denominated promissory
notes may exchange them for peso denominated promissory notes any
time during the first 18 months. Both kinds of promissory notes may
be sold on the secondary market at a discount through a local bank
acting as agent for the transaction under the authorization of the
CB. The proceeds of such sale must be applied to the authorized
investment or deposited with the agent bank until disbursement is
required according to the authorized investment.
There are no limits imposed on the volume of transactions that
can be undertaken over a given period, since approval of
applications by the CB is on case-by-case basis. The CB can refuse
the proposal without expression of cause. Although there is no
official guideline on favored sectors, investment in export
activities are preferred.
Once approval of investment has been granted, the investor is
given access to the foreign exchange market for the purpose of
repatriation of profits, subject to the following conditions:
- a) capital invested cannot be remitted for ten
years from the date on which the investment or capital contribution
- b) profits generated during the first four years
can only be remitted from the fifth year, in installments that do
not exceed 25% of the total accumulated profits. Profits generated
from the fifth year onwards are not subject to restrictions.
Reinvestments are allowed subject to the restrictions imposed on
the original investment.
An important amendment was introduced in 1987, to allow natural
and juridical persons (owned by foreigners) with residence and
domicile abroad, to invest in shares of local open corporations
(sociedades anonimas) through Chilean Investment Corporations
(sociedades de inversion) specially created for this purpose. The
foreign investor (Chileans are not allowed) eligible for such
investments may be private, government or multinationals with a net
worth of not less than US$ 5 million.
There are a number of requirements which apply to the
"sociedades de inversiones". the minimum subscribed capital must be
US million and each share a minimum of US0,000. No
shareholder may hold more than 25% of the shares. The shares, once
subscribed and paid, could be transferred abroad and traded amongst
foreign investors qualified to make such investments.
The life of the sociedades de inversiones cannot be less than 12
years, which is equivalent to a minimum permanence of the initial
investment for such a period. It may not remit any profits until
the end of the fifth accounting year, and thereafter remit up to
90% of net profits every year plus up to 20% of the profits
accumulated over the first five years period. These sociedades are
under the control of the Superintendencia de Valores y Seguros
(controlling agency for public corporations) and the CB.
The foreign funds may be invested in predetermined financial
instruments. These include shares of Chilean public corporations,
debt instruments issued by the CB and the public sector, mortgage
bonds (issued by banks), bonds issued by public corporations and
other authorized instruments. Investments may not exceed 10%, and
in some cases 15%, of the issuing company. Investment in one issuer
may not exceed 10% of the total assets of the sociedades de
inversiones. By the end of the fourth year of operation, at least
60% of total assets must be invested in shares of Chilean public
corporations and not less than 80% in shares plus long term
financial instruments.The "normal" foreign investment law allows
operation of foreign investment funds. But such funds are eligible
for Debt for Equity conversion mechanisms
3.3.2. Chapter XVIII rules
These rules authorize nationals and foreigners, resident or
non-resident of Chile, to acquire eligible external debt
instruments and to use them to obtain local liquidity.
Prior to acquisition of the debt instruments, the debtor or
prospective investor must agree to one of the following
- a) that the instrument shall be paid immediately
upon delivery, in cash, with or without discount, in Chilean pesos;
- b) that the instrument will be substituted for one
or more instruments denominated in Chilean pesos, in indexed
"Unidades de Fomento" or foreign currency payable in Chilean
The CB imposes limits on the number of conversions that can take
place every month according to monetary and exchange rate policies.
The CB sells the right to buy discounted debt (called cupos) to
banks, authorized to operate in international exchange
transactions, at auctions, usually held twice monthly. These awards
are transferable between banks during a given month. These rules
were modified in 1986 to put Chilean nationals on more equal
footing with foreign investors with the so called Annex 4.
It allows Chilean corporations and banks and financial
institutions to substitute their own external debt for equity as a
result of a new share issue, without being subject to the auction
of rights (cupos) for the peso prepayment. The private corporations
which apply for such procedure be heavily indebted and draw a
direct benefit from the D/E conversion. These operations are also
approved by the CB.
Unlike Chapter XIX, conversions through Chapter XVIII do not
have to be applied to a specific use, previously approved by the
CB, except for conversions made under Annex 4. The scheme has
mainly be used by Chilean banks to retire their own external debt
by taking advantage of the secondary market where it is traded at
deep discounts. After adding the cost of the debt (around 60%), the
commission to the CB and the effect of the foreign exchange gap,
the effective cost of debt retirement is approx. 90%.
The success of the Chilean program stems from its clear cut
rules and the government's commitment to the objectives it was
seeking: to reduce or maintain the level of its external debt and
to attract foreign investment. It was helpful to increase savings
in Chile in order to facilitate the capitalization of private
sector companies and banks.
These government objectives were translated into a liberal and
relatively easy to use Debt for Equity conversion program.
Mexico's program objective is the promotion of new investments
that increase productive capacity and export earnings. It is highly
structured. It reflects the thrust of the program to ensure the
bona fide use of the funds generated through conversion and to
channel investment towards priority sectors. The program was
initiated in the legal framework governing foreign investment and
only foreigners were allowed to participate.
The program is administered by the Ministry of Finance (MoF).
But authorization for all foreign investment comes from the
National Commission on Foreign Investments. An operating manual has
been produced jointly to set out the specific guidelines and
procedures for using the program. Conversions are subject to a
monthly ceiling in order to control monetary expansion.
The Mexican companies eligible for investment under the program
(in order of preference) are:
- companies already 100% foreign owned;
- companies with foreign owned majority;
- companies which are to be converted into majority
or minority foreign ownership.
Preference is also given to those companies that are export
oriented and produce surplus in their BOP; with high technology;
with higher degree of Mexican content; small and medium sized
The funds acquired after the conversion may be utilized in the
- for acquisition of fixed assets for expansion, new
lines of products or new economic activities which result in
- for payment of the following liabilities in pesos:
due to Mexican banks, due to Mexican suppliers of Mexican capital
goods, obligations placed with the general investing public in
The rules specifically prohibit that funds to be used for the
- investment in working capital, except when needed
for the development of an approved project, provided payments
outside Mexico are not involved;
- payments of foreign liabilities to banks,
affiliated companies or suppliers.
The discount applicable on redemption of public debt in local
currency is decided on case-by-case basis by the Ministry of
Finance. The decision is made on the basis of a set of
pre-established percentage discounts contained in the operating
manual for nine different categories of benefits expected from the
The gain on redemption in local currency is subject to tax to
the foreign investor at 20% of the redemption payment net of
discount or 30% of the gain. Remittance of dividends and capital
are subject to the normal tax rules governing foreign
Capital generated through debt conversion cannot be repatriated
for 12 years. Dividends resulting from the approved investment can
be remitted when available. Under the restructuring agreement with
the creditor banks, investment redemption cannot take place on a
basis more favorable than the amortization of the original