i Structure of the law
The capital markets in Bulgaria are regulated mainly by the following:
- the Public Offering of Securities Act (promulgated by State Gazette2 (SG) 114/1999, last amended by SG 24/2018) (POSA), which contains regulations on public companies and requirements for prospectuses for offering of securities;
- the Markets in Financial Instruments Act (promulgated by SG 15/2018, last amended by SG 24/2018), which introduced into Bulgarian law the requirements of Directive 2014/65/EU (MiFID II);3
- the Activity of Collective Investment Schemes and Other Collective Investment Undertakings Act (promulgated by SG 77/2011, last amended SG 27/2018), which introduced into Bulgarian law the requirements of Directive 2009/65/ EC (the UCITS Directive);
- the Special Purpose Investment Companies Act (promulgated by SG 46/2003, last amended by SG 65/2018), which contains regulations of funds that may invest in real estate and receivables;
- the Application of Measures against Market Abuse with Financial Instruments Act (promulgated by SG 76/2016, last amended by SG 15/2018), which implemented into Bulgarian law Regulation 596/2014/EU (the Market Abuse Regulation); and
- the Financial Supervision Commission Act (promulgated by SG 8/2003, last amended by SG 27/2018), which establishes a unified regulatory and supervisory authority of all non-bank financial institutions.
The development of the Bulgarian legislation on capital markets has been marked by a clear trend of decodification and harmonisation with EU legislation. Thus, until 2003, the POSA was the only law that regulated this field. However, there are now five more separate legal acts regulating matters that originally fell within its scope.
Laws regulating capital markets in Bulgaria are harmonised with EU law and there are no substantial differences in the national legislation.
ii Structure of the courts
The judicial system in Bulgaria is comprised of regional courts, district courts, including the Sofia City Court, administrative courts, courts of appeal, the Supreme Court of Cassation (SCC) and the Supreme Administrative Court (SAC). As a general rule, civil cases are heard in three instances, and depending on the material interest, the first instance is a regional or district court, the second is a district court or a court of appeal, and the third, when not excluded by the law, is the SCC. Administrative cases are heard in two instances, the first being at an administrative court, and for cassation, before the SAC.
There are no specialised courts that examine disputes related to capital markets. As a general rule, disputes regarding securities traded on capital markets or between capital markets participants should be heard at first instance by a district court, at second instance by a court of appeal and, if admitted to cassation, by the SCC. Administrative acts of the Financial Supervision Commission (FSC) may be appealed before the SAC.
Outside the system of state courts, there are numerous arbitration institutions that may hear disputes regarding capital markets in one instance. The arbitration institution with the longest history and, relatively, the largest number of cases is the Arbitration Court at the Bulgarian Chamber of Commerce and Industry.
The Rules of the Bulgarian Stock Exchange – Sofia AD (BSE – Sofia AD) (the regulated market of financial instruments in Bulgaria), and in particular Part VII, provide for the existence of an arbitration court at the Stock Exchange, which may hear disputes regarding the conclusion and execution of stock exchange transactions, disputes between members of the Stock Exchange and disputes related to other cases of trade with financial instruments. Despite its specialisation, this arbitration court currently is not established as the main institution that examines capital markets disputes and does not hear a significant number of cases.
There is also an arbitration court at the Central Depository AD (the only depository institution in Bulgaria). Within its authority is the hearing of:
- disputes between members of the Central Depository (banks, investment intermediaries and international depository institutions);
- disputes between the Central Depository and its members, and between participants in the settlement system operated by the Depository;
- disputes between the Central Depository and participants in the settlement system; and
- complaints from entities who are not admitted to membership in the Central Depository.
Similarly to the arbitration court at the BSE – Sofia AD, and because of its scope of jurisdiction, this arbitration court is also not of particular relevance to the capital markets.
iii The role of local agencies and the central bank
Financial Supervision Commission
With the adoption of the Financial Supervision Commission Act, Bulgaria introduced the model for establishing one 'super regulator' that supervises the entire non-banking financial sector – capital markets, insurance markets and social security markets. Only banks are outside the supervision of the FSC; they are subject to regulation by the Bulgarian National Bank (BNB). When a commercial bank wants to operate as an investment intermediary, it has to obtain a licence from the BNB after the latter has considered the opinion of the FSC.
The FSC is an independent administrative authority consisting of five members – a chair, three deputy chairs who supervise capital markets, insurance markets and social security markets, respectively, and a fifth member who is engaged mainly in protecting the interests of consumers of financial services. The chair and the members of the FSC are elected by the National Assembly.
In terms of regulating capital markets, it is interesting to distinguish the distribution of functions between the FSC and the deputy chair supervising capital markets. At the proposal of the deputy chair, the FSC issues licences for operating in the field of capital markets (investment intermediaries, management companies, mutual funds, etc.), authorises the transformation of participants in the capital market, confirms the prospectuses for public offerings of securities, etc. The deputy chair independently issues the permits and approvals as provided by law (for acquisition of a qualifying shareholding, transformation of public company, etc.), and imposes compulsory administrative measures and penalties on capital markets participants, among other things.
The FSC provides guidance on the application and interpretation of laws regulating the activities of non-bank financial institutions, including laws regulating capital markets (see above), and the secondary legislation relating to their implementation.
Council for the Development of the Bulgarian Capital Market
In October 2016, a new organisation was created for the development of the capital market in Bulgaria, as an official platform for cooperation between organisations in the field of the non-banking financial sector. The objectives of the Council are creating an overall strategy and road map for development of the capital market, increasing market capitalisation and the trading volumes on the regulated market, and improving the financial markets regulations. It also aims to introduce new financial instruments for trading on a regulated market, creating an opportunity for public offerings to be funded by programmes and funds of the European Union, etc. The objectives of the Council shall be fulfilled by the Coordination Management Group, whose main functions are to analyse the state of this sector, to initiate public discussion and all kinds of scientific research on current topics, to prepare proposals for legislative amendments and to increase the financial knowledge of potential clients of financial services. The Council consists of members of the FSC, the BSE – Sofia AD, the Central Depository, the Association of Banks in Bulgaria, associations of the market participants, such as investment firms, management companies, special purpose investment companies, the American Chamber of Commerce in Bulgaria and other major organisations within the financial sector.
II THE YEAR IN REVIEW
i Developments affecting debt and equity offerings
Markets in financial instruments
At the beginning of 2018, a new Markets in Financial Instruments Act (MFIA) was adopted, which introduced into Bulgarian law the requirements of MiFID II. Since the provisions of MiFID II should be analogical in every Member State, this section focuses only on what is significant and new from the point of view of the Bulgarian capital market.
Through the MFIA, emission allowances (known as EUAs) were added to the financial instruments list. This forces the companies that until now have been engaged in their trade to seek licensing for investment firms or partnerships with investment firms. Furthermore, despite not being explicitly defined as financial instruments, providing advice regarding structured deposits (bank deposits where the yield is more related to the movement of stock indexes than to interest rates), and the sale of such products, are also within the scope of the MFIA. In addition, the scope is widened in respect of derivatives on commodities and currencies, the trading of which is regulated by the Directive; specifically it applies to a wider spectrum of derivatives on commodities and currencies that are physically settled (i.e., when the contract leads to settlement of the underlying commodity).
One of the new elements in the regime deriving from EU legislation is the option for investment firms to conclude contracts with tied agents. The tied agent may be a natural person or a legal entity and, in return for a remuneration, it may provide certain services on behalf of an investment firm, for which it is solely and fully full responsible. According to the law, tied agents should be registered with the FSC after providing evidence that they are compliant with all the established regulatory requirements regarding education, experience and good reputation. Requirements for the responsibility of the investment firm for the activities of the tied agents with whom they have concluded contracts were introduced, as well as exercising control on their activities. There are already Bulgarian investment firms that are taking advantage of the options available and there are tied agents registered with the FSC.
The facility for an investment firm to organise not only a multilateral trading facility (MTF) but also an organised trading facility (OTF) has also been introduced. An OTF is a platform where the trading interests of many parties meet, as a result of which financial instruments transactions are concluded. The OTF differs from the regulated market and the MTF in three major aspects:
- a the OTF operator plays an active role in the pairing of orders leading to the conclusion of transactions by performing an evaluation of how and whether to pair certain orders;
- b an OTF operator is obliged to provide the best performance for its clients when performing its orders, including when it cooperates and evaluating whether to pair certain orders on the platform it has organised; and
- c the OTF may trade only bonds and derivative instruments (i.e., not shares or exchange-traded funds.
The MFIA introduces a new group of services related to the delivery of data:
- a approved publication arrangements (persons or entities that publish data for concluded financial instruments transactions);
- b approved reporting mechanisms (persons or entities that report the concluded transactions to the regulatory authorities); and
- c consolidated tape providers (persons or entities that publish data for all transactions involving certain financial instruments so that the participants may have an overall view of the trading with these financial instruments).
The introduction of these new services is intended to secure the market of high-quality data for all instances of trading with financial instruments that have resulted from MiFID II widening the scope of the requirement for transactions to report to a wider range of financial instruments, including those allowed for trading on MTFs and OTFs. In view of the foregoing, it is expected that the number of reported transactions will increase significantly.
ii Developments affecting derivatives, securitisations and other structured products
Special purpose investment companies
The first significant amendments to the regulation of special purpose investment companies (SPICs) was made during the past year, 15 years after the initial regulation was promulgated. These amendments have attracted interest as they were initiated by the business community and they are intended to bring the regime of SPICs up to date and not comply with EU regulations. According to the transitional and final provisions of the amended Special Purpose Investment Companies Act (the SPIC Act), the companies must make their activities compliant with the new rules within 18 months of the adoption of the amended SPIC Act, in other words by February 2020.
A significant new provision in the Act is that it is now possible for SPICs to arrange securitisation of immovable properties to invest in a 'specialised company with exclusive scope of business activity', by which is meant a company that acquires immovable properties and real rights on immovable properties, carries out construction and improvements for the purpose of assigning them for management, renting, leasing or leasehold and sale. Practically, this makes it possible for SPICs to perform their activities indirectly, through investment in other companies that have a similar analogical business scope but are not public.
The main purpose of this amendment is that, through these companies, SPICs will be able to acquire properties not only in Bulgaria but also in the territory of other EU Member States, which is not allowed by the SPICs themselves but has long been desired by the business community. What effect this legislative amendment will have has yet to be seen, owing to the fact that (1) only SPICs, not other shareholders, may participate in these companies, (2) many of the requirements applicable to the SPICs themselves are applied to the specialised companies, and (3) additional requirements have been introduced in respect of their activities and financing. The amendment also provides that a SPIC that securitises immovable properties may invest up to 10 per cent of its assets in another SPIC that securitises immovable properties.
Other amendments to the law have created certain benefits for SPICs that invest in agricultural land, including removal of the requirements for them to (1) hold insurance, and (2) carry out an annual re-evaluation, which may now be done once every five years. The regime for using a depository bank, when financing is provided by another bank, is facilitated, and the amendment to the regulation of servicing companies means it is now possible for certain activities, such as accountancy and correspondence maintenance, to be carried out by the SPIC itself.
Without a doubt, these amendments to the law will have a positive effect and may revive the market of SPICs to some degree. How much existing companies will take advantage of the new possibilities will not become evident until 2019.
iii Cases and dispute settlement
During the past year, a very limited number of disputes relating to the capital markets have been heard by a state court. Of these, we focus our attention on two cases, although final court decisions have not been issued yet.
Admission to trading of bonds
Futures Capital JSC is a public company that has placed a private emission of bonds in the amount of €5 million for investing in immovable properties. With the funds acquired through the emission, the company has bought bank loans that are secured with immovable properties, which is in accordance with what is permitted for indirect investment in immovable properties. Three loans from one bank to one company were acquired, and all were secured with properties in one holiday resort. After the investment was completed, the company filed with the FSC a proposal for admission to trading of the emission of bonds on a regulated market.
The FSC refused to approve the proposal on the basis that the interests of the investors in securities had not been protected. The main argument in that regard was that, according to the FSC, before starting this transaction, the company should have registered itself with the BNB as a financial institution since the completed investment came under the requirements of Article 3, Paragraph 1.i.1 of the Financial Institutions Act4 and the Ordinance of the BNB No. 26, dated 23 April 2009, on financial institutions.5 These requirements are that (1) the person or entity performs the activities of a financial institution as a regular occupation, and (2) the activity should be significant for the person or entity (i.e., the invested funds should exceed 30 per cent of the balance of its assets).
However, a three-judge panel at the SAC6 found the FSC's refusal to approve the proposal to be unlawful. The SAC determined that there was a dispute between the parties as to whether the acquisition of receivables under the loan agreements was a regular occupation or not. First, the SAC pointed out that the FSC's opinion that the acquisition of receivables under three loan agreements, whereby the company had concluded three transactions, was sufficient proof of carrying out such activities as a regular occupation, could not be accepted. According to the SAC, the purpose of the transaction was to acquire receivables in a specific amount, thus counting the separate actions for achieving this aim was without judicial relevance. Furthermore, the SAC pointed out that, in line with court practice, it is without dispute that the criteria for what constitutes 'regular occupation' is not the number of transactions, but whether the activity is regarded as being of a systematical, lasting and constant nature by the person or entity, is consistent with risk undertaking and is intended to be a source of income.
This decision is important in view of the fact that it provides further proof of the very free approach taken by the FSC in interpreting the law and ordering the refusal of proposals for public offerings or admissions to trading of securities.
Possible amendment of the parameters of an issued emission of bonds
The managing company Capman Asset Management had invested in bonds of the company Florina Bulgaria JSC through one of its managed common funds. At a general meeting of bondholders in 2012, where 84 per cent of issued bonds were represented, it was agreed to adopt amendments to the emission parameters. The decisions were supported by all the bondholders present (providing a majority of 99 per cent), except Capman Asset Management. Capman Asset Management considered that the general meeting was not competent to amend the terms and conditions of emissions of bonds already issued because a bond loan is an agreement that is concluded between an issuer and each bondholder separately. Thus, the proposed amendments to the terms and conditions would be possible only if, at the general meeting, all bondholders explicitly declared their consent. In other words, for the decisions to be valid, it would have to be adopted unanimously by all bondholders.
Neither the court of first instance, Sofia City Court, nor the court of second instance, Sofia Appellate Court, upheld Capman Asset Management's claim, and pointed out that the only competent body to amend the bonds emission parameters was the general meeting of bondholders and that because the law has not implemented a requirement for a unanimous decision, no such decision was necessary. The Supreme Cassation Court (SCC) ruled to allow an appeal by Capman Asset Management to cassation on the grounds that the legal framework was incomplete regarding the competence of the general meeting of bondholders and the method to be used for amending the terms and conditions of issued emissions of bonds. The SCC also cited its own lack of experience with regard to the relevant substantive law matters and the possibility of a controversial settlement. In view of all the foregoing, a ruling is expected from the SCC by the end of the year on the following questions:
- Is the general meeting of bondholders competent to make decisions regarding amendments to the terms and conditions under which bonds of the stated emission of bonds by a joint-stock company were subscribed?
- In the event of a positive answer to the first question, what majority is required for an amendment to the terms and conditions, under which bonds of the stated emission of bonds were subscribed, to be legally binding for all bondholders, including those not present or not represented at the meeting and those who voted against the amendment?
- In a proposal for an emission of bonds, is an explicit provision of the possibility for an amendment to be made to the terms and conditions under which bonds are subscribed and the method for adopting an amendment, a mandatory requirement within the competence of the general meeting of bondholders?
The ruling of the SCC is a subject of interest because it will provide the Court with its first opportunity to present a statement and opinion on the above questions. On the other hand, allowing a matter to progress to cassation is usually interpreted as a precursor to a reversal of current practice, which would be quite surprising due to the fact that current court practice is in accordance with Bulgarian principles, as well as with international resolutions on such matters.
iv Relevant tax and insolvency law
Collective investment schemes that are admitted for public offering in Bulgaria and national investment funds are not subject to corporate tax. Special purpose investment companies are also not subject to corporate tax.
The income gained by local and foreign individuals and legal persons from transactions on a regulated market (BSE – Sofia AD) with financial instruments is not subject to corporate or income tax. According to the law, 'transactions with financial instruments' are transactions:
- with shares and units of collective investment schemes and national investment funds, shares and rights executed on a regulated market;
- concluded under the terms and conditions of redemption of collective investment schemes, admitted to public offering in the country, in another EU Member State or in a country that is party to the EEA Agreement; or
- concluded under the terms and conditions of a tender offer under the POSA or similar transactions in another EU Member State or in a country that is party to the EEA Agreement.
Under the Corporate Income Tax Act (promulgated by SG 105/2006, last amended by SG 58/2017), when the disposition of shares and tradable rights of shares of public companies, stocks and shares of collective investment schemes is performed on a regulated Bulgarian market for securities, when determining a financial result for tax purposes, the accounting financial result is reduced by the profit, determined as the positive difference between the selling price and the documented cost of acquisition of the securities, and increased by the loss, determined as the negative difference between the selling price and the documented cost of acquisition of the securities.
The income from dividends distributed by Bulgarian companies obtained by local and foreign individuals is taxed at a rate of 5 per cent, which is charged at source and is final.
Insolvency in Bulgarian law is regulated by the Commercial Act (promulgated by SG 48/1991, last amended by SG 62/2017). Insolvency proceedings shall be opened when a merchant is insolvent or in debt to a significant degree (applicable only for equity commercial companies). Insolvency proceedings may be initiated against both companies and cooperatives, a sole proprietor and an unlimited liability partner in a company. Bulgarian law does not provide for insolvency proceedings against individuals other than sole proprietors and unlimited liability partners. The initiative for the opening of insolvency proceedings can come from the creditor or the debtor. The proceedings are opened before the district court at the seat of the merchant. Insolvency acts are subject to registration in the Trade Register under the electronic file of the merchant. Following the opening of proceedings, the court appoints an insolvency trustee, selected by the first meeting of creditors – individuals who organise the liquidation of a debtor's assets and the distribution of the proceedings between creditors. In addition to liquidation of the assets of the debtor, the Commercial Act allows for the possibility of settlement of the creditors by adopting a restructuring plan.
Bulgaria has a special law regulating the insolvency of banks: the Bank Insolvency Act (promulgated by SG 92/2002, last amended SG 95/2016). Therefore, the insolvency provisions under the Commercial Act are applied subsidiarily to those of the Bank Insolvency Act. Insolvency proceedings against a bank may be initiated only if the BNB has withdrawn its licence to perform banking activities. Thereafter, the only party entitled to request the opening of proceedings is the BNB. Insolvency proceedings against a bank do not include a meeting of creditors and a reorganisation plan may not be adopted. Of significant importance in such proceedings is the role of the Bulgarian Deposit Insurance Fund, which protects the interests of creditors and supervises the lawful and appropriate exercise of the powers of the trustee. Although it was adopted in 2002, the Bank Insolvency Act had not been applied until the Corporate Commercial Bank was declared bankrupt in 2014; thus, the proceedings against this bank will be the first to be developed under this Act and to form future practice under it.
v Role of exchanges, central counterparties and rating agencies
BSE – Sofia AD is the only stock exchange operating in Bulgaria. It is a regulated market for financial instruments within the meaning of Directive 2004/39/EC on markets in financial instruments, and has been licensed to operate by the FSC. Since June 2008, BSE – Sofia AD has used the Xetra trading system developed by Deutsche Börse. The regulations for trading on BSE – Sofia AD are laid down in Parts III and IV of its Rules.
The markets organised by the stock exchange are the Main Market, in which there are nine differentiated segments, and the Alternative Market, in which there are two differentiated segments. The main principle is that upon initial admission to trading, the shares of a public company are traded on the Main Market, 'standard' segment shares, in view of the criteria laid down in the Rules (such as number of transactions, turnover, free-float), may subsequently be moved to the higher segment of 'premium' shares on the Main Market, or to the lower segment of shares on the Alternative Market. Moving to the Alternative Market is only possible for issues of shares that have previously been traded on another market and only by an ex officio decision of BSE – Sofia AD.
At present, the state owns the majority of the capital of BSE – Sofia AD (50.1 per cent).
The only depository institution entitled to operate in Bulgaria is the Central Depository AD, which maintains a national registration system for dematerialised financial instruments and performs, inter alia:
- registration of financial instruments and transfers of financial instruments, as well as storing and maintaining data on financial instruments by opening and keeping accounts of their issuers and holders;
- clearing and settlement of transactions of financial instruments, including keeping monetary settlement accounts and making payments related to transactions with financial instruments;
- administration of financial instruments, including keeping a book of shareholders and holders of other financial instruments, distributions of dividends, interest and other payments; and
- registration of special pledges and financial collateral on financial instruments.
The Central Depository operates a system for settlement finality aiming to ensure the settlement of transactions with financial instruments.
As with BSE – Sofia AD, the state is the majority shareholder of the Central Depository. Therefore, it is expected that it will be privatised, and that it might be privatised with the stock exchange.
In mid 2015, the FSC prepared draft amendments to the POSA by which Bulgarian legislation will comply with the requirements of Regulation (EU) No. 909/2014 on improving securities settlement in the European Union and on central securities depositories. The proposed changes will create the possibility for more than one depository institution to exist in Bulgaria, and that those institutions will provide cross-border depositary services.
There are no branches of any internationally recognised credit rating agencies in Bulgaria. The only national credit rating agency is the Bulgarian Credit Rating Agency AD, which was entered in the register of the FSC in 2011. The Agency prepares credit ratings of Bulgarian financial institutions (banks, insurance companies, leasing companies, etc.) and of public (including municipalities) and private bond issuers.
III OUTLOOK AND CONCLUSIONS
The harmonisation between the Bulgarian capital markets legislation and the EU regulations continues its development during 2018. The changes adopted this year, and those yet to be adopted, enhance transparency in the capital markets, which creates a more attractive environment for local and, more importantly, foreign investors.
It is becoming increasingly clear that adoption of EU regulations alone does not lead to any stabilisation of companies trading on the stock exchange or contribute to a change in the type and quality of the services provided to market participants. In fact, the turnover of BSE – Sofia AD is still low, and new regulations are pushing local companies out of business at the expense of international banking and financial groups. The overly restrictive policies of the FSC in recent years cannot be regarded as a positive step for the capital market.
1 Viktor Tokushev is the managing partner at Tokushev and Partners.
2 Publishing in the State Gazette (SG) is the official way of announcing new legislation in Bulgaria.
3 This is a new law that repeals the previous one with the same name, which was in line with MiFID I (Directive 2004/39/EC).
4 Promulgated by SG No. 59/2006, last amendment SG No. 77/2018.
5 Promulgated by SG No. 36/2009, last amendment SG No. 68/2014.
6 Supreme Administrative Court, VII Division, Decision No. 10277/31.07.2018 on Administrative Case No. 1318/2018.