Kuwaiti Financial Stability Law

This post summarizes what I consider to be  the key points in the Law for the Strengthening of Financial Stability ("Financial Stability Law" or "FSL").  I'll follow-up with a second post to discuss issues relating to TID using the FSL for its rescheduling.

On 26 March 2009, the Amir of Kuwait issued the FSL as Decree Law #2 of 2009.  He had dismissed the Majlis Al Umma on 18 March so the Majlis' ratification took place after the new elections of 16 May. 

So you can follow along and as well perform your own analysis, here's the English language version (note the Arabic text above governs). Also here are the draft implementing resolutions in both Arabic and English.  

The FSL is composed of  Preamble and 5 Sections with a total of 33 Articles.

1. The Preamble provides the legal basis for the law as well as definitions (Article #1).
2. Part 1 Banks.  The Government acting through the CBK will provide a guarantee to banks to cover shortfalls in their provisions for (a) loan losses or (b) declines in their local security and real estate investments - all of which assets must be existing as of 31 December 2008. (Articles 2 – 7). 
3. Part 2 Productive Local Business Sectors.  Provides for a State of Kuwait guarantee for 50% of certain types of collateralized new finance offered by local banks to companies in this sector. (Article 8 – 9). 
4. Part 3 Investment Companies. Chapter 1.  Provides procedures for restructuring debt outstanding as of 31 December 2008 for solvent companies.  As part of the program,  the CBK will provide a guarantee of up to 50% of  collateralized new facilities  to facilitate a restructuring.  (Articles 10 – 14). 
5. Part 3 Investment Companies Chapter 2.  Establishes the legal basis and mechanism for a US Chapter 11-like cramdown of creditors (Article 15 – 21). 
6. Part 4 Penalties.  Outlines the penalties to be applied for supplying misleading information or attempting to exploit the law. (Articles 22 – 27). 
7. Part 5 General and Final Provisions. (Articles 28 -33).
   

Part 1 "Banks" 

1. The Kuwaiti Government will provide an adjustable guarantee for provisions and investment "shortfalls" against credit facilities and investment portfolios existing as of 31 December 2008. Shortfalls in provisions on assets created or acquired after this date will not be covered. 
2. Changes in values of the portfolio as of 31 December 2008 occurring in 2009, 2010 and 2011 will be considered and the guarantee adjusted. 
3. After 1 January 2012 the guarantee may not be increased. 
4. Banks have to continue to monitor these assets and make efforts to collect them. The program is not a license to walk away.
5. Banks are required to build provisions to cover the deficit.  Starting from 31 December 2011, they must take provisions of at least 8% of the shortfall per year.  Thus, the guarantee is intended to be reduced over time.  It is not bailout (government assumption of the shortfall) but as a bridging mechanism to allow the banks time to take the required provisions.
6. The guarantee will be for a maximum of fifteen years with a 1% per annum guarantee fee. 
7. If a bank cannot cover the deficit over time, the KIA has the right to subscribe for sufficient equity to cover the shortfall.  This is the potential bailout, though it comes with increased government ownership.
8. The Central Bank of Kuwait (CBK) will set the terms of the guarantee including  conditions to the issuance of the guarantee: costs controls (including over management salaries and bonuses), imposing mergers, etc.  To get the guarantee the bank must secure shareholder approvals to these conditions.
   

Part 2 "Productive Sectors" 

1. The Kuwaiti Government will provide a guarantee of up to 50% of new  collateralized facilities extended by local banks to companies from productive sectors. 
2. The loans may not be used to refinance existing debt. Nor are they to be used by the borrower for "speculating or trading" in real estate or securities.   They are supposed to be used so the company can conduct its core business to the benefit of the Kuwaiti economy.
3. Loans are for a maximum of five years and must have regular principal amortization during their term. As noted above, they must be sufficiently collateralized.
4. The guarantee will cover 50% of the net loss after collateral has been realized and applied to the entire loan. So this is a shortfall guarantee, not an absolute guarantee of 50% of the face amount of the facility.
   

Part 3 "Investment Companies" - Chapter 1 – Restructuring Plans. 

1. Companies will be screened to determine if they  have sufficient capital (الملاءة) and are able to continue in business and face their financial problems.  Thus, the FSL is designed to help Investment Companies with liquidity problems not those with solvency problems. 
2. Specialist firms – appointed by the CBK or proposed by the company and acceptable to the CBK – will undertake studies to determine the financial condition of the firm and prepare a report taking into consideration the three points mentioned above. 
3. The FSL makes a particular point of noting that to be granted a facility the company must have   الملاءة.  I've seen this term most frequently used to mean adequate capital so it would appear it's not just a case of having a positive net worth but having sufficient capital and reasonable leverage to  be able to continue its business.
4. If the study is positive (the company meets the three tests) and the CBK believes it is qualified for the FSL program, the State will provide a guarantee for up to 50% of new finance provided by local banks. The new finance may be used for two purposes only.  First to settle obligations to local parties (but NOT local banks) that were outstanding as of 31 December 2008. Second, to support rescheduling to foreign banks and financial institutions, provided that the initial cash repayment not exceed 25% of the debt with the remainder rescheduled as per the specialist firm's study above. 
5. The company must provide sufficient assets by way of collateral to cover in full the company's rescheduled obligations and the new loans made under the FSL.
6. With respect to Kuwaiti banks providing such loans, the Government of Kuwait will include this new finance in its guarantee provided in Part 1. (The one exception to the 31 December 2008 asset rule).  Note banks are not forced to provide such loans. 
7. There's also a provision for the injection of capital by shareholders or the KIA into the investment company.  Again the government has the right to subscribe for equity.  And can take over the company if the capital need is large enough and the existing shareholders don't step up.
8. The CBK will appoint a local bank as manager of the restructuring. It will determine the amount of new loan to be provided by local banks and the collateral to be taken.  It will take part in negotiations with foreign creditors to craft a rescheduling. The Central Bank of Kuwait must approve the terms of the rescheduling.  In effect then the manager will propose these terms to the CBK, but the CBK will have the final word. 
9. The restructuring plan will have similar restrictions on expenses and a requirement for possible mergers along with CBK imposed changes in the management and organization of the company. As with banks, the investment company must obtain agreement from its shareholders to these conditions before it can obtain the guarantee.
   

Part 3 "Investment Companies" Chapter 2 Legal Matters. 

1. The FSL establishes a special Circuit Court at the Court of Appeals.  This Court has  exclusive jurisdiction to review and rule rescheduling plans on a summary basis.  Its decision are final and not subject to any appeal.
2. The CBK or the company may present a restructuring plan to the chief judge of this special court along with all documents necessary to support the plan. Once the chief judge records receipt of these documents there is an automatic four month stay of all legal action. All creditors must be notified. 
3. Any interested party may appeal but the appeal must be (a) lodged within 15 days of receipt of notice of the original decision and (b) well organized and giving a reason why the stay should be lifted. The Circuit Court will make a decision whether to continue the stay.   A mere objection without reasons will be rejected.
4. If the Court decides to uphold the stay, CBK then will cause a detailed study to be made of the financial position of the investment company. The study should be submitted within four months, though there is a provision for an additional extension of up to four months. The restructuring plan will then be submitted to the Court for its approval or rejection. 
5. If the Court approves the plan, then all legal cases are stayed. If it rejects the plan, affairs return to their pre-stay condition.  In this case, creditors may again seek redress through the courts.  The judgment of the court is final. The company must then advise all creditors. 
6. In the case where the plan is approved, the CBK monitors compliance. 
7. If after a rescheduling plan is approved and implemented and the company fails to comply with its terms,  the CBK shall refer the failure to the Court to render the restructuring plan null and void. In which case creditors regain their rights to sue under the original loan contracts.
   

Parts 4 and 5 deal with respectively "Penalties" and "General and Final Provisions". If you're interested you can take a look.

Some quick observations: 

1. The FSL is designed for solvent companies, except for banks where the CBK guarantee program is designed to forestall mandatory declarations of insolvency and wind-ups. 
2. The programs under the FSL come with a heavy price tag. The CBK may mandate cost cuttings, changes in organizational structure and force mergers. The Government has the right to become a shareholder.  Any new loans must be collateralized.
3. The bank and investment company programs are unlikely to be used, except in extreme situations. 
4. The guaranteed loan  program for productive sectors is also unlikely to be utilized.   Banks are being careful with new loans.  They certainly won't be making new loans to clients already past due. Companies are going to have trouble finding unpledged collateral sufficient to support new loans.   With the decline in asset values, banks have asked companies to top up existing collateral.  Not much is left to support loans of any value.