Trendy junk. Why have junk securities gone up in Ukraine?
The sales and purchase of securities generate a sustainable cash flow making them work for both the economy and the people, for whom securities are the only real alternative to deposited savings.
This can only happen once there is an effective stock market in place. Without it, things turn out the same way they do in Ukraine.
The situation with junk securities is a very illustrative example.
Junk securities and their designated purpose
By junk securities, developed countries understand high-yield noninvestment-grade securities.
As a rule (but not always), the issuers are non-liquid businesses, companies on verge of default and so forth.
By selling their stocks and bonds, they try to recover their financial position. That said, emitters have to offer increased premiums to investors to offset the high exposure to risks.
As a result, the yield of junk securities can exceed the key interest rate of the Central bank by few percentage points or even be several times larger.
With a clever approach, which implies choosing an emitter wisely, such an investment can bring solid revenues.
The purchase of junk securities often intensifies when other better-quality investment instruments on the stock market show extremely low yields.
For example, such a tendency was observed on the exchange market in August last year. Back then, the ten-year US Treasury yield was at 2% a year, while the average yields of US junk bonds were struggled at 5.8% according to Bloomberg.
According to the analytical platform Informa Global Markets, that difference gave a strong surge of transactions in junk bonds.
The emissions of junk bonds accounted for US$17.65 billion in August last year, which is almost 900 billion higher than in 2016.
And what about Ukraine?
We have no stock market or a solid mechanism to protect investments, and the legal framework for investment activities is extremely deplorable. Therefore, junk securities are traded in Ukraine in an unusual way. With a local touch, so to speak.
Here, in Ukraine, by ‘junk’ we generally understand fictitious securities issued by fictitious companies and backed with no real assets.
They are created for trivial reasons – tax evasion and money laundering.
By purchasing fake stock, companies artificially overstate their expenditure side and decrease earnings subject to a 25% income tax.
Another common scheme is shifting the profits abroad. To that end, a company sells cheap fictitious securities to a non-resident only to repurchase them at a maximum price, thus, allowing to shift the profits abroad.
The bottom line is that the funds stay abroad, and the worthless securities return and settle in Ukrainian banks. Which are neither large or credible in the vast majority of cases.
This proves the recent statement of the Fund Deposit Guarantee reading that liquidated banks show a high concentration of junk bonds – nearly 13 billion. To add insult to the injury, their securities portfolio totals 15 billion.
All these figures are indicative of the extent of the shadow economy in Ukraine and what happens in the absence of an efficient stock market.
With no legal framework to govern this area, tax officials cannot even prevent fraudulent schemes effectively.
The Law of Ukraine “On Securities and Stock Markets” even has no definition of ‘junk’ or fictitious securities, let alone the counteraction measures.
For that reason, the National Securities and Stock Market Commission of Ukraine cannot ban the emission of such stocks or bonds directly. They will have to find a formal reason for that. Which are very often to be appealed before the courts.
What to do?
An obvious solution would be to reform the stock market.
One has to produce a new development program for the entire segment, create a database of security issuers available for all investors, implement mechanisms for investment protection, control of the issuers and so forth.
An important criterion for the stock market efficiency is its accessibility to the general public. Not only it is a stimulus to the economy, but a sign of transparency over the entire segment. The USA is the perfect example. Nearly a half of the US families are stockholders. There are special institutions to protect specifically the interests of small investors.
In Ukraine, however, the stock market is rather a restricted area only for the few to enter guided by its own rules. It is no surprise such conditions warrant the growth of junk securities in the state.
To that note, the tax law must be changed.
Ukraine by any reckoning imposes a significant tax burden on the business and offers no measures for its support. Having such expenses on their ledgers, many are compelled to find off-the-books solutions. And, unfortunately, that is what the junk securities provide for.
This post is also available in: Russian