Kazakhstan has reformed the financial sector regulation: what do we need to know?

Legislative regulation of the financial market in Kazakhstan needs to be modernized to remain efficient and competitive. Therefore, on 12 July 2022, the President of the Republic of Kazakhstan signed the Law providing for significant changes in the legislation on securities market, insurance and banking activities (the “Law”)¹. The Law came into effect on 12 September 2022, with the exception of certain provisions (number of which came into effect retrospectively, i.e. before adoption of the Law).

Objective

Compared to financial markets in developed countries, Kazakhstan is quite acute with weak involvement of the population in transactions on the stock market, non-compliance with the required corporate governance standards, and low quality of published financial statements and insufficiency of electronic services on the financial market. These factors definitely reduce the attractiveness of this sector for investors and, accordingly, limit the inflow of funds to the capital market. For this reason, the Law, principally, is aimed at further development of more favourable conditions for performance of Kazakhstan’s financial market. Below is a summary of what we believe to be the most significant changes.

Key changes

Possibility to issue perpetual bonds²

Earlier, the company had to set a specific maturity term in advance when issuing bonds, but now bonds are permitted to be issued and circulated without indication of such term and bring fixed-interest income for an indefinite time — these are bonds with no maturity or so-called perpetual bonds.

Perpetual bonds have their own specificities and limitations. In particular, (1) they can only be issued to qualified investors; (2) they cannot be converted into shares; (3) they may not exceed 10% of the company’s equity capital; and (4) an investor may not demand the company to repurchase perpetual bonds. At the same time, the company’s right on buyback of perpetual bonds is preserved, i.e. in cases stipulated by the terms of the issue (specified in the prospectus), the company has the right to buyback and, accordingly, redeem them at par value.

Important to note the unclear provision of the Law with respect to the interest rate limitation of the issue depending on the amount of equity capital. Given that the amount of equity capital is a variable value, it is not clear what amount of equity capital is concerned: as at the time of making a decision on the issue or as at some different time. It is reasonable to assume that the equity capital for purpose of determining the cap on the issuance of such bonds shall be calculated at the time of its issuance.

Repo transactions — a new type of sale and purchase is introduced³

A repo transaction is an unified transaction consisting of 2 parts:

• Part 1: the sale and purchase of securities between the seller and the buyer; and
• Part 2: the buyback of securities by the seller on a certain date and for a predetermined amount of money plus the buyer’s interest.

In other words, it is a purchase of securities with the sell back obligation. At the same time, these securities must be of the same issue, unless the parties agree otherwise. Under repo transactions, it is possible to make transactions in shares, bonds, depositary receipts and other financial instruments. From an economic perspective, repo transactions are analogous to lending against securities pledge, but in contrast to the pledge, the securities are transferred exactly into the ownership of the buyer, which gives it an increased security comfort (compared to the pledgee) in case the seller does not repurchase the securities and does not pay an interest.

Currently, repo transactions with securities are already actively conducted in the KASE trading system. The order and terms of repo transactions at the KASE are set by the rules of KASE. Thus, though this type of securities transactions has been known in practice for a long time, the legislative stipulation of the regulation of such transactions directly in the text of the Civil Code establishes a basic set of regulative rules, applicable by default, which will allow the market participants to avoid disputes, if any terms were not specified in their agreement.

Possibility of joint stock company’s shares split⁴

Split of shares is an increase in the number of placed shares due to the proportional split of each share (i.e. substitution of one share with a higher value for a number of shares with a decreased value).

It is necessary to establish a certain split ratio — 2-for-1, 3-for-1, etc. However, a share split does not lead to an increase or decrease in the amount of share capital and does not require an additional issue of shares. For example, a 2-for-1 split of 2,000 shares at a price of KZT 1,000 each will result in 4,000 shares at KZT 500 each. The decision on split of shares is made by the general meeting of shareholders primarily to increase the liquidity and availability of the shares on the market. Thus, while the share split increases the number of outstanding shares and proportionally reduces the share price, accordingly, the market capitalization of the joint stock company as a result of split does not change.

Notably, when ordinary shares are split, the same split shall be applied to preferred shares and vice versa. At the same time, any limitations on shareholders’ rights are not allowed, except that the amount of guaranteed dividends on preferred shares is subject to split by the same coefficient, as well as other cases stipulated by the laws of the Republic of Kazakhstan.

A joint stock company has the right not to observe the pre-emptive right of shareholders in certain cases⁵

The law provides for the following cases when a joint stock company may place shares without observing the pre-emptive right of shareholders:

• payment of remuneration to members of the board of directors in shares;
• incentives for employees in shares; and
• conducting an initial public offering of shares or depositary receipts on a Kazakhstan or a foreign stock exchange.

It should be assumed that such decision can be taken both in relation to initial and subsequent issues of shares and in relation to shares already placed, but repurchased by the joint stock company itself. The procedure, number and terms of such placement shall be determined by resolution of the general meeting of shareholders or by the charter of the joint stock company.

Introduction of this provision allows resolving the long-standing issue of joint stock companies, which wished to reward their employees and the members of the board of directors with shares being placed, but could not do this without observing the right of pre-emptive purchase of shareholders, and were not able to carry out such reward if existing shareholders bought back all such shares being placed and were not able to do it without exercising the shareholders’ pre-emptive right, and had no opportunity to implement such bonus if the existing shareholders repurchased all such offering shares.

This opportunity is one of provisions included in the Law, which came into effect retrospectively, i.e. before adoption of the Law. The grounds for such legislative decision are not clear; it is possible to assume that it was made for some specific transaction where the pre-emptive right was impossible or unreasonable to exercise.

New special types of bonds were introduced⁵

• social bonds;
• green bonds; and
• sustainability bonds.

The significance of such bonds lies in the intended use of funds received from investors. The funds received as a result of the placement of these bonds should be used exclusively to finance projects in the relevant sectors. For instance, in case of green bonds – it is the financing of projects in the sector of ecology, renewable energy, water or energy conservation, etc. Funds from social bonds shall be used to finance the construction of affordable housing, healthcare, etc. The terms and procedure of the issue of such bonds shall be determined by the Agency of the Republic of Kazakhstan for Regulation and Development of Financial Market (the “ARDFM”).

Requirements for placement of securities on foreign stock exchanges have changed⁷

Now, it is not required to obtain a preliminary consent of the ARDFM for the issue and/or placement of securities on a foreign exchange. However, after the placement of securities on a foreign exchange, the issuer has to notify the ARDFM of the results of the placement of such securities. This requirement applies to resident organizations of the Republic of Kazakhstan, but a new wording of the Law, in contrast to paragraph 3 of the previous wording of Article 22-1 of the Law “On Securities Market”, does not contain a definition of the term “resident organisation”, which in fact means that from now on foreign holding companies of Kazakhstan companies may issue securities without the need to make local 20% offering of such securities in Kazakhstan. Thus, now it is much easier to issue securities abroad.

Improved protection of broker and dealer clients’ interests

The court and the court officer, when seizing the bank accounts of brokers and dealers, have no right to seize the money intended for accounting their clients’ money⁸. Moreover, courts, tax and customs authorities are prohibited to foreclose on money held in the bank accounts of brokers and dealers on their debts, if such money is also intended for accounting their clients’ money⁹.

Transition to electronic format of securities’ state registration from 1 June 2023¹⁰

The procedure of filing an application and necessary documents for registration of the issue, as well as introduction of amendments to the prospectus and bond program will be conducted only through the applicant’s (issuer’s) account on the website of the ARDFM. The certificate of state registration of the issue of shares and bonds will also be sent to the issuer in electronic form.

Security deposit  — a new way to secure performance of obligations¹¹

The key point of the security deposit structure is as follows:

• it is, among other things, an amount of money, a security and other types of financial instruments;
• which is transferred by one party to the agreement to the other party;
• as a security for future monetary obligations, including damages and penalties; and
• which is set off by the creditor against the performance of obligation, if such monetary obligation actually arises.

It should be noted that the scope of application of this method of security is highly broad, given that it can cover almost everything, including payments for goods or services, damages, penalties and other monetary obligations. However, such construction is not new for the turnover, although it was not directly provided by the legislation. For instance, such was a certain amount of deposit, which was paid and used to cover possible claims of the lessor to the lessee in case of property damage, lease payments delay fee, etc.

Taking into account that all methods of securing an obligation which are provided by the legislation (advance payment, guarantee deposit, pledge, penalty and others) have the same securing function, this poses the question about the main differences of security deposit from other methods. Proceeding from the literal content of the relevant provisions, so far we can conclude that:

• a: a security deposit secures an obligation that may arise in the future: future losses and future penalties, the occurrence of which is not predetermined. As for a guarantee deposit and an advance payment, since they are most often used to ensure the conclusion and execution of an agreement, including bidding, among other things, they exercise a penalty function. For instance, an advance payment and a guarantee deposit are withheld if the party that provided it evades the conclusion of the agreement, does not participate in the auction, etc.
• b: in contrast to an advance payment and a guarantee deposit, a security deposit may be paid not only in cash, but also in shares, bonds and other types of financial instruments;
• c: in contrast to a pledge, in case of a security deposit, the amount of money is transferred to the ownership of the creditor in advance, while in a pledge, the property remains in the ownership of the pledgor.

Therefore, in order to avoid potential problems with the use of the security deposit structure, it is necessary to determine the following in the agreement in each case:

• in which breaches the amount of the security deposit is set off against performance;
• the procedure for refunding a security deposit if no breach has occurred; and
• the security deposit amount, especially if it concerns transfers of securities and other non-monetary assets.

Banks will not be able to establish or participate in other legal entities in case of their unprofitable activities¹²

Recall that a bank and a bank holding company may establish or participate in a subsidiary only with the prior approval of the ARDFM. Now, banks and bank holding companies will be denied the right to establish/participate in a subsidiary if, based on the financial statements for each of the last 2 completed fiscal years, their operations were unprofitable.

Mandatory pre-trial settlement of insurance disputes¹³

As of 1 January 2024, disputes connected with refusal of insurance compensation by the insurance organization must be considered and settled by an insurance ombudsman before applying to the court. Importantly that not only an insurer, who has contractual relations with an insurance organization, but also an insured person and a beneficiary have the right to address an insurance ombudsman. It makes sense when the insurer, the insured person and the beneficiary are different persons. However, the answer to question of whether the insured person and the beneficiary have the right to apply to court against the insurance organization in case of disagreement with the insurance ombudsman’s decision remains ambiguous.

It is allowed to insure risks in a foreign insurance organization and in an insurance organization, which is an AIFC participant¹⁴

Now, inter alia, residents of the Republic of Kazakhstan will be able to apply to foreign insurance organizations and AIFC participants in the following cases:

• for insurance of risks in accordance with the principles of islamic insurance; and
• for insurance of legal (court) expenses, title insurance and guarantees insurance.

At the same time, the Law provides that insurance in a foreign insurance organization and an insurance organization which is an AIFC participant in the foregoing cases is allowed only if the insured property (property interest) is outside the territory of the Republic of Kazakhstan. It is quite unclear how the property interest can be located in any territory, but we believe that it is a matter of legal technique and legislator has in mind those cases when the property is located abroad or an obligation under a guarantee arises before a foreign person.

Mandatory professional indemnity insurance of insurance agent¹⁵

As of 1 January 2025, an insurance agent is required to insure its risks associated with professional indemnity to third parties. Such insurance agreements cannot be concluded with an insurance organization, which is mediated by such insurance agent on the insurance market. This requirement will not apply to insurance agents, which are legal entities.

The procedure for determining the share price in case of buyout of a minority shareholder’s shares by a large shareholder (95% and > of the voting shares) has changed¹⁶

Earlier on the buyback price of shares traded on the stock exchange was determined as the market value of the share on the exchange as at the day of demand for buyback, and now the price shall be determined as the highest price of the following:

• the average price of shares on the stock exchange for the last six months preceding the date of the transaction as a result of which the shareholder became the owner of 95% or more of the voting shares;
• the price of shares in a transaction, as a result of which the shareholder became the owner of 95% or more of the voting shares;

If the shares of the joint stock company are not traded on a stock exchange, the price shall be determined as the highest price of the following:

• the market price of the shares as determined by an appraiser;
• the price of shares in the transaction, as a result of which the shareholder became the owner of 95% or more of the voting shares.

Considering that the approach to regulating this issue has changed significantly, it is not yet known to what extent the new rules will be unambiguously understood and applied in practice. Another positive point in the new approach is the six-month period used to calculate the average share price during exchange trading. Since previously the price was determined on the basis of the share price during exchange trading as of the date of submission of the demand for buyback, it caused a lot of questions in practice. The situation was especially complicated when the share price could not be determined by the results of stock exchange trading, because on that day the share might not have been traded at all.

Restrictions have been imposed on the right of a shareholder to request information about the activities of a joint stock company¹⁷

Now the joint-stock company has the right to refuse a shareholder’s request for information and documents, if the request concerns inter alia:

• financial statements and other information published on the financial statements depository’s website;
• the document is requested repeatedly within the last 3 years, provided that the shareholder's first request for it has been fully satisfied; and
• the document relates to the past periods of the company’s activities (more than 3 years prior to the date of the request), except for documents on transactions executed as of the date of the shareholder’s request.

Brokers and dealers can be established in the form of LLPs¹⁸

Now brokers and dealers, which do not keep client accounts as nominee holders, but carry out only intermediary activities on submission of client orders for purchase and sale of securities, can be established in the legal form of LLP, but with mandatory formation of supervisory board in the structure of management bodies. 

Conclusion

Considering that the extent to which the foregoing and other innovations in the Law will work successfully and contribute to the development of the financial sector has yet to be determined in practical application, it should be noted that the Law represents a recognizable positive development in the country’s policy on regulation of financial market and financial services. In addition, we hope that the Law will increase confidence of participants of various transactions in the financial market and many processes taking place in the financial market will become clearer and simpler.

_{1 The Law of the Republic of Kazakhstan dated 12 July 2022 No. 138-VII “On Introducing Amendments and Additions to Certain Legislative Acts of the Republic of Kazakhstan in relation to the Regulation and Development of the Insurance Market and Securities Market, and Banking Activities”.
2 Paragraph 1 of Article 136 of the Civil Code of the Republic of Kazakhstan (General Part).
3 Paragraph 7 of Chapter 25 of the Civil Code of the Republic of Kazakhstan (Special Part).
4 Article 30-2 of the Law “On Joint Stock Companies”.
5 Paragraph 7 of Article 16 of the Law “On Joint Stock Companies”.
6 Article 20-1 of the Law “On Securities Market”.
7 Article 22-1 of the Law “On Securities Market”.
8 Article 740.1 (5-1)(5-2)(5-3) of the Civil Code of the Republic of Kazakhstan (Special Part).
9 Article 741 (5-1)(5-2)(5-3) of the Civil Code of the Republic of Kazakhstan (Special Part).
10 Articles 11, 12 of the Law “On Securities Market”.
11 Paragraph 8 of Chapter 18 of the Civil Code of the Republic of Kazakhstan (General Part).
12 Sub-paragraph 11 of paragraph 6 of Article 11-1 of the Law “On Banks and Banking Activities”.
13 Paragraph 2 of Article 842 of the Civil Code of the Republic of Kazakhstan (Special Part).
14 Paragraph 2 of Article 5-1 of the Law “On Insurance Activities”.
15 Paragraph 1-1 of Article 18 of the Law “On Insurance Activities”. 
16 Paragraph 4 of Article 25-1 of the Law “On Joint Stock Companies”.
17 Sub-paragraph 3 of paragraph 1 of Article 14 of the Law “On Joint Stock Companies”.
18 Paragraph 1 of Article 47-1 of the Law “On Securities Market”.}

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

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