Focus on: Banking and Finance in Cyprus

Elias Neocleous & Co LLC

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Cyprus’ Banking and Finance sector has worked hard to restore its credibility following the 2009-2013 economic crisis and subsequent EU bail out. The economic crisis was largely precipitated by over exposure to the Greek economy and sovereign debt and, a severely overleveraged property sector; all factors which resulted in Cyprus banks portfolios containing an unacceptably high proportion of non-performing loans (NPL) some in excess of 50%.  In March 2013, the Cyprus Government, in return for EU bail out assistance, signed ‘The Economic Adjustment Programme Memorandum of Understanding (MoU). The other signatories were the European Commission representing Eurogroup, the International Monetary Fund (IMF), and the European Central Bank (ECB).  The three main objectives of the Memorandum of Understanding (MoU) financial support program were to (a) restore the health of the financial sector, (b) apply fiscal reorganisation measures, and (c) implement structural reforms to enhance the competitive position of the Cypriot economy.

A key part of the MoU process included the assessment of the needs and weaknesses of the banking system. Following this, key targets were set, and actions implemented to achieve them. This included the recapitalisation and restructuring of credit institutions as well as the strengthening of the regulatory and supervisory framework of the banking and finance systems together with legal reforms such as the securitisation laws.  Whilst the path to achieving these ends was often brutal the results have produced local banks which have been rationalised, are stable, have stronger balance sheets and most importantly, have invested in corporate governance.  Prior to the Covid-19 crisis, the NPL rate, although still high, was reducing and despite the crisis, banks continue with plans to sell off elements of their NPL portfolios, with all major banks having in recent year’s offloaded large portions of their NPL portfolios to international funds.

Regulation and Supervision

Cyprus has been a member of the EU Single Supervisory Mechanism since late 2014.  It has enacted all necessary legislation to harmonise banking and finance domestic law with applicable EU directives and regulations.  This includes most recently the 5th Anti Money Laundering Directive (5AMLD).

Ultimate responsibility for the authorisation and supervision of significant EU credit institutions to be incorporated in Cyprus rests with the European Central Bank (ECB).  However, the Central Bank of Cyprus (CBC) is designated as the national ‘Competent Authority’ and therefore all applications are submitted via the CBC. The CBC vets all applications based on their compliance with the criteria contained in the ‘Business of Credit Institutions Laws of 1997’ and it makes recommendations to the ECB. The CBC has sole responsibility for the regulation and supervision of financial institutions established or registered in Cyprus, for branches or representative offices abroad of those financial institutions and, of representative offices in Cyprus of financial institutions established abroad carrying on banking activities and investment and ancillary services and activities. The supervision of branches of credit institutions from third countries which are active in member states remains the exclusive competence of the CBC.  Under Cyprus’ AML legislation the CBC is also the supervisory body for banks and persons licensed to provide money transmission services.

The CBC exercises the Supervisory Review and Evaluation Process in respect of all Cyprus incorporated credit institutions licensed by the CBC which are subject to capital requirements.  It has authority to enter and inspect.  If the CBC ascertains in its examination and supervision of a credit institution that it is not in compliance with the laws, directives and regulations of the CBC, it has powers to impose significant administrative fines and may amend, vary or revoke any license of a credit institution. The infringement by a credit institution of any of the laws and regulations of the CBC may constitute an offence punishable by imprisonment not exceeding five years or a fine.

Register of Credit Institutions

The CBC maintains a public register of all credit institutions licensed to operate in Cyprus.  Currently there are:

  • Seven local authorised credit institutions.
  • 22 Foreign authorised credit institutions and branches of foreign credit institutions from EU member states operating under the “European Passport” scheme including:
    • Four subsidiaries of foreign credit institutions including one from a non-EU state.
    • Five branches of foreign credit institutions from EU states.
    • 13 branches of foreign credit institutions from non-EU states.

Banking and finance activities

As the list of regulated institutions suggests, banking and finance activity in Cyprus extends significantly beyond purely domestic regulatory and transactional issues.  Located in the Eastern Mediterranean at the crossroads of Europe, Asia and Africa and, with strong historical ties to the UK, Cyprus is very well-placed as an international business and financial centre. Since joining the EU, it has established itself as the natural portal for inward and outward investment between the EU and the rest of the world, particularly the rapidly growing economies of Russia, Eastern Europe, the Middle East, India and China.  Its excellent business infrastructure, with a benign tax regime and an extensive network of double-taxation treaties, make it an ideal base for non-EU companies seeking to enter the EU market, and for EU and third-country companies seeking to broaden their horizons, especially with regard to expansion into Central and Eastern Europe.

In view of the above banking and finance transactions frequently involve complex consortia of companies obtaining finance not only from local banks but through major EU, American and Middle Eastern Banks.  Transactions are frequently syndicated and are generally led by major UK and EU law firms.  Cyprus law firms tend to be involved with these deals as local counsel advising on the Cyprus aspects of the transaction and cross-border regulatory issues.  Of particular concern in most cases is the need to ensure the perfection of Cyprus security for these transactions and the registration of charges.  It is common to take security in the form of a pledge over the shares of the Cyprus company as, in general this is easy and cost effective to contractually enforce.  A pledge over a Cyprus company’s shares allows enforcement, without the need to apply for a court order.  However, if the Cyprus company does hold assets of value in Cyprus then other forms of security including fixed and floating charges and assignments of receivables may also be put into place.  Typical services required from local law firms will include:

  • Preparation of loan documentation for single-lender and syndicated loans.
  • Preparation of security documentation including charges over assets and undertakings of companies, debentures, pledges of share certificates and security assignments of rights.
  • Restructuring of existing loans and collateral.
  • Refinancing of existing debts.
  • Project finance and asset finance.
  • Financing of international trade, including letters of credit, negotiable instruments and related matters.
  • Construction and project financing; finance leasing.
  • Preparation of indemnities and guarantees.
  • Preparation of documentation for aviation finance and leasing.
  • Compliance with perfection requirements and registration of charges.
  • Legal opinions and legal due diligence on proposed transactions.

New entrants to Cyprus, and in particular those from non-EU member states, will also often require advice and support to achieve compliance with the legislation applicable to banks and other financial institutions, including:

  • The Cyprus Banking Law, the Payment Services Law, the E-money Institutions Law, the Transfer of Banking Loans Law and the Financial Leasing Law.
  • The directives, regulations and guidelines issued by the Central Bank of Cyprus.
  • The EU legislative framework on regulatory capital.
  • The Banking Recovery and Resolution Directive, as implemented in Cyprus.

Growth areas

The impact of the Covid-19 pandemic on the country’s tourist sector was substantial.  However, Cyprus has a resilient economy and its persistent underlying budget surpluses pre-pandemic, which peaked at 3% of GDP in 2019, and robust GDP growth averaging 4.4% in 2015-2019 increased its capacity to absorb the pandemic shock.  Following an estimated 5.7% GDP contraction in 2020 a return to growth of between 3.2 and 3.7% GDP is predicted for 2021.  An important factor in the recovery is a government led drive to bring forward several significant infrastructure projects which will require project financing, such as the development of Larnaca Port and Marina and the development of an LNG processing facility.  Development finance will also be required elsewhere.  Cyprus is also striving to become a regional energy hub and there are numerous projects on the horizon linked to solar energy and the exploitation of the island’s natural gas fields.  Despite the termination of the Cyprus Investment Programme, many residential and luxury housing projects continue to move ahead.  Cyprus Banks in total still have a very high level of NPLs (approximately 30%) and it is crucial that they continue to focus on tackling this and cleaning up their balance sheets.  Numerous issues relating to this will require the input of legal specialists. Progress to date has involved loan restructurings, sale of loans, debt to assets swaps and foreclosure. International players have also bought distressed asset portfolios from local banks.  At a higher level the ECB continues to push for greater consolidation in the EU banking sector raising the possibility of acquisitions and mergers which could involve Cyprus based concerns.