JAMES P. HEALY,
GLOBAL HEAD OF EMERGING MARKETS
CREDIT SUISSE FIRST BOSTON
INTERNATIONAL FINANCIAL ARCHITECTURE
BEFORE COMMITTEE ON BANKING AND
U.S. HOUSE OF REPRESENTATIVES
MARCH 23, 2000
Mr. Chairman, Members of the Committee: My name is James P. Healy. I am a Managing Director and the Global Head of the Emerging Markets Group at Credit Suisse First Boston. I am pleased to testify before you today to discuss allegations of misuse of economic assistance from the International Monetary Fund ("IMF").
Let me say at the outset that Credit Suisse First Boston appreciates the opportunity to testify and to present the facts on the record which may help to correct the misconceptions and speculation that have been part of the public dialogue to date. Credit Suisse First Boston is prepared to provide to you any information we can to clarify the transactions we conducted with the National Bank of Ukraine ("NBU") from 1996 through the present. Further, we are cooperating with the independent audit of the NBU that is currently being conducted by PricewaterhouseCoopers at the request of the IMF.
Credit Suisse First Boston ("CSFB") is a leading global investment banking firm, providing comprehensive financial advisory, capital raising, sales and trading, and financial products for users and suppliers of capital around the world. It operates in over 60 offices across more than 30 countries and six continents, and has over 15,000 staff.
CSFB is one of the world's largest securities firms in terms of financial resources, with approximately $6.7 billion in revenues in 1998 and $7.1 billion in equity and $291 billion in assets as of December 31, 1998. The Firm is organized around the following four major operating divisions: (1) Investment Banking; (2) Fixed Income and Derivatives; (3) Equity; and (4) Private Equity. The Emerging Markets Group is part of the Fixed Income and Derivatives division.
I have been with CSFB since 1983, and have held a succession of positions. In November 1998, I became Global Head of the Emerging Markets Group, and in that capacity I am testifying on behalf of the Firm today. While I did not personally participate in the transactions in issue, I have familiarized myself with their history through the Firms internal review.
Since the collapse of the Soviet Union, we have been a major banker to the emerging democracies of Eastern Europe. While these investments are not without risk, as the events of the last few years show, CSFB believes that western, free-market economic values and principles are critical to the success of the efforts to democratize and privatize the former states and satellites of the Soviet Union. CSFB and other western financial institutions bring such nascent democracies to international markets. Among our activities, we underwrite their stocks and bonds and sell them on an international scale in global markets, we assist in their privatizations, we help them attract direct foreign investment, and we assist in domestic and cross-border mergers and acquisitions for them.
During the past ten years, CSFB has participated in many important transactions involving the developing countries of Eastern Europe. For example, in 1991, CSFB advised the Czech government on the sale of its national car manufacturer to the Volkswagen Group. Today, this transaction is widely recognized as one of the most successful privatizations for the Czech government. In 1995, CSFB assisted the leading Czech corporate bank, Komercni Bank, in the first ever international share offering from a Czech company on the international markets.
In 1991, CSFB led the National Bank of Hungarys $200 million Eurobond issue. In 1995, CSFB organized the $850 million privatization and sale of MATAV, Hungarys state telecommunications company. In 1997, we organized that companys $1 billion initial public offering.
In 1993, CSFB advised the government of Poland on its $2.2 billion joint venture with Fiat. CSFBs more recent involvement in Poland includes the I.P.O. of Bank Pekao, and subsequent sale to a strategic investor, which raised a total of $1.3 billion for the Polish government.
The Emerging Markets Group engages in the trading and structuring of fixed income and foreign exchange products in developing countries in Asia, Eastern Europe, Latin America, Africa and the Middle East. Our products include sovereign and corporate debt, foreign currency, derivatives, futures contracts, money market instruments and repurchase agreements (frequently referred to as "repos").
The Committee has asked us to address business relationships that involve a CSFB affiliate, CSFB Cyprus. CSFB Cyprus is a wholly owned subsidiary of CSFB and conducts investment banking and sales and trading activities, mainly in Eastern Europe. Cyprus is and has been for some time a commercial center for Eastern Europe and other countries, in part because of its favorable tax treaties with those countries. CSFB Cyprus is subject to the Banking Law of Cyprus and the rules and regulations of the Central Bank of Cyprus. As a subsidiary of CSFB, it is also subject to the oversight of the Federal Banking Commission (often referred to as the "EBK") in Switzerland. In 1999, CSFB Cyprus had a capital base of approximately $900 million.
There have been some allegations concerning CSFB Cyprus' relationship with and payments to two Cyprus companies, Cypronavus and Cymanco. Cypronavus is a service company of Chrysses Demetriades & Co., a major law firm in Cyprus. Cymanco is a service company of KPMG Cyprus. Cypronavus and Cymanco were the nominal shareholders of CSFB Cyprus (then "Credit Suisse Cyprus") when it was incorporated in 1995 and held these shares on behalf of Credit Suisse. In July 1996, Cypronavus transferred its share to Credit Suisse and Cymanco transferred its share to an officer of Credit Suisse. The use of service companies of a law firm or an accounting firm is the standard means of incorporation in Cyprus; we use similar service companies for this purpose in the United States. Our books and records reflect that during the period from 1997 through 1999, CSFB Cyprus made no payments to Cypronavus and paid a total of $9,217 to Cymanco, consisting of standard fees for the provision of Company Secretary and professional services rendered.
Under both Cyprus law and Swiss law, our customers are entitled to privacy protections, which in most circumstances prevent us from disclosing our transactions with them to third parties or even whether they are customers of CSFB (see attachments). In order to be able to discuss the facts with you today, CSFB has asked all of the relevant parties for full waivers under applicable Cyprus and Swiss law. We have received a waiver from the NBU to provide you with the information contained in this statement and can therefore confirm that the NBU was and is our client. In the absence of waivers from the other non-NBU parties, we are able to tell you specifically about the structure of the NBU transactions but only generally about the facts as they relate to any third parties and without identifying them by name.
Ukraine became an independent nation in 1991 in the wake of the dissolution of the Soviet Union. Since then, Ukraine has been striving to establish itself as a sovereign nation, both politically and economically.
Politically, Ukraine has struggled to consolidate its independence. Despite conflicts with Russia and its own internal regional divisions, Ukraine has managed to strengthen its nationhood and to become a member of the international community, most notably by ratifying the Strategic Arms Reduction Treaty ("START I") in 1994 and eliminating its nuclear weapons.
Ukraine has also struggled economically. In its initial period of independence -the early 1990s - Ukraine's economic management faced unusually severe challenges. Most of the institutions of a market economy had to be built from scratch. It suffered from a huge energy deficit. Its heavy industries needed overhauling. Its main trading partners were plunged into crisis themselves. The Ukrainian economy was paralyzed by hyperinflation, which was fueled by chronic budget deficits and political pressure on the government to spend.
Beginning in 1994, Ukraine made gradual but substantial progress towards restructuring its economy and establishing a market system. In 1994, Ukraine embarked on significant economic reforms and began to curb spending and to increase privatization, drastically reducing inflation. In addition, significant tax reform starting in 1995 eliminated thousands of loopholes, widened the tax-base, and generally lowered taxes for most Ukrainians. By 1996, the government had instituted a new currency, the Hryvnia, an important gesture indicating its determination to avoid the repeated cycles of hyperinflation. These reforms brought about modest, but positive changes in the Ukrainian economy. Government spending was lower, thousands of businesses were becoming privatized, and inflation was under control. Following years of double-digit negative growth, the Ukrainian GDP was poised to post positive gains.
In the fall of 1997, however, the stock market crash in Hong Kong made western investors wary of foreign investments, including Ukrainian T-Bills. Then, in August 1998, Russia defaulted on $40 billion worth of its government debt. The default put even more pressure on the Hryvnia, resulting, over the course of the next several months, in a substantial depreciation and increasing inflation.
Although the Asian and Russian financial turmoil was a significant set-back for Ukraine, its economy now appears to be stabilizing once again. Inflation is still a concern, but government spending has been reduced. The 2000 budget is the first non-deficit budget in the country's recent history.
The National Bank of Ukraine is the central bank of Ukraine, equivalent to our Board of Governors of the Federal Reserve System. The NBU reports to the President of Ukraine and to the Ukrainian Parliament. The NBU came into existence when Ukraine's independent banking system was established in March 1991. The Ukrainian branch of the former Soviet State Bank was severed from Moscow, shorn of most commercial banking activities, and renamed the NBU.
Like many central banks throughout the world, the NBU administers monetary and exchange rate policy and engages in various transactions in order to maintain the stability of the financial system, including by granting credits and loans to domestic banks. Also like other central banks, the NBU regulates and supervises the commercial banks by, among other things, setting minimum capital and reserve requirements and writing regulations for foreign exchange operations. The NBU is also responsible for transactions involving Ukraine's gold and currency reserves.
Since the mid-1990s, the NBU has played a significant role in working to achieve financial stabilization and economic growth in Ukraine. Among other things, the NBU has tightened its credit policy and managed to avoid the hyperinflation that Ukraine experienced in 1992 and 1993.
From the earliest stages of this fledgling democracy, CSFB has been committed to helping Ukraine develop its capital markets and attract foreign investment. CSFB opened its Kiev office in 1996. In addition to the NBU, CSFB has also had significant dealings with other Ukrainian clients, such as providing trade finance for clients in Ukraine's telecommunications, steel, and oil and gas industries. Other major financial institutions, such as ING Barings, Nomura International, Merrill Lynch and Chase Manhattan Bank, have done substantial business with the NBU and with other agencies and instrumentalities of the Ukrainian government. Just within the last month, ING led a syndicate of international financial institutions, including CSFB, Salomon Smith Barney and Commerzbank, to help Ukraine restructure $2.8 billion of its debt, providing another opportunity for economic reform.
From 1996 through 1998, CSFB and the NBU entered into several transactions, which fall into six general categories: (1) foreign currency swaps; (2) foreign exchange options; (3) gold reserves management; (4) a time deposit; (5) Ukrainian financial sector support; and (6) short-term debt management. In addition, the NBU has maintained routine correspondent banking and asset management relationships with CSFB.
I will go through each of these six types of transactions in greater detail. However, there are a few important principles and facts that are common to all of these transactions between CSFB and the NBU that I would like to share with you from the outset.
First, all of the transactions were legal and were entered into by CSFB at the request of duly authorized officials of the central bank of Ukraine and our other customers. Neither the NBU nor any other customer has made any complaint or raised any issue concerning the discharge of our duties to it.
Second, we do not know of any misuse of IMF funds. Indeed, CSFB was not told whether we were ever entrusted with IMF funds, nor could CSFB be expected to discover that on its own, as during the time period of many of the transactions at issue the NBU received funds from various other sources.
For example, from August 1997 to April 1998, Ukraine undertook a number of Eurobond issues, including issues in the face amount of $450 million, 1 billion Deutschemarks and one-half billion ECUs (the "European Currency Unit," which was the predecessor to the Euro), raising aggregate proceeds equal to roughly one and a half billion dollars. As stated in the IMF's press release of March 14, 2000, "IMF credits in 1997 and 1998 together amounted to $675 million, compared with foreign loans from other official sources (including the World Bank and the European Union), and private sources (including Eurobonds), of nearly $3 billion in 1997 and 1998. It is therefore impossible to establish whether it was the foreign exchange provided by the Fund that was used in [the transactions at issue]."
Moreover, there were things that we could do and things that we could not do in transactions with the central bank. We could check the credit history and reputation of the central bank. We could assess the central bank's economic rationale for a transaction. We could require that the transaction be approved by duly authorized officials within the central bank. We could not, however, audit the cash flows of a central bank. Nor could we monitor how the central bank calculated its various performance criteria in its IMF program, which were kept confidential.
Third, in CSFB's limited role in these transactions, we have found no evidence that they involved a diversion of NBU funds to unauthorized third parties.
Based on the available information and surrounding circumstances, it was CSFB's general understanding that the central bank of Ukraine entered into these transactions to encourage foreign investment, to maintain the stability of its interest rate and currency exchange rates, to obtain liquidity for its gold reserves, to provide Ukrainian financial sector support, and to reduce the cost of the Ukrainian government's foreign debt. These are precisely the types of activities that central banks are expected to engage in and do routinely engage in throughout the world.
To the extent that the NBU disclosed its reasons for entering into these transactions, we relied on its representations, which were made by duly authorized officials of the NBU and appeared reasonable. There was nothing in the facts available to us that made these transactions seem questionable for a central bank to be engaged in, or that indicated any purpose other than those disclosed to us by the NBU. Our general understanding of the NBUs intentions at the time of the transactions has been largely confirmed by recent official statements by the NBU.
Let me now turn to a more detailed description of the structure of each of the six types of transactions.
The first type of transaction involved foreign currency swaps. CSFB and the NBU entered into three of these transactions, which were all short-term currency swaps. One was between Deutschemarks ("DEM") and U.S. Dollars, and two were between ECU and U.S. Dollars. It was our understanding that, from the NBU's standpoint, the purpose of these swaps was to manage the interest rate and currency exchange risks on Ukraine's outstanding DEM and ECU Eurobonds. These were standard currency swaps, which are routinely conducted by both sovereign and corporate entities in order to manage their foreign currency liabilities.
On the initial exchange date, CSFB paid to the NBU the contracted for (or "notional") amount in U.S. Dollars and the NBU, in turn, paid CSFB the notional amount in DEM or ECU. During the life of the swap, CSFB paid the NBU a DEM or ECU coupon, which was calculated at a fixed rate multiplied by the DEM or ECU notional amount. In turn, the NBU paid CSFB a U.S. Dollar coupon, which was also calculated at a fixed rate multiplied by the U.S. Dollar notional amount.
At the NBU's request, all three currency swaps were terminated in September 1998. This resulted in the NBU's gain of approximately $33 million on these three transactions. This gain to the NBU was netted against a foreign exchange option between CSFB and the NBU (described below) that was also terminated at the same time at the NBU's request.
The second type of transaction involved foreign exchange options. CSFB purchased three such options from the NBU. Each of these was a "UAH put, USD call option." In other words, CSFB purchased from the NBU the right to sell to the NBU Hryvnia and to buy from NBU U.S. dollars at a fixed exchange rate, i.e., the "strike" price, at a date in the future. It was our understanding that the NBU sought to encourage foreign investment it provided an incentive for CSFB to invest in the Ukrainian currency and T-bill market at a time when foreign investment in such markets was subject to considerable risk due to fluctuations in the foreign exchange rate.
The first option was part of CSFB's purchase of Ukrainian T-bills with a face value of approximately UAH 88 million from the NBU in November 1996. The NBU agreed to exchange into U.S. Dollars the Hryvnia proceeds from those T-bills, at an agreed-upon exchange rate. In August 1997, this option expired worthless, with the NBU retaining the premium of approximately $500,000.
The NBU sold the second option to CSFB in May 1997, for a notional amount of $50 million. It expired in November 1997 worthless, with the NBU retaining the $250,000 premium paid by CSFB.
The NBU sold the third option to CSFB in November 1997. This time the notional amount was $100 million, and CSFB paid the NBU a premium of $500,000. In August 1998, three months before the expiration of the third option, the Ukrainian currency rate began to depreciate dramatically following the Russian financial crisis. At the NBU's request, the option was terminated in September 1998, for value in favor of CSFB in the amount of approximately $30 million. When netted against the NBU's gain of $33 million on the foreign currency swaps (described above), this resulted in a net gain to the NBU of approximately $3 million on the aggregate of the foreign currency swaps and foreign exchange options.
In the third type of transaction, the NBU deposited gold with CSFB in exchange for the payment of fixed U.S. dollar coupons during the life of the deposits. In this manner, the NBU obtained an income stream of U.S. dollars for an otherwise illiquid asset. There were three such transactions with CSFB. As part of these transactions, CSFB purchased call options on the gold, for which we paid a premium. These options were not exercised. The NBU terminated its gold deposits in February 2000. Gold deposits are regularly conducted by central banks all over the world.
The fourth type of transaction involved a time deposit. In December 1997, the NBU deposited $75 million with CSFB. Under the deposit agreement, CSFB had the option at maturity (October 1998) either to repay the principal plus interest in U.S. dollars, or to deliver to the NBU Ukrainian T-bills in a face amount of UAH 180 million. Again, it was our understanding that, through this deposit agreement, the NBU wished to spur foreign investment in Ukraine by providing CSFB with an incentive to invest in the Ukrainian T-bill market.
Indeed, we did purchase Ukrainian T-Bills in late 1997 and early 1998. There have been allegations that CSFB earned exorbitant returns of 40% to 50% on the Ukrainian T-bills that it bought. Such allegations are very misleading, as they overlook the foreign exchange risk that offset the yields on these T-bills. In this transaction, the changing valuation of the Ukrainian currency virtually offset the yield on the instruments themselves. The markets require higher yields when there is serious currency exchange risk; these yields were not at all unusual under the circumstances.
In September 1998, in the wake of the Russian financial crisis and the ensuing dramatic depreciation of the Ukrainian currency, the NBU requested that this deposit agreement be terminated. CSFB consented and, with the agreement of the NBU, delivered to the NBU Ukrainian T-bills in a face amount of UAH 180 million, which, at the market foreign exchange rate, had a value of $80 million and which was roughly equivalent to the NBU's principal plus accrued interest in U.S. dollars.
The fifth type of transaction involved Ukrainian financial sector support. Starting in 1996, the NBU approached CSFB and requested our assistance in providing such support, in the form of loans to various Ukrainian banks. Our understanding was that the NBU sought CSFB's involvement in an intermediary role in order to avoid the domestic political pressures it would face if it engaged in direct lending of U.S. Dollars to Ukrainian banks. In other words, we thought that, at a time when U.S. dollar financing was in short supply, the NBU did not want to be inundated with demands for loans, but rather, wished to use its scarce resources to finance domestic banks in the manner that the NBU thought was most appropriate for the Ukrainian economy.
CSFB and the NBU entered into six loans of this type from 1996 through 1998. Each of these transactions involved the NBU depositing a certain amount of U.S. dollars with CSFB and CSFB, in turn, lending that amount to a Ukrainian bank that was specifically designated by the NBU. In these transactions, if the bank to whom CSFB lent funds defaulted on its obligation to repay CSFB, CSFB would be relieved of its obligation to repay the deposit initially made by the NBU, and the NBU would have recourse against the third-party bank. CSFB received fees in the range of 1% to 2%.
There have been some allegations that one or more of these transactions may have been used to mislead the IMF. CSFB does not know of any such conduct, nor has it ever been in a position to know. We relied on the NBU's representations regarding the purposes of these transactions and we ensured that they were approved and signed off by duly authorized officials of the NBU. We can also confirm that, with the exception of one bank that defaulted on a $15 million loan, all of the money that the NBU deposited with CSFB (totaling approximately $500 million), and that CSFB in turn lent to the Ukrainian banks, was ultimately returned to the NBU, with interest.
In the sixth type of transaction, the NBU deposited funds with CSFB, which in turn lent the funds (at the NBU's direction) to a third party, in exchange for that third party's pledge of Ukrainian State External Loan bonds as collateral. There were two such transactions, each involving approximately $100 million. The pledged bonds were sovereign dollar-denominated bonds that represented the Ukrainian government's debt obligations. In the event that the third party did not repay the loan to CSFB, it would forfeit the pledged bonds without recourse. Further, CSFB would be relieved of its obligation to repay the deposit to the NBU, which would enforce its rights against the pledged bonds without recourse. CSFB received fees of approximately 1% to 2%.
It is our understanding that, in the first of these transactions, the NBU sought to guard against a massive influx of Ukrainian State External Loan bonds into the Ukrainian sovereign debt market at a time when Ukraine was planning to do a new Eurobond issue. The transaction therefore prevented the third party's holdings of its Ukrainian State External Loan bonds from flooding the Ukrainian T-bill market and undermining the value of Ukraine's planned issue of fresh Eurobonds. At the end of this transaction, the third party repaid the loan to CSFB, and CSFB repaid the full deposit to the NBU, together with accrued interest.
In the second transaction, the NBU approached us and asked us to work on the same type of transaction with a different third party, which we independently determined to be a reputable and established international company. We understood that the purpose of this transaction was to fund the purchase of coal for Ukraine. Specifically, the purchasing agent for the coal would use the borrowed funds to purchase the coal and then sell the coal to the government in exchange for Ukrainian State External Loan bonds. These bonds would be pledged to CSFB, which, in turn, would pledge them to the NBU. As it turned out, at the end of this transaction, the third party forfeited the pledged bonds to CSFB, and CSFB forfeited the pledged bonds to the NBU. The bonds matured and the government paid the NBU in full.
What I have outlined for you today are the facts concerning CSFB's transactions with our client, the National Bank of Ukraine, based on what we knew at the time of the transactions. These facts demonstrate that CSFB's conduct with respect to all of its transactions with the NBU has been entirely appropriate.
I trust that what I have shared with you today will put to rest some of the allegations that have been circulating about CSFB's transactions with the NBU. The first allegation is that IMF funds were somehow diverted for the enrichment of third parties. As I have said, we know of no evidence to support any such allegations. If we had possessed any such evidence at the time, we would not have entered into the transactions. Furthermore, as I have indicated, of the total amount that the NBU deposited with CSFB and that CSFB, in turn, lent to third-parties, which is approximately $705 million, all of it was returned to the NBU with interest, except for one $15 million loan default.
The second allegation is that CSFB's transactions with the NBU involved the misuse of IMF funds, i.e., that the NBU used IMF funds in these transactions and somehow violated the IMF's restrictions or requirements. As I have already noted, CSFB did not gain any indication from the NBU that the NBUs proposed transactions would constitute or facilitate a violation of any existing IMF restrictions or requirements relating to the IMF Ukraine program. CSFB had no knowledge from the IMF or any other source that the NBUs entering into these transactions could be regarded as such a violation. Furthermore, we believe that CSFB could not have gained any such knowledge from any IMF document available to CSFB at the time of the transactions. We relied on the fact that all of our transactions with the NBU were approved by duly authorized officials of the central bank of a sovereign nation and the reasonableness of what we understood to be its economic rationales for these transactions. Moreover, CSFB could not divine the source of the funds used in these transactions with a sovereign central bank, especially when its reserves came from a variety of sources.
The third allegation is that CSFB's transactions with the NBU resulted in a misreporting of the NBU's reserves. CSFB was not aware of the reserve requirements imposed by the IMF on the NBU, nor was CSFB aware of any agreements or understandings that may have existed between the IMF and the NBU at the time of these transactions as to the correct method for reporting the impact of these transactions on the NBU's reserves.
Thank you again for the opportunity to testify before this Committee. I would be happy to answer any questions you may have.