Originally published in the Journal of International Banking Law and Regulation

The securities business is in its early stages in Vietnam. Not many products are available to investors. The Law on Securities largely recognizes only more traditional products: stocks, bonds and investment fund units. The legal framework for securities that are held indirectly through securities intermediaries is inadequate. While almost no securities derivatives have been issued in Vietnam, a number of offshore brokers are looking for a structure that will permit them to offer more sophisticated products to Vietnamese investors.

This article briefly examines the legal framework that governs the offer and trading of a particular type of securities derivative. We refer to notes linked to equities that are traded on the Vietnamese securities market. We will further discuss how an offshore broker can issue these products to Vietnamese investors.

General legal framework

What are equity-link notes? Simply stated, they are debt instruments whose return is tied to the equity markets. The return on equity-linked notes may be determined by a stock index, a basket of stocks, or a single stock. Although equity-linked notes have been traded on stock exchanges elsewhere, the concept is rather new in Vietnam.

The Law on Securities defines securities to include:

  • Stocks, bonds and investment fund units; and
  • Pre-emptive rights, warrants, call options, put options, future contracts, pools of securities and securities indices.

Equity-linked notes seem to be closer to the second category -- i.e. pools of securities and securities indices.

So the question is how and by whom can equity-linked notes be issued and traded. The first hurdle is that, the law only contains regulations on the issuance and trading of stocks, bonds, and investment fund units. It is silent on the issuance and trading of derivatives.

Can a securities intermediary like a securities company in Vietnam issue equity-linked notes? The Law on Securities permits a licensed securities company to engage in the following securities businesses:

  • Brokerage services (acting as an intermediary to perform transactions to purchase and sell securities for clients);
  • elf-trading (trading for its own account);
  • Underwriting services; and
  • Financial consultancy and securities investment services (including direct consultancy on securities investment, consultancy on financial restructuring, consultancy on division, split-up, consolidation and merger of enterprises, and consultancy on securities issuance and listing by enterprises).

There is no authorized service that will permit a securities company, even a company that is licensed to carry out the broadest scope of business, to offer structured products like equity-linked notes. The informal position of the State Securities Commission ("SSC") confirms that a securities company licensed in Vietnam may not issue structured notes in general and equity-linked notes in particular. The SSC cites the lack of specific regulatory rules as the limiting factor.

There are related regulations under Decision No. 07/2008/QD-NHNN of the State Bank of Vietnam ("SBVN") dated March 24, 2008 ("Decision 07") and they may be helpful. These regulations govern valuable papers issued by credit institutions. Decision 07 provides a definition of valuable papers:

"Valuable papers are certificates issued by a credit institution in order to mobilize funds; [the certificates] record an obligation to pay a debt within a certain period of time on certain interest payment conditions and subject to certain commitments between the issuer and the purchaser".

Valuable papers may include bonds, notes and similar debt instruments. However, the intention of Decision 07 appears to be to limit such valuable papers to debt instruments issued by credit institutions (including banks and financial companies). Even so, there are no regulations for listing or trading valuable papers on the stock exchange.

Offer of Vietnamese equity-linked notes by offshore brokers

The existing regulatory framework regulates only securities companies licensed in Vietnam. A number of offshore brokers are seeking ways to offer equity-linked notes to their clients who are both Vietnamese and foreign investors.

Typically, products of an offshore broker involve two transactions: (i) the broker and its client enter into an arrangement, specifically structured so that the client assumes certain exposure to particular Vietnamese securities, and (ii) the broker acquires the underlying Vietnamese securities on the Vietnamese stock exchange in order to hedge its own exposure in relation to the agreement it has reached under transaction (i).

Firstly, we look at the first transaction -- that is, to the transaction between the offshore broker and its client. Even though the transaction involves Vietnamese equities, the transaction does not require the offshore broker to render any of the securities services contemplated in the Law on Securities. Therefore, the offshore broker is not required to be licensed as a securities company in Vietnam in order to offer Vietnamese equity-linked notes. It can certainly offer such products to offshore investors. We discuss below whether and how an offshore broker can offer the products to Vietnamese investors.

There are regulatory requirements with which the offshore broker must comply in order to enter into the second transaction -- that is, to acquire the Vietnamese securities, an offshore broker must obtain a Securities Trading Code ("STC"). As long as the offshore broker has a valid STC, it is permitted to acquire securities that are traded on the stock exchange in Vietnam. There is a statutory limit on foreign investment in Vietnamese listed equities. A foreign investor can acquire up to 49% of a Vietnamese issuer's stock listed on the stock exchange. There are no restrictions on foreign investors selling Vietnamese securities, except for possible restrictions on selling during lock-up periods. For example, an offshore broker may sign an investment agreement with a Vietnamese issuer, which provides that the broker can purchase the issuer's securities at a favorable price; in return, the broker must commit not to sell the securities within a certain period of time. In addition, an offshore broker has to comply with the disclosure requirement in respect of the Vietnamese securities that it acquires. That disclosure relates to the level of shares it owns.

In addition, according to the Law on Securities, a shareholder of a public company1, including an offshore broker, must report to that public company and to the SSC if its holdings, being aggregated with those of related persons, reach 5% of the voting shares ("substantial shareholder"). If the public company is a listed entity, the same report must be made to the Stock Exchange ("SE") or the Securities Trading Centre ("STC")

A substantial shareholder must also report to the public company, the SSC, and the SE or the STC (as the case may be), if its holdings, when aggregated with those of its related persons, increase or decrease by at least 1%. That is, the reporting obligation is triggered whenever there is a change of at least 1% in the holding of a substantial shareholder -- not when its holding crosses a particular threshold. Further, the reporting obligation is triggered irrespective of whether the change has occurred either by action of the issuer or the shareholder.

In any event, no disclosure is required in respect of information on the identity of clients who purchase products linked to Vietnamese equities, nor the extent of their holdings of the products. There is simply no mechanism.

Who can purchase equity-linked notes issued by an offshore broker?

An offshore broker can offer Vietnamese equity-linked notes to a client located overseas, without being subject to the law of Vietnam. Neither the offshore broker itself nor the overseas client is required to register, or to notify, or to obtain approval from Vietnamese regulators to perform an offshore transaction that involves Vietnamese equity-linked notes. As the transaction occurs offshore, it is subject to the law of the jurisdictions in which it takes place.

If the client is a Vietnamese investor, the purchase of equity-linked notes issued by an offshore broker is considered to be an offshore "indirect investment". The Vietnamese client must comply with foreign exchange controls under the Ordinance on Foreign Exchange ("Ordinance") in connection with any offshore investment. According to the Ordinance and its implementing regulations, an institutional or individual investor can make an offshore indirect investment only if it satisfies conditions and follows procedures established by the SBVN. Under draft regulations of the SBVN on offshore investment, an offshore "indirect investment" is treated differently depending on the type of investor:

  • An investor that is a credit institution, i.e a bank, may purchase offshore products if it has a permit to provide international foreign exchange services ; such a permit is separate from its general banking license;
  • An investor that is not a credit institution, may make an offshore indirect investment pursuant to the SBVN's separate regulations. According to the SBVN's draft regulations on offshore investment, entities and individuals in Vietnam may make an offshore indirect investment if they have obtained a Certificate of Indirect Investment from the SBVN. One of the conditions for an investor that is not a credit institution to obtain a Certificate of Indirect Investment is that, it must mandate its investment to a credit institution that has a permit to provide international foreign exchange services. The Certificate of Indirect Investment will be issued based on the scope of the mandated agreement that has been registered with the SBVN. That is, the investor may invest in, through the mandated credit institution, the types of offshore investment instruments that are specified in the registered mandated agreement.

However, there is no indication when these draft regulations on offshore "indirect investment" will be issued. Pending the issuance of these regulations, credit institutions which are licensed to offer international foreign exchange services may make offshore indirect investments. Other Vietnamese investors, however, may not.

Offering equity-linked notes to Vietnamese investors

Pursuing the question further, can an offshore broker offer its equity-linked notes to Vietnamese investors through an onshore entity -- say, an onshore securities firm -- so that such investment by the Vietnamese investor is not subject to the regulations on offshore "indirect investment" As we point out, an onshore securities company is not authorized to provide financial investment services such as to offer equity-linked notes issued either by itself or by an offshore broker.

An offshore broker may, however, engage an onshore bank to act as its agent to sell its equity-linked notes -- as a type of valuable papers -- to Vietnamese investors. Even so, such an agency arrangement does not override the requirements on approval of offshore "indirect investment" under the Ordinance. The alternative is for an onshore bank to create its own product and to offer it to investors in Vietnam. These products would be backed by equity-linked notes tied to Vietnamese securities but purchased from an offshore broker.

Market conditions

The financial markets in Vietnam are still fairly unsophisticated. As we have said, investment products are limited to traditional and standardized financial instruments like stocks and bonds. There are almost no investment products provided by professional financial intermediaries. Of course, this is partially attributable to the lack of a specific legal framework for the issuance and trading of these products.

It is reported that in September 2005, the Hong Kong and Shanghai Banking Corporation ("HSBC") received permission from the SBVN to offer foreign exchange rate-linked deposits, and so became the first bank permitted to offer this service. Reportedly, HSBC planned to launch interest rate linked deposits and then gradually to introduce equity-linked products. However, to our knowledge, this service has not been fully developed.

Although the conservative approach may be to wait until regulations on foreign exchange in connection with the purchase of offshore investment instruments are issued, in fact, there appears even now to be a permissive structure. Some preliminary steps have been taken. It has been reported that one local bank has been engaged by an offshore broker to act as its agent to distribute the broker's structured notes to Vietnamese investors.

While commercial practice continues to evolve to fill the gaps, legislative support is clearly required.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.