On January 13, 2021, President Trump signed an Executive Order amending Executive Order 13959 of November 12, 2020. The original Executive Order banned transactions by United States persons in publicly traded securities, or securities derivative of, or designed to provide investment exposure to, securities of designated CCMCs, starting on January 11, 2021. A structured note linked to the performance of a CCMC security would fall within this category, as would an exchange traded fund, no matter how small a percentage of the ETF's underlying index is represented by a CMCC constituent.10 As discussed above, certain CCMCs are components of some emerging markets indices, and were removed from those indices by their respective sponsors. Also as a result of the original Executive Order, on January 6, 2021, the NYSE announced the delisting of the American Depositary Shares of China Telecom Corporation Limited (CHA), China Mobile Limited (CHL) and China Unicom (Hong Kong) Limited (CHU).11 These shares were delisted on January 11, 2021. 

The amendment to the original Executive Order (as amended, the "Executive Order") goes further, banning possession by United States persons12 of existing CCMC securities after November 11, 2021. If a Chinese issuer is in the future determined to be a CCMC, possession of the securities of such an issuer by a United States person would be prohibited 365 days after the date of such determination. Structured notes linked to the performance of a CCMC security are subject to these same prohibitions. Any transaction in CCMC securities or a structured note linked to a CCMC security, solely to divest, is permitted prior to the respective cut-off date for ownership.

As one might imagine, the Executive Order has created a stir among structured products issuers. Individual holders of the shares of the delisted CMCCs, who had to dump their shares in a hurry and most likely at a loss, have already been harmed.

What is permitted under the Executive Order with respect to structured notes linked to CCMC securities, and which actions are not permitted? Here is a non-exclusive list:

  • Prior to November 11, 2021, structured note issuers may pay coupons, redeem or buy back from holders structured notes linked to existing CCMC securities;
  • After November 11, 2021, structured note issuers that are United States persons may not redeem or buy back from holders structured notes linked to existing CCMC securities;
  • Prior to 365 days after an issuer of an underlying security is determined to be a CCMC, structured note issuers may pay coupons, redeem or buy back from holders structured notes linked to such CCMC securities;
  • 365 days after an issuer of an underlying security is determined to be a CCMC, structured note issuers that are United States persons may not redeem or buy back from holders structured notes linked to such CCMS securities;
  • By November 11, 2021, structured notes issuers that are United States persons should cancel any structured notes linked to CCMC securities;
  • By 365 days after an issuer of an underlying security is determined to be a CCMC, structured note issuers that are United States persons should cancel any structured notes linked to such CCMC security;
  • Market intermediaries and other participants may engage in ancillary or intermediate activities that are necessary to effect divestiture of CCMC securities during the relevant wind-down period that are not otherwise prohibited under the Executive Order;13 and
  • To the extent that the following support services are not provided to United States persons in connection with prohibited transactions, clearing, execution, settlement, custody, transfer agency, backend services as well as other support services in CCMC securities are permitted.14

What should structured note issuers be doing now?

  • Review the delisting provisions in underlying documents governing structured notes linked to equity securities;
  • Consider amplifying risk factors for structured notes linked to emerging markets equity securities, indices or ETFs, keeping in mind the reach of the Executive Order;
  • Consider the effect of the Executive Order on holders of structured notes linked to CCMC securities and whether to communicate with such holders about the effect of the Executive Order and the relevant cut-off dates; and
  • Consider whether buybacks, tender offers or exchange offers may be necessary to help investors who will be forced to divest from any structured notes linked to existing or future CCMC securities.

If a U.S. person does not divest from its structured note linked to a CCMC security by the respective cut-off date, could the issuer of the structured note continue to make any required payments to the holder? It would seem so, as the payment of, for example, a coupon, or the payment at maturity, would not be a "transaction," as defined in the Executive Order. 15 However, the issuer would be in the position of making a contractually required payment to a U.S. person who is in violation of the Executive Order. The OFAC FAQs do not address this point, but that is not to say that the U.S. government will remain silent on this issue. This uncertainty makes it all the more important for issuers to communicate to holders of their structured notes linked to CCMC securities the importance of divesting prior to the respective cut-off date.

It is important for structured notes issuers that are United States persons to plan for the situation where holders of structured notes linked to existing or future CCMC securities have not divested their structured notes prior to the respective cut-off date. Holders of such structured notes should be clearly warned in advance that failing to divest their structured notes prior to the respective cut-off date will result in their being in violation of the Executive Order and holding a security that will be essentially worthless.

Footnotes

10 See U.S. Department of the Treasury – Office of Foreign Assets Control – Sanctions Programs and Information - Frequently Asked Questions – Chinese Military Companies Sanctions, available at: https://home.treasury.gov/policy-issues/financial-sanctions/faqs/topic/5671  (the "OFAC FAQs")

11 See the NYSE announcement at: https://s2.q4cdn.com/154085107/files/doc_news/NYSE-Announces-Suspension-Date-for-Securities-ofThree-Issuers-and-Proceeds-with-Delisting-2021.pdf

12 A "United States person" is defined in Section 4(f) of the Executive Order to mean "any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction with in the United States (including foreign branches), or any person in the United States." "Person" is defined in Section 4(c) of the Executive Order to mean an individual or entity.

13 OFAC FAQ 865.

14 OFAC FAQ 863.

15 The term "transaction" is defined in Section 4(e) of the Executive Order as "the purchase or sale for value, or sale, of any publicly traded security ...."

Originally published in REVERSEinquiries: Volume 4, Issue 1.
Click here to read the articles in this latest edition.

January 19 2021

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