Background

Cyprus’ Banking and Finance sector has been transformed in the years 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).

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 recapitalization and restructuring of credit institutions as well as the strengthening of the regulatory and supervisory framework of the banking and finance systems.  Whilst the path to achieving these ends was often brutal the effect was to produce local banks and finance institutions which were rationalized, stable, better capitalized and most importantly invested in corporate governance.

Running alongside these changes was a recognition that there was a lack of diversity within the finance sector. For many years bank lending and tax focused corporate structuring had dominated the landscape.  Following the EU bail out a conscious effort has been made to add sectors such as Investment funds,  fintech, cryptoassets and crowdfunding into the mix. The investment fund sector, in particular, showed rapid growth following an overhaul of the regulatory framework.  Assets under management increased from €2.7 billion in 2012 to €11.6 billion in 2022.   Cyprus in 2022 is home to a unique blend of banking and finance organisations.

Covid and Ukrainian war

The Cyprus economy entered the Covid pandemic in a strong position relative to the majority of other EU members. This was also true of its revitalized banking sector which entered the crisis well capitalized and with ample liquidity.  Prior to the Covid crisis the NPL rate, although still high, was reducing and despite the crisis, banks continued to sell off elements of their NPL portfolios.  The pandemic did, however, impact upon the rate of momentum achieved although by the end of 2021 the NPL rate stood at 9.8% of all loans as opposed to 17.5% in 2020 and 27.9% the previous year. The Cyprus economy as a whole rebounded strongly in 2021 recording a 5.5% growth in GDP largely thanks to a recovery in consumer expenditure whilst the general government deficit narrowed to 1.8% of GDP against a target of 4.9%. One positive impact of the pandemic has been the acceleration of digital strategies across the country due to widescale lock downs imposed on most of the population.  This has been accompanied by a significant shift to the use of online, card and crypto transactions and away from cash. Overall, the Banking and Finance sector has exhibited resilience and flexibility throughout the crisis.

The principal impact of the Russia – Ukraine war is likely to fall on Cyprus’ tourist sector.  Russian tourists generally account for 20% of all tourists and the Cyprus government is now seeking to compensate for this by targeting other markets.  There are also significant financial linkages with Russia in terms of Special Purpose Entities which have limited impact on the domestic economy although they will affect demand for legal and financial professional services. The exposure of Cyprus banks to Russia is negligible.  However, the geopolitical tensions and uncertainty related to the war have been the catalyst for a significant change in the Cyprus banking sector relating to RCB Bank Ltd. Prior to the start of the war RCB Bank Ltd had, with Bank of Cyprus and Hellenic Bank, been one of the three key domestic banks and subject to oversight by the European Central Bank (ECB).

On March 24, 2022, RCB Bank Ltd (RCB) announced that it had taken a decision to transform itself into a regulated asset management company.  In agreement with the ECB Banking Supervision, it ceased entering into new business with clients with respect to both deposits and/or loans from that date.  This followed an earlier announcement that it had entered into an agreement with Hellenic Bank Public Company Ltd for the sale of a performing loan portfolio of up to c. €556 million, related funds on the accounts of the corresponding borrowers and related off-balance sheet obligations.  Much of RCB’s business had depended on the Russian market and there were significant outflows of cash from the bank in anticipation of sanctions, at the start of the war.  The escalation of the war and broadening of sanctions increased the uncertainty about its future. The closure was decided on by the European Central Bank’s (ECB) Single Supervisory Mechanism. It was managed smoothly by the authorities and with full co-operation from RCB Bank Ltd, preventing shocks to the Cyprus banking sector and ensuring RCB’s depositors would not lose any money. The move further consolidates the Cyprus Banking market.

Regulation and Supervision

Cyprus is keen to prove itself to be a business-friendly destination which is fully compliant with EU and international laws and standards.  Compliance frameworks are installed across the banking and finance sector and competent authorities, in the form of the European Central Bank, the Central Bank of Cyprus and the Cyprus Securities and Exchange Commission, ensure their smooth operation.

Banking

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

Ultimate responsibility for the authorization 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 (as amended). Following this it makes recommendations to the ECB. The CBC has sole responsibility for the regulation and supervision of credit and other financial institutions established or registered in Cyprus, for branches or representative offices abroad of those institutions and, of branches in Cyprus of credit and 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 Cyprus 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. Moneyval reports have commended the CBC for its AML procedures and supervision.

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 of up to 1,000,000 euros.

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

Financial Services

The Cyprus Securities and Exchange Commission (CySEC) is responsible for the supervision of operations and ensuring the compliance with all relevant legislation, including the Fifth Anti-Money Laundering Directive (5AMLD)of the following entities:

In the context of the implementation of pan-EU requirements, including crypto-asset service providers (CASPs) under the Fifth Anti-Money Laundering Directive (5AMLD), Cyprus recently updated its definition of obliged entities under the Prevention and Suppression of Money Laundering and Terrorist Financing Law 2007 (AML/CFT Law), as amended, to bring crypto asset service providers (CASPs) into its scope. Moreover, Cyprus authorities have also decided that Cyprus CASPs should become approved and registered with the Cyprus Securities and Exchange Commission (CySEC).

In January 2020, CySEC published the “Directive DI87 - 10 on the provisions of crowdfunding services in respect of transferable securities” (“Crowdfunding Directive”).   CySEC’s Crowdfunding Directive relates solely to investment-based crowdfunding through transferable securities and excludes loan-based, reward-based and donation-based crowdfunding. The Crowdfunding Directive comprises a set of secondary rules for investment-based crowdfunding under the Law. It is complementary to MiFID II’s obligations. The Crowdfunding Directive also imposes additional provisions aimed at ensuring investor protection on Cyprus Investment Firms (‘CIFs’) acting as Crowdfunding Service providers. The EU Regulation 2020/1503 expands on CySEC’s Directive and will be fully implemented by November 2022.

Banking and finance activities

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 Central and Eastern Europe, 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 enforce. A pledge over a Cyprus company's shares allows out of court 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 may also be put into place.  Typical services required from local law firms will include:

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:

Outlook

Cyprus’ economy has, to date, proved remarkably resilient.  Despite the huge negative impact on foreign tourism arising as a result of the Covid pandemic and the Russia-Ukraine war key credit agencies such as Fitch, Moody’s and S&P have not downgraded their long-term outlook for the country (BBB-) and state they regard it as stable. This is due to institutional strength, above average GDP per head when compared with others in the BBB grouping, and government policy credibility backed by eurozone membership. A continued improvement in the NPL position would see the rating improve.  The pandemic has also boosted the digitalisation of the economy significantly with corresponding impacts on the potential of fintech.

At the end of 2021 the government announced a new investment strategy focusing on high value added and sustainable businesses.  In particular it singled out the shipping, pharmaceuticals, biogenics, and high technology sectors along with innovative businesses.  Legislative changes and incentives are already in hand to help to boost the sector with associated opportunities for banking and finance professionals.  The government has also brought forward several significant infrastructure projects to stimulate economic growth such as the  Larnaca Port and Marina redevelopment.  The government is also committed to the EU Green deal and Blue deal and hence investment funds and banks are starting to include ESG factors with some funds and loan portfolios actively targeting or exclusively dedicated to sustainable projects or businesses facilitating sustainability such as solar panel manufacturers.

Other investment opportunities also exist such as distressed loan portfolios, mergers and acquisitions, venture capital funds and projects, high end tourism development and oil and gas projects.

Despite the adversaries encountered in recent times prospects for growth of the banking and finance sector remain – particularly if traditional funders and fintech providers engage in cooperative efforts.