Attracting Investments through the Astana International Financial Centre: Effective Mechanisms and Instruments

Attracting Investments through the Astana International Financial Centre:
               Effective Mechanisms and Instruments инструменты

Yerbol Nazhmidenov

Legal Adviser, AIFC Legal Services Board

Law firm Law Council Group

Astana International Financial Centre (AIFC) is rapidly becoming a key financial hub in Central Asia, offering unique opportunities for capital raising and business development. In this article, we will explore the main tools and mechanisms available through the AIFC.

We will begin by discussing equity instruments, such as investments in private companies, listing on the AIX exchange, and venture capital investments. These instruments allow companies to raise capital through the sale of shares and equity stakes. Next, we will examine debt instruments, including bonds, loans, and convertible notes, which provide flexible means of raising borrowed capital. We will also cover hybrid instruments such as convertible loans, and investment agreements like SAFE and KISS.

Finally, we will touch on investment mechanisms such as collective investment schemes and venture clubs based on Special Purpose Companies, which provide platforms for collective and venture investing. These instruments make the AIFC attractive to businesses and investors, offering flexible opportunities for capital raising and participation in the region's growth.

Equity Instruments Investing in Private Companies Operating in the AIFC

Equity-based instruments represent ownership rights in an asset. In the case of private companies registered in the Astana International Financial Centre (AIFC), such instruments may include shares or stakes that grant investors rights to participate in the company's capital. Companies attract investors by selling equity instruments to obtain additional funds for business growth and development. It is important to note that the AIFC tax regime exempts dividends paid on such shares from taxation, as well as capital gains tax on the sale of shares of AIFC-participant companies. This makes investments in private companies registered in the AIFC attractive to both local and international investors.

Listing on AIX and Securities Issuance

For companies seeking to enter public markets, the Astana International Exchange (AIX) in the AIFC offers the opportunity to list and issue shares, options, bonds, and other securities. Listing on AIX provides companies with access to international capital and enhances their visibility among global investors. An Initial Public Offering (IPO) on the AIX allows companies to attract significant financial resources necessary for expansion and strategic plans. After the IPO, shareholders can freely resell their shares on the exchange, contributing to liquidity and maintaining an active market.

Options also play a crucial role in the securities market, giving holders the right, but not the obligation, to buy or sell shares at a predetermined price within a specified time frame. This instrument can be used for hedging risks or speculating on stock price movements. Thus, companies registered in the AIFC can raise capital through both private investments and listing on the AIX, offering investors a wide range of opportunities to participate in their growth and success.

Venture Investments

Venture investments involve investing in promising startups or companies planning significant expansion in the future to achieve high returns. The term "venture investment" comes from the word "venture," meaning "risk" and "adventure."

Investors create such companies by investing money in them. Although this carries substantial risk, investors' belief in the project's potential is far more important for the venture capital industry. Venture projects offer investors the chance to expect a thousandfold return within the first few years after the company's creation, while traditional investments are more likely to yield moderate, steady growth.

To achieve profitability and reduce risks, venture investors typically use a diversification strategy, distributing capital across various asset types and projects from different industries. Zoom, Uber, Google, and Amazon started as venture projects before achieving success and increasing their capitalization a thousandfold.

When discussing the development of the venture environment in Kazakhstan, it is important to note the decisive role of the Astana International Financial Centre and Central Asia's largest IT startup technopark, Astana Hub. Kazakhstan became the leader in the number of venture deals in Central Asia and the Caucasus in 2023, according to research by RISE Research in collaboration with partners EA Group and BGlobal Ventures (a subsidiary of JSC "Qazaqstan Investment Corporation"), as well as Crunchbase, the Ministry of Digital Development, Innovations, and Aerospace Industry of the Republic of Kazakhstan, and KPMG Caucasus and Central Asia. The venture market in Kazakhstan is experiencing dynamic growth, with the volume of venture financing in the country growing more than fivefold over the past five years.

List of venture firms and funds operating in Kazakhstan:

• 1. Tech Garden, Autonomous Cluster Fund "Park of Innovative Technologies."
• 2. Incubator MOST and venture fund MOST Ventures Fund.
• 3. Venture fund QazTech Ventures.
• 4. Venture fund Quest Ventures.
• 5. National Agency for the Development of Innovations QazInnovations.

Debt Instruments

One of the fixed-income instruments for raising funds is debt instruments. These oblige the borrower to repay the creditor the amount of the debt and interest in accordance with legal requirements. The obligation is recorded and contains all contract information, such as interest rates, the collateral used, the maturity date, and the interest payment schedule. Consumers can apply for a loan for various purposes, including debt repayment, inventory acquisition, and larger purchases to be repaid over time.

Bonds can be issued by enterprises or the government on financial exchanges, including AIX (AIFC). The market value of the bond will be paid to the issuer by the investor. They will guarantee the repayment of the loan in exchange for the guarantee that coupon payments will be made on time. The annual interest rate on a bond is represented by the planned coupon payments, expressed as a percentage of the bond's nominal value.

The Tax Code of the Republic of Kazakhstan establishes rules for taxing bondholders' income. Income from coupons and capital gains from securities listed on Kazakhstan's official stock exchanges are exempt from taxation. Thus, Kazakhstan residents receiving this income are not subject to tax.

Loans are available from financial institutions and can be used for various purposes. When applying for a loan, the borrower agrees to repay the lender a certain amount of money within a specified time. Each payment includes an interest component calculated at the stated rate. It is important to note that when reviewing a loan application, various international financial institutions pay attention to the type of company activity, its legal status, and structure. Operating within the AIFC framework is a significant advantage, as companies registered in the AIFC undergo a strict due diligence process. Furthermore, the AIFC's legal system is based on the principles and precedents of English common law, which is well-known to international financial institutions. This increases trust in such companies and improves their chances of obtaining a loan on more favorable terms.

Hybrid Instruments

The hybrid instruments that we will discuss further can only be optimally structured within the AIFC jurisdiction, as Kazakhstan's law is not adapted to these models. In particular, there are issues related to the choice of the enterprise's organizational form. A joint-stock company is closest in structure to international standards, but the requirement for a minimum base capital of 50,000 monthly calculation index (MCI) is unattainable for startups in the early stages of development. Therefore, startups and investors view the AIFC financial hub as the most optimal legal base for concluding deals.

Convertible notes are financial instruments originally intended as debt investments but have the feature of later being converted into equity by repaying the principal amount plus accrued interest. Through this method, investors receive financial returns comparable to those from equity investments, but the initial investments can be made faster and with lower initial legal costs for the firm.

This instrument is popular among startups, especially those raising early-stage funding. A critical step to increase the project's or company's attractiveness to potential investors is to register the company and structure the convertible note deal within the AIFC jurisdiction. This legal regime, based on English common law principles and norms, is familiar and understandable to foreign investors. The main advantage lies in the simplicity of contracting with foreign partners since all documentation is prepared in English, eliminating the need to study the nuances of Kazakhstan's law.

A Simple Agreement for Future Equity (SAFE) is a financial instrument introduced by Y Combinator in 2013 that gained popularity in the startup ecosystem, especially among early-stage companies. SAFE does not provide an immediate equity stake in the company; instead, it grants rights to receive equity in the future, which is activated upon the occurrence of certain events, such as a financing round or acquisition.

Key points about SAFE include its flexibility, as it does not require an immediate company valuation and has no interest or maturity date. It is often used to finance early-stage startups, and the conversion into equity typically occurs at a discount or a set valuation when a predetermined event, such as a financing round or IPO, takes place. If no trigger event occurs by a certain maturity date, the investor may choose to convert their investment into equity or demand repayment.

KISS (Keep It Simple Security) is a financial agreement created by 500 Startups in 2014 in response to Y Combinator's SAFE. KISS combines elements of a convertible note and SAFE. KISS is available in two versions: the debt version, which includes a maturity date and an interest rate, and the equity version, similar to SAFE, which does not involve debt, a maturity date, or an interest rate.

The main terms in a KISS agreement may include the loan amount, maturity date, interest rate, conversion terms, a Most Favored Nation Clause, and an M&A exit provision, which determines the return on investment if the startup is sold before the next financing round. There is also a lead investor rights clause, which gives investors who invest $50,000 or more priority in additional investments. KISS serves as a "middle ground" between a convertible note and SAFE, providing protection for either the investor or the startup, depending on the chosen version.

Investment Mechanisms

Now let's consider investment mechanisms—Collective Investment Scheme and venture investing through a Special Purpose Company.

A Collective Investment Scheme (CIS) in the Astana International Financial Centre (AIFC) is a mechanism for collective investment, allowing the pooling of funds from various investors for joint investment in various financial instruments, such as shares, bonds, and other assets. This instrument is regulated by specific rules and regulations established by the AIFC and operates as follows:

1. Creation of the Fund

The fund is created and registered in the AIFC jurisdiction. It can be an open-end or closed-end fund, depending on the structure and investment objectives. A fund manager is appointed to manage the fund's assets and must be licensed and regulated by the relevant AIFC authorities. CIS must comply with the rules and regulations set by the AIFC Financial Services Authority (AFSA). These rules ensure transparency, investor rights protection, and efficient fund management. All documentation, including prospectuses and reports, is prepared in English, facilitating the attraction of foreign investors.

2. Attracting Investors

The fund issues equity or unit securities, which are sold to investors. These securities represent a share in the fund's assets. Investors buy units or shares of the fund, contributing their funds to the pooled assets.

3. Asset Management

The fund manager makes investment decisions on the collected funds in various financial instruments based on the fund's investment strategy. The fund's assets are diversified to minimize risks and maximize returns.

4. Reporting and Control

The fund is required to regularly provide reports on its activities, asset status, and investment results. These reports are available to investors for review. AFSA oversees the activities of the funds, ensuring compliance with established standards and regulations.

5. Payments and Income

Investors receive income from the fund's investments in the form of dividends or capital gains, depending on the fund's performance. The fund may also offer the option to redeem units or shares, allowing investors to exit their investments.

The Collective Investment Scheme mechanism in the AIFC ensures professional asset management, transparency, and investor rights protection, making it an attractive tool for collective investment for both local and international investors.

Venture Clubs and SPC

To begin, let's understand the functionality of a Special Purpose Company (SPC). A Special Purpose Company (SPC) in the AIFC serves several key functions, especially useful for structuring complex financial deals and asset management. SPCs are created for specific tasks or projects, and their functions include:

Deal Structuring: SPCs are often used to structure various financial deals, such as asset securitization, bond issuance, investment raising, or organizing collective investment schemes. This allows risks and liabilities associated with a specific deal to be isolated from the parent company or other participants.

Asset and Project Management: SPCs can be created to manage specific assets or projects, simplifying control and reporting. This is particularly useful for large infrastructure projects, real estate, venture investments, and other long-term investments.

Tax Optimization: Due to the AIFC's special legal and tax regime, SPCs provide opportunities for effective tax planning, which can reduce the overall tax liabilities of a group of companies or investors.

Attracting Investments: SPCs can be used to raise funds by issuing securities such as bonds or shares, allowing investors to participate in specific projects or assets without being exposed to the risks of other assets or operations of the company.

Legal Flexibility: The AIFC provides SPCs with flexibility in governance and structure, including in matters of management, liquidation, and reorganization, making them attractive to international investors and market participants.

Thus, SPCs in the AIFC serve as important tools for risk management, tax optimization, and structuring complex financial and investment projects, providing companies and investors with flexible and effective solutions. One such solution is a venture club.

A venture club or venture syndicate is a group of professional investors or business angels who come together for joint investment in early-stage startups. These clubs are often created through Special Purpose Companies - SPCs, also known as SPVs (Special Purpose Vehicles) or SPEs (Special Purpose Entities), specifically designed for investment in a particular startup. An SPC is created to execute a specific project, in this case, to acquire and hold shares in a startup. Club members invest in the SPC, which then invests in the startup, acquiring its stake.

Early-stage investments are the riskiest and only justified with a broad portfolio diversification. Clubs allow business angels to spread their risks by investing in a larger number of startups with smaller checks. This means that a business angel does not need to independently close the allocation received in a startup, as it is proportionally distributed among the club members.

Clubs bring together business angels with various expertise and specializations, making collective investment decisions more balanced and justified. Startups are evaluated from different perspectives by multiple investors, each contributing their unique expertise and value to the club. Investing through a club allows business angels to significantly reduce legal, financial, and consulting costs. These costs are shared among all club members, making investing more cost-effective compared to independent investments.

Conclusion

In conclusion, the Astana International Financial Centre (AIFC) offers companies and investors unique opportunities to raise capital and execute projects through various financial instruments and mechanisms. Equity and debt instruments, hybrid solutions like convertible notes, SAFE, and KISS, as well as specialized mechanisms for collective and venture investing, make the AIFC an attractive center for businesses and investors both within Kazakhstan and beyond.

Utilizing the AIFC jurisdiction allows companies to effectively structure deals, manage assets, optimize tax liabilities, and attract investments on favorable terms. The transparency and flexibility of the legal system, based on English common law principles, ensure a high level of trust from international financial institutions and investors.

Thus, the AIFC contributes to the development of venture capital, attracts international investments, and supports the growth of the startup ecosystem in Kazakhstan, offering innovative and effective solutions for businesses and investors looking to implement their projects in Central Asian markets.

All conclusions and recommendations presented in this article are for advisory purposes only and do not obligate third parties to take any specific actions. If you have any questions, please contact us (WhatsApp: +77073848352, email: info@lcg.kz).