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By Piyush Mishra
The domestic corporate bond market has seen a resurgence in recent times. The number of public issuances of non convertible debentures has increased from a mere three in the financial year 2009-10 to twenty in 2011-12 and the number of private placement of listed corporate bonds has increased from 1278 to about 1953 during the same period. Even in terms of aggregate size of issuances and placements, there has been a remarkable rise of approximately 38%. Goldman Sachs had estimated that even at a continued gradual pace of reform, the total debt market in India could grow upto $1.5 trillion by 2016 with the non-government segment ballooning to $575 million.
There are various factors contributing to the growth of bond markets in India including high base and prime lending rates, which form the basis of lending, and the exposure norms for lending, which, among others, regulate sectoral and group exposure of banks. The rupee bond market has matured over the years and shown some innovative structures to help fund projects at competitive rates. It has been used by financial institutions and various infrastructure and manufacturing companies. In terms of sectors- power, annuity highway projects as well oil & gas companies have tapped the bond market (domestic and foreign) from time to time. However, the rupee bond market still has a long way to go. The market is still, by and large, dominated by the banks and financial institutions. This is not unusual but rather in line with the experience the world over in terms of the development of the bond markets. The financial institutions hold the bulk of corporate bonds in most countries. But there is an urgent need to increase the reach and depth of the rupee bond market. The tax policy on infrastructure bonds has helped in attracting retail investments in such bonds but it still is an institutional market. Further, so far only well- known credit worthy borrowers have been able to successfully access the bond markets. There is little appetite for bonds below high investment grade (typically AA/Aa) category.
As the Indian bond markets gradually expand and display more liquidity and depth, they may present a viable financing option for large corporates in near future. Considering the swings in the equity markets, the developments in the bond markets are likely to be keenly followed by potential issuers. Since corporates traditionally had more exposure to syndicated lending and the issues faced therein, it is important that the while evaluating financing options, they should carefully consider the differences between the two markets- syndicated lending market vis a vis the bond markets. This article seeks to put that in perspective.
The Legal Regime & Transaction Costs
The first thing to consider in relation to domestic bond issuance is the difference in the applicable legal regime in comparison to that governing a syndicated financing transaction. Typically the syndicated lending market is less regulated since it is assumed that both the borrowers and the lenders are sophisticated institutions familiar with the risks and practices of lending and can strike a fair bargain amongst themselves. The lending arrangements are regulated broadly within the framework of laws governing companies, contracts and the banking regulations.
When dealing with listed bonds on the other hand one also has to take into account the securities regulations governing debt capital markets including the bye laws of the relevant stock exchange, listing agreement, SEBI and/or RBI regulations and SCRA. The role of intermediaries (merchant bankers, debenture trustee etc.) in an issuance is critical and regulated under various regulations. If a prospectus is required the regulations have to be carefully considered since any breach of their requirements can have catastrophic consequences. Issuance of listed bonds on private placement basis presents comparatively less issues and an information memorandum is sufficient. An information memorandum does not require the same level of details as is typical in case of a prospectus. In each case, the transaction is carefully structured keeping in mind the regulatory framework and issues that may arise on account of regulations. For example, even the composition of investor class needs to be taken into account to determine applicability of certain norms such as those relating to ‘Public Deposits’.
Yet another difference is in terms of transaction cost implications such as stamp duty treatment. Lack of prepayment options and ‘negative carry’ with bonds are some further issues to be considered. Some institutions have established a bond issuance programme to enable them to access bond markets at regular intervals with less cost while others have issued partly paid debentures to get around these issues.
The Myth of Sophisticated Parties
As noted earlier, it is assumed that the lenders and borrowers are sophisticated parties that understand the risks associated with a typical syndicated financing structure. The investors in bonds are no less sophisticated- banks and financial institutions, insurance companies, pension funds are all players in the bond market. However, in theory the issuance of debt securities by way of public offer entails a differential and more regulated approach. In the end the idea is to broaden the reach of the bond market to attract public at large and it is very difficult to frame regulations taking into account investors into individual transactions.
In practice too, unlike in case of lending where the negotiations are with the lender, the bond holders have a limited say in the documents since they are many of them each with differing interest and limited negotiating leverage. The negotiations are generally with the underwriters, issue managers, the debenture trustee and the rating agencies (if the bonds are rated the rating agencies are likely to seek structural comforts to justify a certain rating). A lot is governed by the historical development of bond markets and the customary provisions that have been established in the relevant bond market. This change in negotiating parties has important bearing on the documentation process.
In syndicated facilities down-selling and secondary trade is more complex and takes place through novation process, sub-participation or standardized secondary trade documents such as those prescribed by the Loan Market Association in London markets. Bonds are typically freely transferable and more liquid (depending on the market conditions and regulations).
The fragmentation of bond holders and lack of a unified bargaining interest also means that waivers and renegotiations can be quite tricky. While a lenders’ meeting is easy to call and waivers or consents are comparatively easily processed, arranging a meeting of bondholder and obtaining their consent/waiver can prove to be a tedious affair. This has important bearing on the documentation process. In a typical facility agreement the covenants are heavily negotiated and a lot of actions (beyond a threshold) may require the consent of the lenders. Lenders’ often prescribe that borrower can always come back for waiver, consent on a particular item and, if justified on facts, banks will not be unreasonable in withholding consent. An argument on similar lines is seldom encountered in bond negotiations since debenture trustee is unlikely to keep a lot of discretion (and liability) with him and getting the bondholders to agree on something can at times prove difficult. Therefore, covenants in a bond deal are typically limited and with high thresholds to allow operational flexibility to the issuer. Lenders keep close tab of the progress of the underlying project through information covenants when the bondholders seek limited information such as accounts. The debenture trustee is tasked with the process of granting administrative and technical consents or clarifications that are not prejudicial to the interests of bondholders. Same is the case with events of default, where the wish list of a bond holder is much smaller and permissive (MAC unlikely, limited cross- default etc.) than that of a lender.
In case of a restructuring of loans, the lenders are generally more willing to advance ‘new monies’ and restructure the deal. Existing bondholders cannot typically advance ‘new monies’. Though bondholders have been open to ‘haircut’ in recent sovereign debt restructurings (e.g. Argentinean and Greek debt restructurings), but a private work-out can be quite troublesome -the Wockhardt restructuring is a case in point where the negotiations have been tricky. Bondholders typically do not like to renegotiate since they have a comparatively easy option- to exit through sale. At the same time in a restructuring, ‘hold out’ bondholders can present significant issues.
A host of factors go into devising a suitable debt plan for a corporate. The issues to be contemplated include term, currency, interest rates and appropriate mix of instruments. In this context, it is an opportune time for the corporates to consider the bond markets also while devising their financing strategy. At any rate the developments in the bond market merit a close scrutiny. There is a lot of choice in terms of variety of instruments prevalent in the bond market. One need not even be bound by the prevalent instruments- a lot of hybrid and new securities have been added over time with many more yet to come. Bond markets allow a lot of flexibility to tailor the financing to suit the needs of the issuer. Variety is the very essence of corporate finance and bonds cater to this requirement very well.
Piyush Mishra, is a Partner at Luthra & Luthra Law Offices. The views expressed in this article are the personal views of the author and do not represent the views of the firm. It is informational and not an expression of opinion or advice.
 Goldman Sachs, Bonding the BRICs: A Big Chance for India’s Debt Capital Markets, November 7, 2007.
 Brealy & Myers, Principles of Corporate Finance, P 393 (7th ed, Reprint 2006). See also, Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States, F.212 & L.212 (March 8, 2012).