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Bonds Notes

LPC Law Notes > Debt Finance Notes

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A more recent version of these Bonds notes – written by Cambridge And Oxilp And College Of Law students – is available here.

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BONDS??A bond is a security that is issued in connection with a borrowing arrangement. The borrower (issuer) sells a bond certificate to a lender (investor/bondholder) for a specified amount of cash. The certificate states that a loan has been made for the principal amount/par value. The borrower has to pay interest (coupon) annually or semiannually over the life of the bond, and when the bond matures, the issuer must pay back the par value to whoever holds the bond at that time. E.g. "The Boots Company PLC PS300,000,000 5.5% Bonds due 2019" o Aggregate amount: PS300,000,000 o Coupon: 5.5%
o Maturity: 2019 Focus on 'eurobond' a bond targeted at the international market: o A bond denominated in a eurocurrency other than that of the country of issue
[UK company issues a US Dollar bond]
o A bond denominated in the currency of its country of issues but sold to international investors [UK company issues Sterling bond to Japanese investors]
NB: A eurocurrency is a currency held outside of its country of origin.

Comparing a syndicated loan and a bond issue OBJECTIVE Raise a large sum of money

Bond issue

Minimise initial costs in setting up finance

Syndicated loan

Limit the number of parties to the deal Preserve confidentiality

Syndicated loan

Ensure easy tradability

Bond issue

Syndicated loan

Wider investment base (institutional investors). Less risk means lower interest rates as well. Very little regulation to comply with, along with much fewer documentation and parties. Hence, costs are significantly lower than a bond issue (if bonds are listed, ongoing regulatory compliance can be expensive). Many more parties in a bond issue (see below) Publicity and disclosure requirements for listed bonds may make it an unsuitable method of finance [e.g. for acquisitions]. Although both syndicated loans and bond issues can be traded on a secondary market, the secondary market for bond issues is significantly larger. No formalities to be satisfied for legal transfer of a bearer bond. In the case of a registered bond, transferee's name must be registered in the register of bondholders. Note: Bond issues are not usually listed to use the exchange as a

Benefit from current low interest rates

Bond issue

Access as wide an investor base as possible

Bond issue

To borrow a sum to be repaid in 25 years' time Get access to funds as soon as possible

Bond issue

Flexibility in terms and conditions

Bond issue

Syndicated loan

marketplace. Most of the trading will take place away from the exchange (OTC trading). Listing demonstrates, however, that the bond issue has satisfied the requirements of the exchange. This makes the bonds more marketable. Interest rate for bonds is usually fixed, whereas for loans it tends to be floating (LIBOR + Margin). Securing a low fixed rate now is likely to make a bond cheaper over the length of the term than a loan. Institutional investors and high net worth individuals may invest in a bond issue. Under a syndicated loan, the borrower's options are usually limited to banks. Banks will rarely commit large sums over a long period of time. A syndicated loan can start and complete in a few days, whereas regulatory compliance for a (listed) bond can significantly lengthen the timetable. Choice of currency/type of investor Less onerous covenants (bond issues tend to be by investment grade companies, and would not be workable to have very restrictive covenants). Size and maturity of debt can be more varied than in most commercial loans

Factors to assess risk/fix the price of a bond issue a) Identity of the issuer (investment grade or wellknown companies will mean lower interest) b) Issuer's sector of activity (highrisk?) c) Maturity date (the longer the loan, the higher the risk and the higher the interest) d) Extra features (secured, guaranteed or equitylinked [convertible] bonds may allow issuer to pay a lower interest rate) e) Prevailing market conditions and interest rates f) Credit rating obtained from credit rating agencies (both on the bond and the issuer - crucial factor for issuer)The market price of a bond will change according to the above factors, but the issuer will continue to make the same interest payments and the redemption amount will not change. However, these factors are all relevant when the issuer initially prices the bond.

Parties to a bond issue

PARTY Issuer and guarantor Lead manager (usually an investment bank)

Fiscal agent or trustee

ROLE Issuer issues securities and will sometimes be backed by a guarantor. a) Assesses market risk and advises the issuer on the structure, timing and target market b) Manages the entire issue procedure ('building the book', negotiating the documentation, carrying out the due diligence, and organizing the roadshow, etc) c) Form the syndicate (the group of banks who buy the bonds from the issuer in the primary market and resell them in the secondary market, and who underwrite the issue) d) Liaise with the listing authority (UKLA) Commercially, the lead manager takes responsibility for the success or failure of the issue. It stands to gain large fees and prestige from its position. There may be comanagers. Most issues are administered by a fiscal agent (the cheapest method). Its main responsibilities are to administer the payment of interest and principal to the bondholders and will also act as the principal paying agent. It also has some administrative functions (e.g. publishing notices to the bondholders, acting as depositary for the issuer's financial information and maintaining records relating to the issue). However, a trustee is required when a secured bond is being issued, and may be useful when bonds are convertible or include complex financial covenants [reassuring for bondholders], or to enforce the subordination terms and direct the payments pursuant to it [where there is a subordination agreement]. Its main responsibility is to ensure that everything runs smoothly throughout the life of the bonds. It has administrative powers similar to a fiscal agent such as acting as depositary for the issuer's financial information and calling bondholder meetings, but also has wider powers to act on behalf of the bondholders.

Principal paying agent and paying agents

Clearing system

Common depositary

Legal advisers

Advantages/disadvantages of either a fiscal agent or a trustee from both the issuer/bondholders' POV are considered below. Only necessary for a separate principal paying agent if a trustee structure is being used [as the PPA is the agent of the issuer, and the trustee cannot act in a paying agent role]. PPA is responsible for coordinating the overall process of payment of principal and interest. Clearing systems are owned and financed by major banks, who are participants of the systems. Each participant holds a cash account and a securities account with the clearing system. When a participant buys bonds an electronic entry is made to increase the securities held in its securities account, and the price of the bonds will be debited from its cash account. The clearing systems enable bonds to be easily transferred globally. They electronically record transactions, collect interest and other payments on behalf of the bondholders. A depositary is a financial institution appointed by a clearing system to act as custodian of global bonds. The depositary safeguards and holds the bond on behalf of the clearing system. Individual bonds will then be traded electronically. Lead manager will appoint lawyers (acting in the interest of the syndicate), and the issuer will appoint its own legal advisers.

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