‘Better bond documentation needed’

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The European bond market must improve documentation in new issues to avoid intervention from regulators, some of the region’s biggest investors have warned.

Trade associations representing European investors, companies and investment banks on Thursday proposed steps to improve the documentation that states the rights and commitments of investors and borrowers in new bond issues.

Bond investors are seeking better protection amid rising leveraged buyouts and other corporate events detrimental to bondholders, which can lead to large losses in portfolios.

The trade bodies called for greater clarity of the terms used in covenants and a minimum period of time to assess documents before an issue was launched. Peter Montagnon, head of investment affairs at the Association of British Insurers, said a failure to improve standards would increase the pressure from regulators. “If we don’t succeed, there will be more pressure of regulation, because investors and savers need to be protected,” he said.

The proposals were presented by the ABI and the German, Dutch and Italian investment associations, which represent some of the biggest bond investors in Europe.

Unlike previous efforts to improve documentation, the new proposals have support from the other participants in the market, including trade bodies that represent borrowers and investment banks.

“This is the first time representatives from all sides of the market have come together,” said Stephen Haddrill, director general of the ABI.

Investors’ need for protection has been highlighted by a series of LBOs, which tend to hurt credit quality, that have left bondholders with large losses. Last year, the leveraged buyout of ISS, the Danish cleaning services company, by a group of private equity companies, sent its bonds tumbling more than 20 per cent as investors were not protected against a leveraged takeover.

Earlier this year BAA, the UK airport operator, was forced to amend the terms of a new £2bn issue after Ferrovial, the Spanish construction group, said it considered launching a takeover bid for the company.

Joseph Biernat at European Credit Management, the asset manager, said the market did not like interference, but added: “The threat of regulation may be what is needed. You need a pretty big stick to make some people move.”

One reason why the market has been slow to change is that demand for corporate bonds has outweighed supply in recent years, which has left investors with little bargaining power. Mr Montagnon said: “The European bond market is structurally under supplied. There is too much money chasing too few deals. It is very difficult to negotiate proper protection.”

The trade bodies said they did not want covenants that protected investors from LBOs to become a required feature in all new issues.

“It would be unrealistic and undesirable to seek harmonised standards [for covenants]. Issuers should have the freedom to propose conditions,” they said in a joint statement. Instead, the associations said the market should focus on clarifying the terms used in the documents. They said one term that was not universally understood was “senior”.

“Investors buying senior debt may be under the impression that senior implies some form of enhanced debt – this impression would be mistaken,” they said.

Another controversial term in bond documentation is the “negative pledge”. Many investors expect a negative pledge to protect them from being subordinated to any new debt in a company.

But the trade bodies said: “A negative pledge can have less value where issuers are free to pledge assets to bank lenders, thereby placing bank creditors ahead of bond investors.”

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