Chris Horte, consultant, and Mindy Hauman, professional support counsel, at White & Case LLP look at key topics and documentation trends in debt capital markets in the first half of 2017, including green bonds, the Market Abuse Regulation, the new Prospectus Regulation and US risk retention rules for asset-backed securities.
What are the key topics and issues in the debt capital markets at the moment?
- green bonds
- the Market Abuse Regulation
- the new Prospectus Regulation
- US risk retention rules for asset-backed securities
It is almost ten years since the World Bank issued the very first green bond and, in the short period of time since then, the market’s depth and volume has expanded to such a degree that green bonds are now considered mainstream. The International Capital Market Association published the first set of Green Bond Principles in April 2014, which brought increased standardisation to the green bond market. The value of green bond issuance has tripled in the past three years and with a greater variety of issuers and investors, is set to continue to grow.
Green bonds are akin to mainstream bonds in many ways. Pricing and transaction costs are similar, and they are listed, traded and regulated in the same way as other bonds. Like conventional bonds, green equivalents are based on the creditworthiness of the issuer and are risk-weighted and credit-rated using the same methodology. From a credit perspective, a green bond is often indistinguishable from other bonds and functions as other conventional debt instruments would.
However, the key difference is the way the proceeds are used—for green bonds, the proceeds are earmarked for ‘green projects’. As the green bond market has developed, a movement to develop a collective understanding of ‘green’ use of proceeds has followed. Today, the majority of green bonds issued by corporates and financial institutions are based on the ICMA Green Bond Principles. However, it is important to note that most green bonds do not include any tangible consequences related to any failure to fulfil the intended ‘green’ use of proceeds.
On 14 June 2017, the International Capital Market Association published a revised version of the Green Bond Principles, together with the new Social Bond Principles. It also published new guidelines for issuers of sustainability bonds—which are bonds that are aligned with both the Green Bond Principles and Social Bond Principles. These developments will add to the momentum in this market over the remainder of 2017.
Market Abuse Regulation
The Market Abuse Regulation (MAR), Regulation (EU) No 596/2014, came into effect on 3 July 2016. MAR replaced and updated the previous regime under the Market Abuse Directive (MAD), Directive 2003/6/EC, in relation to the disclosure of inside information and insider lists, obligations on dealings and related notifications by persons discharging managerial responsibility, as well as establishing procedures for market soundings. While MAR represents an evolution, it is also much broader in scope than MAD and has therefore become a more significant consideration in debt capital markets transactions. The scope of MAR includes instruments traded on multilateral trading facilities (MTFs) and other organised trading facilities, as well as instruments the price or value of which depends upon or has an effect upon the price or value of a financial instrument admitted to such facilities.
Since MAR has come into effect, there is increasing interest in listing certain debt instruments that were historically listed on MTFs, and so were outside the scope of MAD, on exchanges that remain outside of the scope of MAR, most notably the Channel Islands Securities Exchange.
The UK Listing Authority has recently made updates to its knowledge base to account for the coming into force of MAR. These amendments include notes regarding delaying release of inside information, the assessment and handling of inside information and preliminary statements of annual results.
Earlier this year, in a letter to the European Commission, the Luxembourg Stock Exchange raised a number of challenges that MAR presents for debt issuers listing on European MTFs, including for non-EU based issuers. These challenges include:
- increased administration and costs
- difficulty in complying with multiple regulatory regimes, notably for US reporting issuers
- the fact that a ‘one-size-fits-all’ approach imposes unnecessary requirements on issuers of wholesale debt instruments relative to the potential risk for market abuse
In May 2017, the Financial Markets Law Committee published a discussion paper exploring, among other topics, uncertainty as to the financial instruments that fall within the scope of MAR and the new market soundings regime. The paper noted that practical issues may arise for a non-EU issuer that has debt securities admitted to trading on a facility within the scope of MAR when the issuer is issuing securities in its home jurisdiction outside the EU. The paper suggests that further guidance from the European Securities and Markets Association or national competent authorities is required to address these uncertainties.
Ongoing discussion in relation to the implementation of MAR and market practice will continue in the second half of 2017.
The new Prospectus Regulation, Regulation (EU) 2017/1129, was published in the Official Journal in June 2017 and entered into force on 20 July 2017. The majority of the provisions under the Prospectus Regulation will apply from 21 July 2019.
The Prospectus Regulation will replace the current Prospectus Directive, Directive 2003/71/EC, and will make several important changes in relation to debt capital markets transactions. One provision that will apply immediately is the new 20% cap on the admission of shares resulting from conversion or exchange of other securities, such as convertible bonds. While the effective date for most of the provisions is still some time off, as that date approaches, the market will increasingly adapt to reflect aspects of the Prospectus Regulation.
US risk retention rules
In 2010, the US Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The regulations brought in under the Dodd-Frank Act include risk retention rules intended to promote alignment between the interests of originators asset-backed securities and those of investors.
The scope of the US risk retention rules is very broad, with ‘asset-backed security’ being defined to include any fixed-income or other security collateralized by any type of self-liquidating financial asset that allows the holder of the security to receive payments that depend primarily on cash flow from the asset. Consequently, the US rules may affect many securities that would not traditionally thought of as asset-backed securities, including, for example, loan participation notes and Islamic finance instruments. In contrast, the EU risk retention rules are narrower, applying to transactions or schemes dependent upon the performance of an exposure or pool of exposures, where the subordination of tranches determines the distribution of losses.
If a transaction involving any type of security that may be an asset-backed security under the US risk retention rules will include an offering or sale of any of the securities in the US, advice from US counsel should be obtained.
Have there been any key cases that have had an impact on the debt capital markets so far this year?
The recent case Commerzbank Aktiengesellschaft v Liquimar Tankers Management and another  EWHC 161 (Comm) is notable as it addressed asymmetric jurisdiction clauses, which are common in international finance documentation. Such clauses typically provide that a borrower or issuer may commence proceedings under the agreement in a particular jurisdiction, but the other parties (the financial institutions) may bring proceedings in any court of competent jurisdiction. Decisions in certain EU courts had cast some doubt on the validity of such clauses, however, the court in this case held that asymmetric jurisdiction clauses in certain loan agreements and guarantees in question were exclusive jurisdiction agreements for the purposes of Article 31(2) of the Recast Brussels Regulation. The court not only reiterated the validity of such clauses in English law, but also suggested that it would undermine the parties’ agreements, and ‘foster abusive tactics’, if the relevant clauses were treated as non-exclusive. The decision indicates that, in the English courts, it will be difficult to circumvent an asymmetric jurisdiction clause under the Recast Brussels Regulation, at least where the transaction is between commercial entities.
Are there any documentation issues that practitioners should be aware of?
- alternative performance measures
- the Regulation on Packaged Retail and Insurance-based Investment Products (PRIIPs Regulation), Regulation (EU) No 1286/201
- the recent FCA ban on rights of first refusal for future services
- protecting payments by sovereign issuers from third party enforcement claims
Alternative performance measures
In 2015, the European Securities and Markets Association published its final guidelines on Alternative Performance Measures (APMs). APMs are financial measures that are not prescribed by applicable accounting standards, commonly referred to as non-IFRS or non-GAAP measures. The guidelines are applicable to issuers with securities admitted to trading on a regulated market that are subject to the Transparency Directive, Directive 2004/109/EC. In summary, the guidelines provide that APMs should be appropriately defined, presented clearly, reconciled to the relevant measures provided for under applicable accounting standards, explained in terms of the rationale for their use and presented together with comparatives for prior periods. Regulators may require confirmation that disclosure on APMs in a prospectus has been presented in accordance with the guidelines before approving the prospectus. Certain issuers (notably US reporting issuers) may already be presenting APMs in a way that complies with the guidelines. However other issuers, particularly those outside the EU, may need to make adjustments to prior disclosures of APMs for purposes of including such measures in a prospectus in order to comply with the guidelines.
PRIIPs Regulation and wholesale debt issuance
The PRIIPs Regulation, Regulation (EU) No 1286/201, requires certain disclosures to be made to retail investors in respect of investments in packaged retail investment and insurance products. It is expected to become applicable from 1 January 2018. PRIIPs include investments where the amount repayable is subject to fluctuations because of exposure to reference values or to the performance of one or more assets which are not directly purchased by the retail investor, as well as certain insurance products. Among other requirements, manufacturers of PRIIPs, being the underwriters, in the case of debt securities subject to the regulation, are required to prepare a factsheet referred to as a key information document (KID) providing standardised disclosures regarding the debt securities, and persons who distribute PRIIPs are required to ensure that retail investors receive the KID before transactions are concluded. For wholesale debt issuance, difficulties arise as a result of the broad definition of PRIIPs, which means that confirming whether a security is a PRIIP may not be straightforward. The definition of retail investor under the PRIIPs Regulation also does not include a carve out for securities with a minimum denomination of at least €100,000 to parallel the one in the Prospectus Directive. Where a wholesale debt security has features which may mean it falls within the definition of a PRIIP, it is appropriate to include a legend and selling restrictions to prevent participation by retail investors and to confirm that no KID will be provided.
FCA Ban on rights of first refusal
The FCA has recently published its final rule in relation to contractual clauses that restrict a client’s choice of future providers of primary market, debt and equity capital markets, and mergers and acquisitions services. From 3 January 2018, regulated firms will be banned from entering into agreements containing clauses that give them a right to provide such future services to a client, rights to act or rights of first refusal. The rule excludes bridge loans, where there is a tie in to services for take-out financing related to the bridge. The rule also expressly provides that terms which do not oblige the client to use the firm are acceptable, such as a right to pitch, right to be considered alongside others or right to match other quotes, but not in the latter case if it would require the client to accept the matched quote. It has been fairly usual for financial institutions to include rights of first refusal in their debt capital markets mandate letters in relation to associated hedging and tap issues. We would expect that such clauses will be increasingly drafted as rights to be considered or rights to match, or will simply be removed from mandate letters going forward.
Protecting payments by sovereign issuers from third party enforcement claims
There has been significant issuance by developing market sovereign issuers in recent years. Particularly for sovereigns that have not previously issued bonds, or that are returning to the market after a period of absence, there may be a risk that third parties holding historical debt claims, typically disputed, may take enforcement measures with respect to interest and principal payments on the bonds as they are paid through paying agents to the clearing systems. For example, very recently a payment by the Republic of Congo to the trustee under its outstanding bonds was frozen under a US court order made at the request of a former contractor having a historic disputed claim against the Republic.
Therefore, issuers often wish to structure payments and draft documentation to reduce the likelihood that payments may be subject to such proceedings by third parties. For example, issuers may wish to make payments directly to the clearing systems, or to include provisions in the documentation which state that payments received by the agents are held for the benefit of noteholders, allowing the issuer to argue that it has ceased to have any interest in funds held by an agent.
What will DCM practitioners be primarily focused on for the second half of 2017?
The forgoing publication is prepared for general information and is not comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice. Views or opinions expressed in this publication are those of the authors and do not necessarily reflect the views of White & Case LLP or LexisNexis.