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Are Bond Investors Getting a Raw Deal Again?

24 Jun 2019

Olga Constantatos / Credit & Equity Process Manager

Article

JSE Debt Listings Requirements – an update on Futuregrowth’s perspective

A bond issuer operating without a Board, a material degradation of an issuer’s asset base, a potential default on payment, debt restructures and debt haircuts – all done with impunity. Bond investors on the JSE have had to contend with all of these prejudicial events in recent history.  To add insult to injury, the usual protections available to lenders do not exist in any meaningful way in the JSE Debt Listings Requirements. The JSE has recently proposed some bold – and, in our view, welcome and overdue - amendments to better balance investor protections against the needs of other stakeholders.

Futuregrowth Asset Management participated in this process, together with other investors and interested stakeholders, and in this note, we want to update you on some of the proposed changes, outline some of the responses to the proposals, and issue a clear and direct warning about the risks posed by banks to the inclusion of meaningful bondholder protections.


Introduction

In previous articles, we have written about the need for improved bond listing standards. Pension fund members’ assets need to be more adequately protected through improved standards of transparency, disclosure and an increased focus on real, effective corporate governance.

The JSE is currently the exchange on which listed bonds trade. For the purposes of this article, I exclude all government bonds and only refer to the bonds issued by corporates, banks, securitisations, municipalities and SOEs. The value of this market as at 31 December 2018 was R880.91bn and the graph below shows the composition of the credit market.


Source: JSE, RMB Global Markets | CLN - Credit Linked Note; ABCP - Asset Backed Commercial Paper

In order to list a bond on the JSE, an issuer must comply with the Debt Listings Requirements (DLR).  In September 2018, the JSE issued an updated draft of the DLR that proposed some significant – and long overdue – amendments and improvements.  

Many of these changes were in direct response to investors’ requests for improved standards of disclosure, protections and corporate governance following the national debacles of ABIL, Steinhoff, SOE malfeasance, and other recent events involving bond issuers.

The JSE requested stakeholders to provide written commentary on the proposals by 31 October 2018. Futuregrowth, together with our fellow ASISA FISC[1] members, provided extensive comments to the JSE for consideration. We believe that, in addition to investors, several other interested parties (issuers, debt arrangers, advisors) provided commentary to the JSE.

Some examples of the proposed changes, and the Futuregrowth view on these, are provided below as an illustration.

Corporate governance disclosures
Many of the entities that list debt on the JSE are corporates that also list their equity on the JSE. Examples of such issuers include the banks, Barloworld, Bidvest and Growthpoint, amongst others.

Bond market issuers that also have listed equity

What the issuers in the diagram above have in common, is that they are all regulated by the Companies Act, they are used to a regular practice of SENS disclosures for market-moving information, and they all adhere (or at least claim to adhere) to the King Code on Corporate Governance – all as required by the JSE’s Equity Listings Requirements (ELR).

However, there are some key provisions missing from the DLR that are requirements in the ELR.  For example, until the September draft amendments, there was no requirement in the DLR for debt issuers to notify the market promptly via SENS of any director appointments or resignations (this requirement exists for all listed equity issuers in the ELR).  As bond investors, we cannot be reliant on bond market issuers meeting their ELR requirements without a similar provision being a requirement in the DLR. Furthermore, what about issuers without listed equity, the SOEs, municipalities and unlisted corporates, for example? Without this proposed addition to the DLR, these issuers are under no obligation to meet such reporting requirements and bond investors are unable to properly monitor issuers or hold them to account.

The proposed changes to the DLR seek to entrench additional corporate governance disclosures and to make the regular and public disclosure of these matters – either via SENS, on their websites or in their Integrated Annual Reports - an ongoing requirement that issuers must comply with in order to maintain their bond listings. The September draft changes propose to make it a requirement that, inter alia:

  • issuers comply with the King Code on Corporate Governance;
  • that issuers provide suitable and timely public disclosure (CV’s, experience etc.) of all new director appointments, including details of the nomination and appointment process;
  • public and timely disclosure is made of all conflicts of interest of directors and executive management; and
  • public and timely disclosure of all transactions conducted with Domestic Prominent Influential Persons[2].

The proposed amendments to the DLR include additional provisions for SOEs and other quasi-government organisations – making it a requirement that they publically disclose details of their procurement policy as well as details (parties, date, duration, and quantum) of their material procurement contracts.

As you likely know, Futuregrowth has done extensive work on the governance failures at many of the SOEs that issue listed debt. One of the recommendations we made in the report we issued in February 2018, is that the JSE needs to strengthen bond market standards to ensure greater transparency and disclosure, and this amendment is just one such mechanism to do this

Knowing what we know now about malfeasance at the SOEs, we believe these requirements are an additional – and necessary line of defence against the repeat of such activities.

“Sunlight really is the best disinfectant” and we strongly support the JSE in their endeavours to play their part to ensure higher standards of disclosure and a balance of protections for investors.

It is our considered view that the proposed additional disclosures are not onerous and do not qualify as competitive or proprietary information for issuers. Companies and SOEs that are raising funding from a public capital market effectively your and my pension fund should be disclosing this information to allow bond investors to assess the risks inherent in each bond issuer.

Additional investor protections
A more contentious proposed amendment to the DLR is the inclusion of an Investor Representative to act for bondholders.  This amendment is strongly supported by Futuregrowth and the ASISA FISC members. Investors’ rationale for supporting this amendment is that an Investor Representative will act for bondholders and will provide:

  • Transparency in the setting of bond terms, which will allow for the views of the all the contracting parties to be considered. Currently, arrangers and issuers are dismissive of investors’ comments on draft legal agreements and the inclusion of suitable protections.
  • A much-improved ability to call meetings of bondholders in the instances of credit events. We have many examples where bond issuers like PPC, Umgeni, African Bank, CIG and Steinhoff defaulted on their obligations, and bondholders were unable to call a meeting and take action to protect investors’ rights.
  • Improvements and standardisation to the bondholder meeting quorum requirements and voting rights, which aim to provide clarity and certainty in instances when bondholders have to vote on matters relevant to their rights and obligations.
  • The ability to appoint attorneys to act on investors’ behalf when necessary. This would have been helpful in instances like Umgeni, where the company was operating illegally (the Minister dismissed the entire Board in July 2017 and did not appoint a replacement Board). It is untenable for bondholders to be unable to solicit legal advice in instances where the issuer is not meeting its obligations. As a comparison, we know that in the unlisted loan market, the normal practice is for two sets of lawyers to be appointed: one to act for the issuer, and another to act for the investors. In the loan market, the issuer bears the cost of both sets of lawyers. This is both an SA and internationally recognised practice and something we firmly support as an amendment to the listed bond market requirements.

Subsequent to the written submissions received by the JSE from various parties, the JSE invited stakeholders to an Indaba Day, chaired by Michael Katz, in January 2019, to hear the various viewpoints. This Indaba was attended by investors (including Futuregrowth), arranging banks, and a limited number of issuers, advisors and lawyers. At this Indaba Day, we had the opportunity – for the first time – to hear the arranging banks’ views on the proposed amendments, including their objections to the inclusion of an Investor Representative as a requirement of the DLR.

From the meeting, it is clear that the banks are fighting tooth and nail to ensure that the additional investor protections proposed in the September draft of the DLR are deleted. We find this objectionable. Past experience has taught us that banks:

  • will sell bonds to the institutional investor market on terms and at pricing levels at which they themselves will not buy;
  • do not provide any liquidity or capital to the credit bond market;
  • are conflicted due to the fact that the banks are among the biggest issuers of listed bonds (they make up 36% of all outstanding listed issuance);
  • when making loans in their banking books, ensure that significant protections (security, covenants, inter-creditor arrangements, provision for the issuer to pay legal costs etc.) are included as part of the protections that the banks as lenders enjoy;
  • often subordinate institutional bondholders to their own loans through their actions, as described in the point above;
  • have in the past, actively worked against transparency, reporting and improved standards;
  • work for the issuers (and hence against investors) when there is a credit event;
  • have no responsibility or accountability for the instruments they bring to market;
  • often misrepresent facts to investors; and
  • have in the past, blacklisted or avoided investors who ask too many questions.

One of the banks’ objections is linked to the additional costs of an Investor Representative, arguing that this would make issuing a bond too expensive for issuers. ASISA has done some research on this subject. The table below shows the envisaged costs of an Investor Representative, as part of the total cost of issuing a bond on the JSE.

At an annual cost of c.R120 000 out of the total bond issuing costs of over R4m (and compared to the R1m arranging fees that banks earn), we believe this argument is a red herring.

We fail to understand why the banks, who have a vested interest in protecting their fees and the status quo, should be given any say when it comes to reasonable requests from investors for what we believe are suitable investor protections.

To use a quote from Steve Eisman, from Michael Lewis’s book The Big Short about the US sub-prime mortgage crisis: “I can understand why Goldman Sachs would want to be included in the conversation about what to do about Wall Street’, he said, ‘What I can’t understand is why anyone would listen to them.”

Conclusion

The JSE published a further draft of the DLR for public comment on 30 April 2019 (the “April draft”). The deadline for public comment on this new draft is 21 June 2019. Futuregrowth has provided extensive commentary to the JSE and ASISA on this latest draft.

We welcome the opportunity to provide further input to this process and look forward to the day when the DLR will contain suitable and appropriate protections to ensure that bond investors – you and me through our respective pension funds – have the necessary and suitable protections we would expect from a public capital market.

Our view is that a “public capital market should be a public amenity which is a safe place for buyers and sellers to meet and conduct trade in a fair and transparent way”. We need to ensure that the changes to the DLR do just that.

While the corporate governance disclosures have been retained in the April draft, there has been a significant removal of some key investor protections. Notably, the April draft does not include an Investor Representative, and rather seeks to ensure a “similar” investor protection through a detailed mechanism of:

  1. the appointment of a Compliance Officer, who is appointed by the issuer and is required to ensure that the issuer meets its obligations under the DLR;
  2. an obligation on the Compliance Officer to ensure that all potential investors have a (limited in our view) ability to be notified of other investor’s comments on the DMTN terms and conditions at the launch of a bond or for any proposed amendments; and
  3. a more rigorous process for noteholder meetings with defined timeframes to ensure that noteholders are able to force the issuer to call a noteholder meeting.

While we recognise that the JSE has attempted to address bondholder concerns through their alternative proposal to the Investor Representative as detailed above, we believe that this is not enough. The Compliance Officer is employed by the issuer and yet tasked with looking after investor interests – an obvious conflict of interest. The April draft also – in our view – does not sufficiently detail the level of seniority that this role requires in order to ensure that the position is able to withstand the obvious conflicts inherent in the  role.  

In addition, there is notably no provision in the April draft for investors to collectively access legal representation in situations where  obligations are not being met by the issuer, or situations where the terms and conditions of the notes are being renegotiated. The rights of lenders to access collective legal representation in these situations is a common and efficient practice where debt is issued via the Loan Market Association (LMA) standards as well as in the unlisted debt space in general. This omission in the April draft is not satisfactory to us as bondholders, and our comments to the JSE and ASISA have communicated this.

In conclusion, we believe that, while the JSE has taken some first steps to better balancing the rights and obligations of investors and issuers in the listed bond market, there are some material shortcomings in the April draft. We remain hopeful that the JSE will make further additional changes to the final draft of the DLR that address some of these shortcomings in the interests of a safe, fair and transparent public capital market.


[1] Association of Savings and Investment South Africa, Fixed Income Standing Committee.

[2] Defined in the Sept draft of the DLR as: “a person as defined in the Financial Intelligence Centre Act No. 38 of 2001, as amended.