The increased presence of bondholder representatives in Russia, to protect investor interest, has made the market more attractive.
On 1 July this year, it became obligatory to assign a bondholders' representative (BR) for secured bonds to be listed by public offering, or by private subscription, in favour of 500 people or more (excluding bonds with state or municipal guarantee) and listed bonds (excluding securities for qualified investors).
The presence of a BR is also obligatory for the inclusion of unsecured bonds rated lower than BB-/Ba3 to quotation lists of the second and third levels.
This change in legislation has boosted the protection of bondholders' rights. In addition to receiving the nominal value and interest, bondholders have other legal rights. For example, in some cases bondholders have a right to early bond redemption, pledge enforcement, or court access to adjudicate in the event of issuer/guarantor bankruptcy.
Despite its novelty, the legislation concerning BRs has undergone some changes. In July 2013, a new chapter of the law "On Securities Market" introduced notions of a BR and a General Bondholders Meeting (known as a GBS). In June 2015, changes to the above mentioned chapter limited the number of cases when a BR appointment is obligatory. In October 2015, new listing rules came into effect, and defined additional criteria of having a BR in order to include bonds to quotation lists of the second and third levels. The latest changes, effective 1 July this year, strengthen the protection of bondholders' interests even further.
Bondholder's representatives offer benefits
BR participation in deals provides the following for participants. Firstly, it brings new opportunities regarding institutional and technical matters, such as:
- the ability to introduce technical changes (e.g. correction of technical errors) to the issuing documents without holding a GBS (which saves time and reduces costs)
- in the event of arbitration, the BR can take proceedings on behalf of all bondholders
- the BR can function as a pledge holder (pledge manager).
Secondly, the BR's participation in the deal provides an additional control point to oversee the activities of an issuer. This brings greater peace of mind for investors and urges an issuer to fulfil obligations regarding information disclosure and withdrawals from security accounts (if BR is a pledge manager). Functioning as a controller, the BR has a right to participate in the issuer's general meetings (without a vote) and request information from the deal participants (eg. issuer, specialised depository and auditor) in order to fulfil its obligation. Since the range of this information is not defined by the law and BRs' rights and obligations can be regulated by the issuing conditions or GBS decisions, this mechanism is an effective way to oversee the issuer and overall functioning of the deal.
Another control function of a BR is the obligation to inform bondholders about events and detected violations, such as:
- circumstances that may lead to the violation of the rights and legitimate interests of bondholders
- non-performance or improper performance of the issuer's bond obligations
- current or potential conflicts of interest and the measures taken in this regard
- circumstances, due to which a BR will not meet the requirements that are imposed on it by the law.
It should be noted that information can be distributed by publishing it on the Interfax newsfeed or a BR's website. It makes the process similar to the information disclosure by an issuer and somewhat duplicates it.
How BRs make the Russian bond market more attractive
Having a BR in a deal makes it more transparent for an investor and encourages rating agencies to assign a higher investment rating. For example, the first Russian auto loans securitisation deal had a "control agent". It fulfilled functions similar to those of a BR. Even though its actions, rights and obligations were not subject to any law (unlike BRs), its participation in the deal enabled it to meet the Moody's requirements and obtain the desired investment rating.
Who can be a bondholders' representative?
- The law "On Securities Market" defines the range of institutions that can serve as bondholders' representatives.
- Professional securities market participants: brokers, dealers, depositories, etc.
- Any Russian entities existing for more than three years.
- For mortgage-backed securities, it is separately stated that the functions of a representative can be fulfilled by a specialised depository for mortgage coverage.
In addition, mentioned entities should be included in the Central Bank's list which is available on its official website.
At the same time the law restricts what entities can serve as a BR. A bond issuer, collateral provider, underwriter (excluding cases when such a BR is selected by the GBS), and other entities that have a conflict of interest preventing a BR from executing its responsibilities, cannot be a BR.
An issuer appoints a bondholders' representative in proper lawful cases. The GBS should approve the candidacy if the appointment happens after the placement of bonds. The GBS has the right to select a BR at any time, including the replacement of a BR appointed by an issuer.
A bondholder's representative acts by virtue of an agreement signed with an issuer.
The main functions of a BR, compared to a trustee
The BR's main function is to represent and protect bondholders' interests and execute GBS decisions. The presence of such a party helps to improve the protection of bondholders' rights and provide additional oversight of the execution of the issuer's bond obligations. The BR presence allows balancing the interests of an issuer and different classes of investors while restructuring a bonded debt, and simplifying their interaction. In addition, the law "On Securities Market" provides that at the bondholders' request, a BR is obliged to pay inflicted damages. Despite the fact that the law allows for the restriction of a BR's responsibility for careless actions, this limit cannot be less than ten times the size of its annual remuneration.
The BR's function extends beyond that of a trustee. In foreign practice a trustee actually passes information among investors, issuer, and various deal consultants. Its actions are limited by a contract and it is not permitted to make independent decisions. A trustee appoints external consultants for fulfilling any actions, including document preparation. The cost of external consultants is either paid in advance or reimbursed by an issuer or bondholders. The trustee's responsibility is significantly limited by a contract, and it is not liable for its actions (excluding criminal behaviour such as fraud).
In contrast, a BR's functions, rights, and responsibilities are partially defined in the law, but the list is open-ended. In addition, the law does not have strict guidelines on how a representative, issuer, and investor should interact in default cases. This allows a BR to take on more duties during a default. For example, it can sign a settlement agreement on the resolution of a GBS.
In addition, a BR can receive funds or other assets awarded to bondholders by the court during a lawsuit against an issuer. The BR's responsibilities can be determined by the terms of a specific bond issue.
The restructuring of 10 bond issues of Russian airline UTair is one example of a successful project where a bondholders' representative played a major role. During this deal, a BR signed the settlement agreement on behalf of bondholders, based on a GBS resolution. As a result, default was avoided and the entirety of the bonded debt deal was secured.
You can hear from Andrey Korolev at the upcoming V conference; Mortgage-backed securities and securitization in Russia on 27 September 2016 in Moscow. Click here for event details.
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