United States: The U.S. High Yield Bond Market: Opportunities for Foreign Issuers (Part 1)

The U.S. high yield bond market provides an attractive opportunity for non-U.S. companies seeking to raise fixed-rate financing on competitive terms, and for that reason an increasing number of foreign companies have issued bonds in the U.S. high yield bond market. Since the early 1990s, the U.S. high yield bond market has become the preferred financing market for "below-investment grade"¹ U.S. companies (i.e., companies whose debt securities are rated BB+ or lower) that are seeking medium and long term debt financing. Unlike the U.S. investment grade bond market, the U.S. high yield bond market consists of investors who seek high returns, and accept the correspondingly higher risk, inherent to below-investment grade obligations. According to a study conducted by Thomson Financial Securities Data, over U.S. $100 billion of high yield bonds were issued in 2004, while approximately U.S. $123 billion of high yield bonds were issued in 2003.

High yield bonds are issued as an alternative source of debt financing in relation to the international and domestic bank markets. In general, companies that issue high yield bonds have a capital structure that implies a high level of potential risk to investors, although the U.S. high yield bond market is also used by investment grade companies that wish to issue subordinated debt rather than dilute their shareholders by issuing equity, and to provide financing for leveraged acquisitions. High yield bonds are typically unsecured², fixed-rate obligations with maturities generally between five and ten years, which are rated below investment grade by at least one (and often two) of the U.S. ratings agencies. While these bonds are often registered with the U.S. Securities and Exchange Commission (the "SEC"), a significant percentage of these bonds are also issued in the so-called "Rule 144A" or private placement market, and are often accompanied by registration rights, discussed below.

The U.S. high yield bond market provides certain distinct advantages to both domestic and foreign companies seeking to raise debt capital:

• Size: companies can typically raise significantly larger amounts in the U.S. high yield market than in the equivalent international market.

• Liquidity: the U.S. high yield market provides rapid access for borrowers and an active secondary market for investors.

• Cost: spreads on high yield bonds have declined to levels that make them much more attractive than in previous years.

• Disclosure: U.S. high yield bonds can be structured in a fashion to permit their issuance with or without SEC registration, allowing issuers—especially foreign companies—to avoid the burden of compliance with disclosure requirements associated with SEC-registered offerings.

• Process: with the assistance of an experienced investment banking and legal team, the issuance process may be conducted smoothly, free of unnecessary delays and obstacles.

The purpose of this memorandum is to acquaint foreign companies with the U.S. high yield bond market, by providing an overview of the procedures, conventions and legal issues that accompany U.S. high yield bonds, as well as the requirements under U.S. securities laws with which a foreign company must comply in issuing U.S. high yield bonds.

In contrast to Eurobonds, which generally have few, if any, covenants and are not always rated, U.S. high yield bonds have several distinctive features:

First, the bonds are rated by at least one of the U.S. rating agencies, requiring that the issuer go through the rating process, which is discussed below. This results in additional expense, and requires management of the issuer to make a detailed presentation to the rating agency, including providing the agencies with detailed projections of financial performance.

In view of the risks associated with issuers of high yield securities, U.S. investors in these obligations impose restrictive operating and financial covenants, which are discussed below. Several of the most important financial covenants are often based upon the company’s annualized EBITDA (earnings before interest, taxes, depreciation and amortization), and as a result it is important that management is confident that the company will have strong EBITDA growth throughout the term of the bonds. Since these bonds have maturities in excess of five years, it is essential that the issuer formulate reasonable long-term projections to assure that it can avoid future defaults and be able to operate its business within the prescribed limitations.

High yield bonds offered in Rule 144A transactions often give investors registration rights, since high yield investors seek liquidity in their investments. These rights require the issuer, after completion of the initial private placement, to prepare and file with the SEC a registration statement for bonds containing almost identical terms, to be offered to investors in exchange for their unregistered bonds (referred to as an "A/B exchange"). Thus, upon completion of the second stage of the offering process, investors have freely tradable securities. Because of the perceived lack of liquidity of privately placed securities, issuers will typically be required to pay penalties if they do not file a registration statement or complete the exchange offer within agreed-upon time periods.

Where the bonds include registration rights, the company will, as a consequence of registering the exchange bonds with the SEC, become subject to the periodic reporting requirements of the U.S. Securities Exchange Act of 1934 (the "Exchange Act"), as well as certain other obligations under the Exchange Act, including compliance with the disclosure and other requirements of the Sarbanes-Oxley Act of 2002, and the regulations of the SEC that implement that Act (collectively, the "Sarbanes-Oxley Act"), which are summarized in Chapter VI below. Registering the exchange bonds with the SEC, and complying with the periodic reporting obligations under the Exchange Act, require, among other things, that companies file annual and periodic financial information with the SEC, including reconciliation of certain financial information to accounting principles generally accepted in the U.S. ("U.S. GAAP").

However, it is also true that many high yield bonds issued in reliance upon Rule 144A do not include registration rights. These Rule 144A bonds are not, as a result, registered with the SEC, and do not require compliance with the periodic reporting requirements of the Exchange Act, or compliance with the Sarbanes-Oxley Act.

Where the bonds include registration rights, the offering document used in the initial private placement (referred to as an "Offering Circular") will comply with the disclosure requirements for registered public offerings. Where the bonds do not include registration rights, the Offering Circular will typically include disclosure that approximates those requirements. The Offering Circular will include a detailed description of the issuer’s business and financial condition (as described below), a management’s discussion and analysis of the financial condition and results of operations of the issuer and its subsidiaries, and, where the bonds include registration rights, financial statements (and other financial information) that have been reconciled to U.S. GAAP. For any foreign issuer, completing the process of reconciliation of financial statements to U.S. GAAP can be very time-consuming.

Many foreign issuers employ a holding company structure, in which the principal operations exist as operating subsidiaries of a holding company. Often, the holding company is owned and controlled by family shareholders, although it may have a minority of public shareholders. In order to achieve flexibility, financing is often obtained through the holding company, which in turn relends financing proceeds to its subsidiaries, whether for working capital, to refinance existing debt or to finance special projects, such as the acquisition of new assets or government-granted concessions or licenses. In order to provide an acceptable level of credit support for the financing, and to provide bondholders with access to the operating assets of the overall enterprise, bonds issued by holding companies are often guaranteed, jointly and severally³, by each of the holding company’s majority-owned subsidiaries. As a result of these guarantees, in the event of any default by the holding company, the bondholders have recourse against all of the assets of those subsidiaries.

Since dividends from the operating subsidiaries will be the source of repayment of the bonds, U.S. high yield bonds include covenants that impose significant operating and financial restrictions upon the activities of the operating subsidiaries, as well as the issuer. Broadly, these covenants are designed to limit the ability of the issuer and its subsidiaries to incur future indebtedness, and to engage in any activities, or make any investments, that may reduce the resources available for repayment of the bonds, or may give other creditors access to the assets or cash flow of the operating subsidiaries. In this sense, high yield covenants build a "wall" around the issuer and its majority-owned subsidiaries, and restrict the future ability of the operating subsidiaries to independently finance their operations (either on the basis of their own balance sheets, or with the benefit of a parent guarantee).

Where the company’s recent or historic financial performance raises a question concerning the likelihood that the company will have sufficient cash flow to meet its interest payment obligations in the first one or two years following the offering, it is not uncommon for the investment bankers to recommend (or require) that the company employ a reserve arrangement for a portion of the bond proceeds (often referred to as a "reserve note structure").

Under this arrangement, the company is required to set aside at closing, in a U.S. dollar account with the trustee, bond proceeds sufficient to pay scheduled interest on the bonds for an agreed-upon number of semi-annual interest payments (often two, but occasionally four, depending upon the company’s financial condition). Escrowed proceeds are not available to the company, and are typically required to be invested in U.S. government obligations. Not surprisingly, issuers will typically resist imposition of such escrow arrangements.

Many high yield bonds include a provision permitting the company to partially redeem the bonds with the net proceeds of any equity offering that is completed by the company within a specified period of time (usually three years) after the bonds have been issued. This provision, commonly referred to as an "equity offering clawback", is designed to provide the company with the ability to recapitalize its balance sheet through an equity offering that is used, in part, to reduce indebtedness. However, these provisions always limit the percentage of the aggregate principal amount of bonds that may be redeemed (typically up to 35%), and require that the company compensate the bondholders through payment of a redemption premium.

Many high yield bond indentures include a provision that requires the issuer to purchase all or a portion of the outstanding bonds at a purchase price of 101% upon a change of control of the issuer. This change of control "put" provision is designed to give the bondholders the option of divesting themselves of the company’s securities after a merger, acquisition or other significant transaction that results in the transfer of control over the company’s management to a third party. The put provision gives the bondholders leverage to protect their interests when the issuer is being acquired or is engaged in another significant transaction. For that reason, issuers have a clear interest in limiting the put provision and often will seek to require that a change of control be accompanied by a downgrade in the rating of the bonds. Such a limitation protects the bondholders when they have suffered a loss in value, but not in the case where the change of control has a neutral or positive effect on the bonds’ rating.

As indicated in the Introduction, many U.S. high yield bond offerings are implemented in a two-stage process: first, a private underwritten offering to U.S. institutional investors that is made on the basis of an Offering Circular prepared in compliance with the detailed disclosure requirements of the SEC (including financial statements that have been reconciled to U.S. GAAP), and which include registration rights; and second, the filing of a registration statement relating to substantially identical bonds that, once the SEC has approved the registration statement, are offered to the bondholders through an exchange offer.

However, U.S. high yield bonds are also frequently issued in underwritten private placements to U.S. institutional investors, pursuant to Rule 144A, without registration rights, where the Offering Circular complies substantially with the SEC’s disclosure requirements but without any reconciliation of the issuer’s (and any guarantor’s) financial statements to U.S. GAAP. In that circumstance, the portion of this memorandum discussing the requirements under the U.S. Securities Act of 1933 (the "Securities Act"), the periodic reporting obligations under the Exchange Act and the Sarbanes-Oxley Act, do not apply.

When the bonds include registration rights, the initial private placement is made by means of an Offering Circular that describes, in compliance with the SEC’s detailed disclosure requirements, the business and financial condition of the issuer and any subsidiary guarantors.⁴ The Offering Circular will also include a management’s discussion and analysis of the financial condition and results of operations of the issuer and its subsidiaries (the "MD&A"), a summary of the terms of the bonds and of the offering, and any relevant risk factors, including a summary of the political and financial environment of the relevant country. The Offering Circular will ordinarily contain five years of selected consolidated financial data, two years of audited consolidated balance sheets, and three years of audited consolidated income statements and changes in financial position, reconciled to U.S. GAAP. By preparing the Offering Circular in compliance with the SEC’s disclosure requirements, where the bonds include registration rights, the issuer should not need to include any significant additional information in connection with the registration statement on Form F-4, which is filed with the SEC following completion of the initial offering in order to implement the exchange for SEC-registered bonds.

The purchase agreement is the contract pursuant to which investment banks, acting as initial purchasers (the "initial purchasers"), agree to purchase the bonds from the issuer. The purchase agreement typically contains a number of representations and agreements of the issuer (and any subsidiary guarantors), as well as a provision pursuant to which the issuer agrees to indemnify the purchasers against any liability for material misstatements in or omissions from the Offering Circular. It typically will also contain what is commonly referred to as a "market out" clause which permits the purchasers to terminate the agreement in the event of certain events which could affect the market for the bonds or the purchasers’ ability to resell the bonds.

At the time the purchase agreement is signed, a comfort letter relating to the financial statements and data indicated in the Offering Circular will be delivered to the initial purchasers by the outside auditors for the issuer (and any subsidiary guarantors). Closing of the offering will typically be subject to a number of conditions, including the delivery of opinions of counsel and a "bringdown" of the comfort letter. An additional condition typically is that, since a specified date, there has not been a material adverse change in the business, properties, prospects, results of operations or condition (financial or otherwise) of the issuer and its subsidiaries.

The issuer, any subsidiary guarantors and a trustee representing the bondholders will enter into an indenture, which governs the issuance and payment of the bonds and includes the terms and conditions applicable to the bonds, including the covenants which apply to the issuer and its "restricted" subsidiaries (discussed in Chapter II (B) below). Pursuant to the indenture, the trustee⁵ will agree, among other things, to collect principal and interest payments, disburse funds to pay principal and interest on issued and outstanding bonds and review documents to establish that the issuer is in compliance with the covenants set forth in the indenture. The trustee will also act on behalf of bondholders to enforce the provisions of the indenture, including the agreement to make timely payments on the bonds.

Where the bonds include registration rights, the issuer, any subsidiary guarantors and the initial purchasers will enter into an exchange and registration rights agreement prior to (or simultaneously with) the issuance of the bonds. In this agreement the issuer and any guarantors agree to two principal undertakings: first, to complete, according to an agreed timetable, an exchange offer in which the issuer offers to exchange freely tradable bonds for its privately placed bonds; and second, to pay additional interest if it does not meet the specified dates in the agreed upon timetable. Generally, bondholders who fail to exchange their Rule 144A bonds for registered bonds by the termination date of the exchange offer will lose their right to exchange their bonds.

Where the bonds include registration rights, following completion of the initial offering the issuer and its U.S. counsel prepare and file with the SEC a registration statement on Form F-4, the largest part of which consists of the exchange offer prospectus used by the issuer to implement its exchange offer. The exchange offer prospectus is substantially identical to the Offering Circular used in connection with the initial Rule 144A private placement, and incorporates comments of the SEC staff (including its accounting staff) following its review of the registration statement.

To better understand the business of the issuer and to be able to assist in drafting an accurate and meaningful Offering Circular, the initial purchasers, their U.S. counsel, and the issuer’s U.S. counsel (assisted by local counsel) conduct an extensive review, referred to as "due diligence," of the business and financial condition of the issuer and any subsidiaries. In performing their due diligence investigation, the initial purchasers and their counsel typically will meet with senior management, the financial staff and the independent auditors of the issuer, and will often visit the more important facilities of the issuer and any guarantors. In addition, counsel for the initial purchasers will expect to review the issuer’s and each guarantor’s corporate documents, debt agreements and other documents relating to financial obligations, material contracts, relevant governmental licenses and approvals, and other material agreements relating to the issuer’s and guarantors’ business. A thorough due diligence investigation will assist the initial purchasers in establishing a "due diligence defense" against liability upon showing that they had, after reasonable investigation, reasonable grounds to believe that there were no material misstatements in or omissions from the Offering Circular. Although the issuer itself is strictly liable and cannot rely on the "due diligence defense," its officers and directors may be able to avoid liability on that basis.

The registration statement (Form F-4) required for implementing the exchange offer provides detailed instructions about the kinds of disclosure required in the registration statement and the prospectus. Most SEC registration and disclosure forms cross-reference selected items from two core regulations that describe most of the SEC’s specific disclosure requirements. The first of these, Regulation S-K⁶, is the source of most non-financial statement disclosure requirements. The other is Regulation S-X⁷, which is the source of most financial statement disclosure requirements. For foreign issuers, a third source of disclosures referred to in the applicable registration forms is Form 20-F. Form 20-F is the form used by foreign private issuers for their annual reports as well as for the initial registration of a class of securities under the Exchange Act. Form 20-F is used as a repository of disclosure requirements for foreign private issuers and is cross-referenced by the Securities Act registration statements. Foreign private issuers, like domestic issuers, are also required to comply with the disclosure requirements of the Sarbanes-Oxley Act, summarized in Chapter VI below, in both their registration statements on Form F-4 and in their annual reports on Form 20-F.

Items 3 and 4 of the disclosure requirements for Form 20-F provide for the disclosure of information concerning the business of the registrant. In the context of high yield bonds that are issued by a holding company and guaranteed by operating subsidiaries, the "registrants" will include both the issuer and the subsidiary guarantors (since the securities being registered include both the bonds and the related guarantees). Item 3 of Form 20-F, "Key Information," requires the disclosure of selected financial information for each of the registrants’ five most recent financial years, a statement of the registrant’s capitalization and indebtedness and risk factors that are significant to the registrant or its industry that would make an investment in the registrant speculative or high risk. Item 4 is the basis of the "Description of Business" section, and requires the disclosure of significant events in the history and development of the registrant and an overview of the registrant’s business. Item 4 specifically requires, generally by operating segment:⁸

• a description of the principal products and services provided by the registrant in each of the last three financial years (including any significant new products or services that have been introduced) and the status of development of new products and services to the extent publicly disclosed;

• a description of the principal markets in which the registrant competes;

• a description of the seasonality of the registrant’s main business;

• a description of the sources and availability of raw materials (including a description of whether prices of principal raw materials are volatile);

• a description of the marketing channels used by the registrant;

• summary information concerning the registrant’s dependence on material patents or licenses, contracts or manufacturing processes;

• the basis for any statements regarding the registrant’s competitive position; and

• a description of the material effects of government regulations on the registrant’s business.

Item 4 also requires a description of the registrant’s material tangible fixed assets (including leased property) and any environmental issues that may affect the registrant’s utilization of its assets.

Item 5 of Form 20-F, entitled "Operational and Financial Review and Prospects" (generally referred to as the Management’s Discussion and Analysis, or "MD&A") requires a free-ranging discussion by management of the foreign issuer’s:

• results of operations, including reasons for year-to-year changes in line items of the issuer’s consolidated income statement over a threeyear period, plus any interim periods for which financial statements are required, and a description of unusual or infrequent events that affected income and known trends or uncertainties. Management’s discussion must further describe pertinent governmental policies or factors which have affected or could affect the issuer’s operations or investments by U.S. nationals, and is required to include a discussion of any currently known trends, events or uncertainties that have had, or that the issuer expects to have, a material impact (favorable or unfavorable) on the issuer’s financial condition. Management’s discussion should further discuss the effects of inflation and changing prices on net sales, revenues and income from continuing operations;

• short-term and long-term liquidity and capital resources, including internal and external sources of liquidity, sources and amounts of cash flow (including any legal or economic restrictions on the ability of subsidiaries to transfer funds to the registrant), level of borrowings at the end of the period under review, material capital expenditure commitments and information concerning the registrant’s financial instruments, debt maturity profile and currency and interest rate structure;

• research and development policy, including the amount spent on research and development activities sponsored by the registrant during the last three financial years; and

• significant recent trends in production, sales and inventory, the state of the order book and selling prices and known trends that are reasonably likely to materially impact the registrant’s revenue, income from continuing operations, profitability, liquidity or that would cause reported financial information not to be indicative of future operating results or financial condition.

On January 22, 2002, the SEC issued an interpretive statement suggesting that companies improve their disclosures in the MD&A with respect to financial information for the fiscal year ended 2001 and periods ending thereafter.⁹ The SEC identified four broad areas that it believed needed enhanced disclosure in the MD&A: (i) critical accounting policies; (ii) liquidity and capital resources, including off-balance sheet arrangements; (iii) trading activities involving derivatives and non-exchange traded contracts; and (iv) related party relationships and transactions.

On May 29, 2003, the SEC issued an interpretive release providing guidance to companies regarding the preparation of the MD&A which reflects an effort by the SEC to streamline and improve the way in which information in this section is presented.¹⁰ The release did not create new legal requirements or modify existing legal requirements, but provides additional guidance designed to elicit a more informative and transparent MD&A.

The release highlights the importance of communicating management’s perspective to investors in a clear and straightforward manner, emphasizing that this cannot be accomplished by the mere recitation of financial statements in narrative form nor by a series of technical responses to the requirements of the MD&A. In general, in the new release the SEC suggests ways in which companies should enhance their MD&A consistent with its purpose, which is to provide readers information "necessary to an understanding of [a company’s] financial condition, changes in financial condition and results of operations."¹¹

With respect to the overall presentation and focus of the MD&A, the SEC underscores that companies should:

• Present disclosure with a focus on the most important information by using clearer language and well organized presentations of the MD&A without sacrificing the appropriate level of complexity. For example, the use of a tabular presentation of relevant financial information can enhance the understanding of dense disclosures.

• Reduce duplicative information which confuses readers and detracts from the clarity and comprehensibility of the MD&A. The SEC suggests, for example, combining related disclosures into a single discussion and reevaluating issues presented in earlier reports that may no longer be relevant.

• Include an introduction or overview at the beginning of the MD&A which would provide a balanced executive-level discussion identifying the most important matters the management focuses on in evaluating the company’s financial condition and operating performance.

In addition, the release emphasizes ways in which a company can meet the principal objectives of the MD&A and properly disclose information which is "material" in relation to a company by:

• Focusing on material information which advances the "understanding of a company’s financial condition, liquidity, capital resources, changes in financial condition and results of operations."

• Identifying and discussing the key performance factors that management uses to manage the business, which would include nonfinancial information and industry-specific measures.

• Identifying and disclosing trends, events, and uncertainties that would result in the reported financial information not to be indicative of the company’s future operating performance or financial condition.

• Providing not only a description of required MD&A disclosure, but also an analysis which discusses the implications and importance of the required information.

SEC rules require disclosure by foreign issuers of the remuneration paid to all directors and officers as a group during the fiscal year preceding registration, including a description of any material bonus or profit-sharing plan pursuant to which any officer or director remuneration was paid. Aggregate amounts paid for pension or retirement benefits must also be disclosed for officers and directors as a group. Disclosure of individual compensation or benefits is not required except to the extent that any such disclosure is made to the issuer’s shareholders or is otherwise made public.

In addition, foreign issuers are required to disclose, for individual directors and senior managers who beneficially own 1% or more of any class of shares, information concerning their share ownership.

Item 6 of Form 20-F requires the registrant to disclose details of each director’s service contract that provides benefits payable upon termination (or an appropriate negative statement), a description of the composition of the registrant’s audit committee and remuneration committee and the terms of reference under which such committees operate, and information concerning the share and stock option ownership in the registrant of each director and officer.

A foreign issuer is required to file with the SEC a number of exhibits to its registration statement. These exhibits are not included in the prospectus distributed to investors, but do become publicly available on the SEC’s website once filed with the SEC. Such exhibits generally include, among other things, the issuer’s organizational documents, indentures and material loan agreements, various opinions of counsel, voting trust agreements, significant contracts and patents, a list of significant subsidiaries and consents of experts and counsel. Aforeign issuer can, however, request that the SEC keep confidential certain commercially sensitive information contained in such exhibits.

In addition to the information specifically required by Form F-4 under the Securities Act, Rule 408¹² requires disclosure of such further material information as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading. The SEC has applied Rule 408 to foreign issuers to elicit discussion of economic, political and legal factors particular to the foreign issuer’s domicile, including such matters as tax policy, expropriation risks, currency fluctuation and devaluation risks and problems relating to energy, unemployment and inflation.

Where the bonds include registration rights, the financial information included in the registration statement must comply (and the financial information included in the Offering Circular will comply) with the SEC’s requirements relating to financial statements. The SEC’s Regulation S-X and Staff Accounting Bulletins govern the precise form and content of financial statements required to be filed under the Securities Act and the Exchange Act, and an issuer’s financial statements must comply with the prescribed format. The registration statement filed on Form F-4 is required to, and by inference the Offering Circular will, include among other financial data:

• five years of selected financial data;13

• two years of audited consolidated balance sheets; and

• three years of audited statements of income and changes in financial position.14

Under new rules recently adopted by the SEC relating to foreign issuers that are adopting for the first time International Financial Reporting Standards ("IFRS"), registration statements on Form F–4 (and annual reports on Form 20–F) prepared by such foreign issuers would only be required to include two years of audited statements of income and changes in financial position, and would also be permitted to provide selected financial data for only the two most recent financial years. This one-time accommodation will be available to foreign issuers that adopt IFRS for the first time prior to, or for the financial years starting on or after, January 1, 2007.¹⁵

The most recent year of audited financial statements may generally not be older than 15 months at the time of the offering. If the date of a registration statement is more than nine months after the end of the issuer’s last fiscal year, the registration statement must contain interim financial statements, including U.S. GAAP information, covering at least the first six months of the issuer’s fiscal year, which may be unaudited. Annual reports on Form 20-F must be filed within six months of the close of the registrant’s financial year. A foreign issuer’s financial statements must be reported on by independent certified public accountants meeting the requirements set forth in Regulation S-X.

Unaudited interim financial statements, including U.S. GAAP information, covering the first six months of the registrant’s financial year and comparative statements for the same period in the prior financial year are required to be provided if the date of the registration statement is more than nine months after the end of the issuer’s last fiscal year. However, if the issuer has published interim financial information that covers a more current period than the six-month period, the more current financial information must be included. Such information would include revenue and income information even if not published as part of a complete set of financial statements.

Ordinarily, Regulation S-X¹⁶ requires that an issuer prepare its financial statements in accordance with U.S. GAAP. However, Rule 4-01 of Regulation S-X permits a foreign private issuer to prepare its financial statements in accordance with the accounting principles accepted in the issuer’s own country, so long as those financial statements are reconciled with U.S. GAAP. In addition, under recently adopted SEC rules a foreign private issuer may elect to prepare its financial statements in accordance with IFRS.

Items 17 and 18 of Form 20-F provide the rules pursuant to which a foreign issuer must reconcile financial statements prepared under foreign accounting principles to U.S. GAAP. Pursuant to Item 17, among other things, a foreign issuer must provide (i) a discussion of the material variations between the accounting principles used in preparing its financial statements and U.S. GAAP, (ii) a quantified reconciliation of the material variances between the net income of the foreign issuer as presented and the net income according to U.S. GAAP, and (iii) for each balance sheet presented, the amount of each material variation between a reported amount and the amount using U.S. GAAP. Pursuant to Item 18, a foreign issuer must provide all information required by Item 17 and all other information required by U.S. GAAP and Regulation S-X, unless such requirements specifically do not apply to foreign issuers. Annual reports on Form 20-F and initial registration under the Exchange Act by a foreign issuer on Form 20-F may include financial statements that comply with Item 17 or Item 18, at the option of the issuer. Offerings of securities on Form F-4 must include financial statements that comply with Item 18.

Foreign private issuers that elect to prepare their financial statements in accordance with IFRS under the new SEC rules will continue to be required to provide U.S. GAAP reconciliation for the two years of such IFRS financial statements.¹⁷

Management of foreign issuers should bear in mind that reconciliation of a foreign issuer’s financial statements to U.S. GAAP involves a considerable amount of effort.¹⁸

The SEC permits first-time foreign issuers to reconcile the required financial statements and selected financial data for only the two most recently completed fiscal years and any required interim periods.¹⁹ In each subsequent year, an additional year of reconciliation is required. The SEC also allows foreign issuers to provide, without reconciliation, statements of cash flow prepared in accordance with International Accounting Standard No. 7 promulgated by the International Accounting Standards Committee.²⁰

In view of the complexity of the SEC’s rules and regulations regarding financial statements, a foreign issuer contemplating a U.S. high yield bond offering should consult with an accounting firm experienced in complying with U.S. federal securities laws as early in the process as is practicable.

As a general rule, under Regulation S-X the SEC requires an issuer to include separate audited financial statements for each subsidiary guarantor, reconciled to U.S. GAAP, unless (i) each subsidiary guarantor is wholly-owned, (ii) each subsidiary guarantee is unconditional, and is also a joint and several obligation of the subsidiary, and (iii) the subsidiary guarantors comprise all of the direct and indirect subsidiaries of the issuer (other than inconsequential subsidiaries). If these conditions are met, the issuer may present financial information on a consolidated basis only, without having to provide separate financial statements for each subsidiary guarantor.²¹ This financial reporting requirement can be very burdensome for an issuer, depending on the number of subsidiaries for which information needs to be furnished.

U.S. high yield bonds (regardless of whether they include registration rights) customarily contain a number of financial and operating covenants that are broadly restrictive, but which are very different from the "maintenance" covenants customarily found in credit agreements (which require that borrowers continuously comply with financial and operating restrictions to avoid default). Unlike bank covenants, all high yield covenants are "incurrence" covenants, which only apply when the issuer or a Restricted Subsidiary (defined below) proposes to take some action, such as borrowing money or making a restricted payment. In that event, the issuer’s ability to take the relevant action is determined by its ability to comply with a financial ratio, after giving effect to the desired action (such as incurring additional debt).

U.S. high yield covenants restrict the ability of the issuer and its majorityowned subsidiaries (including any future subsidiaries) to (1) incur future debt, (2) make dividend payments, as well as equity and debt investments, (3) grant liens in favor of other lenders, (4) sell assets and the shares of subsidiaries, (5) agree to restrictions with other lenders, (6) engage in transactions on non-commercial terms with affiliates, (7) engage in any unrelated business, (8) undergo any basic change in ownership, or (9) merge or engage in any business combination, among other limitations.

While the precise formulation and level of restrictiveness will vary, there are certain covenants that are characteristic of the U.S. high yield bond market, and it is important for potential entrants into this market to understand the restrictions to which they will become subject. Formulating conservative and realistic projections for a four to five-year period regarding sales, net income and EBITDA²² will be an essential part of the company’s preparation for covenant negotiations. Obtaining consents to waivers and amendments from U.S. high yield bondholders, where an issuer is no longer able to comply with its covenants, is both difficult and expensive, so companies should carefully evaluate in advance the package of covenants proposed to be included in their bonds.

The most common U.S. high yield covenants are summarized below. It is important to remember that covenants are negotiable, within certain limitations, and will be subject to negotiated exclusions (called "carveouts" and "baskets") that will permit the issuer and its subsidiaries to engage in certain limited activities unrestricted by the agreed-upon covenants. Typically, negotiations regarding covenants are lengthy, and often characterized by some friction between investor expectations and the issuer’s desire for less restrictive provisions.

As a general rule, covenants will apply to the issuer and its existing and future majority-owned subsidiaries (referred to as "Restricted Subsidiaries"), effectively building a wall of restrictions around the enterprise. Unless otherwise negotiated, Restricted Subsidiaries will be guarantors, jointly and severally, of the bonds. These restrictions are designed to prevent the issuer and its Restricted Subsidiaries from undergoing adverse changes in their capitalization or capital structure, or from selling or transferring assets (including subsidiaries), thereby diminishing the issuer’s ability to meet its debt service obligations, or permitting the diversion of resources or assets away from the bondholders.

At least two important high yield covenants rely upon EBITDA as an important component, and it is often the case that EBITDA for high yield covenant compliance purposes is defined more narrowly than EBITDA for financial reporting. High yield indentures will often define EBITDA to include income from Restricted Subsidiaries and other subsidiaries in proportion to the issuer’s interest in that subsidiary, but exclude income from subsidiaries and other money sources that are subject to limitations on distribution of dividends or other payments (so-called "dividend stoppers"). The objective of a high yield EBITDA definition should be to ensure that an issuer’s compliance with financial covenants is measured against an accurate picture of the financial assets available to service the issuer’s obligations under the indenture.

The covenants will restrict the ability of the issuer and its Restricted Subsidiaries to incur debt unless the issuer and its Restricted Subsidiaries are able to comply with a specified financial ratio, which is typically an interest coverage ratio based upon the ratio of cumulative consolidated EBITDA for the four preceding fiscal quarters to consolidated interest expense. The required coverage ratio is typically 2 to 1, but can be higher, or step up to a higher ratio over time. For companies in the media and telecommunications industries, this covenant will often require compliance with a ratio of the aggregate consolidated indebtedness at the time of the proposed debt incurrence (and giving effect to such debt incurrence) to consolidated EBITDA.

Certain types of indebtedness are generally permitted regardless of whether the ratio is met (referred to as "permitted" or "carved out" indebtedness). These will typically include, in addition to the indebtedness evidenced by the bonds, (i) indebtedness outstanding on the closing date or under credit arrangements existing on the closing date, and indebtedness to renew, extend or refinance that indebtedness (subject to certain restrictions), (ii) trade payables (or indebtedness under letters of credit issued to trade creditors), so long as the maturity of such debt is short-term, (iii) indebtedness of the issuer to a Restricted Subsidiary, or vice versa, (iv) guarantees by the issuer of permitted indebtedness of Restricted Subsidiaries, (v) indebtedness consisting of performance or similar bonds incurred by Restricted Subsidiaries, (vi) indebtedness arising out of certain agreements related to an asset disposition (such as guarantees and purchase price adjustments), and (vii) indebtedness in an aggregate amount that, not including any of the above, does not exceed a negotiated amount (generally referred to as a "basket" designed to accommodate the unspecified borrowing needs of the issuer and its Restricted Subsidiaries).

During periods when the issuer’s EBITDA is insufficient to permit debt incurrence under the ratio ("formula debt"), the issuer and its subsidiaries will be required to finance all of their financing needs under these (and any other negotiated) carveouts. As a result, an issuer and its counsel will seek as many carveouts as possible, aggregating the largest amount of carved-out indebtedness obtainable under the circumstances.

As representatives of the bondholders, the initial purchasers will resist the inclusion of these carveouts, since any such carved-out indebtedness may be incurred at times when the issuer’s business is performing below expectations (and the bondholders would like to restrict the ability of the issuer to incur further debt), recognizing that any such indebtedness will compete with the bondholders in the event of a debt restructuring or insolvency.

To the extent that an issuer succeeds in obtaining such carveouts for permitted indebtedness, the issuer will also seek the right to secure such excluded debt with liens upon its property. For most high yield issuers, the ability to incur secured debt is often essential since lenders will not make term financing available on an unsecured basis. Therefore, for debt carveouts to provide a meaningful source of financing to an issuer (especially for working capital), the issuer will need the right to borrow under negotiated carveouts (up to some agreed limit) on a secured basis. Because of the disadvantage to bondholders, companies can expect resistance from the initial purchasers to any request for the right to secure negotiated carveouts for permitted indebtedness.

High yield covenants also restrict the amount of cash that is permitted to be paid by the issuer and its Restricted Subsidiaries, in the form of "restricted payments", which are seen by bondholders as "leakages" of money outside the enterprise, since typically there is no consideration received by the issuer. To the extent that money leaves the enterprise, it will not be available to service the issuer’s debt. As indicated below, high yield covenants will generally permit "restricted payments" to be made in an amount not exceeding 50% of the consolidated net income of the company from the issuance date of the high yield bonds, through the most recently completed fiscal quarter, subject to certain adjustments.

"Restricted payments" are, broadly, dividend payments (other than stock dividends), amounts applied to redeem or purchase stock or prepay debt that is subordinated to the high yield bonds, and "investments", which consist of loans or capital contributions to, or purchases of stock from, any company other than a Restricted Subsidiary (i.e., debt or equity capitalization of a new entity which is not limited by the covenants).

High yield covenants will only permit restricted payments (other than "Permitted Investments" referred to below) if, giving pro forma effect to such payments:

In calculating consolidated net income for purposes of this covenant, profit or loss of any unrestricted subsidiary is excluded, as well as any income of any Restricted Subsidiary that cannot be paid because of a limitation on that entity’s ability to pay dividends (under an existing covenant in another debt instrument).

This covenant will always be subject to two important exceptions: "Permitted Investments," that are excluded entirely from the definition of restricted payments, and certain kinds of restricted payments, including a negotiated "general basket," expressed as a dollar amount, of permitted restricted payments.

"Permitted Investments" include (1) investments in any entity that thereafter becomes a Restricted Subsidiary, (2) investments by any Restricted Subsidiary in the issuer, or by the issuer in any Restricted Subsidiary, (3) investments in cash and cash equivalents, and (4) a basket for permitted investments not to exceed a negotiated dollar amount.

"Permitted restricted payments" will include (1) negotiated permitted investments in unrestricted subsidiaries, and companies in which the issuer owns less than 50% of the voting stock, (2) dividends, if paid within 90 days after the date of declaration, and are made in compliance with the formula, (3) purchases or redemptions of capital stock of a Restricted Subsidiary in exchange for the capital stock of the issuer or another Restricted Subsidiary, (4) certain purchases or redemptions of subordinated debt of the issuer or a Restricted Subsidiary in exchange for other subordinated obligations of the issuer or a Restricted Subsidiary, and (5) restricted payments, up to a negotiated amount, since the issue date.

Investors purchasing unsecured bonds from a holding company do not want to compete with secured creditors, who will enjoy a superior right to payment in the event of a workout or bankruptcy proceeding. In particular, bondholders do not want operating subsidiaries to grant liens in favor of creditors who are lending directly against the assets of the subsidiary.

Accordingly, high yield covenants prohibit, with certain exceptions, the issuer and its Restricted Subsidiaries from granting any lien upon their property or assets, without securing the bonds and the subsidiary guarantees on an equal and ratable basis. Common permitted exceptions ("permitted liens") include various customary liens (i.e., liens existing on the closing date, liens for non-delinquent taxes, judgment liens, and liens to secure trade obligations), as well as liens granted to vendors in equipment financing, secured only by the equipment sold, or liens on property constructed in the ordinary course of business to secure the cost of construction, and liens that extend, renew or replace permitted liens.

In addition, the issuer will, for the reasons discussed above, also seek "carveouts" for additional secured indebtedness. These additional permitted liens will often include (i) the right to secure inter-company debt, (ii) the right to secure some portion of the indebtedness which is carved out from the covenant limiting indebtedness (for example, to obtain working capital financing), and (iii) liens to secure debt, or other obligations, which the issuer expects to incur in order to finance particular projects (such as the financing or buildout of acquired concessions or licenses, or financing from bi-lateral agencies or local government export agencies to finance the acquisition of equipment), or capital expenditures.

In order to prevent any interference with dividend and other payments by subsidiaries to the issuer, which are the source of repayment for the bonds, high yield covenants will typically restrict the ability of the issuer and its Restricted Subsidiaries to agree in the future (for example, in a joint venture or in a loan agreement with other lenders) to restrictions on the ability of Restricted Subsidiaries to (i) pay dividends or make other distributions on their capital stock, (ii) make any investment in the issuer or another Restricted Subsidiary, or (iii) transfer any of their property or assets.

As a practical matter, by imposing these restrictions, this covenant limits the ability of subsidiaries to independently obtain financing, or enter into joint ventures or other similar arrangements. As a result of these restrictions, future financing will occur at the level of the issuer, with financing proceeds being loaned on an intercompany basis to operating subsidiaries.

High yield covenants prohibit the issuer and its Restricted Subsidiaries from making any disposition of assets or shares of capital stock of a subsidiary (i.e., a sale or transfer of assets or shares of capital stock of a Restricted Subsidiary to a party other than another Restricted Subsidiary) unless (i) the price is at least equal to the fair market value of such assets or shares, (ii) at least a certain percentage (generally 75%) of the purchase price is in cash or cash equivalents, or consists of assets in a similar business, and (iii) all of the proceeds from such disposition are reinvested in the business of the issuer or its subsidiaries, or are applied to the repayment of outstanding senior indebtedness or the purchase, at par plus accrued interest, of the bonds.

This covenant prohibits the issuer and its Restricted Subsidiaries from entering into transactions with affiliates, except on an arm’s-length basis (to insure that all transactions are on commercial terms), and requires that transactions with affiliates exceeding certain levels receive board authorization, as well as fairness opinions from independent external advisers.

Other customary high yield covenants (i) restrict mergers, consolidations and business combinations, (ii) limit any change in the control ownership of the issuer, (iii) restrict sale-leaseback transactions, (iv) require the issuer to provide information to the trustee on a quarterly basis, including copies of unaudited interim financial statements (regardless of whether these unaudited interim financial statements are provided to shareholders or local regulators), and (v) prohibit the issuer and its subsidiaries from engaging in any business other than a "Permitted Business" (the scope of which is negotiated).