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6 November, 2017
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The local bond market in Singapore has seen an unprecedented number of defaults in recent years, particularly with regards to the offshore marine services sector. The slump in oil prices has adversely affected the cash flow of offshore marine companies and compromised their ability to repay their debt obligations, leading to the series of defaults by issuers such as Pacific Andes Resources Development, Swiber, Ezra Holdings and Rickmers Maritime. Other companies such as Swissco, Nam Cheong and Marco Polo Marine had to seek consent from bondholders to restructure their debt obligations.
The recent spate of defaults and liability management exercises in respect of bonds has triggered an impetus for reform, particularly with regards to providing help for bondholders faced with the dual difficulties of potentially losing capital invested in the bonds and shouldering the cost of seeking redress from the defaulting issuer. Further compounding this issue is the fact that such bondholders can only require action to be taken against the issuer through the trustee of the bonds, and it is not uncommon that the trustee would be required under the terms of the trust deed to be indemnified and/or secured and/or pre-funded before taking action. Whereas this may not be such a big concern for institutional investors, individual bondholders may find it challenging to stump up the money required for this purpose?and there has been at least one instance where bondholders had to accept outside help to satisfy this trust deed requirement.
While in theory such wholesale bonds are only to be sold to “specified” investors (i.e., sophisticated, accredited and institutional investors) under Sections 274 and/or 275 of the Securities and Futures Act, Chapter 289 of Singapore, the reality is that it is not uncommon to find that Singapore dollar denominated bonds issued by local corporations are sold through private banking channels to investors who may be deemed to be “specified” investors under the statute but whose risk appetite may in reality not include such types of investment. These private banks may also extract a sales commission from the issuer, which up until now did not have to be disclosed to investors. This may lead to a potential conflict of interest scenario between a private bank’s duty to its client and its desire to retain a larger commission.
Further clouding the water is the fact that it is also not typical for Singapore dollar denominated bonds issued by local corporations to be rated by any independent rating agencies, thus depriving potential investors of the opportunity to measure such investments against supposedly independent benchmarks. In addition, such bonds are seldom secured by any collateral.
The Proposals
To address some of these concerns, the Securities Investors’ Association of Singapore (SIAS) and law firm Rajah & Tann Singapore LLP have submitted two proposals to the Monetary Authority of Singapore (MAS). Under the first proposal, issuers would be required to take up an insurance policy at the time of issuance, while their finances are still in a relatively healthy state.
In the event of a bond default, the payout from such insurance policy would then fund the legal, advisory and administrative fees of the bondholders to begin taking an action against the issuer. Such fees are currently shouldered by bondholders and can cost up to S$500,000. The insurance policy payout may also be used to pay bond trustees to take action on behalf of investors. This would, it is claimed, effectively minimise the costs currently borne by bondholders and better protect their interests, for example by giving them more clout in a potential restructuring exercise by the defaulting issuer.
Whilst potentially relieving the financial burden of distressed bondholders in the situations set out above, in practice, the commercial feasibility of this proposal may be circumscribed by the fact that it would invariably mean increasing the funding costs of issuers. This may also go against recent efforts by Singapore Exchange Securities Trading Limited to mitigate such funding costs in respect of issuance of qualifying bonds (for example, incentives such as the Asian Bond Grant Scheme and the Green Bonds Grant Scheme). It is also not inconceivable to imagine that issuers would seek to pass on these additional costs to investors, for example, in the form of reduced coupon rates.
The second proposal seeks to diversify the investor base by requiring a minimum of 30 percent of the total issue go to institutional investors, with the intent that in a potential bond default scenario such institutional investors would have the requisite financial resources and expertise to protect collective bondholders’ interests. However, this proposal has received criticism given the lack of demand from institutional investors for unrated corporate bonds. The premise of this proposal is also predicated on the assumption that the interests of institutional investors would be aligned with those of individual investors, which may not always be the case. For instance, the latter category of investors may be motivated to seek a swift resolution to an impending potential bond default (for example, by agreeing to debt restructuring plans proposed by the issuer even if it involves taking a haircut on their investment)?while institutional investors (particularly opportunistic ones) may decide to hold firm in the hopes of securing a better deal which may or may not materialise (and which may in fact accelerate winding-up proceedings). Furthermore, because of the way the collective action clauses are drafted in trust deeds, this would mean individual investors might be held at ransom by their institutional counterparts.
The proposals are now awaiting consideration and action from the Monetary Authority of Singapore.
Buyer Beware
While the proposals and other recent efforts by MAS, SIAS and the Association of Banks in Singapore aim to enhance investor protection in the bond market, investors should themselves take lessons from the recent series of bond defaults and avoid finding themselves in similar predicaments. Justice Arthur Goldberg wrote in a U.S. Supreme Court decision over 50 years ago that the purpose of modern securities law was to “substitute a philosophy of disclosure for the philosophy of caveat emptor”. Investors must be prepared to look beyond the headline yield that is offered to fully understand and assess the risk involved in the bonds they are prepared to invest in. It is hoped that proper product understanding for investors would allow them to make wise investment choices and effectively minimise their exposure to risk.
For further information, please contact:
Pamela Chan, Duane Morris
pchan@duanemorrisselvam.com
