The issue of suitable documentation, minimum covenants, and improved disclosure for corporate bond investors has been under discussion in the UK for some time (see August 2003 issue), but now Europe’s corporate bond investors are following the lead. Last month more than 25 of Europe’s largest investment management companies, including PGGM and ABP Investments, published a consultation paper aimed at improving standards in Europe’s credit market. They say that Europe should follow the US’s example, where SEC registration and disclosure requirements “bring discipline.” According to the group, the immaturity of the European credit market with regards to safe-guarding bondholders is resulting in increased volatility and reduced liquidity.
In the paper, the companies, led by Barclays Global Investors, Gartmore and M&G, have outlined a series of ‘best practice’ principles “aimed at jointly benefiting credit market issuers and investors”. While the group insists that it is not looking for regulatory measures to be taken, it believes that if the principles were observed, the European debt capital market would become more efficient and less volatile.
Says the group: “The lack of European-wide regulation or legislation, together with the relative immaturity of the European credit markets has led to poor market practices, such as unavailability of proper documentation for investment decision-making, and lack of adequate protections in bond indentures, and as a result, bondholders have been left vulnerable to significant capital deterioration in the event of changes in the corporate’s credit rating or capital structure.
The paper sets out proposed best practice in regard to: minimum covenants for corporate investment grade issuers; issuer call options; documentation standards; disclosure; credit ratings; secondary market liquidity; and relationship between issuers and investors, all designed to promote better market practice.
The group is also calling for increased consultation and dialogue between all market participants. A spokesperson for the working group of investment management firms said: “Better levels of disclosure, documentation and correctly structured bonds are good for issuers, investors and the market in general. It is in the interest of all parties concerned to raise market standards so the market can operate more efficiently. But principles do not become market practice overnight. All parties need to see them, understand them and be convinced that they are heading in the right direction for the market to move forward. For this to happen, the market must engage constructively.”
The working group includes: ABN AMRO, ABP, Aegon, Barclays Global Investors, CDC Ixis, Credit Lyonnais, Delta Lloyd, F&C, Fortis, Gartmore, Groupama, Henderson Global Investors, Hermes, HSBC, ING, Lombard Odier, M&G, Morley, Newton, Nordea, PGGM, Robeco, Societe Generale, SNS, SPF Beheer and Standard Life Investments.
James Foster, head of corporate bonds at ISIS, however, has offered warning to the group. “This document is well-intended,” said Foster, “but in practice it amounts to a wish-list of unrealistic expectations which could result in putting prospective bond issuers off altogether. Back in the early 1990s, the debenture market demanded a minimum set of covenants. Subsequently the new issue market evaporated and liquidity dried up. The last thing we want to see is the sterling and euro corporate bond markets going the same way.”
Adds Foster:”In the same way that you go about building equity portfolios, diversification is an absolutely key element for all bond fund managers. While we would encourage issuing firms to pay heed to the report’s calls for greater transparency, there’s a clear risk that demands for unrealistic covenants could end up driving potential issuers to other, less constrained, markets such as the US. The end result could be quite the opposite of what these reforms were intended to do.”