Complex legal issues of ‘fixed for life’ high-yield security

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Road King Infrastructure recently issued the first “fixed for life” senior perpetual security in the high- yield space, which involved several complex legal issues, said the legal counsel involved.

William Liu
William Liu
Partner
Linklaters

“Senior perpetual securities are instruments that rank as senior in the capital structure, like debt, but are accounted for as equity for accounting purposes,” William Liu, a partner in the Hong Kong office of Linklaters, told China Business Law Journal. “Although they are perpetual securities, like equity shares, and could be outstanding forever, they typically have a coupon [interest rate] step-up after a shorter period of time, with the expectation that the securities will be redeemed by the issuer at that time, similar to the principal of a bond being repaid at maturity.”

In contrast, a “fixed for life” security has a fixed coupon that does not step-up or reset – except in very limited circumstances – which fundamentally alters the way in which investors view and price the security, said Liu. “The expectation is that the security will remain outstanding for a much longer period of time than a typical perpetual security, which raises interesting structuring issues for the issuer and investors.”

In this transaction, Road King Infrastructure issued the US$300 million 7.95% senior guaranteed perpetual capital securities through its financing subsidiary, RKP Overseas Finance 2016 (A) Ltd.

Patrick Sheil
Patrick Sheil
Partner
Linklaters

According to Patrick Sheil, a partner in the Hong Kong office of Linklaters, a high-yield security contains complex financial and operational covenants designed to ensure the issuer retains a certain level of financial health, cash reserves and assets in the business. “If the covenants are too restrictive, the issuer will struggle to operate its business; if they are too loose, investors may be at higher risk of having the issuer default,” said Sheil. “Balancing these two concerns requires a detailed review of the then current business and financial performance of the issuer, and the issuer’s expectations of changes to its business and prospects through the life of a security – typically three, five or seven years.”

With a fixed for life perpetual security, which may be outstanding for a much longer period of time, there is greater uncertainty as to how the issuer’s business will perform and grow as it goes through different economic and business cycles, according to Sheil.

“To address this uncertainty, we incorporated a reset mechanism giving the company flexibility to wholesale replace the financial and operational covenants by reference to their most recent bond issuance at the time of reset, which allows the issuer to ‘refresh’ its covenant package at various times in the future as it grows or expands its business, and gives it greater flexibility as its financial performance and credit position improve,” said Sheil. “The mechanics of and conditions to the reset feature required careful consideration and was a fairly novel approach.”

Legal counsel: Linklaters advised JP Morgan Securities, HSBC and DBS Bank as joint lead managers and DB Trustees (Hong Kong) Limited as trustee, with its team led by capital markets partners William Liu and Patrick Sheil.