In order to improve investor protection measures after the occurrence of several default events in the credit bond market, the National Association of Financial Market Institutional Investors issued the Model Investor Protection Clauses (Model Clauses 2016) in September 2016. Since then, with the further downward pressure on the economy and the government-led deleveraging process, defaults on credit bonds in the market have occurred frequently.
On 14 February 2019, the Securities Association of China and the National Association of Financial Market Institutional Investors jointly issued a circular on the business operation and compliance of the credit rating agencies of the bond market in the fourth quarter of 2018. According to the circular, there were 44 new default issuers in 2018.
According to the market, there were 37 in the corporate bond market, and 19 and three in the debt financing instruments market and the corporate debt markets, respectively. In 2018, 43 first-time defaulters were added, setting the biggest high since 2014.
In such a market environment, in order to enhance the protection of investors, the National Association of Financial Market Institutional Investors issued the Model Investor Protection Clauses in April 2019 (Model Clauses 2019).
Model Clauses 2019 provides for six categories of investor protection clauses including cross-protection clauses, prior commitment clauses, prior binding clauses, change of control clauses, debt repayment guarantee clauses, and asset collateral clauses. Compared with Model Clauses 2016, the main changes in Model Clauses 2019 include the following:
- Three categories of investor protection clauses are added, including prior commitment clauses, debt repayment guarantee clauses, and asset collateral clauses;
- The triggering of four categories of the clauses are optimized, including further improvement of the types of debts stipulated in the cross-protection clause, enrichment of 20 financial indicators including the proportion of restricted assets, expansion of the three types of prior-constrained matters such as restricting major investment in others, and optimization of the triggering of the change of control clause;
- Five clause handling mechanisms are detailed: (i) further detail to the triggering and confirmation mechanism of investment protection clauses; (ii) the logic relation between the grace period and the remedy mechanism defined; (iii) options added of no distribution (except for the income paid to the state-owned capital according to law) and no capital reduction in addition to exercise of repurchase option, adding of security, increase of nominal rate, and no increase of debt financing instruments specified in Model Clauses 2016 with respect to “remedy kit for breach of agreement”; (iv) optimized the proposal voting mechanism of the holder’s meeting; and (v) enhanced the liabilities and obligations of each party after triggering of any clause.
Significance of the new model clauses
The introduction of Model Clauses 2019 released a positive signal from the National Association of Financial Market Institutional Investors to protect investors. If the corresponding investor protection clause can be added to the issuance documents of the debt financing instruments, the issuer’s operation, finance, investment and financing, etc., would be further regulated, and investors would be given multi-dimensional reinforced remedial measures to achieve more comprehensive investor protection.
Expansion of the application of Model Clauses 2019
It is worth noting that the first footnote of the National Association of Financial Market Institutional Investors in Model Clauses 2019 suggests that, “the model clauses are for reference by the market only, and the market organizations should choose to use them as needed”. From practice, we can also see that the model clauses are not the standard content of the issuance documents of debt financing instruments.
In practice, there are no detailed explanation and guidance on the setting and implementation of specific investor protection clauses. When formulating the issuance documents of debt financing instruments, potential investors have not yet been determined, and it is not possible for investors to participate in the discussion and negotiation of investor protection clauses. At the time of issuance, however, the contents of the issuance documents of debt financing instruments should have been determined, and there is not much room for adjustment and modification. Investors often have to accept the documents passively.
In addition, these special protection provisions of the model clauses are not conducive to the issuers, and thus issuers often lack the incentive to set investor protection clauses. In reality, whether to add any clauses, and the setting of clauses for different companies, different industries, and different maturity debt financing instruments, are bound to be a complicated and time-consuming process.
In the context of establishment of “no implicit guarantee” and increasing default issuers in the fixed-income market, if investors pay more attention to, and actively participate and promote the design and setting of, investor protection clauses in the issuance documents of debt financing instruments, which are related to their rights and interest, include the asset pool in the repayment of debts, or distinguish the debt financing instruments with property security in terms of subscription volatility and cost acceptance, they can promote their debt financing instruments covered by asset pool or property security in terms of repayment, thereby enhancing the protection of their rights and interests.
The process of the investor’s promotion of right and interest protection by a transition from passive and active attitude will inevitably be lengthy, and will also be affected by the issuer’s cost and income, the willingness of the lead underwriter, and other factors.
Only in this way, however, can the issuer’s corporate governance capability be promoted, and the investor protection clauses be implemented and become an effective measure for risk warning and compensation.
Wu Jiejiang is a partner at Jingtian & Gongcheng