Types of bonds under China’s current legal and regulatory frameworks can be roughly divided into enterprise bonds, corporate bonds, financial bonds, and government bonds. Although the regulatory rules and trading venues of the above-mentioned bonds are different, the nature of their risks and their fundamental legal relationships are identical from the perspective of bond default. Clarifying the regulatory system for behaviours of bond default event related subjects is the starting point of the analysis of bond default events. Taking corporate bonds for example, the core parties involved in a default event are the issuer, the bondholders and the trustee, and the risk-dissolving method is also centered around the regulatory system exercised by the market and the regulatory departments for the behaviours of the above-mentioned subjects.
Issuers. The nature of the legal relationship of corporate bonds is a kind of capital loan relationship established by the companies (debtors) and the investors (creditors) in the capital market. The fundamental purpose of the regulatory system for the behaviours of a corporate bond issuer is to establish its obligation of repayment as a debtor, and to make in a relatively coercive way the credit risk, which is not easy to be discovered, be revealed. The core of the regulatory system includes the issue admission mechanism, information disclosure system, and credit rating. Meanwhile, strict restrictions have been made on the issue mode on the basis of the above regulatory system (non-public issues and public issues).
The essence of a bond default event is that the issuer cannot fulfil its obligation of repayment under the bond contract. But the consequences of such default are not exposed at the last minute of the imminent payment, and once the bond payment risk is incurred, the basis and handling mechanism for the claim of the issuer will be very simple and clear. So, the core of the regulatory system for issuers’ behaviours is the “early warning” before risk exposure, such as the mandatory disclosure of major matters that may affect the solvency and the price of bonds, and the adjustment of the bond credit rating by rating agencies. The mandatory early exposure of risk information is the key to differentiate the regulatory system for behaviours of the bond issuers and that for the general debtors.
Bondholders. The equal negotiation between the creditors and the debtors is the basic trading principle under the loan relationship, but since the bond is a relatively standardized product, it is difficult for the bondholders to participate in the development process of a bond contract. Therefore, the protection of rights and interests of investors is the core value of the bond default risk resolution. But from the perspective of stakeholder risk disposition, the regulatory system included in the regulatory norms for bondholders’ behaviours is focused on the investors’ way of right exercise, especially the collective exercise mechanism.
In the chapter “Protection of Rights and Interests of Bondholders” of the Administrative Measures for the Issue and Trading of Corporate Bonds, the bondholders meeting system, repayment guarantee mechanism, and the bond default relieves have been stipulated. In the practice of bond issue, the prospectus also usually has a chapter to specify the corresponding contents. The foregoing contents established the basic legal framework and contract basis for the protection of interests of the corporate bond holders. In the case of a bond default, the remedies available may, from the perspective of the bondholders, include participation in the bondholders’ meetings and recourse by the bond trustee on behalf of the bondholders, as well as direct recourse to the issuer, but usually taking the collective exercise as the general situation and individual exercise as the exception.
Therefore, the core of the regulatory system for bondholders’ behaviours centers on the bondholders’ meeting mechanism, which is not permanent but best represents the common interests of the bondholders, including the formulation of the rules of bondholder’s meetings, establishment of the repayment working group, and the implementation of the fund management plans. It is an important measure of debt repayment and a framework of the regulatory system for behaviours of bondholders.
Trustees. The bond trustee system mainly applies to corporate bonds. The Administrative Measures for the Issue and Trading of Corporate Bonds has made principle provisions on the duty of loyalty and diligence of the bond trustees, and the Securities Association of China has also formulated some regulatory documents and detailed provisions on the qualification, rights and obligations of the trustees and the way of dealing with the default risk of corporate bonds as well.
In view of the involvement of stakeholders in bond investments, the interests of the bondholders will be realized mainly depending on the trustees. So, the aforesaid regulatory systems for the behaviours of trustees are not only the procedural obligation of surveillance and value supervision (such as the obligation of notification and convening), but more importantly are the right of representation of the trustees.
However, under the current legal framework, the right of representation of the trustees still concentrates on the procedural representativeness and lacks the substantive independence like that of the trust properties managed by the trustees. In the case of a bond default lawsuit, the bondholders should be entitled to the right of recourse because they are the legal subject of right. Even if a bondholder has authorized a trustee to sue on its behalf, it still has the right to cancel the entrustment and sue directly. Therefore, the regulatory system for the active exercise of rights by the trustee in a bond default event still needs to be reconstructed in order to avoid the absence and dilemma of the foundation for the collective action of the bondholders under non-trust relationship.
In this paper, the author only makes a brief analysis on the regulatory system for behaviours of the related subjects involved in a corporate bond default. We will select representative cases involving financial disputes and emphatically analyze them in the subsequent columns in conjunction with the practice of Lantai Partners.
Yao Xiaomin and Wang Qing are partners at Lantai Partners