WHEN 26 UK and European institutional investors put together a working paper calling for improved standards in the euro and sterling credit markets, it attracted plenty of attention. JPMorgan broadened the debate, organizing a seminar in the House of Commons in November, inviting the signatories to the paper, plus some 15 buy-side firms and representatives from rating agencies, the International Primary Markets Association (Ipma) and other banks.
Then things went quiet.
There was little to suggest that the working paper recommendations – which ranged from establishing minimum covenants for high-grade issuers to improved documentation standards to better disclosure and liquidity provision by banks – would be enforced.
Ipma’s market practices committee decided it was not its place to interfere with investor issues. The Association of Corporate Treasurers came out with a lukewarm response in December and bankers were broadly non-committal. In a primary market where demand outstripped supply, they suggested the timing of the working paper could not have been worse. There was no pressure on issuers to enforce the seven key points raised, plenty of European underwriters were prepared to work with issuers however lax their standards, and investors were desperate to buy bonds.
Six months on, though, these issues have regained momentum. For example, German investors have formed a 20-strong working group under the auspices of the Bundesverband Investment und Asset Management (BVI). They might be much more influential than the signatories to the October working paper, who are mostly investors in sterling issues. The Germans have clout in the much larger euro market, representing over e1 trillion in assets, with a big allocation in bonds. Meanwhile, the Association of British Insurers has formed a working group and will publish a paper on disclosure and covenants soon.
These disparate groups are beginning to cooperate. Critics of the initial working paper had doubts that the wider investor community would ever agree on so many specific points. Yet while the BVI is pushing one particular point from the original paper, in essence its views are in line with the group of 26. “We analyzed their paper and formulated our own views. When we looked at it, we decided that the most important element was their request for open information,” says Rudolph Siebel, managing director of the BVI.
The BVI has been meeting various parties to canvass their views. At the beginning of May, Siebel met a group of syndicate heads from six of the biggest investment banks and key German issuers. It is also drafting an agreement about standards of information it would like to see to send to Ipma. It is due to meet the German Pension Fund association and the German Insurers Association this month.
The investor groups are working together. Stephen-Wilson Smith, head of credit research at M&G Investments, which sponsored the October report, presented their views to German institutional investors and Siebel says he is going to meet ABI to see what its priorities are. The ABI is also hoping to form alliances with other interested groups. “Once we have discovered what our own members will countenance, we anticipate we will talk with a wide range of people,” says John Hale, manager of investment affairs at the ABI. “We are also members of the European Association of Insurers and we are keeping them informed about what we’re doing.”
Formalizing consensus The next step is to formalize a way of presenting these collective views on a pan-European basis, either through an existing body or a new forum. “There’s broad consensus, and the BVI is in support of our suggested improvements,” says a person at the centre of the group of 26’s endeavours. “The question is how to bring about change in a seller’s market and who is best able to do that. We as individual investors are busy and can only do so much ourselves, so we are exploring our options and working through an existing organization is the preferred route.” That might mean Ipma or the BVI.
This pragmatic approach partly rebuffs critics who argued that the group of 26 were just out to push their own agenda in the sterling markets, where many of the group are most active. As Karl Bergqwist, head of credit fixed income at Gartmore, puts it: “We’re less concerned about which movement actually goes forward, but that the issues are being aired.”
Siebel says it is up to the sponsors of the October report to decide on the organizational structure, but that the BVI would certainly like to get involved. In the meantime it is going to continue pushing for change in the German market.
All this collective endeavour ensures that the debate about improved disclosure, documentation and covenants in European corporate bonds has not dwindled. In fact, no-one Euromoney spoke to denied that European standards were lax compared with the US markets. They all agreed that banks should not walk away from new issues in the secondary market and that issuers should be as straight with investors as possible.
Some senior debt bankers think that in focusing on one pragmatic point, better documentation standards, the BVI lobby is being received better by intermediaries and issuers than the initial group of 26, which made much wider-ranging recommendations.
The BVI-led investor group is asking for draft prospectuses ahead of a bond’s launch with links to issuer’s websites, disclosure of basic terms of the offering and a few days to do credit work. They also want issuers to post current MTN documentation on their website.
Falling standards in Europe Michael Ridley, head of European syndicate at JPMorgan, accepts that documentation standards have slipped a lot for high-grade issuers, partly because of the frequent use of MTN programmes. “An annual review of MTN documentation is generally done by one bank and every year the issuer wants to drop negative pledge, reduce covenants and slacken standards so it gets weaker and weaker.”
Ridley says that banks should accommodate investors’ requests for documentation several days before a deal’s launch, but points out that this isn’t always practicable. “We can take several weeks explaining the structure of a high-yield deal to investors but if we’ve got to bring a more frequent high-grade issuer to market in a couple of days, we’re unlikely to do this because we’ve got to get on and market it.” Other syndicate heads are blunter. “When we need to do a deal quickly we’ll just sell it to different investors,” says one. That assumes that such investors will always be there to be found.
However, the sponsors of these initiatives say that more and more issuers are already grasping thornier issues raised in the October working paper, such as improved covenants and negative pledges in new bond issues. “Eighteen months ago, for an issuer coming to market, the issues of disclosure and covenants were an afterthought,” says Bergqwist. “Now in sterling and increasingly in euros, they have to think this through.” He cites a utility that recently did a roadshow for an inaugural sterling bond with clearly defined negative pledge and disclosure covenants.
Siebel says he has found that German issuers are generally sympathetic to the need for negative pledges in the most extreme circumstances that can transform a company’s credit, such as a change of control. He also thinks that the current debate means that even the companies that do not bow to these requests are going to be less likely to boast about it. “What I don’t think we will see again is issuers like Metro coming to the market and the lead manager proudly stating that this was fully sold in the market without the need for any ratings or covenants.”
This may be because market conditions are much less buoyant for issuers than they were just two months ago. Ridley says that in a situation where interest rates are rising and bond prices sinking, investors could be able to stand back and not buy if they’re not happy with the covenant package. There’s no real evidence of such concerns scuppering a deal yet. Paul Hearn, head of primary markets at BNP Paribas, says: “The market is not as robust as last year and conditions are certainly ripe for these recommendations to gain more traction. However, this has not come up in any deals we have done at BNP Paribas yet from individuals or groups of investors.”
Investors are not yet in a position to launch a buyer’s strike even if they wanted to, so intermediaries say that most of the group of 26’s proposals could only ever really be agreed to on a case-by-case basis between issuers and investors. “Ultimately, investors have to take a commercial decision and if they don’t like an issuer, they shouldn’t buy their bonds or should pay less,” says a syndicate head.
Other market participants are less complimentary about the current investor action, accusing the more activist institutions of bullying tactics and double standards. “Most of these guys don’t read the prospectuses anyway – they turn up to roadshows and they haven’t got any questions,” one scoffed.
Some corporates have also voiced their opposition to these proposals and even some buy-side firms are sceptical. “The BVI initiative seems to be rather more practical, but if I’m honest, I think the group of 26 are barking up the wrong tree,” says a research head at a large buy-side firm. “They seem to think that having stringent specifications on the information they receive from issuers is going to help their credit research, but I can’t see how they are going to create any business advantage from that.”
He adds that this is a dangerous game. “The sterling market is not very robust as it is, but if investors press for too stringent issuing criteria from companies, they will just issue somewhere else.”
Bergqwist says that investors don’t want to force the issue in any case. “None of us thought we would see a massive change overnight. The aim is to stimulate a debate and raise awareness and not just for the benefit of investors. When there’s poor disclosure, the market is more susceptible to rumours, risks and volatility, which means that companies can’t tap the market at reasonable terms either.”
He adds that the problem doesn’t apply to frequent issuers such as RWE, which has been most vocal in its opposition. “If RWE were the average company, we wouldn’t have a problem. This is not targeted at the large companies that have an ongoing need in the market. It’s the German Mittelstand and the FTSE 300 that issue infrequently that can get taken over, taken private, where the bonds become subordinate and no one’s any the wiser.”
Whether issuers like it or not, investors are pushing the debate forward. “It’s not the first time there have been requests for improved standards, but this time there appears to be a head of steam building about this,” says the ABI’s Hale. Siebel agrees: “In talking to issuers and investment banks, the message is coming out that this is not particularly good time for us, but now we have got a wave going we are going to continue it. We’re not going to wait for the market to deteriorate.”
