Investment banks cannot afford to ignore investor pressure for better terms from bond issuers

More than 40 investing institutions are now supporting the lobby for better covenants and disclosure standards in the European corporate bond market. The three firms that set the bandwagon rolling – Gartmore, M&G and Barclays Global Investors – have organised their own roadshow in Italy and Germany and are planning to take their message to other countries, too. They are prepared for a long campaign.

The pressure for a new deal began in mid-October, when 26 European institutions, said to own a quarter of the euro corporate bond market and a half of its sterling equivalent between them, put their name to a document aimed at promoting better standards in the European corporate bond markets. They want change on three main fronts.

The most controversial is minimum covenants. The group wants covenants to protect investors against event risk (such as a change of control) and strengthened negative pledge clauses. These are supposed to prevent structural subordination of listed bonds by limiting the amount of secured debt the bond issuer can incur. But they are notoriously weak in Europe.

“We believe that if there is a downgrade of the bonds specifically as a consequence of a change of control,” says BGI’s Andrew Winn, “investors should have the right to put the bonds back to the company. This is not an attempt to create a poison pill. If an investment grade issuer is acquired, the ‘new’ issuer has to be financed in such a way as to be consistent with an investment grade rating. Investors can price for trading risk, but not event risk.”

Typical negative pledges, says Winn, offer too many carve-outs. They tend to exclude bank debt or other non-listed debt. Interestingly, the investor group’s document emerged just a few days before Fitch Ratings produced its own paper, Jumping The Queue, which highlighted the weakness of negative pledge clauses in European bond documentation.

Change here is unlikely in the short term. Bankers say the dependence of European corporates on their banks – as opposed to the credit markets – make treasurers and finance directors loath to have their hands tied. They also say that if covenants were really such a problem area, more investors would ask questions during road show presentations. Truth is, few do.

Cliff Dammers, who runs the International Primary Markets Association (IPMA), says this is a perennial issue. “The National Association of Pension Funds and the Association of British Insurers come in every year to make some complaints. I say ‘If you don’t like the paper, don’t buy it.’”

The second issue is documentation and disclosure. The investor group complains that large numbers of deals are priced before even a red herring has been made available. Often bonds are issued off the back of a long-running medium-term note (MTN) programme but the original documentation may not be readily available or have been updated within the past year.

Worst of all, once a company has been taken over, and no longer has publicly listed equity, the flow of information may dry up altogether. The group wants that to change. In the US, a company must continue to make quarterly reports available if there are more than 500 investors in any of its instruments – whether the paper is listed or not. “We want routine disclosure of certain information that can reasonably be expected to move prices and also to receive trading statements on a regular basis,” says Winn. “Companies regularly have equity road shows. We would like to see that copied in the bond markets.”

Dammers says IPMA is keen to talk formally with the group on the disclosure issue. He agrees that too many companies are sloppy in this area. “The regulators are not doing their job in policing the duty to update prospectuses whenever there is a material change. Issuers are able to take advantage of that. Equally, people should not be doing road shows without even the red herring.”

Two European directives – the Market Abuse Directive and the Prospectus Directive – will, he says, reinforce the duty to update and give increased powers to regulators. “Anyone with securities listed in Europe will have to publish in real time any material developments.”

The third big area of concern for the investor group is secondary market liquidity, which, it says, is “generally poor” for corporate credit paper – and especially so in the sterling bond market. There is a message here for issuers. Rather than give their business to the top names in the issuance league tables, the group says, “potential issuers can achieve much better execution, and lower funding cost, by focusing on which lead manager provides the best secondary market liquidity …”

Winn says the group has had issuers contacting it following recent publicity. “We think that if an issuer abided by all these standards investors would be prepared to pay up for the issue in question. Companies could achieve lower funding costs.” That is a powerful message for Europe’s issuers. But, so long as the corporate bond market remains so perky, change will be slow in coming. Says Dammers: “At the moment, we have an extremely hot credit market. There are more investors crying out for paper than issuers issuing it. Even if all the institutions in this group refused to buy corporate paper there are a lot of other people queuing up to take it.”