We will track here amendments to this resource that reflect changes in law and practice.
While the debt markets remain uncertain due to the global liquidity crisis, recent market activity indicates that securities that are perceived to be the safest will continue to attract investors while the sub-prime higher risk securities and issuers will struggle to find investors willing to take the risk of a default. Those instruments with both debt and equity qualities, which give access to both markets, together with the option of switching markets if one is not performing well, will no doubt continue to increase in popularity.
This note gives an overview of recent primary market activity, in the last quarter of 2007 and first quarter of 2008, in the debt capital markets (excluding derivatives), according to type of transaction.
The number of new issues of debt securities decreased substantially in the last quarter of 2007 and first quarter of 2008, compared to the same periods in 2006/2007, as a result of the "credit crunch".
High yield bonds and structured finance products (such as mortgage-backed bonds and collateralised debt obligations (CDOs)) suffered the biggest drop in new issues, but issues of investment-grade corporate debt also decreased dramatically, with the total market value of new issues down by nearly half compared to the first quarter of 2007.
However, in recent weeks there has been a change in investor sentiment and new issues of investment-grade corporate bonds have hit record levels.
Between July 2007 and April 2008, issues of corporate bonds in the international bond markets decreased significantly, due to the global liquidity crisis.
New issues decreased by 26.5% in the second half of 2007 compared to the same period in the previous year, according to figures released by Xtrakter, amounting to a US$ 421.56 billion drop in value of issues for that period.
See Box, New issues by quarter for a chart of quarterly issuance from Q3 2006 to Q4 2007.
One market to buck the trend was the "samurai" bond market, issues of which increased from just over US$1 billion in the first quarter of 2007 to just under US$5billion in the first quarter of 2008, according to the Financial Times (FT). Samurai bonds are yen-denominated bonds issued in Japan by a foreign issuer. The popularity of issuing bonds in Japan may be due to Japan's debt markets being seen as relatively stable, as Japanese banks had less exposure than European and US banks to sub-prime assets during the credit crunch.
However, renewed investor confidence in the rest of the investment-grade corporate bond market in April 2008 led to an increase in issuance levels and a record number of new issues. Globally, the number of bonds issued rose in April by 25% compared to March (according to Thomson Financial), and the number of bonds issued by banks increased to the third-highest level ever (according to Dealogic and as reported by the FT).
The recent surge in issues is attributed to:
Lack of available credit from other sources, such as commercial paper or interbank loans.
Improved investor sentiment after several months of the credit crisis.
Central bank intervention to improve liquidity.
A belief that banks have now revealed most of their "credit crunch" losses.
Issues of long-term investment-grade debt continued to run at record levels during May 2008. Strong investor demand is good news for issuers as over-subscribed deals can mean that the issuer can pay a lower coupon. However, although the bond markets are now showing signs of recovery, investors are likely to be more demanding about the terms on which they will invest.
The downgrading of some investment-grade bonds to junk bonds during the global liquidity crisis has recently prompted bond investors to seek better protection in the covenants in bond legal documents.
For example, in December 2007, the Credit Roundtable, a group consisting of major institutional bond investors, issued a "white paper" calling for covenants they want issuers to include to protect them against losses. The proposed covenants include change of control provisions and step-up coupons, where the bondholder would get higher interest if the issuer is downgraded.
As investors become more discerning about the quality of the bonds they are willing to invest in, issuers may be forced to include more robust covenants in their bond documents in favour of the bondholders.
For more information on bonds, see Practice note, Bond issues: overview. (www.practicallaw.com/4-201-8058)
Non-investment grade, or "sub-prime" securities have unsurprisingly been rather unpopular with investors since their demise during the credit crunch.
High yield bonds (bonds issued by sub-investment grade issuers) have suffered from a lack of investor confidence, with not one new high yield bond having been issued in Europe since July 2007.
However, the market in the US has recently shown signs of increased activity, where US$2.3 billion worth of high yield bonds were issued in the first three weeks of April 2008, which, according to the FT, is almost half of what was sold in the entire first quarter of 2008. By way of comparison, in 2007, average monthly high-yield issuance was around US$11 billion.
There is concern that issuers will now be forced to pay a higher coupon on their bonds to tempt wary investors. This may be made worse by possible over-supply in the market as existing bonds mature and issuers look to re-finance the debt with fewer investors willing to take the risk of an issuer defaulting.
For more information on high yield bonds, see Practice note, High yield bonds. (www.practicallaw.com/1-202-1868)
Short-term securities have been one of the classes of securities hardest hit by the liquidity crisis.
As fears over interest rate rises and inflation persist, investors (particularly financial institutions) are reluctant (or unable) to lend in the short-term, so the volume of commercial paper issued has decreased in comparison to its pre-credit crunch levels.
Commercial paper is used by banks and large companies to borrow money for short periods, and usually has a maturity of about 90 days. On maturity, the debt is often rolled over automatically.
Asset-backed commercial paper (ABCP), which is commercial paper backed by assets such as mortgages or credit-card debt, has been particularly shunned by investors.
ABCP is generally issued by special investment vehicles (SIVs), which are set up by banks. As the US sub-prime mortgage crisis gained momentum and borrowers defaulted on their home loans, investors in ABCP began demanding their money back and refused to roll over the debt.
With investor confidence at such a low, issuers of commercial paper will continue to struggle to find willing investors for new issues until the market stabilises.
Issues of sukuk (www.practicallaw.com/5-203-8720) (Islamic bonds) decreased in the first quarter of 2008 compared to the first quarter of 2007, but have shown more resilience to the liquidity crisis than conventional bonds.
This resilience may stem from:
Continued growth in the popularity of these instruments among private Middle Eastern investors.
The liquidity of Islamic finance houses.
Western companies expanding into and raising finance in the Middle East.
The Islamic bond market looks set to continue to grow globally as demand for sharia compliant financial instruments continues (see Legal update, First sovereign sukuk listed on the London Stock Exchange (www.practicallaw.com/0-381-0573)) and even Western governments consider issuing Islamic instruments (see Legal update, UK Government starts feasibility study into sterling sovereign sukuk (www.practicallaw.com/0-375-9471) and Legal update, Consultation on sukuk: Government's response (www.practicallaw.com/9-382-1280)).
However, the lack of standardisation of Islamic finance documentation and standards in different countries could cause a dent in investor confidence, especially if questions continue to arise among scholars as to whether the products are Islamic. See Legal update, Tougher rules on sukuk sales to be imposed (www.practicallaw.com/8-381-0197) for the latest ruling from the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) on this issue.
For more information on sukuk and Islamic finance generally, see Practice note, Islamic finance: UK law overview. (www.practicallaw.com/3-366-1996).
Issues of UK covered bonds (bonds that are secured or “covered” by a pool of on-balance sheet collateral such as residential or commercial mortgage loans) have decreased dramatically since August 2007 and the start of the liquidity problems in the capital markets, as investors turn their backs on mortgage-backed products.
Lack of investor confidence in these products is due to:
Recent problems in the US sub-prime mortgage market.
The current state of the housing market and predictions of decreases in house prices.
An increase in mortgage defaults as a result of the credit crisis.
It remains to be seen how the market will respond to the new Covered Bond Regulations (see Legal update, Covered bonds regulations come into force (www.practicallaw.com/2-380-9743)), but it is generally thought that the regulations do not provide an adequate regulatory framework and that further consultations will be required.
For more on covered bonds generally, see Article, Covered bonds: in the spotlight (www.practicallaw.com/9-202-3076).
Unlike other bonds, issues of convertible bonds surged to record levels in the first quarter of 2008, with the biggest ever issue of convertibles being issued by Bank of America in January.
Convertible bonds are popular at times when markets are volatile with both issuers and investors.
They give investors both a debt instrument (with interest) and an option to convert the debt into equity. This means they are seen as relatively safe instruments in turbulent times as they give an investor the ability to participate in either debt or equity markets, if either market is doing well, and steer clear of either market if it is not performing well.
For an issuer, convertibles provide a relatively cheap method of financing in volatile times, as the issuer can generally pay lower coupon rates due to the popularity of the product, as investors are attracted by the option of being able to switch into equity.
For more on convertible bonds, see Practice note, Convertible and exchangeable bonds. (www.practicallaw.com/2-107-3971)
Issues of depositary receipts (both global depositary receipts (GDRs) and American depositary receipts (ADRs)) have continued to rise, with the number of GDRs being listed on the London Stock Exchange growing by an average of 18% a year, according to the Financial Services Authority (FSA), and investor demand for these instruments looks set to continue.
Depositary receipts are certificates representing ownership of a company's shares but the certificates can be listed and traded independently of the underlying shares.
They appeal to investors as they are easily tradeable on the international capital markets and also give investors access to equities of companies listed in markets that are hard to access directly, usually in emerging market countries and particularly in fast-growing markets like Russia.
For issuers, depositary receipts also have a strong appeal because they:
Give issuers access to a broad range of international investors that they would not be able to reach in their local markets.
Enable issuers to offer their securities in a sophisticated and developed market (such as London, Luxembourg or New York). Often their local markets are too small and illiquid to absorb the offering.
Have less onerous listing requirements (in London) than for a primary listing of shares. For a primary listing a company must meet the corporate governance standards and disclosure requirements expected of a UK-listed company, which are over and above the minimum requirements of EU directives, including appointing a sponsor. A GDR listing only requires adherence to directive minimum standards, so many emerging market companies seek a dual listing using GDRs.
There have been recent concerns over the listing requirements for GDRs in the UK and worries that investors mistakenly believe that GDR listings are governed in the same way as primary listings. The FSA has confirmed that they do not plan to change regulatory requirements for GDR issuers at present, but continue to review the listing procedure. If the listing rules do change in the future, the number of new issues of GDRs listed in London could decrease. See Legal update, Listing regime review: FSA Discussion Paper 08/1 (www.practicallaw.com/7-380-1810) for more on the FSA's proposals.
Dealogic provides communications and analytical products to the investment banking industry, including providing data on global capital markets transactions. See the Dealogic website (www.practicallaw.com/6-382-1253) for more information.
Financial Times articles and statistics are available from the Financial Times website. (www.practicallaw.com/7-382-1993)
Thomson Financial is part of the Thomson Reuters group. It provides market data on global capital markets transactions in addition to research, guidance and news. See the Thomson Reuters website (www.practicallaw.com/4-382-1254) for more information.
Xtrakter is the market services division of the International Capital Market Association (ICMA). It provides operational risk management, trade matching, regulatory reporting and data services to the global capital markets. Xtrakter is a wholly owned subsidiary of the ICMA Group. See the Xtrakter website (www.practicallaw.com/5-382-1994) for more information.