Debt capital markets FEATUREqxd by tyndale


									Debt capital markets

An introduction

                                                                                                                            Illustration: Andy Lovell

                                                                                                                                                        PLC September 2005
Michael Doran, David
Howe and Richard
Pogrel of Gide

Loyrette Nouel explain
the workings of the
European debt capital

1 July 2005 will be seen as one of the land-
mark dates in the history and develop-
ment of the European debt capital mar-
kets. After extensive debate, consulta-
tion and market consideration, the
Prospectus Directive (2003/71/EC) is
now in force (see feature article “Listing
and prospectus rules: a guide to the new
9841). In addition, the Transparency Di-       this article, the first in a two-part series,       • The role of the international clearing
rective (2004/109/EC) looms just below         sets out:                                             systems.
the horizon (see PLC Opinion “Trans-
parency Directive: improved investor in-       • A broad overview of some core prod-               • Certain key considerations for new is-
formation or over-regulation?”, www.             ucts.                                               suers accessing the debt capital mar- As a re-                                                               kets.
sult, the landscape of the European debt       • An outline of the process of issuing
capital markets has changed immeasur-            debt instruments, the legal docu-                 The second article in this series will look
ably. Against this background of change,         ments and the participants involved.              at derivatives.                                      21

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                       CORE PRODUCTS                                provisions, usually including a negative                ments to issuing English law regis-

                       At the heart of the European debt capital    pledge and a series of events of default.               tered notes.
                       markets is an extensive investor (see        The exact terms and scope of these pro-
                       Glossary) base. For issuers, this gener-     tective provisions will reflect the issuer’s        • Bearer notes afford anonymity to in-
                       ally allows a cheaper and diversified        credit rating and its commercial and fi-              vestors.
                       source of funding relative to traditional    nancial strength, and are usually the re-
                       borrowing from commercial banks.             sult of detailed negotiation between the            However, given that the vast majority of
                       Meanwhile, the ability to access a broad     respective lawyers advising the arranger            notes are now cleared and settled
                       range of products and credit profiles in a   and the issuer.                                     through the clearing systems (see “Clear-
                       liquid market continues to draw in-                                                              ing and settlement” below), with in-
                       vestors.                                     Medium term notes                                   vestors trading their “book-entry inter-
                                                                    Medium term notes (MTNs) developed                  ests” in their securities accounts within
PLC September 2005

                       There are three basic products in the Eu-    as a natural extension of the maturity              the clearing systems, the real commercial
                       ropean debt capital markets, but all are     range offered by commercial paper.                  and legal differences between bearer and
                       essentially the same under English law:      They initially comprised discrete issues            registered notes are essentially irrelevant
                       instruments evidencing a debt under          of notes tailored to meet the investment            for issuers and investors, save only
                       which the obligor of such debt (the is-      needs of particular institutional in-               where particular investors require physi-
                       suer) covenants to pay the beneficial        vestors. Like commercial paper, they are            cal delivery of individual, definitive,

                       owner of such instrument (the investor)      issued under a programme platform (see              bearer notes.
                       a principal amount on a specified future     “Issuing notes” below). In 1991, the first
                       date, usually with interest accruing and     publicly listed, syndicated English law             With the recent coming into force of the
                       payable on certain set dates.                bonds were issued under an MTN pro-                 Savings Tax Directive (2003/48/EC) and
                                                                    gramme platform. This increased fund-               the tax withholding, or information re-
                       Commercial paper                             raising flexibility propelled the popular-          porting requirements, that it imposes on
                       Commercial paper is a short term debt        ity of MTN programmes: in fact, most                paying agents, the anonymity value of
                       instrument with a maturity of less than      notes and bonds issued in the European              bearer notes has probably disappeared
                       365 days. It is highly liquid: many major    debt capital markets today are issued un-           for good.
                       corporations use commercial paper as a       der MTN programmes.
                       form of working capital given its low                                                            ISSUING NOTES
                       cost of funding. It is marketed and sold     Although there are historical differences           Given that the core products are all es-
                       principally on the basis of the issuer’s     in terminology (“notes” traditionally re-           sentially similar in nature, it is no sur-
                       name and rating (see “Rating agencies”       ferred to instruments with a floating in-           prise that the documents are broadly
                       below), is usually unsecured and rarely      terest rate, “bonds” to fixed interest in-          similar for each product (see box “Key
                       contains any form of investor protective     struments), the terms “bonds” and                   documents”). Commercial paper and
                       provisions (such as events of default or a   “notes” are now used interchangeably in             MTNs are generally issued under a “pro-
                       negative pledge). Commercial paper is        the debt capital markets and conse-                 gramme” platform. Simply put, a pro-
                       rarely “listed” (see “Listing” below) and    quently in this article. This article fo-           gramme platform is an uncommitted,
                       is straightforward to document, custom-      cuses on MTNs, as these are now the                 “evergreen” facility (that is, the underly-
                       arily being issued under a programme         most popular form of debt instruments               ing legal documents contain no termina-
                       platform (see “Issuing notes” below).        issued in the European debt capital mar-            tion date) established by an issuer with
                                                                    kets.                                               the help of an arranger and a group of in-
                       Bonds                                                                                            vestment banks as dealers. Once estab-
                       Bonds are debt instruments issued with a     Bearer notes or registered notes?                   lished, programmes are relatively
                       maturity of one year or more. Maturities     Commercial paper, MTNs and bonds                    straightforward to maintain subject, in
                       can range up to 50 years (for example,       are either bearer instruments (where                the case of MTN programmes, to the
                       the recent bond issues by the UK Debt        ownership passes by physical delivery)              production of periodic disclosure up-
                       Management Office and the French gov-        or registered instruments (where owner-             dates.
                       ernment) but most issuance and liquidity     ship passes by transfer being recorded in
                       is in the two to ten year range. Origi-      a register). Historically, most issues of           Programme platforms have considerable
                       nally, the international bond markets        commercial paper, bonds and MTNs in                 documentation, cost and timing advan-
                       were dominated by highly rated sover-        the European debt capital markets have              tages over the once more common
                       eign, state agency, supranational, bank      been in bearer form, largely because:               “stand-alone” issuance process, which re-
                       and multinational corporate issuers, but                                                         quires an issuer to agree and execute a
                       today a broad range of issuers access the    • English law was traditionally the gov-            specific set of documents each time it pub-
                       markets. Bonds create medium to long           erning law of choice for most issues              licly issues bonds. For regular issuers, this
                       term obligations and contain a custom-         and historically there were a number              is an inefficient and costly use of lawyers
   22                  ary combination of investor protective         of potential legal and tax impedi-                and other professional advisers, resulting

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Key documents
Agency agreement.              The agreement between the issuer and the fiscal/paying agents (see Glossary) setting out the agents’ re-
                               sponsibilities for the payment of principal and interest to noteholders. For issues using a trust structure,
                               only paying agents are appointed.

Agreement among managers.      The standard form agreement between the managers, detailing joint and several liability for the subscription
                               of the notes.

Closing certificate.           A certificate to be given by the issuer (or any guarantor) on the closing date. This certificate, which is always
                               a condition precedent to closing, states that the representations and warranties in the subscription agree-
                               ment (see below) (dated on the signing date) are true, accurate and correct in all material aspects on the
                               closing date, and that the issuer has performed all of its obligations under the subscription agreement to be

                                                                                                                                                    PLC September 2005
                               performed on or before the date of closing.

Comfort letter.                A letter given by the issuer’s auditors to the managers/dealers as part of the due diligence process, confirm-
                               ing (among other things) that any financial information included in the relevant offering document or
                               prospectus has been correctly extracted from the issuer’s latest audited financial statements; that all finan-
                               cial information has been properly computed; and usually, that there has been no significant change to such
                               information since the date of its publication.

Cross receipt.                 The receipt signed by the issuer and the managers whereby the issuer acknowledges receipt of the subscrip-
                               tion monies and the managers acknowledge receipt of their interests in the global notes.

Dealer agreement.              The agreement between the dealers under a programme and the issuer, defining the conditions under which
                               the issuer agrees to issue and each dealer agrees to purchase and underwrite notes. The umbrella frame-
                               work of the dealer agreement contains, among other provisions, the representations, warranties and under-
                               takings given by the issuer to the dealers, the conditions precedent to the establishment of the programme
                               and issuance of notes, as well as contractual restrictions limiting the sale of notes in specified jurisdictions.
                               The dealer agreement contains no commitment by the dealers to buy bonds, which are issued and pur-
                               chased on an ad hoc basis.

Global notes.                  The single bearer or registered instrument representing an entire issue of notes while such notes are held by
                               the common depositary for the clearing systems. The global note becomes “live” when authenticated on the
                               closing date and delivered to the common depositary.

Invitation telex.              The telex or e-mail to prospective syndicate members (managers) from the arranger describing a note issue
                               and its terms, and inviting such persons to participate in the underwriting of the issue.

Mandate letter.                The agreement between the issuer and the arranger confirming the latter’s appointment and its role in rela-
                               tion to the proposed note issue. The letter usually sets out the principal details of the proposed note issue,
                               the fees which are to be paid to the arranger on closing and possibly also the terms governing the relationship
                               between the issuer and the arranger.

Offering document.             The document containing, among other things, disclosure relating to the issuer (including business and fi-
                               nancial information), the terms and conditions of the notes, the salient financial terms of disclosure relevant
                               to the issue and a description of the managers’ selling restrictions; and which constitutes (either on its own or
                               together, in the case of a programme, with certain other prescribed documents) the “prospectus” required for
                               an admission of the notes to trading on a regulated market in the EEA or an offer to the public, in each case as
                               required by the Prospectus Directive (2003/71/EC). The offering document does not constitute a contract.

Pricing supplement/
securities note/final terms.   The document which, for an issue under a medium term note programme, sets out the final commercial
                               terms of the notes which are to be issued. The relevant document is read together with the “master” terms
                               and conditions set out in the “base” prospectus or other offering document.

Signing and closing agendas.   The traditional aide memoire agendas setting out the list of actions required at signing and closing and
                               scheduling the required paper trail of authorisations and instructions.

Subscription agreement.        The agreement between the issuer and the managers executed on the signing date under which the man-
                               agers agree to purchase the notes and the issuer agrees to issue the notes. A pro forma subscription agree-
                               ment will usually be scheduled to the dealer agreement agreed on the establishment of a medium term note

Trust deed.                    The contract between the issuer and the trustee by which the notes are constituted. It sets out at length the
                               rights and duties of the trustee and a direct covenant by the issuer to pay principal and interest to the trustee.


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                       in bulky documents and substantial legal

                       and printing bills for each issue. Conse-         Issuing MTNs
                       quently, for plain vanilla debt issues by
                       regular issuers, the stand-alone issue            Assuming an issuer wishes to carry out a syndicated issue under a medium term note
                       process is now rarely used.                       (MTN) programme and apply for the notes to be admitted to the Official List of the UK
                                                                         Listing Authority (UKLA) and to be admitted to trading on the London Stock Exchange
                       Programme platforms are not, however,             plc’s Gilt Edged and Fixed Income Market (see “Listing” in the main text), the princi-
                       suitable for more complex and intensely           pal steps are as follows:
                       negotiated products such as convertible,
                       exchangeable or high yield bonds (for             Award of mandate. An agreement is reached between the issuer and the relevant man-
                       background, see feature article “High             ager(s) (see Glossary) mandated to act as lead manager(s) in relation to a proposed is-
                       yield bond issues: raising the stakes”,           sue of notes. The terms of the mandate may be set out in a mandate letter.
PLC September 2005

                       Invariably these are still issued on an in-       Launch. The principal terms of the proposed note issue (including any negotiated
                       dividually tailored, stand-alone basis.           terms of the notes, pricing details and details of managers’ fees) are evidenced by the
                                                                         invitation telex on or immediately following launch date, the terms of which are ac-
                       The issue process                                 cepted by each manager in the underwriting group. The terms of the invitation telex
                       The issue process for MTNs is more                will include the agreement among managers.

                       user-friendly than that for stand-alone
                       bond issues, using an existing pro-               Instructions to agents. The terms of the issue are promptly confirmed by the managers
                       gramme platform and current disclosure            and the issuer to the fiscal and paying agent, so that the agents can take all steps nec-
                       documents put in place when the pro-              essary (in accordance with their responsibilities under the agency agreement) to pre-
                       gramme was established or most re-                pare for the issue of, and receipt of payment in respect of, the notes.
                       cently updated (see box “Issuing
                       MTNs”). The procedure for an issue of             Signing. The subscription agreement is executed by the issuer and the managers (who
                       notes under a programme (also known               will either be permanent dealers appointed under the programme dealer agreement or
                       as a “take-down” or trade) will be set out        will be appointed as programme dealers in respect of this issue only), and the docu-
                       in the programme documents. A syndi-              ment setting out the final terms of the notes (known as the pricing supplement, securi-
                       cated trade (where the issue is subscribed        ties note or “final terms” document) (pricing supplement) is finalised and executed by
                       for by more than one dealer) involves             the issuer.
                       more procedures and documents than a
                       non-syndicated trade, but is still reason-        Application for “listing”. The pricing supplement is submitted to the UKLA.
                       ably straightforward because the main
                       documents governing the notes are                 Delivery of conditions precedent. The conditions precedent to the issue, commonly
                       agreed and signed when the programme              corporate resolutions and approvals, legal opinions, auditor’s comfort letters and clos-
                       is established, leaving a minimum of key          ing certificates, are issued.
                       points (such as final, pricing information
                       and key commercial terms of the issue in          Closing. The purchase price is paid by the managers and global notes are authenti-
                       question) to be documented and agreed             cated (by the fiscal agent) and issued (see “Clearing and settlement” in the main text).
                       at the issue stage.                               The cross receipt evidences these final steps (closing of the issue).

                       Trustee or fiscal agent?                          Confirmation of listing. The UKLA confirms listing of the notes.
                       MTN programmes and stand-alone
                       bond issues can be structured using ei-
                       ther a trustee or a fiscal agent. Most
                       plain vanilla note issues use a fiscal agent   Where there is a trustee, the trustee may           without qualification. Where a trustee
                       structure, whereas highly structured or        exercise the noteholders’ rights on their           structure is used, individual noteholders
                       secured issues always use a trustee struc-     behalf and will have certain duties and             effectively cede their individual rights as
                       ture. Due to their straightforward, short      responsibilities under the express terms            creditors to the trustee to conduct pro-
                       term nature, commercial paper pro-             of the trust deed as well as the general            ceedings on their collective behalf.
                       grammes invariably use a fiscal agent          provisions of English law relating to
                       structure. The fundamental difference          trusts and trustees. A fiscal agent has a           Listing
                       between a trustee structure and a fiscal       more contractually determined role and              The Prospectus Directive is now the dri-
                       agent structure is that the trustee is the     is little more than an administrative               ving force behind disclosure require-
                       representative of the noteholders,             agent. Crucially, where a fiscal agency             ments in the European debt capital mar-
                       whereas a fiscal agent is the agent of the     structure is used, noteholders may exer-            kets. Since its coming into force on 1 July
   24                  issuer.                                        cise their rights as creditors individually         2005, a person offering notes to the pub-

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lic in the EEA or making an application

for notes to be admitted to trading on a         Bond ratings
regulated market in the EEA, must pro-           Bonds and notes will generally be rated by one of the three leading international rating
duce a prospectus complying with the re-         agencies (Fitch Ratings, Moody’s Investors Service and Standard & Poors Corporation
quirements of the Prospectus Directive           (S&P)) to provide investors with an indication of the issuer’s creditworthiness and the
(Article 3, Prospectus Directive) (see           corresponding level of risk involved in holding such an investment. The different “grades”
PLC Opinion “Debt issues: will the new           awarded by these rating agencies are as follows:
EU listing regime scare away the pun-
ters?”,              Moody's                Fitch and S&P        Interpretation
6689).                                           Investment
An “offer to the public” of notes means

                                                                                                                                                  PLC September 2005
                                                 Aaa                    AAA                  Highest quality
that the issuer (or, in certain circum-
stances, a person other than the issuer)         Aa1                    AA+
makes a communication to persons in              Aa2                    AA                   High quality
                                                 Aa3                    AA-
any form and by any means, presenting
sufficient information on the terms of           A1                     A+
the offer and the notes to be offered, so as     A2                     A                    Strong payment capacity

to enable an investor to decide to pur-          A3                     A-
chase or subscribe for such notes (Article       Baa1                   BBB+
2(1)(d), Prospectus Directive). There are        Baa2                   BBB                  Adequate payment capacity
various exemptions from the very broad           Baa3                   BBB-
scope of these requirements, most no-            Non-Investment
tably exemptions for offers of notes with        Grade
minimum denominations of €50,000 (or
                                                 Ba1                    BB+
its equivalent) and offers to less than 100
                                                 Ba2                    BB                   Likely to fulfill obligations; ongoing uncertainty
natural or legal persons in any EU mem-          Ba3                    BB-
ber state (Article 3(2), Prospectus Direc-
tive).                                           B1                     B+
                                                 B2                     B                    High risk obligations
                                                 B3                     B-
Notes will be “admitted to trading on a
regulated market” for the purposes of            Various C/D gradings                        Vulnerable to default through to default
the Prospectus Directive if the issuer (or,
in certain circumstances, a person other        investment than unlisted debt securities.          to be sold only to professional investors
than the issuer) makes an application for       A further driver is that, in some jurisdic-        and fall within an exemption so as not
the notes to be admitted to trading on or       tions, issuers of listed notes may benefit         to constitute an offer to the public. It
by one of a specified list of European          from certain exemptions from tax re-               remains to be seen whether listings on
stock exchanges or securities markets.          quirements.                                        such exchange regulated markets will
This is commonly referred to as a “list-                                                           prove to be acceptable to, or popular
ing” and is different to the listing nor-       Since the introduction of the Prospec-             with, investors and, in particular,
mally associated with shares. Debt secu-        tus Directive, a “listing” for notes effec-        whether such listings will be sufficient
rities are not usually traded “on-mar-          tively means that a prospectus comply-             to satisfy any applicable internal or ex-
ket”, but rather are traded “over-the-          ing with the detailed disclosure and for-          ternal prudential guidelines.
counter” or “off-market” by profes-             mat requirements of the Prospectus
sional investors. Notes traditionally           Directive must be produced by the is-              Issues of commercial paper are rarely
have the benefit of a listing on or by the      suer and approved by the appropriate               listed as there is no real investor demand.
London Stock Exchange or the Luxem-             regulatory authority. Given the oner-              In addition, commercial paper falls out-
bourg Stock Exchange because most in-           ous disclosure requirements of the                 side the new Prospectus Directive regime
stitutional investors in Europe are sub-        Prospectus Directive and the Trans-                (Article 2(1)(a), Prospectus Directive).
ject to internal and external regulatory        parency Directive, certain European
or prudential guidelines requiring that a       stock exchanges (including London                  Rating agencies
minimum percentage of debt instru-              and Luxembourg) have established                   At the most basic level, ratings guide is-
ments held by them as assets are listed.        “exchange regulated” markets which                 suers, arrangers and investors in pricing
The rationale for this is that listed notes     permit “listings” of notes under re-               bonds. Rating agencies assign a “grade”
must satisfy certain admissibility and          duced disclosure regimes (essentially,             to an issuer, which indicates the relevant
disclosure standards and they are there-        the pre-Prospectus Directive regime in             agency’s views of the likelihood of the is-
fore considered to be an inherently safer       each jurisdiction) where the notes are             suer defaulting on repayment.                  25

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                       Most issues of debt instruments in the

                       European debt capital markets will be            How do the clearing systems work?
                       rated by at least one of the three leading
                       rating agencies: Fitch Ratings, Moody’s                                               Global note
                       Investors Service and Standard & Poors                      Issuer                representing bonds              Common depositary for
                       Corporation. Ratings are important for
                       a number of reasons:
                                                                                                                            Depositary agreement
                                                                              Cash       (2)                               relating to global note
                       • Many institutional investors are sub-                                                            representing note issue
                         ject to internal or external investment
                         criteria, including relating to ratings.                                                                        Euroclear/Clearstream
                                                                               Managers (3)
                         The investor universe available to an                                           Payment, trading
PLC September 2005

                                                                                                         and settlement of
                         issuer will be substantially reduced in                                         bonds
                         respect of notes which do not carry                  Cash       (1)                                                          (4)
                         an “investment grade” rating of
                         BBB/Baa or above (see box “Bond rat-
                         ings”).                                                                                  (4)                    Euroclear/Clearstream
                                                                                                                                           account holders

                       • Superior ratings help an issuer to re-
                         duce its cost of funding.
                                                                         (1) Managers accept funds from investors through the clearing systems.
                       • The display of a rating is often seen as        (2) Managers pay these funds to the issuer against receipt by the common depositary
                         a sign of confidence and trans-                      of an executed and authenticated global note.
                         parency, and therefore is a useful              (3) All managers will be account holders in the clearing systems.
                         marketing tool for issuers.                     (4) Investors either hold interests in the notes directly as account holders or hold their
                                                                              notes via intermediary institutions who are account holders.
                       A recent example of the significant role of
                       the ratings process can be seen in the re-
                       view in June 2005 by Moody’s Investors        counter” directly between counterpar-               • To facilitate trading of the notes be-
                       Services of the default risk of govern-       ties. These trades then settle (usually               tween investors through Euroclear
                       ment-related issuers in Europe. This re-      with delivery of the bonds against pay-               and Clearstream.
                       view led to ratings upgrades of more than     ment received) through the independent
                       40 companies that are partially or wholly     clearing systems.                                   On the closing of a standard note issue, a
                       state owned, including France Telecom,                                                            “temporary” global note and a “perma-
                       Deutsche Telekom and Thales. Ratings          The key to understanding the role of                nent” global note will be delivered to a
                       upgrades boosted the price of these is-       these clearing systems’ function is the use         common depositary on behalf of Euro-
                       suers’ existing bonds and should reduce       of “global” notes.                                  clear and Clearstream. These clearing
                       their cost of funding going forward. A                                                            systems will then credit the securities ac-
                       less propitious example is that of General    Global notes                                        counts of each account holder with inter-
                       Motors, which was recently downgraded         Global notes are simple documents                   ests in the temporary global note equal to
                       to non-investment grade, with signifi-        which set out certain basic provisions,             the amount of their respective invest-
                       cant consequences for its fund raising.       attach the agreed terms and conditions              ments. Accordingly, investors must ei-
                                                                     for the issue of notes and represent the            ther be, or hold notes through, an ac-
                       CLEARING AND SETTLEMENT                       entire aggregate principal amount of the            count holder in the clearing systems (see
                       The bedrock of the present day European       notes being issued. There are three prin-           box “How do the clearing systems
                       debt capital markets is the low profile       cipal reasons for the use of global notes:          work?”). On certification by investors as
                       (and frequently misunderstood) auto-                                                              to certain standard US tax requirements,
                       mated, mechanical and operational role        • To save costs (the costs involved in              the temporary global note will be ex-
                       played by the two major international           printing individual definitive notes,             changed for and replaced by the perma-
                       clearing systems in Europe: Euroclear           with their standard security features,            nent global note, which will thereafter
                       (based in Brussels) and Clearstream             is substantial).                                  represent the entire issue of notes
                       (based in Luxembourg). Nearly all debt                                                            through to maturity. In turn, the perma-
                       capital markets payments, trading, clear-     • To help ensure compliance with US                 nent global note will itself usually be ex-
                       ing and settlement are through these            tax and securities laws of extra-terri-           changeable for individual, definitive
                       clearing systems. In contrast to listed eq-     torial application during the initial             notes in certain limited circumstances
                       uities (which are stock exchange traded),       distribution of the issue (see “US secu-          such as closure of the clearing systems or
   26                  trading in notes is conducted “over-the-        rities laws” below).                              default by the issuer.

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For commercial paper and MTN pro-              • Representations and warranties to be             wise be imposed on the underwriters of

grammes, forms of “master” global                given by the issuer.                             an issue of securities, where such under-
notes will normally be executed by the is-                                                        writers have taken sufficient steps to ver-
suer on the establishment of the pro-          • Events of default.                               ify the information in the offering docu-
gramme and given to the fiscal agent or,                                                          ments.
where a trustee structure is used, the         • Key commercial covenants, such as
principal paying agent for safe keeping.         negative pledge provisions.                      The legal status of due diligence in the
This helps to ensure swift execution and                                                          European debt capital markets is less
settlement of issues of notes. When the        • Indemnification provisions (and any              clearly defined. However, due diligence
issuer chooses to issue a series of notes,       carve-outs).                                     is still an important tool for the under-
the fiscal agent, or principal paying                                                             writers in controlling their liability risk
agent, will retrieve the “master” global       • Fees and expenses to be paid by the              in connection with underwriting an issue

                                                                                                                                                 PLC September 2005
note from its vaults, photocopy it, com-         arranger and the issuer respectively.            of securities. There is no set standard
plete the relevant missing information to                                                         level of, or procedures for, due diligence
represent the particular terms of the          • The need for, and extent of, due dili-           enquiries that are or should be under-
notes to be issued (by attaching the re-         gence (see “Due diligence” below).               taken in relation to issuers in the Euro-
lated pricing supplement), authenticate                                                           pean debt capital markets. On the con-
it and “deliver” the now completed             If the issuer wishes to use other debt se-         trary, the International Capital Markets

global note to itself in its capacity as       curities issued by it (or any other group          Association’s guidance on due diligence
common depositary.                             company) as the basis or precedent on              expressly recognises the impossibility of
                                               which the documents and commercial                 prescribing particular procedures. Es-
CONSIDERATIONS FOR NEW                         terms for the issue are to be based, this          sentially the level of due diligence to be
ISSUERS                                        should be made clear to all parties as             carried out for any particular issuer is a
A new issuer will also have to consider        soon in the process as practicable.                matter for arrangers to determine, de-
the following:                                                                                    pending on the type of notes to be issued,
                                                                                                  the rights attaching to those notes and
Negotiation of commercial points                                                                  the nature of the issuer and its business.
As mentioned above, the documents for                                                             Given recent corporate scandals (such as
issues of debt capital markets products                                                           Worldcom and Parmalat), increased fo-
are relatively standard, so the process of                                                        cus is being directed to the due diligence
negotiating the relevant contractual doc-                                                         process undertaken in relation to all debt
uments (and, if necessary, any disclosure                                                         securities issues, both in the US and in the
document such as a prospectus) should                                                             European debt capital markets.
be relatively painless. However, this is
rarely the case.                                                                                  The arranger will, by means of the due
                                                                                                  diligence process, seek to confirm that
Considerable time and effort (and as a                                                            the information given by the issuer in the
result, cost) is often expended negotiat-                                                         offering document is correct, that there
ing contractual documents. In many                                                                are no material omissions from such in-
cases, this can be substantially reduced                                                          formation and that there are no potential
by focusing in a timely fashion on key                                                            developments affecting the issuer which
commercial provisions. The best time                                                              should be disclosed to investors. As a
for issuers to negotiate such points will                                                         general rule, offering documents should
most often be at the time of negotiating                                                          omit projections of future business activ-
the mandate letter under which the                                                                ities or profits because of the difficulties
arranger(s) are appointed. This means                                                             of verifying such information and the as-
that such issues are agreed at the outset,                                                        sumptions on which such projections are
minimising the scope for subsequent                                                               based.
protracted negotiation. It is also the         Due diligence
stage in the issue process at which issuers    In most circumstances, the arranger will           In order to perform due diligence prop-
have the greatest commercial leverage.         wish to conduct some form of due dili-             erly it will often be prudent (other than in
                                               gence before launch of the issue, during           the case of issues by well established and
Negotiations and commercial discus-            which the arranger verifies the informa-           highly rated issuers) for the arranger to
sions invariably relate to a limited num-      tion contained in the offering document.           visit the issuer and have formal meetings
ber of key provisions which issuers            This practice arose in the US as a result of       with its senior officers and external audi-
should consider in detail at the mandate       US securities legislation which provides           tors. For most plain vanilla issues by reg-
stage:                                         a defence to liability which would other-          ular issuers, such enquiries may take the      27

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                                                                                                                         form of conference calls with analysts

                       Glossary                                                                                          running through a series of pre-prepared
                                                                                                                         and pre-agreed “big-picture” questions.
                       Account holders. Investors (usually institutions) which have their own accounts in the
                       clearing systems to facilitate the purchase, sale, trading and settlement of securities.          Any due diligence process invariably re-
                                                                                                                         sults in considerable work for the issuer
                       Arranger. The investment bank mandated by the issuer to arrange, oversee, document                and its officers. Establishing at an early
                       and close (that is, arrange for the actual issue of and payment in respect of) the rele-          date the extent and depth of any due dili-
                       vant issue of notes.                                                                              gence process (such as the areas to be
                                                                                                                         covered and the documents to be re-
                       Common depositary. The financial institution which holds the global note represent-               viewed) is essential, as is ensuring that
                       ing an issue of notes under a depositary agreement with the clearing systems. Invari-             adequate confidentiality arrangements
PLC September 2005

                       ably the common depositary is the fiscal agent or principal paying agent on any issue of          are in place. This should be of particular
                       notes, albeit in a different contractual capacity.                                                concern for issuers that have equity secu-
                                                                                                                         rities listed on any stock exchange.
                       Dealers/managers/underwriters. The investment banks mandated by the issuer in re-
                       spect of a programme (permanent dealers) or a particular issue of notes (managers or              Disclosure
                       underwriters), to manage and underwrite (on a joint and several basis) the issue of               It is essential that issuers bear in mind

                       notes. They commonly sell the notes to investors on the same day.                                 that the offering document is principally
                                                                                                                         a legal and regulatory disclosure
                       Events of default. Events which trigger rights for holders of notes to seek immediate re-         document, not a marketing document.
                       payment. They usually cover critical events such as non-payment of interest, cross de-            Hyperbole must be eschewed.
                       fault, insolvency events and change of control of the issuer.
                                                                                                                         The content of the offering document
                       Fiscal agent. The bank which handles administrative matters for an issuer, including              will be driven by general legal require-
                       issuing and redeeming notes and handling payments due on the notes.                               ments and, if applicable, the require-
                                                                                                                         ments of the Prospectus Directive and
                       Investors. Pension funds, insurance companies, dedicated bond funds, major corpo-                 the relevant competent authority ap-
                       rate treasury groups, hedge funds and other professional or institutional investors and,          proving the offering document. The of-
                       increasingly, individual non-professional (retail) investors.                                     fering document will include a descrip-
                                                                                                                         tion of the issuer’s (and, if applicable,
                       Liquid market. A market in which assets can be converted easily back into readily                 any guarantor’s) business and opera-
                       available cash or, in relation to a particular security, a market which can absorb a rea-         tions and will also provide, or incorpo-
                       sonable amount of buying or selling of that security at reasonable price changes.                 rate by reference, certain financial infor-
                       Negative pledge. A covenant given by the issuer which restricts the right, and usually
                       the right of subsidiaries, to incur secured indebtedness (which would reduce the mar-             Considerable care should be taken to en-
                       ket value of the existing unsecured debt securities). Permitted carve-outs from this              sure not only the accuracy and suffi-
                       general restriction are often heavily negotiated.                                                 ciency of any such information, but also
                                                                                                                         that the extent of information provided
                       Paying agents. The banks appointed by the issuer to ensure timely payments of inter-              is appropriate for the type of issuer, its
                       est and principal on its notes. There will normally be a “principal” paying agent and a           market position and creditworthiness
                       number of other paying agents (including covering any jurisdiction in which the notes             (the weaker the credit worthiness of the
                       are “listed”).                                                                                    issuer, the greater the amount of disclo-
                       Plain vanilla debt. Debt securities of the most straightforward kind, paying simple,
                       regular interest amounts and which do not contain any complicating features such as               New issuers in particular should reflect
                       conversion rights or complex financial and/or negative covenant packages.                         carefully on the level and detail of disclo-
                                                                                                                         sure they intend to provide. Such disclo-
                       Regulated market. A market for securities which appears in the list of regulated markets          sure will set a precedent for their future
                       drawn up by the European Commission and, where notes are to be admitted to trading on             debt capital markets financings.
                       such regulated market, which will require the preparation and approval of a prospectus.
                                                                                                                         US securities laws
                       Trustee. A professional trust corporation or a major commercial bank providing trustee            The extra-territorial application of cer-
                       services (usually through a specified subsidiary that is a trust corporation).                    tain US securities laws, in particular, the
                                                                                                                         Securities Act of 1933 (US Securities
   28                                                                                                                    Act), means that some consideration will

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need to be given to the application of US

securities laws in relation to issues of         Related information
debt capital markets products.
                                                 Links from and the web
In summary, most issues of notes in the          This article is at
European debt capital markets are is-
sued and offered to investors in compli-         Topic
                                                 Debt capital markets                       
ance with the requirements of Regula-
tion S under the US Securities Act. This
                                                 Practice note
means that the notes are issued in an
                                                 Convertible and exchangeable bonds                    www.practicallaw.com2-107-3971
“offshore transaction” where there is no
direct selling of the notes in the US to US

                                                                                                                                              PLC September 2005
                                                 Previous articles
investors, thereby ensuring that the
                                                 Listing and prospectus rules:
notes have the benefit of a “safe har-           a guide to the new regime (2005)           
bour” under the US Securities Act. This          Debt issues: will the new EU listing regime
means that the complex registration re-          scare away the punters? (2005)             
quirements of the US Securities Act do           Transparency Directive: improved investor
not apply.                                       information or over-regulation? (2003)     

                                                 High yield bond issues:
However, historically, the depth and liq-        raising the stakes (2003)                  
uidity of the US capital markets was sub-
stantially greater than that for the inter-      Weblink
national markets. Non-US issuers often           International Capital Markets Association                   
needed to access US investors in order to
ensure that sufficient investor demand           For subscription enquiries to PLC web materials please call +44 207 202 1200
was available at competitive rates of
                                               volve the use of US-style documents and            The increased costs to issuers of US dis-
Accordingly, from the early 1990s, notes       the inclusion of mechanics facilitating            closure requirements and the provision
were often issued in compliance with           trading of the notes between US holders            of 10b-5 opinions inevitably mean sub-
Rule 144A under the US Securities Act          and non-US holders and between the                 stantially increased costs for issuers.
(Rule 144A) which provides an exemp-           principal US clearing system (The De-              Many issuers now question the desirabil-
tion from the registration requirements        positary Trust Company) and Euroclear              ity of subjecting themselves to the
of the US Securities Act, enabling the         and Clearstream.                                   rigours of the US securities regime (par-
notes to be sold directly to certain speci-                                                       ticularly following the introduction of
fied types of US institutional investors,      The advent of the euro in 1999 and the             the Sarbanes-Oxley Act in 2002) and the
as well as to non-US investors. Compli-        resulting increase in liquidity in, and            attendant increased regulatory and liti-
ance with Rule 144A requires the provi-        depth of, the European debt capital mar-           gation risks, unless the inclusion of a
sion of additional, extensive disclosure       kets has resulted in less Rule 144A is-            Rule 144A option is essential from a
by the issuer, with a resulting increased      sues. Today, Rule 144A issues are essen-           marketing perspective, or to ensure suf-
need for due diligence by the arranger,        tially limited to very large issues (so-           ficient investor demand.
and also invariably means that the             called “global” bonds) and high-yield
arranger and managers will require the         bonds, in each case where US investor              Michael Doran is a partner, and David
provision of legal opinions covering such      participation is a key factor in ensuring          Howe and Richard Pogrel are associates,
disclosure addressed to them (10b-5            competitive funding rates and investor             in the London office of Gide Loyrette
opinions). Such issues usually also in-        demand.                                            Nouel.

                                                                                                          PRACTICAL LAW COMPANY

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