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CERCA ARTICOLI:

Exchangeable Bonds (le obbligazioni convertibili)

Di Nicola Grieco, avvocato.

12 gennaio 2004

 
1. Introduction
 
 
Exchangeable bonds are a form of equity linked note, whereby equities are strictly linked with the bond issue.
A bond will constitute an exchangeable bond if it grants the holder the right to exchange the bond into equity securities of a company other than the issuer.
In the market there is another category of bonds ( convertible bonds) that  grant the bondholder similar rights, except that there is a specific difference between convertible and exchangeable bonds.
A bond is convertible, infact, if it converts into equities of the same company i.e. the issuer.
The appeal of convertible and exchangeable bonds is that they give the bondholders the chance to benefit from any increase in the value of the equity linked to the bonds.
Turning back to the exchangeable bonds, this brief note describes the relevant parties, the relevant agreements and summarises broadly the key features of exchangeable bonds.
 
2. Relevant Parties
 
The relevant parties in an exchangeable bond offering are: an issuer, a guarantor (if any), a bookrunner / lead manager, co-lead managers ( if any), a listing agent, paying agents, and typically a trustee, rather than a fiscal agent.
The role of the issuer, the guarantor and the bookrunner / lead manager is outlined in this section.
 
The issuer could be either a holding company, an operating company  or a special purpose vehicle ( SPV).
Whether the issuer is a holding company, an operating company or an SPV depends on the market and more specifically upon the business advantages for the issuer, for example in respect of tax treatment.
The issuer can be either a limited company or a public limited company, depending upon the jurisdiction of incoporation of the issuer, and the location of the stock exchange where a listing is sought.
If an SPV is particularly favoured, typically a full guarantee will be required to be given by a company of substance or a third party in favour of the SPV.
The Issuer in any case will remain prima facie solely responsible for the payments on the exchangeable bonds during the life of the latter.
The issuer, moreover, is of course party to all the agreements creating the exchangeable bonds.
 
A guarantor of exchangeable bonds could be either a company of the same group as the issuer or a third party.
The request for a full guarantee is market practice where credit support is desired for the issuer of the exchangeable bonds i.e. to provide for the extension of the liability to the guarantor for the obligations arising under the exchangeable bonds.
A guarantee broadly represents an undertaking by one party to be answerable for the debts of another.
The guarantor could have several, or joint, liability with the issuer or joint and several liability with the issuer.
In general, it will depend on the nature of the transaction, but the practice is typically that there is joint liability particularly if the guarantor is a company of the same group i.e. a parent company giving a guarantee in favour of an SPV or a wholly owned subsidiary of the same group.
The request for a guarantor to guarantee the exchangeable bonds will also depend upon the rating of the issuer.
The rating[1]of the guarantor is key to the rating that will be given to the issue of the exchangeable bonds, as a consequence it is generally very high, provided that the guarantor's rating is also high.
The success of a transaction, therefore depends on many factors including the quality of the assigned rating to each exchangeable bond transaction.
 
The role of a bookrunner / manager is twofold.
Firstly a single Bookrunner or Joint Bookrunners will be primarly responsible for the distribution of the exchangeable bonds i.e. to procure subscribers for the exchangeable bonds in the market.
Secondly, their importance as a manager is particularly relevant for the preparation of all the relevant documentation i.e. the term sheet and the underlying agreements, the structuring of the exchangeable bond transaction and its launch and offering, including any roadshows.
The term sheet[2] ( duly agreed by all the relevant parties) contains the summary of the details of each an exchangeable bond transaction.
The term sheet is used in the market particularly for the first valuation of the opportunity of a transaction.
 
 
3. Relevant Agreements
 
The relevant agreements in an exchangeable bond transaction are: the offering circular, the terms and conditions of the bonds, the subscription agreement, the lock up agreement ( if any) and other technical agreements (such as the trust deed, the agency agreement, the agreement among the managers, including bookrunners).
This section underlines the content of each of the offering circular, the terms and conditions of the exchangeable bonds and the subscription agreement.
 
The offering circular, or prospectus or offering memorandum, contains all the information on the issuer and the guarantor (if any), the exchangeable bonds and the equities linked thereto and is prepared in connection with the issue and the offering of an exchangeable  bonds.
It provides all the financial information (including the audited financial statements[3]) and at the same time the business description (the composition and a detailed description of the group and its management) for both the issuer and any guarantor.
The content of the information contained in the prospectus is particularly important because each of the issuer and the guarantor will be solely liable for the disclosure made in it.
This information is relevant for the potential investors because they can assume that the information contained in the prospectus is true, not misleading, accurate and complete in all material respects.
 
The terms and conditions of the exchangeable bonds describe in detail all the relevant technical information (e.g. form, denomination, subordination and security including any guarantees, exchange rights, anti-dilution protection, any limitation on capital distributions and dividends, early redemption rights, events of default and offers and any premium compensation payments to be made in connection with takeovers) for the exchangeable bonds.
The terms and conditions are included in the prospectus and will reflect the actual terms and conditions of the issue of the exchangeable bonds.
 
From a bondholder’s point of view, it is particularly relevant to check the provisions related to the exchange right for the exchangeable bonds, e.g. the period in which the bonds can be exchanged, and the procedure for doing so.
Each bondholder can typically exchange his bonds for a pro rata share of the exchange property at any time during a specified exchange period.
The terms and conditions will set out the formalities to be followed by each a bondholder to exchange his bonds for the pro rata share of the exchange property, which may be, in certain circumstances, cash.
To facilitate exchanges of the exchangeable bonds is one of the primary roles of the Paying and Exchange Agent, the other being the distribution of payments of interest and redemption moneys on the exchangeable bonds, if any.
Events of default applicable to the exchangeable bonds typically include that there is no cross default on other financing, no material litigation, no adverse tax change, no change in the status of any guarantee and no bankruptcy of the issuer or the guarantor during the life of the exchangeable bonds.
The terms and conditions will also set out any early redemption option exercisable by the issuer or the bondholders.
Issuers often have the right to redeem the bonds on the occurrence of certain events prior to their maturity date.
The terms and conditions, finally, will also provide general undertakings made by the issuer and the guarantor, if any, and the mechanics in case of any breach thereof.
 
The subscription agreement contains the agreement by the managers to subscribe for the exchangeable bonds and the agreement of the issuer to issue the bonds.
The issuer and the guarantor will undertake to the managers to issue the exchangeable bonds pursuant to the provisions of the subscription agreement, in a fixed amount, subject to increase pursuant to the exercise of any over allotment option by the managers, on a predetermined date (Closing Date) against the payment therefore by each of the managers.
Each of the parties will execute all the relevant issue documentation on or before this Closing Date.
Each manager will usually agree on a several, but not joint basis [4], to the issuer and the guarantor to procure a subscribers for the bonds and / or failing which itself subscribe and pay for its proportion the aggregate fixed amount of the exchangeable bonds on the Closing Date at the issue price.
 
The subscription agreement is usually signed by the issuer, the guarantor and the bookrunners / managers.
It also specifies in detail all the principal characteristics of an exchangeable bond transaction such as the aggregate principal amount of the exchangeable bonds to be issued, the currency, the relevant stock exchange where the exchangeable bonds are expected to be listed (e.g. the Luxembourg Stock Exchange) and any indemnities given by the issuer, the guarantor and / or the managers.
All the relevant parties are expected to assume undertakings, warranties and representations under this agreement.
Furthermore, both the issuer and the guarantor are expected as a minimum to warrant and represent to the managers as to their due incorporation, capacity, authorisation to issue the exchangeable bonds and as to the validity thereof.
Representations and warranties relating to the equities linked to the exchangeable bonds may also be requested, however the giving of such representations and warranties are very controversial during the negotiation of each an exchangeable bond transaction because of the potential liability of the issuer and the guarantor in furnishing it.
An issuer may agree to warrant the accurate extraction and reproduction of the public information contained in the prospectus related to the issuer of the equities linked to the exchangeable bonds and the equities themselves.
The subscription agreement also will include clauses providing that the obligation of the managers to subscribe for the exchangeable bonds will terminate if the representations and warranties given do not remain true and accurate, there is a material adverse change in the status of the issuer and the guarantor or any force majeure (e.g. the imposition of a banking moratorium, an acts of war etc.) occurs between the signing of the subscription agreement and the issue and subscription of the exchangeable bonds.
 
In relation to the equity linked to the exchangeable bonds, both the issuer and the guarantor, if any, will be expected to have full ownership and legal title to the equities delivered upon exchange.
This number of equities expected to be delivered per aggregate principal amount of the exchangeable bonds upon exchange is agreed by all the relevant parties on or prior to the Closing Date.
The managers will also expect to be indemnified, by both the issuer and the guarantor, if any, against any loss, liability, claims, damage arising out of any untrue statement of a material fact contained in the prospectus.
 
 
4. Other characteristics
 
Apart from the principal characteristics of an exchangeable bond transaction as detailed above, it has to be underlined that in general in Europe all the agreements are governed by English law, even though either the issuer or the guarantor could be incoporated in a jurisdiction other than England e.g. Italy.
In the case of an offering involving an Italian issuer or guarantor, however, the approval and the consent of the Bank of Italy in accordance with Article 129 of Decree No. 385 ( as amended from time to time) is required including the implementing instructions of the latter, pursuant to which the issue of exchangeable bonds in Italy is subject to a prior notification to the Local Central Bank.
This approval has to be achieved before the launch of each exchangeable bond transaction.
Moreover, both the issuer and the guarantor are expected to be secure the listing of the exchangeable bonds on the chosen stock exchange on or before the Closing Date.
 
5. Final Considerations
 
The market of the exchangeable bonds is growing in Italy.
The main reason could depend, on the other things, upon the crisis of the traditional equities market.
There are significant and recent examples of this category of bonds in Italy: the issue of bonds exchangeable into Assicurazioni Generali S.p.A shares launched by the Group UniCredito Italiano S.p.A. on December 2003[5].
There are in this regard at least two further recent transactions to be mentioned: the Caixa Finance B.V. bonds exchangeable into ELE shares of EURO 847,600.00 dated July 2003 and  the BMW  Finance NV bonds exchangeable into RR shares of EURO 560,500.00 dated December 2003.
 
In conclusion, it would seem that exchangeable bond transactions are currently highly appreciated in the EuroMarket.

[1] For further deatils about Credit Rating Criteria, please see www.standardandpoors.com, www.moodys.com, www.fitchratings.com
[2] The validity of a term sheet is very controversial, in particular if it is intended to create a legally binding commitment for all the relevant parties of an exchangeable bond transaction. The main solution is that it depends upon the governing law of the document, the terms and conditions inserted and specified and more in general it is a quaestio facti i.e. to be determined case by case.
[3]  It is very usual to list exchangeable bonds, typically on the Luxembourg Stock Exchange. In this case, the Luxembourg listing rules provide that there are to be included in the Prospectus the financial statements of the last three years of the issuer and the guarantor (if any) duly audited and reviewed by an independent professional auditor.
[4] The managers ’ liability could be joint, several or joint and several but is usually several.
[5] The UniCredito’s transaction was launched on 4 December 2003 with a Closing Date on 18 December 2003 .The Issuer was UniCredito Italiano Bank (Ireland) p.l.c.,the Guarantor was UniCredito Italiano S.p.A., the Joint Bookners were Merrill Lynch, MedioBanca, UniCredit Banca Mobiliare S.p.A., Co-Lead Manager Societe Generale. The aggregate principal amount of  this transaction was Euro 1,262,800,000  with a maturity of 5 years. In this transaction, each a bondholder has the right to exchange the bonds into the  Assicurazioni Generali S.p.A. shares at the beginning of the third year of the issue of these Notes.

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