South African high yield: The new structure that could revolutionise the market

Author: Gemma Varriale | Published: 8 Jun 2012
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A landmark high yield offering with a South African exterior, but New York law interior, could set a structural template for other African countries, lawyers in the region claim.

The as-yet untested structure consists of a euro- or US dollar-denominated offshore tranche and a South African Rand-denominated onshore tranche.

Both tranches have the same covenants, the same events of default and the same definitions. But provisions have been inserted into the issue’s governing documents to establish New York law, and not South African law, as the governing law for the purposes of interpretation of the covenants and anything related to it.

Speaking at IFLR’s inaugural Africa forum last week, Mark Bergman of Paul, Weiss, Rifkind, Wharton & Garrison believed such a structure would work well.

US Bank Global Corporate Trust Services’ Europe chief counsel, Edmond Leedham, said the expectation was that South African courts would give effect to the New York law covenant package under prevailing conflict of law rules.

And that if a South African court faces a particular issue of interpretation, then South Africa will accept in effect a memorandum of law as to what the outcome would have been in a New York court

Begman said the application of two sets of law, would necessitate two telephone calls for approvals, thereby increasing the likelihood of inconsistent answers. Such a concern is magnified in a jurisdiction that isn’t familiar with some of these concepts and doesn’t have a history of adjudicating these types of issues.

The panelists said the structure had already worked well in one bond issuance by an Indian company. The private deal had a rupee tranche on which the holders were represented by local Indian trustee, and a US dollar tranche on which the holders were represented by an English law trustee operating out of London.

For the South African transaction, the instrument would be treated as a single tranche of debt notwithstanding the fact that it was issued in two different markets with two different sets of investors.

"We have tried to reduce the friction between onshore and offshore and at the same time create something that’s really one package so voting is done on a collective basis" said Bergman.

Issuing an instrument in dollars and euros with the same covenant package governed by New York law, eliminates concerns about arbitrage or differences in interpretation.

The structure also allows the issuer to naturally hedge foreign exchange exposure by having a local obligation as opposed to an offshore obligation.

"This is important because the rand/dollar and the rand/euro has significant volatility, and there’s no reason to think that will change going forward" said Bergman.

South African issues are typically covenant light. Leedham said an investment grade issuer that issues debt to the markets rarely goes back to its indenture to decide if they can or can’t do something because there are virtually no covenants. "There might be a negative pledge, or some restrictions, but that’s all," he said.

In contrast, a New York law-governed high yield package will have around 42 pages of documentation restricting a variety of actions.

But there are several things to watch out for. To Leedham, sufficient clarity on how bondholders are meant to instruct the trustees is a particular concern. It is important to establish, for instance, whether the votes of holders of the two tranches are to be aggregated together or the matter be passed by a majority of holders of both tranches voting separately. Where relevant, he said it was also important to establish if there was sufficient clarity on the exchange rate mechanism used to determine voting proportions.

The fundamentals that have to be in place for the model to work are a certain degree of sophistication in the markets, and a pre-existing infrastructure and legal certainty.

A very different market

The general perception of sub-Saharan Africa capital markets in is that there are problems of disclosure, uncertainty with respect to local law, uneven precedents and general transparency issues. But South Africa is very different, said Bergman.

This is partly because historical factors have enabled local banks to develop without external competition, establishing a vibrant local banking market. There are also private equity players that have done a variety of leveraged acquisitions, with financing that has been a combination of bank debt and high yield debt.

"The South African banks have managed to generally insulate themselves from a number of the pressures that banks elsewhere have faced because of the various economic crises," said Bergman. " South Africa is well-positioned to provide local financing alternatives to those of us trying to provide offshore solutions ."