- Keepwell deeds and deeds of
equity interest purchase undertakings have been popular
credit enhancement structures for ChinaCos issuing debt since
Gemdale completed the template deal in October
- The structures are meant to
give investors comfort while mitigating regulatory approvals
required by the PRC to guarantee bonds. It is important to
note that these structures are not equivalent to
- Investors remain concerned
about the enforceability of these deeds in a restructuring
scenario, but these credits remain popular with investors
looking for higher yields and China exposure.
Chinese bond offerings are increasingly incorporating credit
enhancement structures to enable deals to go to market faster.
But investors fear such deals do not offer adequate
compensation for the additional risks involved.
In October Chinese real estate company became the first A-share
company to list a bond without a guarantee by utilising a
keepwell deed and deed of equity interest purchase undertaking
Other Chinese real estate companies have since mirrored the
Gemdale structure to tap the dim sum and US dollar-denominated
bond markets. But as Chinese companies must clear regulatory
hurdles to receive approval to guarantee bonds - most bonds
must be issued through an offshore subsidiary –
usually Cayman incorporated. Investors are thereby structurally
subordinated in a restructuring scenario.
Investors’ scepticism about such subordination is
growing. But the global search for yield may keep them
purchasing these bonds.
Keepwell deeds are intended to give comfort to the investor
that a parent company will support the offshore subsidiary
issuing the bonds. It is a contractual obligation between the
supporting and supported company. It merely suggests
willingness to keep the issuer solvent and is not subject to
approval by mainland authorities.
They are not new structures, and counsel have stressed that
investors are well aware of the difference between a keepwell
deed and a guarantee.
Speaking in relation to Beijing Capital Land’s March offering of
$400 million perpetual bonds with a coupon of 8.375%,
Clifford Chance’s Connie Heng said that a
guarantee as a form of credit enhancement gives the bondholders
a direct claim against the guarantor for the amount of debt
owned under the bonds.
But with a keepwell deed, the issuer’s parent
company undertakes to the trustee of the bonds to ensure that
the issuer stays solvent and has sufficient liquidity. The
parent company also in certain instances undertakes that the
issuer will retain certain financial ratios during the tenor of
This is because the legal nature of the claim that the trustee
has under a keepwell deed is for a breach of contract, which is
different from a debt claim under a guarantee.
"Under PRC law, the keepwell deed – if properly
drafted – does not require PRC regulatory approval as
it is not a guarantee," she added.
If the company fails to fulfill its commitment to maintain
sufficient levels of equity and liquidity to service
obligations to the offshore bondholders, it constitutes an
event of default.
However this is a way for real estate companies to attract
international investors in the debt markets without requiring
extensive Chinese regulatory approvals.
For Chinese companies to guarantee bonds, the
country’s State Administration of Foreign Exchange
(Safe) must approve the notes post-pricing so that the company
can pay interest in principal offshore renminbi during the
tenor of the bonds. This is seen as risky as the bond has
already been priced when it applies for registration.
Although Chinacos such as China Railway Group and Zoomlion
Heavy Industry Science and Technology have applied for and
received guarantees, the approvals are difficult to obtain.
Deed of equity interest purchase
The other structure of interest in the Beijing Capital Land
deal is the EIPU, first used in the RMB bond issue by the
offshore subsidiary of Gemdale Corporation.
"We understand that this technique has previously been used in
direct investments or private equity transactions but not in a
capital markets bond issue," she added.
Deeds of EIPU are increasingly supplementing keepwells, in a
bid to bridge gaps in bond repayment amounts.
Heng explained that under an EIPU the parent company in China
will undertake to buy assets of an offshore
subsidiary’s onshore companies. This creates a
channel for onshore funds to come from the parentco in China.
If there is a default under the bonds, the parent will identify
onshore assets in the form of equity interests in companies,
which they can purchase from the offshore issuer and its
However, she noted, the completion of the purchase is subject
to the relevant Chinese regulatory approvals at the time.
This structure is meant to resolve investors concerns that they
do not have recourse to the company’s onshore
Under the undertaking, the onshore parent company will purchase
the assets of the offshore issuer and its offshore subsidiary
for a price that will cover any debt obligations of the
This structure circumvents the National Development and Reform
Commission approvals required if a Chinese company wants to
provide an offshore subsidiary for more funds. Because this
structure involves the onshore subsidiary purchasing onshore
assets, only the approval of China’s Ministry of
Commerce and Safe would be required.
In a May 9 report titled 'Subordination of Chinese Offshore Debt Issues:
Always Subordinated to Onshore Debt,’ Fitch
Ratings said that the structure, with legally binding deeds,
demonstrates the strong intent of the issuer to service the
The report added the corporate governance track record and
reputation of the issuer in both onshore and offshore funding
markets, was a key consideration.
Fitch said that the treatment of the instrument rating will
necessarily be on a case-by-case basis, because this evaluation
requires significant judgment.
In a March report titled 'FAQ on Credit-Support Structures Used for Chinese
Offshore Bonds,’ Moody’s
concluded that given weaknesses that apply generally for
keepwell agreements, the relatively new nature of these
structures in China and the untested nature of enforcing such
arrangements on the Mainland, the agency is unlikely in most
circumstances to rate the subsidiary at the same level as the
But investors are uncertain of how these structures will be
enforced. Restructuring lawyers warn that the deeds may not be
enforceable in the event of a restructuring, and that it
depends on whether the parent company is committed to
supporting its subsidiary.
Neil Weller, director of alpha strategies at Blackrock,
speaking at Euromoney Conferences’ Global Offshore
Renminbi Funding Forum earlier this month, agreed that the key
issue around these covenants was that a lot of the structures
"Companies have broken covenants, or they haven't been
enforced," he said. "It's as important to understand a
company's intentions and management's commitment to investors
rather than just the precise legal terms of the document."
Further, he noted that recent issues in which companies had
sought to double up in multiple guarantees by onshore parents
hinted at desperation as opposed to confidence that the
covenants were enforceable and would deliver to investors what
the text stated.
"For the development of the market, we need to see the
structures tested when it really matters," he said.
In an April editorial in the FT blog beyondbrics titled 'Beware 'enhanced’ Chinese bond
market,’ Fidelity’s Sabita
Prakash and Bryan Collins expressed similar sentiments.
What to expect
Bank counsel have predicted that these structures would be used
as long as there is demand in the market. Indeed they have been
excited to attract new Chinese credits, especially from the
real estate sector, to the market. This January saw Chinese
real estate company issue $6 billion in debt –
compared to $7 billion throughout 2012.
Sources told IFLR that investor fatigue was
growing following a wave of Chinese real estate credits hitting
the market. The market is now running out of real estate
developers that are prepared to debut in the international
But these bonds remain popular with international investors
looking for higher yields than are currently available in the
US high-yield space. They also provide China exposure, albeit
from a risky sector given the country’s slowing
Further, counsel predict that these credit enhancement
structures will remain popular as they lower the cost of
funding and allow investors to get comfortable with the
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