Contracts or works were in circulation during the recent bull run of the Asian bond market between September 2012 and May 2013. Several Chinese companies used these agreements when issuing new bonds during this period. A good deal is a kind of credit enhancement for a bond. It is issued in place of guarantee and is weaker than guarantee. Credit enhancement reduces the risk associated with bonds and therefore reduces the cost of funds.
When bonds are issued and guaranteed by an offshore non-operating entity or an operating entity with weak assets and cash flow, bonds offer a low degree of protection to investors. In such cases, a special framework called the Keep Well Agreement is used in conjunction with the equity purchase initiative. These agreements basically state that the insured asset-rich parent company / operating entity (which has better credit quality) will ensure that the bond issuer / guarantor maintains adequate resources for minimum equity and debt obligation services. We need to understand the need to issue bonds with such a structure. Bond guarantees require approval from China’s regulatory authorities, although good deeds are not required. Therefore, this framework allows Chinese companies (which cannot directly issue or guarantee offshore notes) access to offshore markets through their offshore subsidiaries.
Another important aspect to examine is whether this bond formation is strong enough. The two agreements indicate that the parent company is willing to provide financial assistance to the bond issuer / guarantor. However, in the absence of precedent, the risk cannot be minimized – the structure has not been legally tested to understand the results in case of default.
To better understand this structure let us consider the example of China Vank. China Vanke Co., one of China’s largest property developers, issued its first offshore bond in 2013 with a well-documented structure. The 2018 Maturity Bond was issued by BestGen Real Estate Limited, a BVI entity and secured by Vanke Real Estate (HK). The bonds were backed by a Keep Well Deed and an equity interest purchase agreement signed by Unshore listed company China Vanc. The guarantee of these bonds requires the approval of the Chinese regulatory authority of China Bank. Therefore, it has entered into such bond structures. The Kip Well Agreement states that China Bank will ensure that i) Issuer BestGen maintains minimum equity and ii) Issuer and guarantor maintain sufficient assets to meet the debt obligation. Otherwise, it would constitute a default event and the bond trustee could go to a Hong Kong court to have China Vanc pay the debt. The equity purchase pledge states that China will buy equity shares of some subsidiaries in the bank in order to obtain the necessary resources to meet the obligations of the issuer and guarantor bonds.
The structure has been used by some high-yield providers in the property sector, such as Beijing Capital Land and Gemdale Properties. Different bond structures provide investment opportunities to investors. However, investors should consult with financial advisors to better understand the complexities and risks involved in the various bond issuance structures.