Forgoing their traditional silence, influential fixed-income investors are publicly lobbying for deep-rooted reforms that would offer bond buyers what they say is much-needed protection.
For decades, bond investors preferred to stay out of the spotlight, opting to fight their battles through regulatory channels or in quiet corners. But after years of frustration with the slow pace of change, major players such as Canso Investment Counsel and Manulife Financial Corp. came together roughly two years ago to create the Canadian Bond Investors’ Association.
While equity markets are highly regulated and relatively transparent, bond markets are often opaque and lack oversight. The CBIA, which now has 32 members that collectively manage $300-billion in fixed-income assets, aims to help fill that void, advocating for change on issues that irk fixed-income investors. “There’s really nobody out there looking out for the interest of bondholders,” said Joe Morin, a Canso vice-president.
Despite the perception that bond buyers “are big boys and they can take care of themselves,” fixed-income investors often feel the market is “stacked against us,” he said. To start rebalancing the equation, the group has published a proposal it hopes will change the way the industry operates.
At the heart of the CBIA’s concerns is the fundamental difference between debt investors and shareholders. While bond buyers have a contractual relationship with issuers of debt, shareholders are the owners of these companies, meaning they control the votes on important matters. “You have no rights the way the shareholders have rights. You can only really rely on the contract,” Mr. Morin said.
The problem, bond investors argue, is that these contracts, formally called indentures, can be full of holes. The gap the CBIA is currently targeting pertains to debt covenants, or the rules that restrict what a company can do after it has sold bonds.
“It is the most glaring area of weakness,” said Jack Alvo, who heads Manulife’s Canadian public bond credit team.
After working with lawyers to draft a working paper, the industry group is now advocating for four fundamental changes to debt covenants. The improvements include new standardized language around a “change of control,” or a switch in company ownership. At the moment, companies can have multiple bonds that each come with different rules on how they will be treated in this situation.
For instance, Safeway Inc., the giant U.S. grocery chain that is now the target of a $9-billion (U.S.) leveraged buyout, has a number of bonds outstanding, and each has different change-of-control provisions. Some bondholders are allowed to sell their bonds back to the acquirer, Cerberus, for full value, while others cannot.
Bond investors are also asking for what is known as a “coupon step-up” should the bonds they own be downgraded for unusual reasons. For instance, this clause could be triggered if a company decides to borrow money to pay a special dividend to shareholders, and loses its investment grade rating for putting its balance sheet at greater risk – a move that benefits shareholders but punishes debt holders.
Such a downgrade is common. In 2010, Tim Hortons Inc. issued its very first series of bonds, rated A (low) by DBRS Ltd. In 2013, management announced plans to borrow money to fund a share buyback, which resulted in a ratings downgrade to BBB, almost pushing the company out of investment grade status.
To address this inequity, bond investors want issuers to be required to enhance their coupon payments by a preset amount – it could be 100 or 200 basis points – in similar situations in the future, but only if a company loses its investment grade rating.
Fixed-income investors aren’t expecting quick changes. They plan to meet with issuers, investment banks, lawyers and regulators to start planting seeds. “We don’t expect that these model covenants will change the market overnight,” Mr. Alvo said.
But they remain hopeful and argue that reforms are overdue. “Over time, we think these measures will get some fairly wide adoption,“ Mr. Alvo said.