Risks And Precautions Related To Private Placement Exchangeable Bonds

The exchangeable bonds(hereinafter referred to as “EB”)are the new darlings in China's capital market.In recent years,their circulation has maintained a high growth momentum.An exchangeable bond refers to a bond issued by a listed company's shareholders,which is subject to the principal and interest payments and can be selected by the investor for a certain period of time to be converted into shares of the listed company held by the shareholders.The exchangeable bonds actually embed the call option,and this financial instrument implies the connotation of stock pledge financing.If the bond investor receives the interest and the principal payment until maturity,the issuer realizes the purpose of low-cost financing.If the investor exercises call option right,the issuer will passively reduce the shareholding,and free from the pressure of debt repayment,on the one hand which will not cause the dilution of the shares of the listed company,but also reduce the shock on the secondary market.Changes in the regulatory environment have caused shareholders financing and shareholdings reduction getting into harsh winter.Exchangeable bonds as a new financing tool can help shareholders realize shareholdings reduction in advance and higher quality financing.Due to the flexible and diverse issuance terms,the exchangeable bonds have the following four functions: low-cost financing,shareholding reduction,capital arbitrage,and mergers and acquisitions.It can be expected that they will be used more frequently in the future.With the booming development of the private placement market,the first exchangeable bond default event occurred in China in 2018.Bond defaults have caused great losses to investors and have also impacted market confidence to a certain extent.Through the case study of the “16 LaiWu Steel EB” private placement bond,this paper calculates that the pledge rate of this private placement bond is as high as 75%.The bond has not defaulted during the lifetime thanks to the issuer's lower conversion price.The investor realized the "debt-to-equity swap",and the issuer passively reduced its shares.At the same time,this article analyzes the risks associated with private placement of bond.For investors,in addition to the credit risk and interest rate risk usually associated with bonds,due to the impact of additional terms,investors may face higher liquidity risks than convertible bonds.Some resale clauses have been rendered useless because the conditions cannot be met.For the issuers,they are facing a higher risk of equity loss.Some controlling shareholder of listed company use pledged shares to issue private placement bonds.The purpose is to raise working capital,not to reduce the company's shares.Investors' active conversion will cause passive dilution of the issuer's equity.Especially for the controlling shareholders of state-owned listed companies,the law prohibits them from transferring control of listed companies.This article suggests that the issuer of the exchangeable bonds invested by potential investors is not in the same industry as the listed company of the underlying stock,to avoid industry policy risks.Investors should be wary of overcapacity industries and high-pollution and energy-consuming companies.In order to reduce the liquidity risks faced by investors,regulators should liberalize the number of investors;at the same time,the issue threshold should be adjusted appropriately to allow highquality small and medium-sized enterprises to participate.Strict review of debt guarantee and debt repayment plans is required for loss-making companies.For the non-public issuance of exchangeable bonds by state-owned shareholders,it is necessary to review its issuance plan to ensure that state-owned controlling rights are not transferred.At the same time,it is important to monitor whether the conversion price set by the issuer is lower than the owner's equity per share of the listed company to prevent the loss of state-owned assets.This article recommends that the regulator implement a “cash and equity” hybrid delivery system on a trial basis.This system can protect the equity required by shareholders while protecting the interests of investors.