Power to the bondholders!

The Dutch Commission for Bonds, a representative body of some of the Netherlands’ largest bond investors, is putting together a discussion paper to address the poor quality of covenant protection in investment-grade European paper. High-yield euro investors have been vocal about the issue of subordination, but this is the first time high-grade euro investors have formally co-operated to demand a better deal from issuers.

Mark Rovers, Amsterdam-based fund manager at Schootse Poort and one of the paper’s main contributors, says: “At this point we are at the discussion stage, but we plan to present a paper to the investment world in due course.”

Sterling – and, to a lesser extent, dollar – investors have been largely successful in collectively demanding effective covenant protection, but the fragmented euro market has struggled to present a united front to issuers.

Robert Manning, senior credit analyst at ABN Amro, says: “Most [of the investors] felt they couldn’t do much about covenants, as there would always be another investor willing to accept the terms. It will be a welcome development if they can come up with a co-ordinated position.”

As he explains: “When an investor buys a bond with triple-B risk, he should not be satisfied with documentation that is only designed to mitigate double-A risk – but that is exactly what is happening. We are highlighting that investors are open to being stitched up by bank creditors, if credit quality deteriorates.”

Proponents of better covenant protection claim that, with issuers now desperate for capital as banks are less willing to lend directly and shareholders more amenable to bondholder influence, bond investors are well placed to press for more information and more say-so in management activity.

“In the structure of corporate governance, bondholders are second-class citizens,” claims self-confessed ‘covenants hawk’ Duncan Sankey, Nomura’s head of European credit research. “Shareholders have always had the nuclear option of firing the management. It’s about time that bondholders started to define the parameters by which they are prepared to lend money. There’s an incredible amount of uncertainty out there.”

Sankey concedes, however, that some restraint is required on the part of investors. “We don’t want to put management in a straitjacket,” he says. “If covenant structures become too restrictive, companies will simply become less willing to issue debt.”

In a report released in late February, Event risk for European corporates 2003, Richard Stephan, London-based chief credit officer for European corporates at Moody’s, said the rating agency continues to pay close attention to event risk and covenants and factor them into its ratings.

Stephan said: “If companies put in place covenants restricting upper levels of debt, Moody’s would factor that positively into a rating consideration.” As such any moves by investors to improve covenant provision is welcomed by the agency.

Meanwhile sterling investors have been complaining about setbacks for covenants in the sterling market. UK retail and business services group Great Universal Stores (GUS) launched a £350 million 10-year sterling bond in mid-February – along with a €600 million euro bond.

The problem, according to investors, is that GUS has been beset by rumours of event risk for some time. GUS recently acquired UK DIY chain Homebase and there has been talk of it looking to sell its retail client advisory business Experian since the late 1990s. But GUS has refused to provide any real covenant protection – apparently it did not feel it would receive a significant pricing benefit from covenants.

Philip Hunt, head of sterling fixed income at F&C in London, says: “GUS’s recent history seems to have been characterised by event risk, so on the launch of this bond it could have either expressed a clear strategy or provided solid covenants on the bond – in the end it did neither.”

The deal still proved popular with sterling corporate investors thanks largely to more and more money being allocated into corporate bonds out of equities and government bonds, according Ian Haylock, investment-grade credit analyst at Investment Asset Management.

And Simon Bond, fixed-income investment manager at Axa Investment Managers, says the deal’s 138bp spread over gilts allowed investors to swap out of other similar retail credits – including GUS’s 2009s – and earn more yield.