Tikristan State Airways: Bond Issue - Essay Example

Tikristan Airways: Bond Issue Introduction: Tikristan Airways plans to lead bond issue in order to finance its activities and has solicited the services of Temaki and Sukiyako Bank. In view of complaints that have been made against a prior aircraft Company on the issue of default and failure to repay investors, it is imperative that Tikristan State Airways plan its bond issue in such a manner that it serves to alleviate the concerns of the public and the investors. Certain initiatives are being considered by the Company, which may prove to be advantageous: (a) the issue of a global bond (b) settlement through Euroclear and Clearstream. Global bonds: The advantage in issuing global bonds lies in the fact that they may be issued in the currency of the country from which they are being used, yet function as international instruments that may be utilized by investors all over the world. They may thus serve to pump foreign currency into the domestic economy. However, in view of the precarious state of Tikristan’s economy, the possibility of a weakening of the global bond issued by TSA must be taken into account. Moreover, the fact that clearance is offered through Euroclear and Clearstream is likely to be a confidence booster for investors. Legal implications of bond issue: The goal that Tikristan Airways seeks to achieve is that of raising finances through the issue of permanent bonds. In effect, an investor and the bond issuer are entering into a contract, whereby the bond issuer agrees to provide a share in its corporation to the investor who offers his money as consideration. Therefore, a default by TSA in repayment of the bond amounts would be construed as a violation of the contract and subject to legal redress. Since TSA plans to issue permanent bonds, the legal structure of the agreement between the parties, set out in the terms of bond issue needs to provide for TSA’s interests. A long term repayment plan is therefore a more desirable option, in order to provide a buffer for TSA to straighten out its finances and ensure sufficient accrual of profits from operation. Lower interest rates may also be offered on long term repayment options. However, since TSA is unwilling to consider amortization of loans, there are two repayment options that may be considered advantageous from TSA’s point of view: (a) incorporating the sinking fund provision (b) offering a balloon payment at the end of a long term period, say, ten years. The sinking fund provision may be utilized by TSA at any point, especially when the state of the economy reaches a critical point, that may prove to be a liability for TSA and its bonds, necessitating a repayment on undesirable terms. However, the sinking fund option provides TSA the option of offering repayment to a randomly selected group of bonds at a lower interest rate, which could help deflect the risk of default. BY making use of this option, TSA will be able to keep its options open and offer a partial payment to at least some of its bond investors to avoid default. Utilizing the provision of balloon payments may be acceptable to TSA since it does not wish to amortize its bond issue. This could prove to be a liability for TSA when its bonds are placed on the open market, since it impacts upon the security aspect of the bonds, which may render it unattractive for investors and pose the threat of a default. Therefore, TSA might consider the balloon payment option on its bonds, which will give the Company a chance to set up in business and endeavor to strengthen its corporate base through its operations in other countries and the securing of a wide foreign investor base. This provides an opportunity for TSA to improve its financial position and be able to pay off its investors. Since TSA proposes to offer global bonds conditioned by U.K. law, they will be governed by U.K.’s Financial Services Authority and will be subject to the provisions of Section 1(1) of the FSA 1986, that designates an investment as “any asset, right or interest falling within a statutory list inserted in Part I of Schedule 1” which also includes securities such as bonds (Zhang, 2000). The Securities and Investment Board is the regulatory agency that monitors all transactions. Any foreign bank that conducts its business in accordance with UK law and plans to accept deposits from investors must establish its subsidiary offices within the U.K. and must comply with the banking regulations laid out in the Banking Act of 1987. (Zhang, 2000). It is also required to maintain a minimum liquidity ratio which, in the case of a representative office, is determined by the reserves available in the parent office. Therefore, the Temaki and Sukiyako Bank will need to set up its offices in the UK and maintain the specified liquidity ratios. In addition, EU regulations will also have to be taken into account. Since the issue of bonds by TSA to investors all over the world may be classified as investment in collective securities, Article 22(4) of the EUs Co-ordination Directive on Undertakings for Collective Investment in Transferable Securities (UCITS), states that : “….sums deriving from the issue of these bonds must be invested in conformity with the law in assets which, during the whole period of validity of the bonds, are capable of covering claims attaching to the bonds and which, in the event of failure of the issuer, would be used on a priority basis for the reimbursement of the principal and payment of the accrued interest." (Hardman, 2005). TSA will therefore have to abide by these requirements and will need to prove availability of assets that can cover the bond issues. This poses a problem in view of the default of Slobo Aircraft. Therefore TSA will need to consider other options such as repackaging and credit swaps. Since TSA does not wish to take up the option of functioning through a trustee, there are two other options available for the issue of its bonds which may be advantageous from a legal standpoint, especially in view of Turkistan’s deteriorating economy and the possible need to restructure foreign currency debts. The first option would be to set up an SPV (Special Purpose Vehicle) and it may be worthwhile for TSA and its authorized bank to consider repackaging of its securities using Gibraltar as the European jurisdiction. This is one way to legally structure TSA’s bond in such a way that the future state of Turkistan’s economy may not be such an issue. The objective is to set up a third party that coordinates the financial activity between two parties by functioning as a “credit derivative. Through this option, many of the traditional security requirements may be waived or eschewed by willing parties, while adhering to the law at the same time. The “credit derivative” is particularly relevant in relation to a particular entity or country. Internal regulatory constraints may prevent a willing investor who is prepared to accept a certain level of risk from investing in TSA’s bond issue, however if a SPV is set up for the purpose, the investor would be classified as the Buyer of risk/seller of protection through the sue of credit linked notes that can be repackaged according to the requirements (www.gibraltarlaw.com). By functioning through an SPV which is a third Party, the transactions of TSA and the investors would be funneled through the SPV, which would be a separate entity that is not limited by the regulatory constraints that may impede the functioning of TSA and/or the buyer/investors. All cash and credit flows go through this third party and are therefore rendered legal and hassle free, providing flexibility of investment options both to the bond issuer and the investor. Another way in which this may be achieved is through “assets swap”, wherein an international investor may purchase TSA’s bonds and thereby pick up the credit exposure on TSA while simultaneously hedging cash flow into a more desirable currency such as say, the U.S. dollar floating bond, by a swapping arrangement with another party where by cash flows are exchanged. (www.gibraltarlaw.com,n.d.) This could relieve the pressure on TSA for immediate repayment of bonds should a financial crisis arise in Turkistan’s economy. The issue of UK’s covered bonds has made this feasible under English law, with the first UK covered bond being issued in July 2003. This bond operates through a “bankruptcy-remote special purpose vehicle” that provides a method of recourse both to the company issuing the bond which in this case is TSA and to underlying assets in the event of a default (Hardman, 2005). Therefore, in conclusion, it would appear that TSA’s best options from a legal point of view would lie in the use of a third party vehicle through which to float its bonds. Works Cited: 1. Feetham, Nigel. (2005). Repackaging takes off in Gibraltar. Retrieved 08/10/2005 from URL: http://www.gibraltarlaw.com/repackaging_gibraltar.htm 2. Hardman, Vanessa. (2005). Covered bonds face tough issues in the U.K. The International Financial law review. Retrieved 09/10/2005 from URL: http://www.arch-fp.co.uk/corporate_bond_funds.htm 3. Zhang, Xiaoyang. (2000). U.K. Financial Markets and the Financial Investor. Murdoch University Electronic Journal of Law, 2000, 7(1) Retrieved 08/10/2005 from URL: http://www.murdoch.edu.au/elaw/issues/v7n1/zhang71_text.html Read More