International Banking Law: Capital Markets and Loans - Essay Example

Advise Emma and Dan: a) on their own and the company’s potential legal liability in relation to the marketing document that they produce for the bonds if they decide to market it to a small group of wealthy individuals and if they decide to market it to the public in general ( 80 marks) b) the consequences of issuing covered bonds for the company and the prospective investors (20 marks) Overview It has been observed from the given case scenario that the two graduates from the University created a public company i.e. Farm Turbine plc. The company deals with the manufacturing of components which are required by the small scaled wind turbines. The two graduates namely Emma and Dan are the sole directors of the Farm Turbine plc. The business was initiated by the two graduates with the help of bank loans and through the financial support from the wealthy individuals as an initial capital for the business. However after the successful trading of the company for a period of two years the company requires funds in order to expand the business. The fund would help the company to increase the capacity of its manufacturing in order to reach more market. In order to meet the fund requirement of the business, Emma and Dan are planning to raise funds by issuing bonds to the marketer or to the wealthy individuals. However, in order to produce bonds the company needs to have few documents in order to market the bonds wherein the prospective of the business and future prospects will be evaluated for the knowledge of the people. Emma and Dan are not sure regarding their action and their idea of listing the bonds in the regulated market of the United Kingdom. Directors are aware of the fact that the performance of the company has been good in the past years. However, Emma and Dan are aware of the fact that the prospective of the company depends on various factors which are not under their control which includes the exchange along with interest rates and the economic condition of the UK and wider Europe. Moreover Emma and Dan have the knowledge that after the initial subscription the first investors have the authority to sell their bonds to the third party. One of the friends of the sole directors has advice to issue the covered bonds which might is believed to be more lucrative to the investors. In this regard, Emma and Dan have to be advised regarding their own and the company’s potential legal liability in relation to the marketing document that they produce for the bonds if they decide to market it to a small group of wealthy individuals and if they decide to market it to the public in general. Moreover, the consequences of issuing the covered bonds for the company and the prospective investors will be discussed. A General View on Bonds Bonds along with shares are components of the capital market which acts as a debt security. It is one of the long term debt instrument which acts as an alternative form of investment. In this regard, it can be stated that bond is a form of loan which is issued by the business for better opportunity to the public or wealthy individuals.1 Bonds are financial instruments which are used by the companies in order to raise money for the expansion of the business. Companies tend to issue bonds to raise money rather than taking loans from the financial institutions2. Bonds are initiated by the companies in the market as it helps in providing benefit in the long term investment need for expansion and better opportunity. Moreover, the reasons for bonds to become promising for the business are because of the benefits it provides3. It is reflected that the bond markets provides more liquidity and lower overall cost along with the flexibilities that are required by the company in order to run their business in a smooth manner.4 As per the case, Emma and Dan are in the frame of mind to use bond to raise money for its public company i.e. Farm Turbine plc. The reason for such initiative might be due to the accessibility of the market from the issuance of the bonds. Another reason for the decision regarding the bond is due to the fact that the Farm Turbine plc. has created a reputation in the market through its services in the past two years. Moreover, funding by the use of the bond is usually preferred by the companies because financing through bonds are relatively cheap5. Bonds are of importance in the changing economic environment of the country and global market. During the time of recession, the bond market is intended to have liquidity which is of importance for the success of the business. There are various forms of bonds that can be issued by the company in order to get the financial support. Bonds are secured, unsecured, registered or unregistered and few are exchangeable and convertible. They are usually traded in the corporate bond market, which can also accurately indicate the prospect of economy and the situation of present capital market.6 Bonds differ in various respects and thus the decision of bond issuance depends on various factors. The bond issuers are basically borrowers who contain a promise to repay the amount along with the interests to the bondholders. And the owner of the bond can make a sale at a current market value without even waiting for the date of maturity. It is observed that usually business organizations issue corporate bonds for raising money on the basis of the reputation of the firm7. In this regard, it is important to mention that the bond issuer has few obligations pertaining to issue of bonds which include regular reporting of the financial condition and development of the company. A Potential Legal Liability in Relation to the Marketing Document, Small Group of Wealthy Individuals and General Public The decision to issue the bond is a strategic decision taken by Emma and Dan who are the sole directors of Farm Turbine plc in order to develop and expand their business. The decision to issue the bond is of benefit on various aspects as the rate of interest to be paid by the company would be less than the bank loan. Moreover, the ability of the company to attain money with low rate of interest increases its capability of growth through infrastructure. The level of freedom which the company may enjoy would be lifted if the money is raised through the issuance of bonds and hence the prospective of growth is high. The bond issuance assists the business to attract more investors as it is beneficial for the company. Keeping track of the efficient investors is easy and the company derives various benefits through the issuance of the bonds. The quality of the credit and the duration is effective for the company. However, with several benefits that the company avails due to bond issuance there are few liabilities that the issuer of the bond has. The obligation that company has after the bond is issued is that they are liable to pay interest to the investors of the bonds. In the case of Farm Turbine plc, if in future it files bankruptcy then it is the liability of the company to pay the bondholders money8. On the other hand, it is important to read the documents before buying bonds and it is the legal liability of the firm to provide a bond transcript which consists of the documents required for the marketing of the corporate bonds or individual bonds9. The documents offered by the company should have the following which includes the preliminary official statement, official statements, purchase agreement which are the part of the long term liability of the company10. Moreover the basics legal documents which are to be provided in the transcript are “indenture/resolution, loan/lease agreement, mortgage/deed of trust, request to authenticate and deliver bonds, credit enhancement documents, tax regulatory agreement, along with the volume upon certification”11. In this regard, the basic legal documents that serve as evidence amid the bond issuer and the other contracting party is indenture which can be defined as a legal contract demonstrating promise from the issuing party wherein the offerings of the bonds are reflected. The other lawful document lease agreement acts as safekeeping for the bonds. Deed of trust in bonds is one of the legitimate documents, which is issued to lenders and it acts as a legal document for the bond. In the form of liability the firm also has to offer relevant state law, certificates of the issuer, certificate of the trustee, credit enhancer along with conduit borrower12. In this regard, it can be stated that it is vital for the firm to produce the documents for marketing in order to maintain the transparency and reliability of the investors in the long run for better future prospects13. Farm Turbine plc is led by sole directors Emma and Dan who have been successful in reaping the opportunities in the last two years. The directors have various legal and financial obligations towards the working of the company. As the firm has two sole directors the business has high level of flexibility. In this context it is important to mention that it is the duty of the directors to abide by the Company Act 2006. The responsibility of the director of the business is to maintain the level of transparency14 and integrity when issuing the bond for the advantage of the company. The directors have the responsibility to meet the legal obligation of the company in order to reduce the breach in relation to the activities taking place. It is to be noted that the public company are subject to certain statutory obligation for better performance of the company. The company and the directors of the company are different legal entity. However, it is important to note that in case of any important decision making process the directors are the responsible member and are legally obligated to the actions performed by the company.15 As per UK governmental law it is observed that the directors are at risk regarding any debt liability of the company. In case the company is unable to meet their legal obligation regarding the money and capital market aspect as per the Company Act of 2006, the directors of the company might be personally liable for the wrong deed or offence of the ‘fraudulent trading’16. The consequences could be such that the director might be disqualified from being the director of the company in the future due to the failure of the legal obligations.17 Another vital decision for Emma and Dan is to evaluate the positives regarding the issuance of the bonds for the general public or for the small group of wealthy individuals. The objective of Farm Turbine plc is to raise money by issuing bonds because of the benefits it has over the bank loans and due to the changing trend in the market. The decision of focusing on the wealthy individuals or on common public was vital point of discussion for the directors. They are aware of the facts that the success of the company depends on various factors which are external and beyond the reach of the directors. The factors include the economy of the country, the exchange rates and the rate of interest18, etc. The Farm Turbine plc initiates the need to issue bonds for the expansion of the company and to have a strong market presence. Emma and Dan can issue bonds and market it to the small group of wealthy individuals. The reason for the purchase of the bonds by the wealthy individuals is due to the fact the tax benefit that the individuals will derive by investing in the holdings such as the certificates and bonds19. It is observed that the wealthy individual would add bonds to their portfolio if they derive benefit. In this regard, if the bonds are marketed to the wealthy individual they will provide the tax benefit option such as the flower bond which has especial provision. It is the liability of the company to offer bonds to the wealthy individuals which will help benefit them in their tax. Another reason for the company to focus on the wealthy investors is due to the reason that if the individuals are richer, the bonds purchased will be higher in number. The Public Limited Company has the authority to subscribe bonds from the public and other group of individuals.20 People who have the intention to expand their wealth have the tendency to acquire bonds and acquire financial independence at low risk. The legal liability of the company towards the people is high as bond is a part of the interest bearing note. The people subscribing the bonds will have to be paid the principal amount along with the interest on the date of maturity which is the legal liability of the company. The liability of the company is to value the underlying contracts amid the issuance company and the bondholder which is known as bond indenture21. As per the financial balance sheet the bond payable is a long term liability of the company. In this regard, it can be stated that the obligation of the company is high when it comes to issuance of bonds. The company issues bonds to raise money from the investor which include the common people and wealthy individual22. The legal liability of the firm in this regard is to repay the loans within the tenure of the bond. The expectation of the bondholder from the company is to get the money and interests in full and on time. The obligation is not only on the basis of the interest and the principal payment but also have some legal responsibility in regards to accounting23. In the accounting the bonds is referred to as long term liability as it recorded in the debit side of the ledger of the cash. The obligation is met when it is credited to cash. Moreover, during the time of default this implies that the company the issuer of bond is unable to pay the amount on the given time. The company is liable to pay the money to the bondholder at first by filing bankruptcy24. The obligation is more in case of the bonds as it is a legal claim which needs to be addressed by the bond issuer25. These are the obligations that are to be met by the issuing company of bonds in order to raise money from the market with several benefits. The subscription of the bond to the public is effective as it helps in creating an image of the company in the mind of the people. The decision to issue the bond either to the wealthy individual or general public is an important issue for the company to evaluate the strategy. It is further observed that companies which are large in volume generally issues public corporate bonds as it will not cause ownership relinquishment26. The holders of the bonds expect the company to be liable to cover the risk of their wealth so that they are able to invest more on the bonds for the benefit of the company and them. It is the liability of the company and of the directors to eliminate the issues regarding the issuance the bond which might hamper the position of the company in the market. The obligation of the issuer with regard to the payment of the principal amount is defined in a particular currency as per the International Banking Law. The bonds are issued and traded in the market which requires documents are reflected above27. The subscription agreement of the bond provides a right regarding the bond issue wherein the managing underwriter gets the power to dismiss an issue in regards to the occurrence of the particular events28. The issuer of the bonds for the proper working of the market and for the fulfilling the responsibilities towards the bond holders appoint a fiscal agent.29 The fiscal agent is the one who is responsible to comply with the duties of the principal paying agent for the issuer. In this case the issuer are Emma and Dan, the sole directors of the Farm Turbine plc who are willing to issue the bonds in order to gain money for the expansion of the business. The responsibility of these agents is to acquire money from the issuer and pay it to the bondholders. Another responsibility of the agent is regarding the publication of the redemption notices wherein the bonds are redeemed before the maturity.30 They are also responsible for the activities which include replacing lost and defaced bonds as per the request of the bond holders. These activities initiated by the fiscal agent are the legal obligation of the issuer which needs to be fulfilled in order to have the effectiveness in the market31. The legal issues faced by the bonds in the market are complex due to the facts that all the bonds are not of the same nature. Investment in the bonds is complex than a normal purchase. In the last few decades the international market for covered bonds has experienced considerable growth outside Europe. It is a web of relations amid the issuer, investors along with other parties. Due to the web of relations the bond faces several legal issues regarding the obligations of the bond issuer32. Moreover, the obligation of the issuer towards the investors is reflected in the bond document. This is an agreement wherein the subscriber and the issuer agree regarding the payment wherein an issuer is liable to give instruments with a promise to pay the amount on a fixed date33. Consequences of Issuing Covered Bonds for the Company and the Prospective Investors Covered bonds are one of the forms of the debt instruments which are usually issued by the credit institution of European Union (EU) and are secured by number of high quality on balance sheet collateral. It has been pointed out that the covered bonds are dual recourse instruments which imply that the investors are recourse on the collateral pool along with the bank. The covered bonds are delivered under the legal structure of Article 52(4) of EU UCITS Directive. The covered bonds are of two types integrated and structured model. In the year 2003 the first covered bond of UK was issued and further amendments were made on the legal aspects of the covered bonds and ‘Regulated Covered Bond Regulations 2008’ was initiated34. The covered bonds provide stable funding to the diverse investors for the long term which is effective. The covered bonds are effective and have strong market presence as it has evaluated resilience in the market when the conditions were not favorable i.e. the period during of economic crisis35. Moreover it is noteworthy that the Financial Services Authority (FSA) is taking initiatives to support the improvement of the covered bond market in the UK36. The support extended towards covered bonds helps in improving the financial stability. The covered bonds are beneficial due to the presence of dedicated legislation. The covered bonds are effective as during the normal market scenario the bonds are the obligation of the issuer. This implies that the investors can be sure regarding the interest along with principal payment on the decided date. Moreover, in case of insolvency, the holders of the covered bonds make their payment by the ‘Special Purpose Vehicle (SPV) on the agreed date. Thus, the benefits of the covered bonds are more in comparison with the other bonds. Furthermore, in regards to the covered bonds, significant favorable markets have been observed recent years. The regulation of the covered bonds helps the issuer of the bond to compete in the market in order to gain high standards along with the best practices in respect to the other companies. The covered bonds are effective for the business and the investors along with few issues which are to be dealt with. The bond is effective in producing liquidity in the market and hence as consequences several companies are trying to become the part of the growth and improvement in order to reply to the substantial growth and mortgage lending event in the EU. The covered bonds are benefiting the market and helping for the economic development of the business along with the economy of the country37. In this regard, it is worth mentioning that the market of covered bonds has witnessed a steady development over the years. The consequences of the covered bonds on the investor and the company are determined by evaluating the essential features of covered bonds. The covered bonds have special law based framework, this implies that the risk are preferential in nature. In this regard, it can be stated that the regulated covered bonds have few benefits associated with them which is helpful for the investors and the issuer to a considerable extent. The benefits that are offered by the covered bonds include increased investment limits. This implies that the Undertakings for Collective Investments in Transferable Securities (UCITS) schemes and non-UCITS retail schemes have the ability to hold at most 25 per cent of their assets in the regulated covered bond if it is issued by only one issuer.38 On the other hand, the limit reduces to 5 per cent if it is the structured covered bonds and issued by only one issuer39. Moreover, the bond provides ‘preferential prudential risk weightage’ and other related benefit. In addition, covered bond holders have dual alternatives to the cover pool as well as to the bank. The advantages of the covered bonds are that it is protected by a specific pool of assets along with the credit of the issuing institution. The investment in the covered bonds is reflected as the safe investment for the company and the investors at large. Moreover, the rating of the covered bond is high and hence can be of importance for Emma and Dan. In this regard, issuance of covered bonds will allow the directors to spread their funding, increase their liquidity at a lower price, and at the same time reduce their probability of default during economic crisis times. One of the critical features of the covered bond for the investor is related to the risk of pre-payment. The covered bonds usually mature on the pre-established dates allowing the issuer to contest the duration of the assets along with the liabilities. Thus, benefiting the company i.e. Farm Turbine plc. Moreover the covered bonds in the EU law acquire preferential treatment if the covered bonds meet the minimum level of regulatory requirements. The reason for such preferential treatment under the law is due to the fact that the asset securing bonds is reflected on the balance sheet of the issuing company. It is noteworthy that the interests of the issuer are linked with the rate of interest of the investors. Thus, with the use of the covered bonds by the issuing company the issuers have to share the risks40. Moreover, covered bond issuances have significant benefits in terms of reducing the liquidity as well as refinancing risk facing institutions. Contextually, the use of the covered bond is effective and will have a positive impact as the treatment of the bond will be conducted by implementing the Basel liquidity framework which will be effective in reducing the liquidity cost of the holding covered bonds. The main advantage of the covered bond for the issuer is that it will be able to attain more access to the funding at a moderately lower cost than the issuance of the unsecured bonds. The credit rating of the bond is high as compared to the issuer and that is the reason they have the ability to be sold in the market for more money. The liquidity provided by the covered bond is more in relation to the other bonds and hence Emma and Dan can issue this bond for better effectiveness. On the other hand, the covered bonds have few issues which affect the performance of the company in the long run. It can be concluded that cover bonds offers investors with risk aversion mechanisms in global financial crisis. It offers greater security to investors on the amount invested by them. Bibliography Books Bamford C., Principles of International Financial Law (OUP 2011) Choudhry M., Bond and Money Markets: Strategy, Trading, Analysis (first published 2001, Butterworth-Heinemann 2003) Elton E.J., Gruber M.J., Brown S.J. and Goetzmann W.N., Modern Portfolio Theory and Investment Analysis (8th edn, John Wiley & Sons 2009) IMF World Bank, Developing Government Bond Markets: A Handbook (World Bank Publications 2001) Kapstein E.B., Essays in International Finance: Supervising International Banks: Origins and Implications of the Basle Accord (International Finance Section, Department of Economics, Princeton University 1991) Kwaw E.M.A, The Law & Practice of Offshore Banking & Finance (Praeger Publishers 1996) LIBF, International Banking Legal & Regulatory Aspects (Macmillan Publishers India Limited 2007) Roberts G., Law Relating to International Banking (first published 1998, Woodhead Publishing 1998) Articles Bondt G.D. and Lichtenberger J., ‘The Euro Are Corporate Bond Market: Where do we Stand Since the Introduction of the Euro?’ (2003) 4(4) E.B.O.R. 517-539 Clifford Chance Briefing Note, ‘Covered Bonds: Changes And Challenges For The UK Market’ [2013] International Financial Law Review, 1-4 Contessi S., Li L. and Russ K., ‘Bank vs. Bond Financing Over the Business Cycle’ (2013) 31 Economic Synopses 1-3 Din S., ‘Understanding Securitisation in the Context of Corporate Recapitalisation and Acquisitions’ (2000) 15(6) J.I.B.L. 128-132 FSA, ‘Review of the UK’s Regulatory Framework For Covered Bonds’ [2011] Hayter D., ‘A Beginner’s Guide to the City’s Financial Markets’ (2008) 8(4) L.I.M. 236-246 Lough S. and Kawecki D., ‘Understanding Bond Documents’ [1996] EO CPE Text Pergam A.S. ( Cleary, Gottlieb, Steen & Hamilton, New York), ‘Choosing Between the Trustee and Fiscal Agent For Eurobonds’ (1985) 8(4) Int’l Fin. L. Rev. 8-11 Schwarcz S.L., ‘The “Principles” Paradox’ (2009) 10(2) E.B.O.R. 175-184 Vera G., Pattani A. and Wackett J., ‘Going Public: UK Companies’ Use Of Capital Markets’ [2011] Bank of England Quarterly Bulletin 319-330 Online Journals Angelovich D., ‘Long-term Liabilities: Bonds and Notes’ [2011] Cengage at Centre for Financial and Management Studies, ‘Regulation of International Capital Markets’ at < http://www.cefims.ac.uk/documents/sample-87.pdf> Charles Russell, ‘Directors Responsibilities’ at CMS Cameron McKenna LLP, ‘Retail Bonds’ at European Covered Bond Council, ‘ECBC Essential Features Of Covered Bonds’ at Baker T., ‘Economic Importance of the Corporate Bond Markets’ [2013] ICMA at Kreitzer R., ‘Covered Bond Markets: An Analysis of Their Impact on Mortgage Underwriting’ at Langley K.A. and Houston M.M., ‘Liability Of The Performance Bond Surety For Damages (Under Contract of Suretyship)’ at Thomas C. and Pennicott I., ‘Bonds, Guarantees and Other Undertakings in English Law’ at Working Papers Fiore F.D. and Uhlig H., ‘Bank Finance Versus Bond Finance’ [2011] MFI Working Paper No.2011-004,1-12 Websites and Blogs Statues Companies Act 2006 Read More