Emerging Markets/Cross-Over High Yield: What Next?

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Standing at the intersection of the Eurobond and high yield markets, so-called "Cross-Over" emerging market deals were more popular than ever in 2021. These deals were not necessarily like the deals that had come before—deals often included different features of Eurobonds or high yield bonds (most notably, the move to senior secured structures, which had not been seen in any significant way before) to make these bonds more marketable to investors. The White & Case Capital Markets team looks at how the market has developed and the tools that might be available to issuers in the future.

Emerging Markets Bonds—A History

In any capital market financing, the key challenge to a successful transaction is to strike the right balance between supporting the issuer's need for ongoing flexibility to run and grow its business and providing investors with sufficient protections to preserve their investments.

Eurobonds have since the 1950s been the mainstay of capital markets outside of the United States and were largely issued by investment grade companies with few or no covenants. Emerging market deals in particular started to take off in the late 1990s across the Commonwealth of Independent States. As a result of structuring restrictions, such as the requirements for licenses to issue securities and/or requirements to publish prospectuses in local languages, for example, these deals were largely drafted as loan participation notes rather than direct issues of securities. These deals contained limited financial reporting covenants and this, in combination with the holding structures of corporate groups, amongst other factors, resulted in these bonds containing loan style covenants rather than bond style covenants. Early emerging market bond covenants were therefore structured as negative covenants prohibiting certain actions by the issuer or the issuer's corporate group. These negative covenants mostly prohibited asset sales and mergers and the deals included very limited financial covenants, if any.

As the number of emerging market bond issuances increased, different styles evolved depending on the issuer's corporate structure, jurisdiction and local law requirements. For example, in Russia and Ukraine, issuances were loan-based and in markets like Kazakhstan and Turkey, these issuances were securities-based.

Emerging market bonds were also only either issued by sovereigns or financial institutions; however, as the bond market began to open up to corporates, the notion of a cross-over bond began to emerge and develop.

Eurobonds vs High Yield Bonds—The Choice

The choice between Eurobonds and high yield bonds derived in part from the historical development of each product as well as the profile of the issuer. Generally:

  • Eurobonds typically assume a strong credit rating or risk profile (i.e., are comparable to investment-grade debt securities in the United States) or a sovereign or sovereign-linked credit support. They have developed outside the constraints of the US securities market and thus provide more flexibility in a number of aspects over more US-centric models.
  • High yield bonds have been widely included as part of the capital structure in the United States since the early 1980s, but only gained significant traction as an international mainstream source of funding following the 2008 financial crisis. Due to investor familiarity with the high yield product, as well as the more thoroughly New York court-tested nature of the covenants, New York law has continued to be the primary governing law of international high yield bonds. 

Some distinctions between Eurobonds and high yield bonds:

  • Eurobonds in emerging markets are typically issued by sovereigns, sovereign-owned enterprises or entities that are strongly linked to the economy of a particular country, such as issuers from the banking sector (even if they are below investment grade), while high yield bonds are by definition bonds by issuers that are below investment grade.
  • Sovereign ratings, which often form a ceiling for corporate or other non-sovereign issuer ratings in the relevant jurisdiction, are often lower in emerging market jurisdictions than in more developed markets. This can present a challenge for corporate entities when compared to similarly performing companies in more established jurisdictions.
  • Traditional investor bases for Eurobonds and high yield bonds were different, although in recent times we have seen more traditional high yield investors investing in Eurobonds and vice versa, creating, for certain credits, industries or jurisdictions, a more limited (or zero) distinction between present investor bases. Eurobonds are increasingly being structured to broaden the possible investor base. 
  • The governing law for Eurobonds is typically English law whilst the governing law for high yield bonds is typically New York law. This choice of governing law is increasingly less influenced by the target investor base (due to the convergence of traditional investor bases) but rather by the jurisdiction of the issuer and the parties involved on the deal. Both Eurobonds and high yield bonds are sold on either a Regulation S-only or Regulation S/Rule 144A basis with most deals being sold on the basis of the latter as it is considered more marketable to investors where Eurobonds and high yield deals are prepared to a Rule 144A standard.

While all transactions have unique features, the following outlines some of the historical structural differences between international Eurobonds and high yield bonds.

  Emerging markets Eurobonds High yield bonds
Structure Senior unsecured1 Typically issued on a "senior" basis, often secured on a pari passu basis with other debt, in certain circumstances, second-lien or behind a "super-senior" liquidity revolving credit facility.
Covenants Includes negative pledge covering other debt, mergers and assets. Covenants are mostly aimed at preserving the capital structure of the issuer. Increasingly light covenants for emerging market issuers that are now investment grade companies. Incurrence-based covenants limiting debt (secured and unsecured), dividends and investments, amongst other things.

Amendments

Through bondholder meetings which require both a quorum and a threshold to pass the resolution. Threshold quorums vary between a majority to 75 per cent and thresholds for voting for extraordinary actions are usually 75 per cent. This is likely because of no Trust Indenture Act legacy issues from United States and the early nature of the Eurobond market where notes were in bearer form. 

Based on aggregate principal amount of notes voting, requiring majority for non-economic terms and 90/100 per cent for economic terms.
Events of default Typically oriented towards emerging markets considerations (e.g., illegality, expropriation).

Based on US precedent.

Early optional redemption by the issuer Increasingly seeing par calls and occasionally make-whole payments.   Increasingly seeing par calls and occasionally make-whole payments.  
Security Typically none. Depends on structure, but frequently secured to the extent possible.
Documentation English law Trust Deed and/or Agency Agreement. US (New York) law Indenture.

The Emergence of the True "Cross-over" Deal

The year 2021 signalled a shift in EM/HY "cross-over" transactions, with a real willingness on the part of market participants to pick and choose from a menu of potential options/structural enhancements in order to increase the marketability of the transaction.

Below is a chart comparing some of the key covenant structures in EM/HY "cross-over" credits in five jurisdictions/geographical areas since 2021 (Nigeria, Eastern Africa, South Africa, Turkey and the Middle East). 

  Nigerian oil & gas business East African Telco South African Conglomerate Turkish Renewables company Saudi Arabian Retail Real Estate company
Issue Date April 1, 2021 February 9, 2022 September 16, 2021 May 27, 2021 March 31, 2021
Details $650,000,000 7.75 per cent Senior Notes due 2026 $420,000,000 7.375 per cent Senior Notes due 2027 $800,000,000 3.625 per cent Senior Notes due 2026 $300,000,000 9.00 per cent Senior Secured Notes due 2026 $650,000,000 Trust Certificates due 2026
Jurisdiction  Nigeria Mauritius South Africa Turkey  Middle East
Public/Private Company Public  Private  Public  Private  Public
Governing Law New York New York English English English
Marketing EBITDA $265.8 million $337.4 million R8,138.1 Million $164.8 million SAR1,384,986
Deal Structure  Unsecured  Secured Unsecured Secured Unsecured
  Nigerian oil & gas business East African Telco South African Conglomerate Turkish Renewables company Saudi Arabian Retail Real Estate company
Includes Restriction on Incurrence of Indebtedness? Yes Yes Yes Yes Yes
Credit Facilities basket Greater of $500 million and 21.50 per cent of Consolidated Total Assets Greater of $210 million and 9.5 per cent of the Total Assets £240 million $754 million  $1,400 million, plus the greater of $70 million and 17.5 per cent of Consolidated EBITDA
Ratio Debt 2.25x FFCR 2.5x CNLR 3.0x CNLR (i) prior to the date that is 12 months subsequent to the Issue Date, 5.25x CNLR, (ii) on and after the date that is 12 months subsequent to the Issue Date, 4.75x CNLR and (iii) on and after the date that is 24 months subsequent to the Issue Date, 4.0x CNLR 2.0x FCCR or if senior debt, 3.0x CNLR
General Basket $250 million (where there is no guarantee); or
Greater of $75 million and 3.25 per cent of Total Consolidated Assets
Greater of $400 million and 18.0 per cent of the Total Assets of the Issuer $100 million Greater of $35 million and 21.0 per cent of Consolidated EBITDA  Greater of $50 million and 12.5 per cent of Consolidated EBITDA
Includes Restricted Payment Covenant? Yes Yes Yes Yes Yes
  Nigerian oil & gas business East African Telco South African Conglomerate Turkish Renewables company Saudi Arabian Retail Real Estate company
General Restricted Payment Basket Greater of $50 million and 2.25 per cent of Consolidated Total Assets Greater of $50 million and 2.2 per cent of the Total Assets $150 million $20 million Greater of $25 million and 6.2 per cent of Consolidated EBITDA
Leverage-based RP Basket No leveraged based RP basket  No leveraged based RP basket 3.0x CNLR No leveraged based RP basket 3.5x CNLR
Investments General Basket Greater of $50 million and 2.25 per cent of Consolidated Total Assets Greater of $30 million and 1.3 per cent of the Total Assets N/A (note, the covenant here does not restrict investments) Greater of $30 million and 2.5 per cent of Total Assets Greater of $50 million and 12.5 per cent of Consolidated EBITDA
Includes Restriction on Asset Sales? Yes Yes Yes Yes Yes
Excess Proceeds $40 million $30 million $50 million $20 million Greater of $50 million and 12.5 per cent of Consolidated EBITDA
Asset Sales Designated Non-Cash Consideration Greater of $50 million and 2.25 per cent of Consolidated Total Assets Greater of $35 million and 1.6 per cent of the Total Assets No designated non-cash consideration basket $20 million Greater of $25 million and 6.2 per cent of Consolidate EBITDA
De Minimis Basket in the definition of ‘Asset Sale' Greater of $30 million and 1.35 per cent of Consolidated Total Assets $15 million $50 million $20 million Greater of $10 million and 2.5 per cent of Consolidated EBITDA
Includes Limitation on Liens/Negative Pledge? Yes, HY-style Yes, HY-style Yes, HY-style Yes, HY-style Yes, HY-style
Permitted Liens Greater of $50 million and 2.25 per cent of Consolidated Total Assets Greater of $50 million and 2.2 per cent of the Total Assets $125 million Greater of $70 million and 47 per cent of Consolidated EBITDA Greater of $25 million and 6.2 per cent of Consolidated EBITDA
Notable Features Yes Yes Yes Yes Yes
  Nigerian oil & gas business East African Telco South African Conglomerate Turkish Renewables company Saudi Arabian Retail Real Estate company
Notable Features 179 day standstill period in respect of any enforcement actions that the Trustee would be otherwise entitled to take against the Guarantors Security granted over Proceeds Loans with extensive provisions restricting the amendment and operation of the Proceeds Loan Agreement including any prepayments or the reduction of interest rates   No restriction on investments contained in the covenants
Payment of dividend conditional on continued listing of the Johannesburg Stock Exchange and dividend amount payable during the life of the bond is capped at R2.90 per ordinary share
 
Issuer is required to maintain a debt service reserve account with an amount equal to at least 6 months' interest until maturity or acceleration of the bond Sukuk bond structure implemented so there was no dividend blocker included  

Key Considerations when Structuring a “ Cross-over” Deal

Whether structuring either a traditional high yield or a cross-over deal from a covenant perspective, care must be taken by all parties to ensure that they work from the issuer's perspective and will not result in a consent solicitation/noteholder meeting process to amend the covenants for actions or corporate activities that could have been reasonably contemplated prior to the marketing of the transaction.

Some of these considerations are as follows:

  • Other debt in the capital structure—is that properly allowed for, including its required place in the capital structure?  In certain jurisdictions, traditional forms of bank debt may still be key sources of financing for the issuer and such bank lenders may not be comfortable being pari passu with bondholders.
  • The jurisdiction—particularly for secured deals, there may be significant timing constraints in providing security and a generous post-closing period may be sensible and/or warranted.
  • Public companies—one of the key covenants in a high yield covenant package is the "restricted payments" covenant, which restricts distributions to shareholders, amongst other things, and this may be particularly hard to deal with if the issuer is a public company. Public companies want, and need, flexibility here to issue a regular dividend.
  • Some covenants may simply be inappropriate for the structure—for example, the typical "dividend blocker" covenant (ensuring that subsidiaries do not have restrictions on their ability to upstream cash to the issuer to repay the bonds) is probably not workable in a sukuk structure.

In our experience, while it might not be appropriate for emerging market issuers to have a high yield approach to covenant flexibility, to the extent that there are learnings or common points that are accepted in the traditional high yield market, it may make sense to give emerging market issuers the benefit of that flexibility. It serves virtually no one to insist that emerging market issuers be stuck with a set of high yield covenants from the 1990s while the rest of the market has moved on to ensure no trip wires are left in the covenant package which have been corrected or developed over time.

Conclusion

Cross-over structures offer issuers the required flexibility to run and grow their business whilst providing investors with the protections to preserve their investments. With the increasing sophistication of emerging market issuers and deal structures as well as the increasing adoption and acceptance of these cross-over structures, we can expect to see more cross-over deals in the coming years. 

1 This does not consider regulatory capital or other capital issuances which may be more akin to equity by their nature and are subordinated the Issuer's other debt. 

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2022 White & Case LLP

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