Appendix 9 Bonds Product Bonds Basic characteristics

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1 Appendix 9 Bonds Bonds form one of the three major ways that a company can raise money and they are also widely used by financial institutions and governments. However, the usefulness of bonds does not stop there as once they have been issued and the company has raised its finances, bonds become key instruments of the secondary financial market, used by large corporations and private individuals alike. In fact, they are some of the most commonly used financial instruments and it is unlikely that a Compliance Officer will not come across them at some point in their career. Probably because they are such common investments there are seemingly innumerable ways in which the characteristics of the basic bond structure can be varied and this appendix is dedicated to guidance not only on the fundamentals of how a bond works, but also on some of the many sub-products to which the bond has given rise. There is also a brief section on securitization. The final section also gives guidance on some of the key regulatory aspects of the bond markets that Compliance Officers should be familiar with. Product Basic characteristics Bonds What is a bond? A bond is an investment that represents the ownership rights to debt, like an IOU. If you own a bond you have the right to receive the payments due (interest and/ or repayment of principal) in respect of the debt that the bond represents. Bonds usually pay a set amount of interest and are generally redeemable on a predetermined date (maturity) set at the time of issue. At maturity, the bondholder will receive the nominal value of the bond (see below), not the amount they paid for it in the market. Also called fixed interest securities or stocks. There are many different types of bond and many varying bond characteristics but the key features all relate to: face value; issuer; interest rate (if any); and maturity or redemption. Purpose Issuer To borrow money at a predetermined rate of interest. Buyer To secure a source of known income from the interest payments made on the money lent via the bond. Who issues bonds? Governments Supranational agencies Companies Local authorities Financial institutions Who buys bonds? This is not a way for individuals to raise finance! Anyone: this is a very popular product among individual and institutional investors alike. 1

2 How does a bond work? There are various ways of issuing bonds of which one of the most common is to use an underwriter. With an underwritten issue the issuer commissions a financial institution to structure the issue of the bonds on its behalf, known as the underwriter. The underwriter is generally responsible for: assisting with the structure of the bond issue and the provision of advice in this respect; pricing the bonds; marketing the bond issue; providing on-going market making and research services; buying the bonds on issue and selling them on to the public/other financial institutions. The underwriter is responsible for ensuring that the issuer raises the amount of money required. This means that they buy up all the bonds irrespective of whether they have found people to sell them on to. An alternative to the underwritten offer is a tender offer in which prospective bondholders are asked to submit bids for the price they are willing to pay for the bonds. When the structure and characteristics of the bond have been agreed these are formalized in a document called the trust deed (or the indenture in the US) which is made between the issuer and a corporate trustee company (see below). Each bond issue is split into individual stocks with a nominal value. This nominal value is also referred to as face value or par value. Each individual bond entitles the owner to receive a set amount of interest and to receive the face value when the bonds are redeemed. Any interest (also called coupon) is paid by the issuer to the trustee, who distributes it to the bondholders. The interest is a percentage of the face value of the bond. (Though not all bonds carry interest see Variations in bond characteristics, below.) Interest is usually paid either quarterly, semi-annually or annually. A bond with a face value of 100 may be sold for either more or less than 100. The price of the bond after issue will depend on many things such as: amount of time to redemption; coupon received on the bond compared to interest available from other sources; the risk associated with holding the bond see below. Risk profile Bonds are usually a lower risk investment than equities as the initial investment will eventually be repaid (unless the issuer goes bankrupt) and because the issuer is legally obliged to pay interest on a regular basis (contrast with equities there is no guaranteed return of capital invested and the issuer is under no obligation to pay dividends). Bonds also rank higher than equities in bankruptcy which means that bondholders will be repaid in full before any cash is returned to shareholders (if indeed they receive anything). However there are many bonds that are much higher risk than equities think, for example, about the risk profile of a start-up company in an emerging market country with an uncertain economic and political future versus that of a blue chip share listed on a major stock exchange. The risk profile of bonds is evaluated by rating agencies such as Moody s and 2

3 Regulated status under FSMA and FSA rules Standard and Poor s. The rating agencies assign short- and long-term risk ratings to bonds, and in respect of sovereign issues also distinguish between domestic and foreign-currency denominated debt. Sovereign bonds such as those issued by the UK or US government carry least risk and will have a high rating, the highest long-term rating being AAA (S&P) or Aa1 (Moody s). And bonds issued by what are perceived to be much more risky issuers are assigned lower ratings such as CCC. Low risk bonds are referred to as investment grade or prime. High risk bonds are referred to variously as: Non-investment grade; non-prime; junk; speculative; or high yield. The risk associated with a particular bond depends on many factors including: the quality of the security attached to the bond; the prospects of the market in which the issuer is active; the country risk of the issuer, e.g. US issuer v. emerging market issuer; the business track record and prospects of the issuer; the credit/default history of the issuer. Contrast the above with the risk profile of equities (see Appendix 8) and of loans (see Appendix 10). Bonds are specified investments under FSMA and are designated investments under the FSA rules. As a consequence firms providing bond-related services are subject to the detailed requirements of the FSA s regulatory regime. Tradability Bonds are tradable instruments (negotiable). Some bonds are much more liquid than others. Exchange Some bonds are traded on exchange and others are traded over the counter or involvement OTC. Clearing and settlement Evidence of ownership Trade reporting (to exchange) Transaction reporting (to the FSA) Documentation If the bond is exchange traded it will be subject to the clearing arrangements of the relevant exchange. OTC bonds will generally settle through Euroclear or Clearstream, although some will need to be settled through local custodians. Bonds initially came in the form of paper certificates but most are now dematerialized which means that ownership is represented by an electronic record maintained by a custodian. A notable exception is Eurobonds which are still issued as bearer bonds (i.e. if you have the bond in your hand, it is yours there is no trustee/ registrar to record official ownership). Trade reporting is required for exchange-traded bonds. Transaction reporting is required to the FSA. A number of agreements and other sorts of documentation are used in connection with the bond markets further details can be found on page 12 below, Pricing Some of the key factors influencing the value of a bond are listed below: repayment risk The risk associated with the issuer and the likelihood of 3

4 them repaying the monies due; interest rates - When interest rates rise, bond prices fall, and vice versa. This is because (simplistically) your bond might be paying only 2% interest whereas you could get 5% interest if you had put your money in a bank account; performance of equity markets When shares do well, bonds normally do less well; the nearer to maturity a bond is the closer its price will be to its face value Few people would want to buy a bond in January for 250 that will mature in February returning a face value of 100 to the holder! The prices of the more liquid bonds will be quoted on screens by market makers or brokers. It is harder to price illiquid bonds The price will basically depend on the price that one person is willing to pay and another person is willing to accept. Duration Can vary from as little as 3 months to 50 years. However, in a very few cases the arrangement is perpetual, as in there is no end date. Risks for issuers The issuer may not be able to meet its repayment or interest obligations. If this happens, it risks legal action being taken against it by the bondholders, generally through the trustee (see below). Some higher risk issuers may only be able to raise the required amount of money through a bond if they make various undertakings (known as covenants) to the bondholders in respect of how the company will be run (representing a loss of autonomy). If the issuer is seen as high risk, it will need to pay higher interest rates to encourage lenders to take on the risk of buying its bonds. There may be unfavourable redemption terms (see below). Risk for buyer The issuer may not be able to meet its payment obligations. In order to mitigate this risk some bonds are secured by means of charges or guarantees. If the bond trust deed is poorly written it may be difficult to make a legal claim on the amount owed in the event of default. There is generally no inflation protection associated with the face value of the bond 100 at issue date is likely to be worth a lot less when the bond is redeemed. Bonds do not give holders the right to a say in how the company is run or managed on an ongoing basis (other than through the covenants). Even if the issuer performed exceedingly well there is no upside for the bondholder, they do not participate in profit in the same way as a shareholder. Illiquidity it is not always easy to trade out of a bond position. There may be unfavourable redemption terms (see below). Benefit for issuer The issuer of a bond does not lose control over the operation of the company as bondholders do not have any voting rights, unless the issuer defaults, triggering bondholders right to invoke the insolvency process or restructure the repayment obligations under the bond. The ownership of the company does not change important for ownermanagers. Financial planning is made easier as future payment obligations associated with a bond are known from the outset. Benefit for buyer Except in cases of bankruptcy, bondholders have the certainty that they will 4

5 receive a particular amount of interest on set dates in the future. They also have the certainty that, at a given time in the future, they will receive the face value of the bond. In the event of bankruptcy, all bondholders rank above shareholders when the assets of the issuer are sold and the proceeds distributed. Bonds are designated investments and therefore bond trading is subject to the protections of the FSA regulatory regime. Trustee The trustee is responsible for: keeping a register of bond holders; monitoring compliance with covenants; collecting interest payments and repayments of capital from the issuer; distributing interest and capital repayments to the bond holders; and representing the bond holders interests if the bond goes into default. The trustee is sometimes referred to as the paying agent. Variations in bond characteristics Issuer Government bonds Generally considered to be very safe investments, especially if issued by a developed-world government such as the US or the UK. The government bonds of different countries are referred to in different ways including: Gilts and T-Bills UK Treasuries and T-Bills USA Bunds, Bobls, Schatz, Tobls Germany BTANs and OATS, and BTFs France JGBs and TBs Japan. Generally issued by a government department rather than a financial institution. In the UK, for example, Gilts are issued by the Treasury and the Debt Management Office (DMO) and in the US, government bonds are issued by the Treasury. Supranational bonds Issued by supranational organizations such as the: World Bank; Inter-American Development Bank; European Investment Bank. Generally considered to be very safe investments in a similar way to government bonds. Corporate bonds Generally more risky than government bonds so tend to offer higher interest rates. Unsecured loan stock Corporate bonds that are not secured. Higher risk as in the event of default, the bondholder does not have a right to the assets of the issuer as compensation. Debentures Corporate bonds that are secured. The security may be in the form of a fixed or floating charge over the assets of the issuer. Fixed charge Linked to a particular asset such as land. Prevents the sale of the asset until the loan has been repaid. More secure than a floating charge. Floating charge Charge not linked to a specified asset and only becomes effective, or crystallizes, if there are arrears on bond repayments. Not as secure 5

6 Local authority bonds Permanent interest bearing shares (PIBs) as a fixed charge. There are various fixed interest securities issued by local authorities. Tend to offer a higher rate of interest than government bonds as they are perceived to be more risky. No longer commonplace in the UK but very widely used overseas, especially in the US. Permanent interest bearing shares (PIBS) are issued by building societies that have not been demutualized. Despite being called shares these are actually bonds. Pay a fixed rate of interest instead of a dividend. Irredeemable and tradable on the London Stock Exchange although they tend to be illiquid. When a building society demutualizes its PIBs are converted into perpetual subordinated bonds Redemption/maturity Bullet Bond with a single, predetermined redemption date. Sinkers Bond with a sinking fund or escrow account. A certain number of randomly selected bonds are redeemed early on a regular basis and the redemption is paid for from the proceeds of the sinking fund. Bondholders do not have any choice in the matter, which can be problematic if the bond was currently offering a higher rate of interest than is available elsewhere. Purchase fund Bonds whose issuer has the obligation to redeem them at market rates when a certain condition, for example trading at a certain level below par, is fulfilled. The redemption is paid for from the proceeds of the purchase fund. Undated Bonds that have no redemption date and will thus never return the face value to the holder. Also referred to as perpetual or irredeemable. Serial notes Bonds of the same issue with different redemption dates. Serial note with Bond issue with different redemption dates with a disproportionately large number balloon of bonds maturing at the same time, creating the balloon. Convertible As well as waiting for redemption or selling on in the secondary market the bondholder has the option of converting the bond into another asset. The proceeds of the conversion are normally the common stock of the issuer. The number of shares that can be obtained per bond will be set out in the trust deed and is derived using a conversion ratio. The arrangement is a type of equity sweetener or kicker. Optional There are various types of optional redemption: redemption callable The issuer has the right to call early redemption; putable The bond holder has the right to have the bond redeemed; double dated The issuer has the right to redeem the bond on or between two set dates. The issuer will clearly time the redemption in the way that is most beneficial to themselves: if an issuer is paying 5% interest on a bond when interest rates generally are only 2%, it is beneficial for the issuer to redeem the bond as early as possible so as to raise finance with a lower interest rate. Medium term notes The name medium term note suggests that MTNs are simply medium term 6

7 (MTNs) Euro Medium term notes (EMTNs) debt instruments but there is more to these investments than that, and many are no longer even medium term, with some maturities up to 30 years. The key characteristic of medium-term notes is that they are very flexible, with new issues available on an ongoing basis rather than as a one-off event. The flexibility stems largely from the fact that they are issued under a programme whereby it is a agreed that a certain amount of money will be raised over a certain period, but that other than this given, issuers are free to vary features such as maturities, currency and interest in response to market conditions at the time of issue. MTNs are usually issued on a best efforts basis rather than being underwritten. EMTNs are like MTNs except that they are traded outside the country in whose currency they are denominated. Interest/coupon Index linked These bonds do not have a fixed coupon. The interest and repayments of principal are adjusted to take account of inflation. Floating rate These bonds do not have a fixed coupon. Often referred to as floating rate notes or FRNs. The interest rate applied is usually linked to a known market rate such as LIBOR. There are various arrangements to determine how the floating rate will work: Drop lock The interest rate floats freely until a certain rate is reached after which the coupon becomes fixed at that rate. Floor Minimum level below which the interest rate cannot fall, but unlike with the drop lock, the coupon rate can rise above the floor level if interest rates rise again. Protection for the holder. Cap/ceiling Set rate above which interest rate cannot rise. Protection for the issuer. Minmax Bond with a ceiling and a floor. The regularity with which the interest rate is refixed varies for each bond. With a mismatched floater the interest rate is refixed more frequently than the interest is actually paid. Stepped coupon The interest rate payable varies in accordance with a predetermined schedule. The interest payable generally rises in line with the bond s maturity. Also know as step up bonds. If the interest payable falls with maturity, this is referred to as a reverse stepped coupon. Zero coupon These bonds do not pay any interest. Instead of paying interest the bonds are issued and trade below par value. Their effective rate of interest is the difference between price paid and redemption value. Also called deep discounted bonds. Dual currency bond A bond issued in one currency and paying interest in another. Heaven and hell A dual currency bond for which the redemption amount is based on changes in the bond Duet bond spot exchange rate since the bond was issued. Bonds for which the interest rate payable is linked to variations between the exchange rates of two currencies. 7

8 Strips A strip is the coupon/interest payment on a bond (e.g. a UK Gilt or a US Treasury) that has been stripped away from, or separated from the bond to which it relates to form a separately traded instrument. As a result, the bond becomes a zero coupon bond and the person buying the strip or strips gains the right to receive the interest payments to which the coupons they have purchased relate. There is an extremely active US Treasury strips market. International bonds Foreign bonds As well as being able to issue bonds into their own home market, companies can also issue bonds internationally, for example, a UK company can issue bonds, denominated in yen, into the Japanese bond market. Various terms are used to describe these international bonds, for example: Bulldog bond Bond issued into the UK market by a non-uk company. Matador Bond issued into the Spanish market by a non-spanish company. Matilda Bond issued into the Australian market. Samurai Bond issued into the Japanese market. Yankee Bond issued into the US market. Eurobonds A bond traded outside the country in whose currency it is denominated. Issuers tend to be governments, supra nationals and highly rated corporates. Eurobonds are now often known as International Securities. Eurosterling bonds Bonds issued in sterling but traded outside the UK so that they are not subject to UK regulation. These bonds are more common than Bulldog bonds (see above). Brady bonds Bonds that have been created by converting non-performing sovereign emerging markets debt into bonds denominated in US dollars. These bonds generally offer less favourable terms for borrowers than the initial debt but are more secure as they are collateralized by US Treasuries. Created in response to the emerging market debt crisis. Other comments The interest payable on the bond is also called coupon because traditionally, interest was received by tearing off a coupon from a physical bond certificate and sending it away in order to receive the interest due. Yield the return to the investor as a proportion of the price of the bond. Also see: Repos, reverse repos and tripartite repos Appendix 14. Commercial paper Appendix 14. Do not confuse with the insurance products known as bonds or National Savings and Investments Bonds (see Appendix 18). Securitization Securitization is becoming increasingly popular and is the process of turning non-tradable assets into securities such as bonds, which are fully negotiable/marketable. In this way it allows the person holding the assets (the originator) to raise finance on the back of their illiquid assets. Any number of assets can be securitized with the crucial requirement being that they have a defined and regular future income stream. 8

9 Assets typically used in securitization include commercial loans, mortgages, credit card receivables and car loans (with the underlying borrowers referred to as the obligors). Singers have even securitized the future revenues they are predicted to earn in royalties! There are two main types of securitization: Asset-backed securitization (creating asset-backed securities by transfer of the assets to a noteissuing SPV); and Synthetic securitization (where the originator transfers credit risk on the underlying assets for example by issuing credit linked notes or buying credit protection but retains legal title to them). The standard process for a non-synthetic securitization involves the originator selling the assets or receivables to a special purpose vehicle or a trust which then issues securities. The securitization vehicle pays for the assets with the proceeds of issue of the securities which are backed by those assets. The assets used for each securitization must all be similar in terms of risk, maturity and income for the process to work it would be no good trying to securitize a 25 year mortgage with a 2 year car loan. Each securitization will normally result in the issuance of different tranches of securities varying in terms of risk and return, with each tranche having its own credit rating. The originator continues to receive cash flows from the obligors which are then passed on to the investors in the securities in the form of interest and capital repayment. Two of the major benefits of securitization to the originator are that it allows future income streams to be turned into immediate cash, and removes credit risk to the obligors, thereby reducing the originator s regulatory capital requirements. Key issues for Compliance Officers As previously mentioned the use of fixed income securities is extremely widespread and it is therefore advisable for Compliance Officers to become familiar with the various bond-related products and the markets on which they are traded. Part of this should clearly be gaining a knowledge of their regulatory environment and some of the main matters to be aware of are summarized below. Issue Diversity/ complexity Comment The concepts applicable to the mechanics of a fixed income security are relatively simple and the key thing for Compliance Officers to watch out for is the vast array of variations on the basic structure. There is so much jargon involved in the spectrum of fixed income products that it is important not to get intimidated by it. Simply find out the specific characteristics of a product that is being presented to you, because the basics, as they have been described above, will always be the same. Another thing to consider is that bonds are used extremely widely and may feature in the activities of many different departments of a financial services firm, for example: New Issues; Proprietary Trading; Customer Sales and Trading; Research; Investment Advice and Discretionary Management; and Corporate Finance. 9

10 Regulatory environment Regulated status Regulatory status of staff Bonds also form the basis of, or are component parts in, a range of other investments such as: Collective investment schemes; and Derivatives. Because of this diversity Compliance Officers should also have a solid understanding of the departments of their firm that use fixed income securities, and of the specific products and services involved, as all have specific characteristics giving rise to their own particular type of regulatory risk. Compliance Officers should be familiar with the legislation, regulations and best practice relevant to the fixed income markets. This is extensive and a list of source material is provided in the table above. Fixed income securities are highly regulated they are specified investments under FSMA and also designated investments under the FSA rules. Front Office staff involved with bonds in the course of advisory and discretionary management services will be covered by the Approved Persons and the Training and Competence rules (retail clients only). Back Office staff providing bond-related services such as custody and settlement for retail clients may also be covered by the Training and Competence rules depending on the exact nature of the activities they undertake. Further guidance on Training and Competence and on the Approved Persons Regime can be found in Appendix A of the main text. Market abuse The risk of insider dealing and market abuse is relatively high with exchangetraded bonds. Particular concerns include: passing on inside information prior to a bond issue; or spreading false rumours about an issuer in order to manipulate bond pricing. Further guidance about market abuse can be found in Appendix A of the main text. Conflicts of interest Firms that offer more than one service in relation to the bonds issued by a particular issuer are exposed to potential conflicts of interest. Be on the look out for the following types of situation: Priority being given to proprietary rather than customer trades when an allocation is being made. Research department being prevented from issuing a negative report on a company because another part of the firm is acting as underwriter for a new bond issue. Customers being advised to buy poorly performing bonds held on a proprietary basis in order to get them off the firm s books. Situations of this type not only constitute conflicts of interest but are also likely to represent specific rule breaches. Further guidance on conflicts of interest can be found in Appendix A of the main text. Conduct of business rules (COBS) As with equities, the FSA s detailed conduct of business rules apply to bondrelated activities where these activities constitute designated investment business (for example, dealing in bonds, managing a bond portfolio on a discretionary basis or safeguarding and administering). Some of the COBs chapters that have the most direct impact on bonds are: 10

11 Trade and transaction reporting Communicating with clients, including financial promotions; Suitability; Appropriateness; Dealing and managing; Investment research; and Reporting information to clients. Compliance with relevant COBS requirements should be kept under regular review. All fixed income trades should be reported to the FSA. Where a fixed income security is listed a trade report should also be made to the relevant exchange. Trade reporting will be undertaken by Front Office and transaction reporting by the Back Office; both should be subject to periodic review to ensure that they are working according to regulatory requirements. Client assets As bonds are designated investments the provision of custody services in relation to them is governed by the FSA s Client Assets rules. The Client Money rules should be applied to any monies held in relation to customer bond trading or to any coupon payments received by a firm on behalf of a client. Where bonds are held as collateral, the FSA s Collateral rules will apply if the activity which calls for collateral constitutes designated investment business. For example, bonds held as collateral for a loan (not designated investment business) are not covered by these rules whereas bonds held as collateral for margin trading (designated investment business) would be covered. Client Assets arrangements will generally be the responsibility of the Back Office and Compliance Officers should therefore conduct regular reviews to ensure that all applicable rules are being complied with. Prospectus rules A prospectus must be prepared each time shares are offered to the public or are admitted to trading on an exchange. The FSA has a specialist sourcebook containing rules relating to the prospectus which are based on the EU s Prospectus Directive (see Appendix 5). Compliance Officers should review each prospectus before distribution to ensure that it does not contain any inappropriate material and that each document complies with the relevant contents requirements of the FSA Prospectus rules. A copy of each prospectus must also be approved by the FSA. The prospectus should also contain appropriate disclaimers and this is something that the Compliance department will often work on with their colleagues in the Legal department. Listing rules Disclosure rules Compliance Officers should be familiar with the FSA s Listing rules if involved with new issues of listed bonds. Compliance Officers should be familiar with the FSA s Disclosure rules if they work for a listed company or if their company provides advisory services to listed companies. Research Extensive FSA requirements apply to the preparation and distribution of research, and this area has been subject to considerable regulatory scrutiny in the past few years. There are also some specific restrictions on personal account dealing by investment analysts. 11

12 Documentation Industry associations It is important to understand any trade agreements or other fixed income documentation that is used by your firm further details are provided on page 12 below. Get to know any industry associations that are involved with the types of fixed income products and services offered by your firm. Such bodies include: The Fixed Income Analysts Society; The European High Yield Association; The European Primary Dealers Association; The Securities Industry and Financial Markets Association; The International Capital Market Association; The Association of Corporate Treasurers; The Stock Lending and Repo Committee of the Bank of England; and The European Securitisation Forum. Key sources of legislation, regulation and guidance for bond markets Document Type Summary Market Abuse Directive (see Appendix 5) EU legislation EU-wide legislation covering market abuse, specifically applicable to bonds. Prospectus Directive (see Appendix 5) EU legislation EU-wide legislation covering the issue and contents of prospectus documents for the new issue of listed bonds (and shares). Market in Financial Instruments Directive (see Appendix 5) Financial Services and Markets Act 2000 (see Appendix 3) EU legislation UK law EU-wide legislation covering the operation of financial markets as a whole, including the fixed income markets. At a high level, sets out the operating framework for financial services within the UK. Companies Act 2006 (see Appendix 5) UK legislation Law governing how companies may raise funds by issuing debt instruments. Directed more at companies than at investors. Part 5 of the Criminal Justice Act 1993 (see Appendix 5) FSA rulebook - multiple sections including: Conduct of Business Training and Competence; Supervision (Transaction Reporting and Approved Persons) Code of Market Conduct Stabilization Listing Rules Prospectus Rules. UK legislation UK regulation Law covering insider dealing. The FSA rulebook covers regulated activities relating to regulated investments, such as bonds. Stock Exchange Rules Regulation Rules covering new issues and exchange trading in bonds. Each 12

13 stock exchange will have its own set of rules. Clearing House Rules Regulation Rules covering the settlement/clearing of bond transactions. Each clearing house will have its own set of rules. Gilt Repo Code of Best Practice Best practice Best practice prepared by practitioners and the Bank of England covering the operation of gilt repo transactions. Joint Statement Regarding the Communication and Use of Material Nonpublic Information Statement of Principles and Recommendations Regarding the Handling of Material Nonpublic Information by Credit Market Participants Guiding Principles to Promote the Integrity of Fixed Income Research International best practice International best practice International best practice This statement was issued in 2006 by a number of international financial services trade associations to confirm their position against insider dealing and market abuse. Guidance on handling price sensitive information for firms involved with credit related activities. Initially issued by The Bond Market Association, now part of the Securities Industry and Financial Markets Association, this document sets out best practice for bond research activities with a particular emphasis on preventing conflicts of interest. Fixed income documentation Some of the most frequently used documentation in the fixed income markets is listed below. Document Comment Listing documents Prospectus May be drawn up as a single document or as three separate documents: the registration document, the securities note and the summary. See Appendix 19. Registration document Section of a prospectus that contains details of the bond issuer. See Appendix 19. Securities note Section of a prospectus that contains the key details of the bonds being offered. See Appendix 19. Summary Section of the prospectus that contains the essential details of, and risks associated with, the issuer, any guarantors and the bonds being offered. Base prospectus A type of prospectus that may be issued in certain types of non-equity securities such as commercial paper issued under an issuance programme that contains information on the issuer and on the securities being issued. Supplementary prospectus A document issued to update an existing prospectus. Information memorandum Another name for the prospectus, which is widely used in the USA. Offering circular Another name for the prospectus, which is widely used in the USA. Listing particulars Generic name used to describe the documents issued in relation to a listing, 13

14 e.g. prospectus, final terms, etc. Final terms Used in conjunction with a base prospectus. Contains the final terms relating to a particular issue of securities under a base prospectus. A new final terms document will be issued in relation to each new issue of securities subject to a single base prospectus. Pricing supplement An old term used to refer to the final terms document. Used prior to the Prospectus Directive but may still be used for bonds issued before that time. Annual information update A document that contains a summary of information that has been issued or made available to the public by a company with bonds listed on a regulated market. There is an exception to the requirement to issue this document for certain fixed income securities. Term sheet Transactional document used to set out the preliminary terms of a primary market transaction in order to gauge interest and negotiate terms. It is not a binding document as final terms are established by the final terms document! Documentation associated with a bond issue Trust deed Only required if there the bond is collateralized. Made between the issuer and the trustee. Trustee acts for the bondholders and has beneficial ownership of the collateral. Custodian agreement (primary market) Agreement between the issuer of collateralized bonds and a custodian. Sets out the terms under which the custodian holds the collateral on behalf of the bondholders. Agency agreement Made between the issuer and the agent. The agent makes payments; Calculates interest; Does admin. Customer documents Trade confirmation note See Appendix 19. Periodic statement See Appendix 19. Custodian agreement See Appendix 19. (secondary market) Client assets agreement See Appendix 19. Bond trading documentation Global Master Securities See Appendix 20. Lending Agreement Global Master See Appendix 20. Repurchase Agreement Other documents associated with bonds Bond certificate Coupon It is still possible to find some bondholdings represented by physical certificates, but most bonds are nowadays held in dematerialized form and there is no paper evidence of holding. It may still be possible to find actual bond certificates with a coupon that can be torn off and sent away to the paying agent in order to receive an interest payment. This is very unusual nowadays however. 14

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