3.3 Bond issuance
Along with the issuance of stocks, Plcs can issue debt securities to raise finance. With the issuance of stocks, companies are searching for partial owners; with the issuance of bonds, they are searching for partial lenders. The financial markets provide the means for companies to borrow money by the issuance of debt securities in the form of bonds.
From an investor’s point of view, owning a company’s debt is different to owning its stock in three main ways:
- Bondholders have no rights to vote and are not entitled to receive dividends. Instead, they receive interest payments (known as coupons).
- A bondholder’s capital is paid back in full at maturity, as compared to shares, of which the value is contingent on the current share price when the shares are sold.
- Bonds outrank stocks in seniority, meaning that in the event of the liquidation of a company, bondholders are among the first to be repaid. Thus, bonds establish a more secure financial relationship with a company as opposed to stocks.
Regulating and documenting the issue of bonds
Companies can raise funds both in the financial market of their home country (domestic bond) or in that of a foreign country (foreign bond). In either case, they have to comply with the regulations of the market in question – for example, those laid down for issuance by the Securities and Exchange Commission (SEC) apply to both US and non-US companies raising funds in the USA. In the UK, the regulatory body is the Financial Conduct Authority (FCA). Public issues of bonds in the international markets still need to be listed on an appropriate stock exchange: for example, Eurobonds are listed on either the London or Luxembourg stock exchanges.
Bond issues need to be accompanied by the documentation specified by the regulator and the listing authority for the relevant market, if the bond is to be entered on to the official list of the local stock exchange. As with equity issuances, usually companies are required to produce – and have approved by the regulator and the listing authority – a prospectus to support bond transactions. Prospectuses also have to be submitted to the credit-rating agencies that provide ratings for the bonds.
In recent years, several universities in the UK have issued bonds to fund their activities. Figure 7 is an image from the prospectus of a £300 million bond issue by the University of Cardiff in 2016. You don’t need to read the prospectus, but if you would like to take a look at it you can find it on the Cardiff University website [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)] .
Debt and credit ratings
Bond issuers will normally have to secure a rating to enable them to issue their bonds on the world’s financial markets. A credit-rating agency is a private company that assigns ratings for issuers of certain types of debt, such as bonds. The three major global credit-rating agencies are Standard & Poor’s, Moody’s, and Fitch Ratings Inc.
The function (and business) of rating agencies is to provide (supposedly) independent information to investors about the financial reliability of bond issuers. This information is called a ‘rating’. The higher the rating of the issuer, the lower the assessed credit risk of investing in it. The specific credit-quality rating assigned varies between agencies. Ratings with a relatively low risk of default correspond to ‘Investment grade’. According to Standard and Poor’s classification, to be included in this category an issuer should be rated BBB or higher.
Using a simplified version of a recent Standard and Poor’s classification, Table 7 summarises the ranking from lower to higher risk for the lender. Click on the grade bands to read how each is viewed by investors.
The following section discusses the main mechanisms of bonds.