Standby letter of credit, credit enhancement
This paper focuses on the characteristics, terms, legal basis and credit enhancement effect of Chinese overseas bonds with standby letters of credit as credit enhancement methods, so as to provide reference for the investment of Chinese overseas bonds under the standby structure.
From the perspective of issuance characteristics, the issuers of Chinese overseas bonds with a reserve structure are mainly low-level urban investment, and the issuing banks are mainly regional city commercial banks. According to the data, since the second half of 2021, the issuance scale of Chinese overseas bonds with a certificate structure has risen, of which the issuance scale of overseas bonds with a certificate structure accounted for 82.8% of the total overseas bonds issued by the reserve structure in the same period, while the issuance scale of Chinese overseas bonds accounted for only 16.1% in the same period. From a hierarchical point of view, since 2020, the issuance scale of urban investment overseas bonds in the central district and county-level districts with a certificate structure has accounted for about 7-8 percent, while the issuance scale of all urban investment overseas bonds in the central district and county-level urban investment has only accounted for about 4-6 percent. With the tightening of regulatory policies for Chinese overseas bonds with a certificate structure, in April 2024 (as of April 19), the issuance scale of overseas bonds of urban investment with a certificate structure was only about 34.9% of the average monthly issuance size in the first quarter of 2024.
From the terms of view, the standby letter of credit has the characteristics of "pay on demand", which is equivalent to bank credit. According to the prospectus, except for the terms specifically agreed, the standby letters of credit comply with the Uniform Customs and Contract for Documentary Credits (UCP600) revised by the International Chamber of Commerce in 2007. It is not mandatory, but it has become a common rule followed by banks and trade circles around the world, and relevant judicial interpretations and judgments in mainland China have pointed out that in the absence of special agreements, this international practice shall be applied to the handling of disputes related to standby letters of credit. In terms of the repayment process, if the bond issuer has an event of default as agreed in the clause, the issuing bank will transfer the compensation amount to the account designated by the trustee within the time specified in the clause after receiving the claim that meets the clause, that is, the standby letter of credit is equivalent to an independent letter of guarantee issued by the bank, and when the clause is triggered, the bank shall bear the primary payment liability, and has the characteristics of unconditional and irrevocable.
For example, Standard & Poor's has pointed out that the repayment obligation of bonds issued with a standby certificate structure is equivalent to the non-subordinated debt of the issuing bank, and the debt rating is equivalent to the issuer's credit rating. From the perspective of actual credit enhancement effect, the debt rating (if any) of bonds issued by the standby structure is usually equivalent to the issuer's rating (the issuer's rating is lower than that of the issuer). At the same time, the yield of the secondary market of Chinese overseas bonds under the certificate structure is generally much lower than that of overseas bonds issued by issuers under other structures.
Judging from the claims cases, the existing claims have been fully repaid by the issuing bank. In the case of overseas bonds with a certificate-based structure (the corresponding bonds have not yet matured) for which the claim has not yet been triggered by the insurer, the enterprise still announced the payment of the coupon on the overseas bonds issued under the certificate structure through financing arrangements when the overseas bonds were suspended and planned to carry out debt restructuring, showing its differentiated arrangements for the repayment of overseas bonds with different credit enhancement methods.
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