SGX flags risks of 'death spiral' bonds

Investors were warned yesterday about risks involved when companies borrow money by issuing "death spiral" convertibles. Such securities came into prominence this week after a bondholder triggered unusual volume movements in the shares of LionGold and Magnus Energy by converting its bonds into shares below market price and then selling them.

"We saw a trend of companies issuing such securities and had heard market feedback on concerns about such convertibles," said a spokesman for the Singapore Exchange (SGX) yesterday.

SGX chief regulatory officer Tan Boon Gin noted that when a share price is in prolonged decline and "death spiral" convertibles are exercised, existing shareholders are at risk because the bondholder is inclined to sell his shares upon exercise.

"Each round of conversion and share sale may drive the share price ever lower, hence the term 'death spiral'," Mr Tan said.

Under existing rules, companies are not allowed to issue convertibles with a discount of more than 10 per cent off the market price by way of a general mandate, and an extraordinary shareholder meeting must be convened to put it to vote instead.

The same shareholder approval must also be sought if a company intends to issue new shares of more than 20 per cent of its existing share base for mainboard issuers or more than 50 per cent for Catalist issuers.

Mr Tan said a company planning to issue "death spiral" convertibles must send shareholders a circular "written in plain English and without overly legalistic jargon, before the shareholder vote". Company circulars must make clear how such a bond could result in massive dilutions detrimental to investors.

Disclosure rules require a company to explain clearly in its circular the rationale for such an issuance, as alternative forms of financing will be hard to come by once a company's shares go into a tailspin. Finally, the SGX said that "death spiral" convertibles are a type of bond and rank ahead of ordinary shares when the company is repaying its creditors.

A version of this article appeared in the print edition of The Straits Times on August 26, 2016, with the headline 'SGX flags risks of 'death spiral' bonds'. Print Edition | Subscribe