How to prevent and reduce the legal risks in the bond market has always been an issue discussed by the legislative, judicial and regulatory bodies in China. On 27 December 2019, the National Association of Financial Market Institutional Investors (NAFMII) issued the Business Guidelines for Trustees of Debt Financing Instruments of Non-financial Enterprises (trial), formally establishing a trustee system in the interbank bond market.
On the next day, the 15th Meeting of the Standing Committee of the National People’s Congress revised paragraph 2 of article 92 of the Securities Law, providing that, “the issuer that offers a corporate bond to the public shall retain a bond trustee for the bondholder, and enter into a bond trustee agreement”. The securities market trustee system was thus established.
So far, China has established a bond trustee system in the two bond markets, of which the provisions for the interbank bond market are the most detailed and specific. The authors will mainly explore the bond trustee system in the interbank bond market in this article.
According to the above-mentioned business guidelines, the following institutions may act as trustees: (1) lead underwriters of debt financing instruments; (2) financial asset management companies with financial licences; (3) trust companies that have obtained the business qualification for underwriters of debt financing instruments; and (4) law firms and other professional institutions with business experience in debt financing instruments.
The trustee system offers new opportunities and challenges to law firms.
A law firm that applies to register as a trustee is required to have issued legal opinions for the registration and issuance of debt financing instruments in the past year, and have the performance of acting as an agent in major and complex litigation and bankruptcy cases.
The law firm should be familiar with the relevant debt financing instruments, able to control or discover the risks that may occur in the duration of the bond, and able to deal with a default event quickly and participate in the subsequent disposal after the bond default.
Manage and dispose of collateral. After accepting the entrustment, the law firm shall promptly obtain the right certification documents of mortgage, pledge, guarantee and other guarantee measures set for the relevant debt financing instruments, and keep them properly.
During the period of trusteeship, the law firm shall continue to pay attention to the value and ownership of the collateral, and the credit status of the guarantor. In case of a decrease in the value of the collateral, or the exercise of the security right agreed in other security documents, the law firm as trustee should supplement the collateral, dispose of the collateral, or require the guarantor to bear the guarantee responsibility in accordance with the agreement of the trustee agreement, or the authorization requirements of the bondholder.
Participate in debt restructuring on behalf of the bondholder. If the debt restructuring of the relevant bond occurs due to debt default, or for other reasons, the trustee may accept all or part of the entrustment of the bondholder to participate in the debt restructuring on behalf of the bondholders, urge issuers, lead underwriters and relevant institutions to carry out debt restructuring, and supervise debt restructuring from the perspective of professional institutions, so as to protect the interests of bondholders.
Apply for property preservation, file a lawsuit or arbitration on behalf of the bondholder. The trustee may accept all or part of entrustment of the bondholders to apply for property preservation, file a lawsuit or arbitration on behalf of the bondholders in its own name, and participate in the corresponding litigation or arbitration proceedings.
Participate in insolvency proceedings on behalf of the bondholder. The trustee may accept all or part of entrustment of the bondholders to participate in the insolvency proceedings on behalf of the bondholders in its own name.
Conduct daily management. The trustee shall disclose information, participate in or convene meetings of bondholders, maintain communication with bondholders, lead underwriters and other intermediaries in accordance with laws and regulations, and trustee management agreements, and perform daily management functions.
Advantages of law firms
As the only intermediary service agency among the four types of trustees, law firms enjoy natural advantages in performing the following duties of the trustee: (1) in the process of daily management, supervision of collateral and supervision of guarantor’s credit, lawyers can react to risks very sensitively, find hidden dangers more easily, and supervise and supplement guarantee timely; (2) disposing of collateral, participating in debt restructuring, applying for property preservation, filing a lawsuit or arbitration, and participating in insolvency proceedings all belong to the professional fields of lawyers, while other institutions will employ lawyers to dispose of risks after the bond is in risk. By comparison, if a law firm acts as the trustee directly, it can deal with the risk quickly, efficiently and accurately, reducing communication and time costs, and protecting the rights and interests of bondholders to the maximum extent; and (3) the business guidelines clearly stipulate that a law firm providing legal services for the issuer shall not act as the trustee of the current debt financing instrument, but the bank acting as the lead underwriter may act as the trustee of the same bond. Therefore, compared with banks, a law firm, if acting as trustee, can better avoid and reduce conflicts of interest, and protect the interests of clients from an independent and professional perspective.
The bond trustee system offers both opportunities and challenges for lawyers. Lawyers should constantly increase their knowledge reserves and improve their professional competence to provide better legal services for bond investors and effectively protect the interests of investors.