Conservation agreements were in vogue during the recent growth of Asian bond markets between September 2012 and May 2013. Several Chinese companies used these agreements when issuing new bonds during this period. A good retention agreement is a type of bond loan improvement. It is issued instead of a guarantee and is weaker than a guarantee. Increasing credit reduces the risks associated with bonds, and thus reduces the cost of financing.
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When bonds are issued and guaranteed by offshore non-operating organizations or operating organizations with weak assets and cash flows, bonds offer a low degree of protection for investors. In such cases, along with the purchase of shares, a special structure is used, called a well conservation agreement. These agreements generally state that the parent company / operating organization with rich assets (which has the best credit quality) will ensure that the issuer / guarantor of the bonds will maintain a minimum capital and sufficient resources to service the debt obligations. We need to understand the need to issue bonds with such a structure. Bond guarantees require the approval of regulators in China, while the storage of wells is not required. Thus, this structure facilitates access to offshore markets for Chinese companies (which cannot directly issue or guarantee offshore notes) through their offshore affiliates.
Another important aspect to study is whether this communication structure is strong enough. Two agreements indicate the readiness of the parent company to financially support the issuer / guarantor of the bonds. However, the risks cannot be undermined, given that there is no precedent – the structure has not passed a legal check to understand the results in case of default.
Let us consider the example of China Wanke to better understand this structure. China Vanke Co., one of the largest developers in China, issued its first offshore bonds in 2013 with a well-conservation structure. The bonds maturing in 2018 were issued by Bestgain Real Estate Ltd, an BVI organization, and were guaranteed by Vanke Real Estate (HK). The bonds were backed by a well conservation action and a contract to buy a stake in China Vanke, a land exchange. China Vanke needed the approval of Chinese regulators to guarantee these bonds. So he went for this type of bond structure. The conservation agreement well stated that China Vanke would ensure that i) the Bestgain issuer would maintain minimum capital, and ii) the issuer and guarantor would maintain sufficient resources to service the debt obligations. Otherwise, it will be a default, and the trustee could go to a Hong Kong court to demand that China’s Wanke service the debt. The stock buying company said China Vanke would buy a stake in some subsidiary so that the issuer and guarantor would receive the resources needed to service the bond obligations.
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This structure has been used by some high-yielding real estate issuers such as Beijing Capital Land and Gemdale Properties. Different bond structures provide investment opportunities to investors. However, investors should consult with financial advisors to better understand the complexity and risks associated with different bond issuance structures.