Analysis of the Application of the Standby Letter of Credit for Chinese Issuers’ Offshore U.S. Dollar Bond Issuance

Characteristics of Standby Letter of Credit

With the rapid growth of Chinese issuers’ U.S. dollar bond issuance in the offshore bond market in recent years, standby letter of credit (“SBLC”), as a credit enhancement measure, has been increasingly recognised and adopted by Chinese enterprises. SBLC is a letter of credit or a letter of guarantee issued by a domestic bank or an overseas bank to provide guarantee for the issuance of bond in favour of the trustee of a bond as the beneficiary which makes the SBLC issuing bank (“LC Bank”) to be jointly and severally liable for the payment of principal and interest of the bond upon the bond’s maturity date. Generally speaking, Chinese bond issuers usually use SBLC provided by financial institutions as a credit enhancement measure to reduce the interest rate and issuance costs of the bond. 

Advantages of SBLC 

SBLC is currently one of the most effective credit enhancement measures for Chinese issuers’ US dollar bond issuance in offshore bond market. For Chinese issuers’ US dollar bond issuance, the greatest advantage of SBLC is that it can effectively reduce the issuance costs of offshore bond issuance. 

On one hand, SBLC can change the determination basis of the interest rate of the bond from the bond issuer’s credit to the LC Bank’s credit. In the current Hong Kong bond market, the qualification and international recognition of the LC Banks are generally much better than that of the bond issuers. On the other hand, bond issuers with SBLC as their credit enhancement measures do not need to apply for investment rating for their bond issuance. Not only does it save the costs and expenses incurred for rating but it also enables Chinese issuers to obtain investors’ recognition without ratings from international credit rating agencies. Therefore, Chinese bond issuers can utilize SBLC to lower the interest rate of the bond to a greater extent and thereby smoothly and successfully issue the bond. Once the SBLC has been issued, the LC Bank shall undertake the responsibility and payment guarantee to the beneficiary. If the Chinese issuer fails to or is unable to repay the principal and interest of the bond, the LC Bank shall take the obligation to repay the principal and interest of the bond to the bondholders.

Disadvantages of SBLC 

SBLC, as a credit enhancement measure for offshore bond issuance, may bring certain negative effects on the bond issuance as well. Firstly, the LC Bank will require the bond issuer to pay certain guarantee service charge for the issuance of the SBLC. Therefore, Chinese enterprises should take into account the overall issuance cost especially the extra cost of SBLC issuance when considering SBLC as a credit enhancement measure. 

Secondly, the LC Banks normally require the Chinese bond issuers to provide counter-guarantee for the SBLC. Therefore, when a Chinese bond issuer chooses SBLC as a credit enhancement measure, it should determine with the LC Bank in advance in relation to the issuance requirements of the SBLC in order to avoid the negative effect on the company’s overall bank facility amount with the bank. The author acted as the issuer’s Hong Kong legal adviser and participated in an offshore bond issuance with SBLC. The LC Bank required the issuer to provide share charge as a counter-guarantee measure. Certain LC Banks may also require issuers to provide valuable immovable property as counter-guarantee for the issuance of SBLC. 

Thirdly, the LC Banks shall complete the internal approval process for the issuance of SBLC and it will normally take bond issuers at least one to two months to complete the SBLC issuance. Therefore, Chinese bond issuers shall consider the extra time costs and additional work required for the SBLC as a credit enhancement measure. It is suggested that Chinese bond issuers shall reach a preliminary agreement with the relevant commercial banks before the commencement of the bond issuance rather than apply the SBLC after the start of the bond projects in order to save lots of time costs. 

In practice, banks which are willing to issue SBLC for Chinese issuers’ offshore U.S. dollar bonds are mainly commercial banks, such as China Zheshang Bank, Bank of Chongqing, Bank of Xi’an, etc. If a commercial bank has a bank facility arrangement with the bond issuer before the bond issuance, it will be easier for the bond issuer to obtain the SBLC.

Several Recommendations on the Adoption of SBLC

In order to ensure the effectiveness of SBLC, it is recommended that the following points shall be considered for the preparation of the SBLC related documents. 

Firstly, it is suggested that the limit of the guarantee should be clearly set out in the terms and conditions of the bond. The general guarantee cap shall be the total amount of the principal and interest of the bond. In the offshore bond issuance deals with SBLC which the author acted as the issuer’s Hong Kong legal adviser, the LC Bank is normally responsible to repay the principal and interest of the bond. If the LC Bank agrees to undertake the extra fees, costs, expenses and indemnity payments which may be incurred by or payable to the trustee, the maximum limit to be paid by the LC Bank shall not exceed U.S. $ 1 million. It is suggested that the guarantee limit which is agreed to be paid by the LC Bank should be clearly set out in the relevant clause of the bond in order to avoid future disputes. 

Secondly, it is suggested that the number of draw-down of the guarantee should be clearly set out in the terms and conditions of the bond. Generally speaking, the LC Bank shall only take the responsibility for the payment guarantee after the bond issuer triggered an event of default. If a bond issuer is unable to make any payment once it is due, the mandatory redemption clause will be triggered, and the bondholders can immediately request the bond to become mature. The LC Bank shall make the payment for the amount due only for one time. If there is no clear agreement on the number of draw-down of the guarantee, the LC Bank shall take the obligation to repay the principal and interest for any subsequent default of the bond issuer. This will increase the repayment pressure of the LC Bank.

Thirdly, it should be clearly stipulated that the term of the SBLC is longer than that of the bond. In practice, the term of SBLC is generally one month longer than that of the bond. For instance, in the offshore U.S. dollar bond which was issued by Xianyang Financial Holding Group Co., Ltd. in June 2020, in which case Bank of Chongqing acted as the LC Bank and the offshore U.S. dollar bond issued by Neijiang Investment Holding Group Co., Ltd. in which case China Zheshang Bank acted as the LC Bank, the terms of the SBLC were both one month longer than that of the bonds in order to protect the rights of the trustee and the bondholders. This arrangement can provide bondholders and trustees a certain period of time to have recourse against ineffective payment resulting from the breach of the bonds and ensure sufficient protection of the SBLC.

As an effective credit enhancement method, more and more Chinese bond issuers adopt SBLC in offshore bond issuance projects. It is believed that SBLC can help the Chinese bond issuers to obtain the recognition of the investors, increase the success offering rate of the Chinese bond issuance and lower the interest rate of the bond. It is expected that the increasing cooperation between the commercial banks and Chinese bond issuers in offshore bond issuance will help more Chinese bond issuers to issue more offshore bonds successfully and thus diversify their financing channels.  

Jurisdictions: 

Partner, Jeffrey Mak Law Firm

Ms. Ji Hui is the partner of Jeffrey Mak Law Firm. She is a Hong Kong qualified lawyer and has a Master of Law degree. She mainly specializes in corporate nance related legal services, including but not limited to bond issuance of large-scale state-owned enterprises and private enterprises, including public bonds, private placement bonds and perpetual bonds, etc, and initial public offering of the shares of Chinese enterprises on the main board or GEM board of Hong Kong Stock Exchange. She also represented Chinese enterprises to deal with various loan transactions and merger and acquisition transactions.