Trading in distressed bonds

The trading ban is gone. The unnecessary restriction has been lifted. Retail clients have been saved from harm. The time of distressed asset funds is coming.

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Sometimes one can feel a certain satisfaction when the legislator amends much criticised and harmful regulations several years after they entered into force. I have always regarded the exclusion of trading in bonds after the record date (so-called D-day) as such. It prevented trading in such problematic assets and thus, for example, excluded the possibility of settlement of tax losses.

Although the legislator did not delete the problematic provision, it added several others that significantly change the legal status.

Until now, there was only the statement that “Once the persons entitled to benefits from the redemption of a bond have been determined, the rights from such a bond may not be transferred” (Art. 8 para. 4)[1]. It was as simple as the cut of an executioner’s sword. The time limit has expired, so any trading is excluded.

Now it has changed, because if the issuer fails to provide the benefits from bond redemption within the time limit provided for in the terms and conditions of issue, or provides them only in part, the transferability of the bond rights will be restored after the expiry of that time limit (first sentence of Art. 8 para. 5). Thus, we have a period of trading exclusion which is relatively short, as it begins on D-day (record date) and ends on P-day (payment date). The wording of the provision is not the best because, knowing my fellow lawyers, I am already waiting for an interpretation stating that in the case of partial redemption, as provided for in the terms and conditions of issue, even if the issuer performs, the possibility of trading in the bonds will not be restored. Before that happens, however, we can safely move on. The transferability of the bonds is restored in the event of a default. The issuer fails to pay on time and the bondholders are free to dispose of such distressed bonds.

However, I may have exaggerated a bit with the “free” part. It is heavily limited by the next sentence, which states that the bonds may not be transferred to a retail client within the meaning of the Act on Trading in Financial Instruments (second sentence of Art. 8 para. 5). A retail client is anyone who is not a professional client, i.e. who is not – to put it simply – a financial institution or a large enterprise. The exclusion of retail clients from buying distressed bonds precludes the possibility of their listing on organised markets. Anonymous exchange trading makes it impossible to identify the buyer. Bonds can only be transferred on the basis of agreements concluded directly between the bondholder and the buyer, or agreements concluded through brokerage houses. Bondholders who are retail clients will only be able to dispose of distressed bonds. Professional clients will be able to both dispose of and buy such bonds.

The restriction on disposal of bonds cannot be extended to non-disposal events. As a result, even a retail client will be able to become the owner of bonds on the basis of universal succession, i.e. in the case of natural persons – by inheritance, and in the case of companies – by merger or demerger.

The possibility to trade in distressed bonds changes the status of those entitled to outstanding (unpaid) benefits. The seller of bonds will cease to be entitled and the buyer will take their place. This entails the need to update the list of those entitled to benefits from the bonds. The legal basis for such an update has been provided for in the new Art. 8 para. 6.

The trading ban is gone. The unnecessary restriction has been lifted. Retail clients have been saved from harm. The time of distressed asset funds is coming.

[1] all references to the provisions of the Act on Bonds

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