[Inside Chodong] Information Transparency Needed to Prevent CB Loopholes

[Asia Economy Reporter Hyungsoo Park] It has been eight months since the Financial Supervisory authorities implemented the amendment to the "Regulations on the Issuance and Disclosure of Securities" (hereinafter referred to as the Securities Issuance Regulations) to enhance the soundness of the convertible bond (CB) market. This measure aims to reduce abuses such as major shareholders and institutional investors exploiting conversion price adjustments (refixing) or put options (call options) to illegitimately expand their equity stakes or engage in unfair trading by issuing CBs through private placements.

In the first half of this year, the issuance volume of mezzanine securities such as CBs and bonds with warrants (BWs) decreased to about half of the same period last year. According to the Korea Securities Depository, the total mezzanine issuance amount in the first half of this year was 2.7268 trillion KRW, down 54.3% from 5.9669 trillion KRW in the first half of last year. By type, CBs accounted for 2.2527 trillion KRW, BWs for 174.5 billion KRW, and exchangeable bonds (EBs) for 299.6 billion KRW.

The investment banking (IB) industry views the amendment of CB-related regulations as a factor leading to the contraction of the mezzanine market. Previously, CB investors carefully examined whether they could realize capital gains by converting to common stock rather than focusing on the bond interest rate. This was why 0% interest CB issuance was possible. However, according to the amended Securities Issuance Regulations implemented since the end of last year, if the stock price rises, the conversion price of privately placed CBs must be mandatorily adjusted upward. The upward adjustment range is about 70% to 100% of the initial conversion price. It has become more difficult to realize gains through stock conversion. Listed companies issuing CBs to raise funds are now offering higher interest rates to attract investors. Some listed companies issue CBs without refixing clauses. Instead, if the stock price falls below a certain level, they lower the conversion price and reissue CBs to reduce investors' risk factors.

A KOSDAQ-listed company in the entertainment business issued CBs in early last month. All CB subscribers were previous CB investors. The conversion price of the newly issued CBs was about 22% lower than that of the previously issued CBs. The funds raised by issuing CBs were used to acquire the previous CBs before maturity. As a result, although CB investors faced more complexity, they succeeded in lowering the conversion price. Since there is no refixing clause, even if the stock price rises before the conversion period, the conversion price does not change.

In the past, when the authorities blocked private placements of detachable BWs, cases of major shareholders using CB call options to expand their equity stakes increased. As regulations on CB issuance are strengthened, new alternatives are emerging. This is why there is a movement to add refixing conditions to redeemable convertible preferred stocks (RCPS) for issuance. Attempts to circumvent regulations continue despite stricter rules. Of course, the authorities’ efforts to establish various institutional safeguards to protect investors’ rights are important. However, it is also necessary to consider whether these institutional improvements reduce market functions.

The reason listed companies conduct initial public offerings (IPOs) is to increase external recognition and help raise funds. CBs have been preferred by both companies and investors because they allow lower interest rates in exchange for granting conversion rights. Excessive CB issuance increases the number of shares that can be issued, raising concerns about shareholder value dilution. Efforts should also be made to improve systems so that general investors can easily identify listed companies with significant potential sell-off volumes (overhang) concerns. As the capital market rapidly advances, institutional improvements alone are insufficient to protect investors. As complexity increases, investors must develop the ability to assess opportunities and risks, and authorities must strive to provide information that listed companies are reluctant to disclose.