FSC expect to revise the rule of Golden CB and BW issuance

Mr. Gordon Gekko proudly proclaimed that ‘greed is good’. In nature, investors seek their maximum return from their investment as always. As long as it is not illegal to do so, there is no reason for them not to implement their optimal method of investment. As an instrument of financial investment, golden CB (Convertible Bond) and BW (Bond with warrant) had been favored by investors in Korea stock market until now.

Golden CB and BW are different from generic CB and BW in terms of fixing the conversion or exercise price of issuance. Generally when the company issue CB or BW to financial investors in order to replenish its cash flow, both parties, the company and financial investors are necessary to agree on the certain condition in prior to make it official. Typical condition of CB is as follows: the issuer is obliged to pay X % of interest of the initial borrowing in return during the period (usually 3~4 year period) at semi-annual basis. Creditors who acquired convertible bond issued by the company have a right to receive an interest payment as well as exercise their preference to convert its bond to common share at the certain price per share – in general, the right to demand its conversion is not allowed until one year after the day of issuance. Therefore the conversion price shall be determined based on the price of share when the claim executed. Provided that if the estimated price of conversion per share expect to be lower than the price of initial issuance due to the capital increase or other capital changes, the conversion price can be adjusted under the consideration of capital changes during the period (possibly lower). Once the claim is filed, the company shall issue new shares to investors based on the estimated price per share. Should investors claimed 100% of conversion of bond, they are supposed to becoming shareholders of the company now, which they are able to trade their share at the current market price. If it is significantly higher than the share price they received from the company during the conversion process, investors expect to generate the certain amount of profit from its margin. However, since conversion/exercise price does not correspond to the market price change, creditors who hold golden CB or BW are able to gain more capital gain than who hold generic bonds. Usually the conversion price can be reset in every three months for generic BW. So either conversion or exercise price of CB or BW should be responded in proportion to the price change. However, as for golden CB/BW, the company still has to issue new shares at significantly lower price per share, even though the current price is skyrocketing. Evidently investors will be more than glad to receive new shares which already accounted for higher value.

According to the press, just right after decide to reduce its capital of the company, some malicious major shareholders of the company teamed up with the certain group of investors secretly issued golden CB to their investors. Furthermore, the company did get away with their obligation to announce the public notice of issuance since there is no need to issue public notice if the amount of CB is less than KRW 1 billion – they issued CB slightly less than 1 billion(0.999 billion).

Does it sound like illegal? The answer is not necessarily so. Until now, golden CB/BW are being traded between investors and companies. As for investors, investment tools such as golden CB/BW can be highly secured and profitable especially the company do have upside potential and it drives the stock price go up.  However, newly issued converted shares might distort fair value of the company. It may lead the price to drop severely and general investors end up lose their investment.  Due to the frequent base cases of golden CB/BW, Recently Financial Services Commission has set to revise the current regulation on CB/BW issuance, which any CB/BW to be issued is subject to change in proportion to the market price change. After the series of discussion with relevant government committee and officials, the amendment will be in effect from early November. But there is a catch. Golden CB/BW is still allowed to issue under the certain condition. If it is agreed to issue golden CB/BW from special resolution at shareholders’ meeting and it guarantees the conversion price per share can be adjustable; which it shall be issued at least higher than the minimum price range of issuance. Also it will be acceptable if the company intend to issue golden CB/BW according to CRPA (Corporate Restructuring Promotion Act) – such as those who filed chapter 11 or claimed its bankruptcy etc. In addition, this amendment is not retroactive which cannot be effective to the previously issued golden CB and BW already.

Every law and regulation has a loophole. It is not necessary to criticize those who take an advantage of. In terms of investor’s viewpoint, especially those who hold golden CB/BW, it is certainly secured instrument of their investment. However, some unfair cases which elaborated above shall be prevented from the beginning because it will not only damage the reputation of Korea stock market, but cause huge losses among general investors. In its sequel from ‘Wallstreet’, Mr. Gekko served in prison almost eight years for insider trading and securities fraud and is now promoting his new book, ‘Is Greed Good?’ Greed is good. But let’s be fair.

Jinmok Kim (jinmok.kim@gmail.com)

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