Perpetual Securities

In recent years, the Singapore market has seen an increase in issuances of perpetual securities to raise funds. The following guide highlights some of the key features and risks of perpetual securities.

Perpetual securities at a glance

 

What are perpetual securities?

Perpetual securities, otherwise referred to as “perps”, are hybrid securities issued without a maturity date. Perpetual securities share some of the features of both bonds and shares. Although they are often referred to as “perpetual bonds” and “perpetual notes”, they are not to be confused with conventional bonds and should be considered with caution.

Issuers of perpetual securities usually offer to pay fixed distributions. However, unlike bonds, issuers of perpetual securities often have the discretion to stop paying distributions altogether without triggering a default. Perpetual securities have no maturity date, so they can continue to exist perpetually, unless they are redeemed by the issuer. For a comparison of perpetual securities with bonds, shares and preference shares, please see the table here.

Perpetual securities are often issued with the following features:

Distributions

Most perpetual securities pay a distribution, say a fixed interest rate at fixed intervals, typically every 6 months.

Distribution deferral clauses (deferral of distribution payments)

While perpetual securities pay out distributions, there are deferral clauses which allow the issuer to defer or not declare distributions (depending on whether the perpetual securities are cumulative or non-cumulative) under certain conditions without having to seek investors’ consent. Such deferral and non-payment of distribution would not constitute a default by the issuer under the perpetual security, and could continue for an indefinite period. Investors will not receive any distribution payment during this deferred period. Given the possibility of a deferral, investors should not depend on distributions as a source of regular income or cash flow.

A decision by the issuer to defer distributions or not to exercise its redemption right at a scheduled call date may be viewed negatively by investors, and could affect the prices at which the perpetual securities may trade in the secondary market.

In recent years, some issuers of perpetual securities, such as Noble Group Holdings, have deferred their distribution payments.

No maturity

Perpetual securities have no maturity date. This means the issuer has the right to never return the principal amount to you. 

A call schedule

While perpetual securities have no maturity date, the issuer may have the right, but not the obligation, to call or redeem the securities on specified dates according to a call schedule. For example, call dates can occur from the 3rd, 5th or 10th year after issue date.

Issuers of perpetual securities are likely to redeem them if they can borrow at more favourable rates, for example, if interest rates have fallen since the securities were issued or if their credit standing has improved. You may not be able to re-invest at a similar level of interest rate.

If the issuer chooses to exercise the call, the issuer can choose to pay the principal amount in full or in part to you. If the call is not exercised or if there is no call schedule, the perpetual securities could exist forever without being redeemed. This means you will never get your principal amount back.

Step-up feature

Some perpetual securities have a step-up feature where the issuer is obligated to pay a higher rate of interest after a certain number of years if the perpetual securities have not been redeemed. You should not take such a step-up feature as an indication that the issuer is likely to exercise the right to call or redeem the securities before the step-up interest rate kicks in. In situations where an issuer’s financial standing has worsened and its cost of borrowing has risen, the issuer may find it cheaper to pay the step-up interest rate and decide not to redeem the perpetual securities.

No voting rights

Perpetual securities do not entitle their holders to voting rights, unlike shareholders who would have a right to vote on important corporate matters such as a fundamental change of business or a major acquisition or divestment of assets.

Financial covenants and cross default clauses

Some perpetual securities contain little or no financial covenants which means you will have little recourse when the issuer experiences financial problems. This is unlike most bond issuances that usually provide for financial covenants and cross default clauses as safeguards for investors.

Financial covenants take different forms and may include adherence to a set of financial ratios that an issuer must maintain to demonstrate its continued financial health and/or profitability.

The lack or absence of financial covenants means that the issuer has greater flexibility in running its business and is under no obligation to operate in a financially prudent manner. For instance, the issuer may choose to pursue short-term growth by taking on debt beyond a level that is sustainable. This could significantly alter its risk profile and adversely affect its ability to meet its financial obligations including those under the perpetual securities.

Further, in the absence of a covenant prohibiting the issuer from issuing securities which rank senior to, or pari passu with, the perpetual securities, the issuance of any such securities will reduce the amount that holders of perpetual securities may recover in a winding up or liquidation scenario.

The inclusion of a cross default clause means that a default by the same issuer in another borrowing could be sufficient to trigger an event of default for the bonds that you hold which may lead to the bonds becoming immediately due and payable. However, such covenants may not be provided to investors of perpetual securities.

Why do perpetual securities offer higher yields than bonds?

Higher yields for higher risks

Investors may be attracted to the higher yields offered as perpetual securities typically pay out higher distributions than plain vanilla bonds* of the same issuer to compensate investors for the higher risks involved. These include holding the perpetual securities indefinitely and the risk that distributions might be deferred and may not accrue interest.

*Plain vanilla bonds usually refer to bonds which are unsecured and rank senior (or equal) to other debt obligations of the issuer during a liquidation.

What risks will I be exposed to and what is the maximum I can lose?

You could end up holding the perpetual securities forever  

Issuers of perpetual securities have a right but are not obligated to call or redeem the securities. This means that the issuer has no obligation to return to you the principal amount of the perpetual securities and you have no right to require the issuer to do so, unless the issuer defaults. Where an issuer is not obliged to redeem the perpetual securities, non-redemption by itself, will not be considered a default.     

If an issuer does not exercise a right to redeem the perpetual securities or a call option, you can only exit your investment by selling your perpetual securities in the secondary market. This is provided there is a liquid secondary market for the perpetual securities you hold. When intending to sell in the secondary market, you will be exposed to market price fluctuation and liquidity risks.  

The market value of securities that are callable may be capped by their redemption value on the next call date. In addition, if the issuer so decides to call the securities, it could be redeemed at a price lower than the price you initially paid for the securities. 

You could hold them forever without reward

Perpetual securities often allow the issuer to defer all or part of any distributions. As an investor, you could end up holding perpetual securities which do not pay distributions and the principal amount of your securities is never returned to you.

You may be exposed to reinvestment risks if the issuer redeems the perpetual security

If the perpetual securities you hold are redeemed, you will be exposed to reinvestment risks, i.e. you are likely to have to reinvest your money in a lower yielding market.

How do I assess the credit quality of the issue?

It is important to assess the credit quality of the issuer of the perpetual securities when you buy the securities. As this may change at any time after purchase, it will be vital to constantly review and assess the credit quality of your perpetual securities holdings.

You, as an investor, must monitor your own investment. If the perpetual security or the issuer is listed on the Singapore Exchange (SGX), you should keep a lookout for announcements and any news relating to the perpetual security or the issuer.

If the issuer is listed on SGX, its financial statements are required to be announced on a quarterly or half-yearly basis, and its annual report must also be made public. If the issuer is not listed on SGX but its perpetual securities are listed and available for retail trading, its financial statements must be disclosed regularly as approved by SGX. You should also refer to the periodic financial statements, the annual report, and other documents the issuer may publish.

There could also be news reports on the financial position of the issuer, on the issuer’s industry outlook as well as any price movements of the securities. You need to assess whether to hold on to the perpetual securities, or to sell part or all of your investment. Seek professional advice if needed.

If you have some concerns about the company’s compliance with SGX’s listing rules, or about possible market misconduct, you may wish to contact SGX. SGX is the frontline regulator and is required to administer a sound regulatory framework to maintain a fair, orderly and informed market.  

How can you buy and sell perpetual securities?

Primary market

Buying perpetual securities in the primary market basically means subscribing to the initial offer from the issuer. Where it is a public offer made to retail investors, investors apply through ATM or internet banking channels similar to an initial public offering for shares. The offer would be accompanied by a product highlight sheet and prospectus or offer information statement (i.e. offer documents). The offer documents include information about the issuer, the terms and conditions of the securities, as well as the risks relating to the issuer and the securities.

For private offers not made to the general retail public, applications for subscription may be submitted through a bank or broker. Such offers would usually be accompanied by an information memorandum.

Investors should read and understand the offer documents before investing. If you do not understand the information, you should seek professional advice.

Offers in large size amounts (denominations) of at least $200,000

Wholesale bonds refer to bonds that are offered only to institutional and accredited investors or in large denominations of at least $200,000. Issuers making such offers (including those of perpetual securities) are exempted from the requirement to register a prospectus with MAS. Accordingly, the regulatory safeguards for the protection of retail investors, such as criminal and civil liabilities under sections 253 and 254 of the Securities and Futures Act, do not apply to such exempted offers.

A retail investor who purchases a wholesale bond continues to be protected under the Financial Advisers Act (FAA) if he purchased the wholesale bond on the recommendation of the financial institution. However, should a retail investor choose to purchase the wholesale bond on an execution-only basis, he will forgo the protection under the FAA.

Investors considering an investment of at least $200,000 

The $200,000 threshold applies to the sale of wholesale bonds (including those of perpetual securities) to retail investors. If the issuer offers the bonds in denominations of less than $200,000 to retail investors, the prospectus requirements would apply.

If you are a retail investor considering an investment of at least $200,000 in such an issuance, even if you are not provided with a prospectus, the financial institution you deal with would still be required to provide you with clear and adequate information so that you can make an informed decision. If you still have doubts or are unclear about the information the financial institution has provided, you should enquire further. Whether the consumer safeguards under FAA applies to you depends on whether financial advice has been provided. The provision of information on its own does not constitute advice, in which case the safeguards under FAA will not apply to you. In practice, financial institutions will typically offer to conduct a financial needs analysis, which could lead to financial advice and product recommendations. In such a case, you will be afforded the protection available under FAA if you purchase a wholesale bond that is recommended to you. But if you choose to purchase an investment product on an execution-only basis (i.e. without receiving any financial advice), you will forgo the protection under the FAA.

Accredited Investors

But if you have declared to be an accredited investor, i.e. if you have at least S$2 million of net personal assets or earned at least S$300,000 in the previous 12 months, the financial institution you deal with is not required to provide you with such advice or disclosure and the FAA does not currently provide any safeguards for accredited investors. If you are an accredited investor, it is important that you conduct your own due diligence and ensure that the product you are considering is suitable for your investment objectives and own financial situation.

In the case of exempted offers, the type of documentation and information provided to you may differ from institution to institution. Do make sure that you receive sufficient information in order for you to make an informed decision.

Buying and selling perpetual securities in the secondary market

You can buy perpetual securities in the secondary market, if it is traded on a secondary market such as SGX. You can go through your broker and pay the market price of the perpetual securities at the time you buy. You will also need to pay brokerage fees for the perpetual securities.

If you wish to sell your perpetual securities, you can do so in the secondary market via your broking house, just like how you trade bonds and shares.

Otherwise, holders of perpetual securities can opt to wait for the issuer to call or redeem the perpetual securities, if there is a callable feature.

When is a perpetual security considered to be "in default"?

Please note that if the issuer of a perpetual security does not pay a distribution, it is generally not considered a “default”. This is because the issuer usually has the right to defer payment of distributions indefinitely.

The perpetual security may also give the issuer an option to redeem the securities at a specific date. Since the option gives the issuer the right but not the obligation to redeem the securities at a specific date, the failure to do so would also not be considered a “default”.

Do check the documentation you are provided with to see what constitutes an “event of default”. In general, it will only be where a court order has been made for the issuer to be wound up.

As such, holders of perpetual securities are more similar to shareholders as compared to bondholders as there is no assurance of distributions or the repayment of their investment principal.

What are the possible outcomes for holders of perpetual securities when an issuer is wound up?

When a company is wound up, it ceases to operate its business, and the assets are sold off. The proceeds from the sale of assets would be paid to creditors and shareholders. In the case of perpetual securities holders, they usually rank behind senior creditors but ahead of ordinary shareholders, for the return of the issuer’s assets. This means that you may lose some or all of your investment.

An issuer may structure its debt into different classes – senior debt and junior debt. Usually, secured debt is classified as senior debt while unsecured debt is classified as junior or subordinated debt. Among investors, senior debt is paid first, followed by junior/subordinated debt. Do check where your perpetual securities will be ranked. In general, perpetual securities are junior/subordinated debt. Whether you and other creditors are able to be repaid all or part of your monies depends on the amount of proceeds available from the liquidation.

Priority of payment in liquidation

What is a trustee and what is its role? 

A trustee may be appointed by the perpetual securities issuer. Trustees are expected to exercise reasonable care and skill in carrying out their duties.

Where a trustee has been appointed, its duties and obligations are provided for under the trust deed (between the issuer and trustee) and the law. The trust deed also contains provisions for the protection of the rights and interests of perpetual security holders, as well as the procedures for convening meetings to consider matters that affect perpetual security holders’ rights or interests.

The trustee acts for the perpetual security holders on the terms contained in the trust deed. Perpetual security holders should read the key terms and conditions of the trust deed provided in the offering document. The issuer is obliged to promptly inform the trustee when it becomes aware of any event of default or when any condition of the trust deed cannot be fulfilled. However, you should note that the trustee does not usually have any obligation to carry out active monitoring of the issuer’s financial health.

It is common for trust deeds to provide the trustees with the right to seek an indemnity and pre-funding from perpetual security holders before taking the action requested by perpetual security holders as the trustees may incur costs (e.g. legal expenses) and could be exposed to legal liability that may arise from taking such action.

Do note also that before a trustee acts on a request from perpetual security holders, it would have to take steps to verify that the request comes from the beneficial owners of the perpetual securities and that the value of the perpetual securities held by the instructing perpetual security holders meets the relevant threshold under the trust deed. Where the perpetual securities are held through custodians or nominee banks, the trustee would have to work with these parties during the verification process. This process can take some time.

Checklist before investing in perpetual securities

Do read the most current documentation available before you invest in perpetual securities. If you are buying the perpetual securities in the primary market you are strongly encouraged to read the offering documents so that you can better understand the offer and make an informed decision.

As for investing in perpetual securities in the secondary market, you can get the offering documents, as well as the latest developments of the companies on the SGX website (if the issuer is listed on SGX) or their respective corporate websites.

Are perpetual securities suitable for everyone?

Perpetual securities are investments which are not easy to understand and may not be suitable for everyone. Hence, you should consider perpetual securities with caution.

Perpetual securities pose risks, including the possibility of loss of principal/capital. You need to assess whether the investment is suitable for you given your own personal circumstances. You need to understand and be able to evaluate the following:

  • Your ability to withstand never being repaid the principal. As perpetual securities do not have maturity dates, you could lose all the money you invested if no calls and no distributions are made and the issuer is wound up or liquidated.
  • Your ability to withstand market price fluctuations caused by market conditions like interest rate movements as well as the perceived credit quality of the issuer.  
  • Your ability to withstand a permanent income loss if distributions are deferred forever.
  • The features and risks of the investment you are making, including
    • the ability of the issuer to meet its distribution and other payment obligations,
    • the factors that will impact the market value of the investment
    • the liquidity risk you are exposed to as it may be difficult to sell perpetual securities in the secondary market, say when you urgently need to free up some cash. You will also be subject to price risk.  
  • How the investment will impact the risk-return profile of your overall investment portfolio,
    • e.g. whether it will adversely impact how your portfolio is currently diversified, especially if the $200,000 you are planning to invest in a perpetual security makes up a significant part of your overall investments.

     

Comparison of Returns and Risks across Different Investment Asset Classes for the Same Issuer

Returns/Risks Bonds

Perpetual Securities

Preference Shares

Ordinary Shares

Amount of payout
received from issuer

Holders will typically receive the lowest payout compared to securities ranked lower issued by the same issuer.

Holders will typically receive higher distribution payments than bondholders who rank more senior.

Holders will typically receive higher dividend payout than bondholders and perpetual security holders which rank senior.

Dividend payout will depend on the profitability of the company.

Coupon/ Distribution/ Dividend payouts

Holders will typically be paid before perpetual security holders, preference shareholders and ordinary shareholders.

Holders will be paid after those ranked more senior are paid.

Issuer has the right to defer distribution payments.

Holders will receive dividends after bond and perpetual security holders which rank senior are paid.

Holders will be the last to receive dividends.

Investment risk in terms of underperformance in return and risk of losing some or all of investment

Usually lowest compared to other securities issued by same issuer

Usually medium

Usually medium

Usually highest

 

In the event of an issuer’s liquidation

 

Holders will be paid before perpetual security holders and shareholders.

Holders will be paid after bondholders.

Holders will be paid after perpetual security holders.

Holders will be the last to receive any payout.