Bond financing has recently become quite popular in the Czech Republic and companies often finance their business needs by issuing corporate bonds instead of the more usual credit financing. Obviously, the popularity of corporate bonds is also associated with the greater willingness of investors to buy them. Bonds are perceived by the general public as a safe and conservative investment instrument. Nevertheless, recent market developments show that corporate bonds issued by private companies may not always be a safe investment, as evidenced, for example, by the insolvency of online fashion store Zoot, which funded its expansion by issuing bonds.
The Czech Ministry of Finance acknowledges that retail investors are not always sufficiently informed about the investment risks and creditworthiness of borrowers. It has therefore prepared an amendment to the Bonds Act that should strengthen the protection of retail investors, in particular with respect to bonds issued without a public prospectus. To better understand this amendment, it is useful to recall a few basic facts related to bond issues and the possibility of a public offering.
The general documents for the issuance of bonds are the prospectus and emission conditions. As the prospectus contains a lot of information not only about the bonds but also about the emitter, some emitters try to avoid it by issuing bonds without following the Czech National Bank’s approval procedure. This is possible in two cases: First, for a below-the-limit bond issue with a value less than EUR 1 million (within a 12-month period), or second, for an issue valued at over EUR 1 million that is offered only to qualified investors (without limitation to the number of such investors) or as a private offer to unqualified investors (i.e., to a limited number of investors). Under law a maximum of 149 private offers can be made, but the Czech National Bank (CNB) interprets the term “public” more strictly, as it considers the public to be more than 20 people (for the purpose of financial market regulations), which limits the number of private offers.
For a public offering of bonds, the CNB must approve the bond prospectus, but this approval is only formal, i.e., a verification that the prospectus contains all statutory requirements. If bonds are offered to retail investors based on the above-mentioned exemptions from the obligation to publish a prospectus, the main source of information for investors is the emission conditions. Although in accordance with the Bonds Act the emission conditions contain enough information about the issued bonds, they contain almost no information about the emitter and its financial situation, which raises doubts about the ability of the emission conditions to protect investors. Therefore, the amendment to the Bonds Act proposes to modify the existing regulation in two respects.
First, all bond issues should now be assigned an identification number under the International Securities Numbering System, which should ensure their proper registration. Second, the emission conditions should include information on whether and to what extent the CNB is supervising the issue and their emitter. If the prospectus is approved by the CNB, the emission conditions should state that: i) the prospectus is assessed solely for the completeness of the information contained therein; ii) the CNB does not assess the issuer’s financial results or financial situation when approving the prospectus; and iii) approval of the prospectus does not guarantee the emitter’s future profitability or its ability to repay the bond’s yields and nominal value.
Of course, the real question is whether these amendments are enough to protect retail investors. Although a retail investor will be sufficiently informed that the CNB does not verify the creditworthiness of the emitter, this does not guarantee that such an investor will be able to correctly assess the suitability of his or her investment in the bonds.
Ondrej Havlicek, Head of Banking & Finance, Schoenherr Prague
This Article was originally published in Issue 6.9 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.