Interpretation of model investor protection clauses (2019)

In order to improve investor protection measures after the occurrence of several default events in the credit bond market, the National Association of Financial Market Institutional Investors issued the Model Investor Protection Clauses (Model Clauses 2016) in September 2016. Since then, with the further downward pressure on the economy and the government-led deleveraging process, defaults on credit bonds in the market have occurred frequently.

On 14 February 2019, the Securities Association of China and the National Association of Financial Market Institutional Investors jointly issued a circular on the business operation and compliance of the credit rating agencies of the bond market in the fourth quarter of 2018. According to the circular, there were 44 new default issuers in 2018.

According to the market, there were 37 in the corporate bond market, and 19 and three in the debt financing instruments market and the corporate debt markets, respectively. In 2018, 43 first-time defaulters were added, setting the biggest high since 2014.

In such a market environment, in order to enhance the protection of investors, the National Association of Financial Market Institutional Investors issued the Model Investor Protection Clauses in April 2019 (Model Clauses 2019).

Model Clauses 2019 provides for six categories of investor protection clauses including cross-protection clauses, prior commitment clauses, prior binding clauses, change of control clauses, debt repayment guarantee clauses, and asset collateral clauses. Compared with Model Clauses 2016, the main changes in Model Clauses 2019 include the following:

1. Three categories of investor protection clauses are added, including prior commitment clauses, debt repayment guarantee clauses, and asset collateral clauses;
2. The triggering of four categories of the clauses are optimized, including further improvement of the types of debts stipulated in the cross-protection clause, enrichment of 20 financial indicators including the proportion of restricted assets, expansion of the three types of prior-constrained matters such as restricting major investment in others, and optimization of the triggering of the change of control clause;
3. Five clause handling mechanisms are detailed: (i) further detail to the triggering and confirmation mechanism of investment protection clauses; (ii) the logic relation between the grace period and the remedy mechanism defined; (iii) options added of no distribution (except for the income paid to the state-owned capital according to law) and no capital reduction in addition to exercise of repurchase option, adding of security, increase of nominal rate, and no increase of debt financing instruments specified in Model Clauses 2016 with respect to “remedy kit for breach of agreement”; (iv) optimized the proposal voting mechanism of the holder’s meeting; and (v) enhanced the liabilities and obligations of each party after triggering of any clause.

Significance of the new model clauses

The introduction of Model Clauses 2019 released a positive signal from the National Association of Financial Market Institutional Investors to protect investors. If the corresponding investor protection clause can be added to the issuance documents of the debt financing instruments, the issuer’s operation, finance, investment and financing, etc., would be further regulated, and investors would be given multi-dimensional reinforced remedial measures to achieve more comprehensive investor protection.