Tighter convertible bond issuance regulations to curb unfair practices

Korea’s financial regulator is tightening its grip on the issuance of convertible bonds in a bid to curb widespread unfair practices that favor large shareholders often at the expense of retail investors.

The Financial Services Commission Vice Chairman Kim So-young speaks during a press conference held at the Korea Exchange in western Seoul on Tuesday on the regulator's plan for a convertibles-related regulation overhaul. [YONHAP]

Korea’s financial regulator is tightening its grip on the issuance of convertible bonds — debt securities that can be converted into the company’s shares — in a bid to curb widespread unfair practices that favor large shareholders often at the expense of retail investors.

The revision follows an intensive investigation into allegations involving private convertible bond issuance, which uncovered unfair gains worth 84 billion won ($63 million) as of July last year.

The latest plan by financial authorities includes imposing greater reporting obligations regarding convertible bond issuance and tougher rules against so-called “refixing,” or downward conversion price adjustment, a practice largely unique to Korea among advanced economies in terms of its prevalence.

Such a plan for a convertibles-related regulation overhaul was announced by the Financial Services Commission (FSC) on Tuesday during a press conference held at the Korea Exchange in western Seoul, with its Vice Chairman Kim So-young in attendance.

“In Korea, convertible bond issuance has been combined with a call option feature and ‘refixing,’ thus serving as a major funding channel for smaller companies and startups,” said Kim.

The vice chairman, however, pointed out that a lack of transparency in the market and loosely regulated refixing practices turned convertibles into “a tool abused for unfair trading by some that exploit its unique features to expand their shareholdings and gain unfair profits.”

Refixing enables downward adjustment of the predetermined conversion price of convertibles in case of a share price decline. The practice is almost exclusive to Korea — except for Japan, where convertible bond issuance has been comparatively slow — in terms of its prevalence and frequency. Combined with a call option, it allows bondholders to buy more shares to expand their stakes or maximize gains, which as a result dilutes the ownership stake of the existing shareholders.

The FSC will impose tougher rules on refixing going below the minimum threshold, which stands at 70 percent of the initial conversion price. Because below-70-percent adjustment has been prevalent despite it being only allowed in case of exceptions such as restructuring in principle, the financial regulator will now mandate getting approval through a shareholders’ meeting for a refixing of less than 70 percent.

Moreover, the bond issuers will be obligated to provide greater disclosure of information related to convertible bond issuance, such as details on call option rights holders, that may have an impact on the company’s shareholder value.

Other measures include bolstering the guidelines for refixing regarding the condition and scale of price adjustment, to more transparently reflect the market value of the company’s share.

The FSC vice chairman said: “Many experts pointed out that Korea’s convertible bond market is significantly different from that of matured economies, such as the United States and European Union,” adding that the system has grown into the current abnormal condition due to investors being overly risk-averse and companies trying to raise funding in any way they can.

“We will implement fundamental measures on convertibles issuance so that large shareholders will no longer be able to abuse it as a means to enrich themselves,” said Kim, promising to “take a zero-tolerance approach in rooting out convertibles-related unfair trading practices.”

BY SHIN HA-NEE [shin.hanee@joongang.co.kr]