The perplexing perpetual bonds

The UK government is said to have pioneered perpetual bonds to finance Napoleon wars.

It now issues perpetual bonds under the name of consol, but heaven forbid, should the uninitiated, without the understanding of its grave implications, invest in these bonds, there is no way they can be consoled if things go wrong for them and the market is down.

EQUITY SHAREHOLDERS

Perpetual bonds are said to have the characteristics of both equity and debt.

They carry a fixed coupon rate of interest, which is naturally a few notches higher than that on bonds that are redeemable, to compensate for the money permanently locked in.

Of course, its holder can seek an exit through the bourses, as in the case of equity shareholders, where he may make profits or incur losses accordingly, depending on if the prevailing interest rates for similar bonds are lower or higher, vis-à-vis the bond he is holding, among other things.

It has, but accoutrements of equity, in the sense that like equity, it is not redeemable, and hence a permanent source of finance for the issuer, which is why Basle-scarred banks have been lapping up the instrument with alacrity, with manufacturing and companies too getting into the act lately.

The one-sided nature of the instrument would be apparent if one considers the take-it-or-leave-it features written into such bonds by the issuers. Some of the typical features are that the issuer may choose to call the bonds anytime, after say five years; the issuer may choose to convert the bonds into shares and so on, with the holders of the bonds not having the put or indeed any other option.

Despite the odds against the investors, perpetual bonds have been a huge hit with insurers and pension funds abroad, ever on the lookout for long-term avenues to park their funds, and wanting to lock into an attractive rate of interest, from which there is no reneging by the issuer.

Tata Steel has already tapped the wholesale market in India for perpetual bonds denominated in rupees, and raised as much as Rs 1,500 crore and is gearing up for an overseas issue, its appetite having been sharpened.

BOOMING MARKET

Quite a few other Indian companies are girding their loins to get into the bandwagon. The bonds do not strain the cash resources of the company, except at the time of payment of periodic interest, which is why from its standpoint, it is as good as equity.

If anything, slightly better, because while raising of equity calls for an elaborate procedural and regulatory drill, a bond issue is much faster and relatively hassle-free.

One might of course say, in the Indian context, equity would still be a better choice, especially if a company is lucky enough to make an IPO in a booming market, because it invariably walks away with a mind-boggling premium on which it doesn't have to pay any user charges.

Come to think of it, there aren't any user charges either on the face value, because dividend isn't mandatory, but reputation-minded companies try to keep the investors in good humour.It is curious that the law speaks with a forked tongue on perpetual instruments.

While equity conceptually and by definition is perpetual, the Companies Act, 1956, doesn't permit postponement of the denouement beyond twenty years, insofar as preference shares are concerned.

In other words, not only can't companies in India issue irredeemable preference shares, but their redemption must happen within twenty years of their issue.

This is as it should be, given the fact that an investor in preference shares gets only a marginally higher coupon rate vis-à-vis bonds, but sans security, and it would have been advisedly better for him to put his money in bonds for a similar maturity.

Be that as it may, Section 120 couched in legal jargon, has, in fact, been gathering dust till a clutch of Indian companies took heart from its generosity, and thought it fit to extract the maximum out of it. It reads as follows:

LEGAL ASPECT

“A condition contained in any debentures, or in any deed for securing any debentures, whether issued or executed before or after the commencement of this Act, shall not be invalid by reason, only that thereby, the debentures are made irredeemable or redeemable only on the happening of a contingency, however remote, or on the expiration of a period, however long.”

Besides reeking of laboured drafting, the section is a complete retreat from Section 80, which makes an all out effort to safeguard the interests of the preference shareholders when it comes to redemption.

Retail investors should stay away from perpetual bonds, even if offered to them, because it simply isn't their cup of tea. In comparison, deep discount bonds emerge as a much better choice, because they call for a very low upfront investment, with the possibility of handing a bonanza over to generation next, on maturity, even though inflation, meanwhile, could make inroads into the perceived excessive returns. On the other hand, putting money in perpetual bonds would mean denial of liquid resources to progeny, to get which they would be driven to entering the market, which is never free of minefields.

(The author is a Delhi-based chartered accountant.)

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