Several loopholes in issuance of corporate bonds

SGI

Since Decree 163/2018 was issued more than a year ago, corporate bonds (CB) have become an important channel for raising capital for businesses.

Illustrative photo.

Illustrative photo.

However, the corporate bond market has several shortcomings, which many businesses are using for their own benefit. It is not certain if the draft amendment to the decree will fix these issues or not.

Regulations on interest rates for corporate bond issuance should not exceed the interest rate prescribed in Article 468 of the 2015 Civil Law, of 20% per year. This regulation is probably not important, because the Hong Hoang Company was the only case in the past that issued corporate bonds to buy shares of founding shareholders of a new bank that established this interest rate.

In principle, the interest rate of bonds should be based on the risk principle of the bond issuer, through the credit rating organization of the bond issuer. However, this was not mentioned in the draft amendment. That is, the issuance of corporate bonds is just an interest rate loan agreement between the issuer and the investor. Therefore, the interest rate must be based on the regulations of the 2015 Civil Law.

This regulation leads to the issuance of corporate bonds with interest deductible rates that must be determined according to tax regulations. Accordingly, interest expenses must not exceed 150% of the basic interest rate announced by the State Bank (currently 9%), as prescribed in Clause 2.17, Article 6, Circular 78/2014/TT-BTC. Thus, the interest rate determined for tax deduction currently under the regulations is maximum 13.5% per year.

Earlier, many businesses issued corporate bonds at higher interest rates. Therefore, for the bonds of the Hong Hoang Company issued at an interest rate of 20% per year, shareholders must accept the non-deductible expenses corresponding to 20% at 6.5% per year. If calculating the total value of bonds issued of VND 1,400 bn, Hong Hoang is not allowed to deduct corporate income tax of VND 91 bn (1,400 x 6.5%) annually from interest expenses.

According to the regulations of the Law on Credit Institutions, when granting credit to enterprises, they must supervise the purpose of loan, capital use and at the same time disburse them for the purpose of loan use. At different times, the State Bank assesses the risk level of the purpose of loans of enterprises to regulate the loan flow at credit institutions. Regarding the Law on Securities, amended in 2019, there are also regulations on the purpose of using capital when offering shares to the public as per Article 15. Accordingly, enterprises issuing securities, such as stocks and bonds, to the public must have plans on use of capital.

This draft also amended Point b, Clause 1 of Article 14 to specify the purpose of using capital from issued bonds. This regulation is not intended to verify the application file for issuance of corporate bonds, nor is it intended to monitor the use of capital from the competent authority. This regulation is only if there are disputes between bondholders and issuing companies. Therefore, when there is a change in the purpose of capital use, businesses only send notices to bondholders and the issuing authority of corporate bonds.

Thus, whether private or public bonds, the issuance documents which announce the purpose of using capital are only a formality, and this purpose is adjusted when the issuance is completed. This will never happen to credit institutions when reviewing loan documents. Therefore, the draft should add regulations on the report on the use of capital from the issuance of corporate bonds in accordance with the original purpose, approved by a competent authority. The State will then monitor capital flow from indirect investors into the corporate bond market.

Decree 20/2017 regulates tax administration for enterprises with associated transactions, and only limits the total interest expense that cannot exceed 20% of the total net profit from business activities plus interest expenses, and depreciation of fixed assets. Therefore, depending on the business sector, size as well as business efficiency, businesses determine the appropriate loan amount. Therefore, there should be no regulation on controlling debt ratio when issuing corporate bonds. Instead, it is required that the records of the businesses be transparent as noted in Decree 20/2017.

When businesses issue corporate bonds to restructure debt, such as issue new debts to repay old debts, the debt-to-equity ratio at the time of issuance can reach three times the equity. If the issuing company uses the right capital to pay for old debts, after the issuance of corporate bonds, the debt ratio of the enterprise is only three times of the equity, instead of six times.

The draft amendment for Decree 163 must aim at evaluating the financial capacity of businesses and monitor the purpose of the capital for issuance of corporate bonds, rather than have tough regulations on controlling interest rates and loan terms. These regulations will close the door for newly opened capital and eliminate important capital mobilization tools in the economy.

Translated by Mathew Hùng

Le Dat Chi, Department of Finance, University of Economics, HCMC

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