Country Garden opens CB doors, but will others follow?
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Country Garden opens CB doors, but will others follow?

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The Asian equity-linked market had a rare treat last week when Country Garden Holdings sold a convertible bond using a call spread feature. Its success has ignited hopes of more such deals, but ECM bankers and issuers should be wary of mixing dreams with reality.

Call spreads on CBs are common in the US, favoured by companies in the technology sector where stocks are extremely liquid. They are used in conjunction with a bond when the issuer buys a call option for its new notes from one party, typically its bookrunner, and then sells a call option at an inflated strike price to the same party.

For Chinese company Country Garden, the bookrunners were Goldman Sachs and JP Morgan. The property developer worked with them to raise HK$7.83bn ($1bn) last week, opting for a call spread as the only way to achieve its desired 80%-plus conversion premium — exorbitant in a market where 20%-30% is the norm. The five year non-call three trade was part of a concurrent buy-back of its outstanding HK$15.7bn 364-day notes.

Equity-linked bankers on and away from the deal have heaped it with praise, saying the use of this novel structure, the first for a Hong Kong-listed company, is a sign of more innovation to come in the asset class.

But the optimistic bunch may be better off holding back for now. Country Garden’s deal is undoubtedly a breakthrough, but in Hong Kong, there isn’t a long list of companies that could replicate the CB structure.

For starters, a call spread requires a liquid stock so that banks can actually write the calls, and be able to trade the underlying stock. But a chunk of the most traded names on the Hong Kong bourse are Chinese state-owned enterprises, which are prohibited from using such structures.

There are also no other obvious local property developers liquid enough to opt for such call spreads. Evergrande Group is a possibility, but it is understood to have wrapped up its fundraising for the year, so an imminent deal is not forthcoming, according to bankers. 

Liquidity is also not the only issue. It’s telling that a call spread CB has taken so long to appear in Hong Kong despite its primary market regularly topping global league tables and repeated efforts by equity-linked origination bankers in the city to push the structure. 

The HKEX’s accounting rules are particularly unhelpful for call spread transactions. CBs are considered equity by the bourse and issuers are expected to buy back the equity in the open market, posing a challenge for these structures. Country Garden managed to get a waiver for its trade.

There are many obstacles but that’s not to say the door isn't open for adventurous issuers looking for call spread CBs in the region. Country Garden has paved the way. Now it is up to ECM originators and issuers.

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