21 April 2020

Does my debt offering circular need to mention COVID-19? (Part 2)

In a recent client note with this same title we discussed recent guidance published by the United States Securities and Exchange Commission (the “SEC”) Division of Corporate Finance (“DCF”) regarding COVID-19 disclosure considerations. Less than two weeks after that initial guidance letter, the Chairman of the SEC and the director of the DCF released a joint statement with a similar theme but with increased emphasis on the responsibility of public companies to not only inform their shareholders of the immediate impact of the COVID-19 pandemic but also their plans and expectations for resuming normal business. Although intended for use by companies with ongoing disclosure obligations in the United States, the joint statement provides useful considerations for Asia (ex-Japan) issuers of debt securities to consider when drafting their offering documents. Following the same format as our initial note with this same title, this article examines the new SEC joint statement within the larger context of the reasons for disclosing the impact on an issuer’s business of the COVID-19 pandemic, and it identifies the specific sections in an offering document where such disclosure may be appropriate.

The joint SEC Chairman and DCF Director statement is available at https://www.sec.gov/news/public-statement/statement-clayton-hinman. The initial SEC guidance is available at https://www.sec.gov/corpfin/coronavirus-covid-19.

Offering documents exist so investors can make an informed investment decision

For U.S. law purposes, offshore debt offerings of Asia (ex-Japan) issuers are typically made pursuant to the provisions of either Regulation S or Rule 144A under the United States Securities Act of 1933, as amended (the “Securities Act”), so as to be exempt from the requirement to register the securities with the SEC. The offering document typically includes the terms of the securities, risk factors, capitalisation and indebtedness, business, board of directors, underwriting arrangements and audit reports. Offerings that are conducted under New York law (such as high yield and Rule 144A offerings) will also frequently have a financial information or MD&A chapter. Complete and accurate disclosure minimises the possibility that an investor or a regulator might accuse the issuer and the banks assisting with the offering of fraud for not having provided all the information necessary for an investor to make an informed investment decision.  

The recent SEC joint statement states optimistically that there is an emerging consensus that, anchored by the advice of healthcare specialists, market participants and governments can begin to incrementally foster economic activity. The target audience is companies in the United States whose business has essentially come to a halt over the last one to two months. As market participants accessing non-U.S. capital markets often look to U.S. legal and market practices for guidance, the joint statement may be of interest to such participants as well, including parties with operations in China where efforts to return to pre-COVID levels of economic activity are well under way. The SEC joint statement states that company disclosure should reflect this “back to business” state of affairs and outlook and, in particular, respond to investor interest in: 

  1. where the company stands today, operationally and financially;
  2. how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing; and
  3. how its operations and financial condition may change as efforts to fight COVID-19 progress.

In reverse order, we will examine each of these in the context of where in an offering document one would expect to see such disclosure.

Risk Factors

The question of how an issuer’s operations and financial condition may change as efforts to fight COVID-19 progress (the third item above) is the type of disclosure that an investor would expect to see in the risk factors section of an offering document. The SEC joint statement is very clear in stating that despite the challenges of knowing when pandemic mitigation measures (such as business openings and travel restrictions) will be loosened, disclosure should avoid generic, or boilerplate, language that does little to inform investors of company-specific status, operational strategies and risks. Instead, “companies and their advisers should make all reasonable efforts to convey meaningful information — information that provides investors a level of insight that allows them to see the key operational and financial considerations and challenges the company faces through the eyes of management.”  In our view, examples of such risk factors might include the following (in approximate order from broad to narrow):

  • The Group’s revenue, profit and operating cash flow are likely to suffer a material decrease in 2020 due to the impact of the COVID-19 pandemic on economic activity in the markets where the Group operates.
  • If the Group’s sales in certain provinces and cities do not rebound in the second half of 2020 following the lifting of COVID-19 travel restrictions, the Group may be forced to lay off workers and/or close stores.
  • If the cost of raw materials continues to rise because of the impact of COVID-19, the Group may be forced to postpone certain projects.

As the SEC suggests, providing as much specific detail related to such risks is of more value to an investor than generic, boilerplate statements.

Description of the Business

The business section of an offering document typically includes an overview of the business, a description of strengths and strategies, disclosure of the company’s business lines, information on customers, suppliers and markets and internal company information such as the number of employees, employee recruitment and employee training. Given the time of year, offshore debt offering documents are now likely to include disclosure of the first quarter or first six months of operational and financial results. The SEC joint statement advises being specific about the impact of COVID-19 on these results. In addition, as indicated by item (2) above, the SEC suggests companies include information on how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing. We suggest extending this to suppliers as well. Such disclosure could point out, for example, when COVID-19 movement restrictions were lifted in specific markets or among specific target customers and suppliers and what the status is of the issuer’s employees. This is also an opportunity for a company to demonstrate its corporate social responsibility contributions by highlighting what specific activities it may have participated in to mitigate the impact of the pandemic. It is possible that for certain issuers the reaction to the pandemic may even find its way into the disclosure of its strengths, for instance in a strength that describes a cooperative relationship with the government or with the issuer’s customers or suppliers.

Management’s Discussion and Analysis

An MD&A section is frequently included in the offering documents for high yield notes sold outside the United States in a Regulation S offering and investment grade bonds sold in the U.S. in a Rule 144A offering. Although there is some overlap with the business section disclosure, the MD&A section presents an opportunity for issuers who will disclose their first quarter or first six-month results to be very specific in terms of the financial impact of COVID-19 on various line items in the issuer’s income statement and balance sheet. For a Rule 144A offering, issuers should also consider the effects of the pandemic on its sensitivity analysis of certain market risks, such as foreign exchange and commodity prices.

Factual statements versus forward looking statements

Some of the disclosure discussed above will involve forward looking information. The SEC joint statement states emphatically that companies should, in essence, not be shy when it comes to disclosing what they expect the impact of COIV-19 to be, and especially how they expect to get back to business. Only through such complete disclosure, even if subject to material change, can investors and the entire market begin to see the light at the end of the tunnel that is the COVID-19 pandemic.

Please refer to the link here for the Part 1 of this article.

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