Keep Well agreements or deeds were all the rage during the recent bull run in Asian bond markets between September 2012 and May 2013. These agreements were used by various companies in China when they launched new bond issues during this period. Keeping the contract or deed well is a type of credit enhancement for bonds. It is issued in lieu of collateral and is weaker than collateral. Credit enhancement reduces the risk associated with bonds and therefore reduces the cost of financing.

When the bonds are issued and guaranteed by non-operating offshore entities or operating entities with weak assets and cash flows, the bonds offer a low degree of protection to investors. In such cases, a special structure called a well maintenance agreement is used in conjunction with the share purchase commitment. Basically, these agreements state that the asset-rich parent company / onshore operating entity (which is of better credit quality) will ensure that the issuer / guarantor of the bonds will maintain a minimum capital and adequate resources to service the debt obligations. We need to understand the need to issue bonds with such a structure. Bond guarantees require the approval of regulatory authorities in China, while good works do not. Therefore, this structure facilitates the access of Chinese companies to offshore markets (which cannot directly issue or guarantee offshore notes) through their offshore subsidiaries.

Another important aspect to examine is whether this link structure is strong enough. The two agreements indicate the willingness of the parent company to financially support the issuer / guarantor of the bonds. However, the risks cannot be undermined as there are no precedents: the structure has not been legally tested to understand the results in case of default.

Let’s consider the example of China Vanke to better understand this structure. China Vanke Co., one of China’s largest real estate developers, issued its first offshore bond in 2013 with a maintenance deed structure. The bonds maturing in 2018 were issued by Bestgain Real Estate Ltd, a BVI entity, and were guaranteed by Vanke Real Estate (HK). The bonds were backed by a conservation deed and a share purchase commitment deed from China Vanke, the publicly traded company. China Vanke needed approval from the Chinese regulatory authorities to guarantee these bonds. Therefore, he opted for this type of link structure. The well maintenance agreement stated that China Vanke would ensure that i) the issuer Bestgain would maintain a minimum capital and ii) the issuer and guarantor would maintain adequate resources to pay the debt obligations. Otherwise, it would constitute a case of default and the trustee of the bonds could go to court in Hong Kong to demand that China Vanke pay the debt. The share purchase commitment stated that China Vanke would buy shares in a subsidiary so that the issuer and the guarantor obtain the necessary resources to meet the obligations of the bonds.

This structure has been used by some high-yield issuers in the real estate sector such as Beijing Capital Land and Gemdale Properties. The various bond structures provide investment opportunities for investors. However, investors should consult financial advisers to better understand the complexity and risks involved in the various bond issuance structures.