Understand keep-well agreements

Keep-well agreements, or deeds, were all the rage during the recent bull run in Asian bond markets between September 2012 and May 2013. Several companies from China took advantage of these agreements when issuing new bonds during this period. Keep Well Agreement or Deed is a type of credit enhancement for the bonds. This is issued in place of a guarantee and is weaker than a guarantee. The credit rating reduces the risk associated with the bonds and thus the financing costs.

When bonds are issued and guaranteed by non-operating offshore entities or operating entities with weak assets and cash flows, the bonds offer investors a low level of protection. In such cases, a special structure called a keep-well agreement is used along with an equity purchase commitment. Essentially, these agreements state that the domestically wealthy parent/operating entity (with better credit quality) will ensure that the bond issuer/guarantor maintains minimum equity and adequate resources to service debt obligations. We need to understand the need to issue bonds with such a structure. Guarantees for bonds require approval by regulators in China, while depositary deeds do not. Therefore, this structure facilitates access to offshore markets by Chinese companies (which cannot directly issue or guarantee offshore debt securities) through their offshore subsidiaries.

Another important consideration is whether this binding structure is strong enough. The two agreements demonstrate the parent company’s willingness to provide financial support to the issuer/guarantor of the bonds. However, risks cannot be undermined as there is no precedent – the structure has not been legally tested to understand the results in the event of a failure.

Let’s look at China Vanke’s example to better understand this structure. China Vanke Co., one of the largest real estate developers in China, issued its first offshore bond with a keep-well-deed structure in 2013. The 2018 maturity bonds were issued by Bestgain Real Estate Ltd, a BVI company, and guaranteed by Vanke Real Estate (HK). The bonds were backed by a “Keep Well Deed” and a “Deed of Purchase of Participations” from China Vanke, the listed onshore company. China Vanke needed approval from Chinese regulators to guarantee these bonds. Hence, it chose this type of binding structure. The keep-well agreement stated that China Vanke would ensure that i) the issuer maintains Bestgain a minimum level of equity and ii) the issuer and the guarantor maintain adequate resources to service the debt obligations. Otherwise, it would be a default and the bond trustee could apply to the Hong Kong court to order China Vanke to service the debt. The equity purchase commitment stated that China Vanke would acquire an equity interest in a subsidiary to provide the issuer and guarantor with the resources necessary to service the bond obligations.

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