Investors in Japan’s corporate bond market are increasingly advocating for safeguards against potential credit risks linked to takeover situations. As major companies face ownership changes, there’s a growing demand for Change of Control covenants—provisions allowing bondholders to redeem their investments prior to maturity when significant ownership shifts occur. Historically rare in Japan’s expansive ¥100 trillion credit landscape, many financial experts now believe these covenants are essential.

The Need for Change of Control Covenants

The focus on these covenants has intensified due to the uncertain ownership scenarios involving frequent issuers such as the retail powerhouse Seven & i Holdings Co. and the automotive giant Nissan Motor Co. According to Hiroyuki Miyata, a credit portfolio manager at Nissay Asset Management Corp., “The introduction of Change of Control covenants across bonds is vital, irrespective of credit ratings.” He emphasized that investing in yen-denominated notes without these protections poses considerable risks.

Rising Yields Amid Takeover Pressures

Amidst mounting pressures to enhance corporate value, Seven & i has witnessed a surge in its yield premiums. Additionally, the bond spreads for Macromill Inc., a market research firm, and Topcon Corp., known for optical equipment, have reached unprecedented levels as private equity firms pursue them. This escalation in spreads reflects investor anxiety over the potential repercussions of ownership changes, including increased debt, delistings, and downgrades in ratings.

• Key points to consider:
  • Increased inquiries from bond investors regarding risk management.
  • The likelihood of higher premiums for companies with low price-to-earnings and price-to-book ratios if no protective measures are implemented.

A Shift in Market Dynamics

Change of Control clauses are typically prevalent in more established bond markets outside Japan, especially among junk-rated issuers. Historically, Japanese firms have leaned on banks for financing, resulting in fewer speculative-grade borrowers that might attract takeovers. However, the recent surge in M&A activity is prompting a reevaluation of investor protections.

Kentaro Harada, a chief credit analyst at SMBC Nikko Securities Inc., noted the influx of inquiries from bond investors on how to navigate these emerging risks. The unpredictable nature of leveraged buyouts by private equity can catch bondholders off guard, especially when investing in high-grade companies.

Collaboration for Better Protections

In response to these concerns, the Japan Securities Dealers Association convened working groups last year to discuss the integration of Change of Control clauses and reporting requirements for bonds rated BBB or lower, ensuring flexibility in conditions. Katsuyuki Tokushima, head of pension research at NLI Research Institute, stressed that such clauses would provide critical assurance for long-term bondholders. He asserted, “Issuers and underwriters should proactively consider implementing these covenants.”

Anticipating Future Risks

As the momentum for M&A activity continues, Hidetoshi Ohashi, chief credit analyst at Mizuho Securities Co., warned that the likelihood of Japanese companies becoming acquisition targets is higher this year compared to the last. Companies will increasingly need access to the debt market for substantial funding, beyond traditional bank loans.

• Expert Insight:
  • Akiko Kimura, a member of the working group and counsel at Anderson Mori & Tomotsune, highlighted that if demand for covenants escalates, bonds may start incorporating Change of Control clauses.

With the evolving landscape of Japan’s corporate bond market, the call for protective measures like Change of Control covenants is becoming a pivotal topic, ensuring that investors can navigate the complexities of ownership changes with greater confidence.