What is the basic definition of debt finance and its types for doing business in Hong Kong?


Debt finance is the source to raise capital for the company after HK company formation and thus ascertaining its importance and it is required to get into depth of it. There is the need to understand the situations and suitable type of debt financing because correct decisions are very vital in corporate sector. Hence, to establish mark in the corporate sector, it is mandatory that controller or manager of the company should know, when does company really need debt financing or are there some other ways to raise capital for the company?

For the situation where company needs additional funds so that business operations of the company could go smooth, then credit loan is the most suitable and common approach. Credit loan is something which provides interim financial accommodation to the debtor, by the creditor. As per the general view of loan credit, the debtor enters into an agreement with the creditor to obtain something which is in dire need by the company and agrees to repay it to the creditor, later. The type of credit we are going to discuss in this article is the “Loan Credit”. Sale credit is another type of credit, as per which debtor can obtain the required services or products with the facility of deferred payments.

We will now proceed to discuss the types of debt and let’s see what type of debt, shall suit you after HK company formation.

Secured and Un-Secured Loans

Loans can be classified into the secured and un-secured loans with respect to the level of security they require after open company in Hong Kong. Unsecured loan is considered to be high risk loan as it involves the higher rate of interest, however this does not mean that secured loans do not possess any risk. But, rate of risks associated with the secured loans tends to differ.

In case company is subjected to winding up, secured loans with the fixed charges offers class holder with higher level of security. However, the loans secured with floating charges forces charge holder to lag behind certain classes of unsecured loans.

Fixed Charges

Securing loan through the fixed charges gives the chargee an immediate possession and propriety rights over the acquired assets. Charger is not allowed to dispose off this conferment without the informed consent of the charge or without prior approval or consent of chargee.

Floating Charges

Securing loans with the floating charges allows the hovering over the assets of the company, to those who borrowed while allowing the company to trade with the assets during normal business operations. The floating charge will tend to crystallise in case of certain events such as the default of company. In case company gets defaulted, then floating charges shall tend to become the fixed charges.

Debt Subordination

Secured loans are considered to be safe after open company in Hong Kong however, unsecured loans are considered to afford a high risk. Now the question arises that; How shall extent of risk be ascertained and how borrower would be able to determine the risk associated with the unsecured loans. Debt subordination is the only method through which risk could be determined. Debt subordination is defined as:

Subordination is the type of transaction as per which one creditor, which most probably be a junior creditor, agrees that borrower should not repay him or her until and unless all other creditors, which most probably be senior creditors, have been paid with reference to their claims.

There are two methods to obtain subordination and these two methods are:

  • Trust Subordination.
  • Contractual Subordination.

Trust Subordination

As per trust subordination, junior creditor would agree to hold any dividends or receivables, to be received by him or her, for the claims of senior creditor on the terms of respect and trust.

Contractual Subordination

As per the terms of contractual subordination, junior creditor agrees to the debtor that his or her payable debts shall be paid after senior debts have been paid fully, in case senior debts are outstanding.

This is considered to have possess the characteristic of equity, because in case of winding up of company, junior debts are not paid until senior debts have been paid fully and same is the situation in case of contractual subordination and may be that is why it is considered to have the characteristic of equity. On account of being analogous to the equity, deferred unsecured notes are called the “mezzanine finance”.

Legal commentators think that, subordination is the way to let company come into the situation where it would be able to secure further unsecured loans. But such unsecured loans would be subjected to the situation where insiders of the company such as directors or any holding company of the borrower is willing to subordinate their claims in respect of claims of the new lenders or senior creditors.

Debenture and Debenture Trust

Debenture and debenture trust are the ways through which debt could be obtained. Let’s get into detail that what does debenture and debenture trust usually imply to?

Debenture

There are various meanings of the word debenture in the common law and each reference defines this in relation to the referred situation. One definition says that:

Any written document which acknowledges the debts owed to the issuing company is known as the debenture.

2nd definition states that:

Any written document which not only acknowledges the debt owed to the issuing company but also charges the subjected company with the payment of debt, is known as the debenture.

As per the 3rd definition, debenture is defined as:

Any written document which acknowledges the debts of the company, charges company with the payment of debt and furthermore restricts the company to exercise its freedom or power to bring any change in the said property.

If we analyse all three definitions then legal commentators believe that; 2nd and 3rd definition is considered to be the relevant and the more common example. So, if we summarise both of these definitions then; debenture is the written acknowledgment of the secured debt.

Debenture Trust

Debenture trust is established so as to create the sense of protection to the debenture holders. As per terms of debenture trust; not the debenture holder himself/herself, but the trustee would hold the debentures on behalf of the debenture holders in the capacity of the beneficiary of the debenture. It is considered to be the useful tool to coordinate the relationship of borrower and the debenture holder, while the foremost goal of debenture trust is to safeguard the interests of the debenture holder. For the situation where number of issued debenture becomes large, then appointment of single person as the beneficiary of all the issued debenture would be helpful to protect the interests of the different lenders or debenture holders. This suggestion is based on the argument which says that; single beneficiary or the appointed person would be in a better position to receive interests and if on contrary any uncertain circumstances arise, then he or she would be able to enforce and take the right actions on behalf of all the debenture holders. To reinforce the protection to the debenture holders, company can also appoint the debenture trustee as a nominee director of the company so that he or she may best be able to protect the rights and interests of his or her appointor.

Syndicated Loans

A situation where number of financial institutions through their respective agents provide and lend money to the borrower through a single document or agreement, is known as Syndicated Loans. This situation is analogous to the situation where multiple financial help is targeted towards the common goal through respective agents of each financial institution or organisation. There are several rights and obligations under the syndicated lending. As the explanation implies, syndicated lending is approached in the situation where the required sum of money is so large that it would not be possible for the single lender to bear the risk of lending, alone.

Club Loans

The club loan is a multi-lender financing mode because there are multiple lenders from whom borrower is borrowing finance to meet his or her business needs and all of the financers shall provide finance parallelly, on the same terms as other financers are providing finance to the borrower. Now you may be thinking that isn’t club loan similar to the syndicated loan? Well! You may be right in the general sense but if we talk strictly and technically then relevant answer would be a NO. Club loan is different from the syndicated loan because there is no agent involved in the club loan such as the lead bank and there is also an absence of typical syndicate lending terms such as the unified funding mechanism, syndicate voting mechanism and the provisions related to the payment distribution. In the perspective of the borrowing market, if the borrower is a strong one then it is possible for the borrower to obtain favourable terms such as the pricing and loan agreements under the club loan strategy. While this offer is not available in the case of the syndicate loan because there is no role of the lead institution in the subjected transactions.

High Yield Bonds

Bonds which possess the higher risk but have the characteristic of having a high return, is known as the high yield bonds or junk bonds. These bonds are called junk bonds because there is a high risk involved in them and furthermore it is rated very low by the investment rating agencies.

Redeemable Bonds

Such bonds which gives the bond holder, an option to redeem it before its maturity date, are called Redeemable Bonds. When bond is issued, it will have the note which tells about the date on which and the price at which it can be redeemed on the date of maturity. Hence on account of this, issuer of the bond has the option to get it redeemed when it is offering a higher coupon than the present interest rate. It can be explained in other words as the situation where the issuer of the bond has the chance to reissue the same bonds on the lower interest rate, upon the redemption call. However, if we sum up the market trends and the general outlook of the redeemable bonds then it is seen that, the rate at which bonds are redeemed is generally higher than the price at which they were issued.

Foreign Bonds

Foreign Bonds are those bonds which are issued in the currency of the country where they are issued, and the issuer of the bond is a non-resident company or the one starting a business in Hong Kong as a foreign. Now the question arises that if it will be issued in the currency of the country, where it is issued then why would it be called a foreign bond? Let’s answer this question by referring to the example; consider the situation where a German company issues a bond which has the Hong Kong Dollar as the currency medium, then such issued bonds would be foreign bonds. Foreign bonds are regulated by the regulatory authorities of the country, where it is being issued and the place chosen for starting a business in Hong Kong as a foreign. There is no compulsion on the specific name of the foreign bond and it is totally upon the discretion of issuing authority to choose the name of their choice. For example, London has the foreign bond named as Bulldogs, New York has the foreign bonds named as Yankees, Tokyo has the foreign bonds named as Samurai, Netherland has the foreign bonds named as Rembrandt, Spain has the foreign bonds named as Matador and China has the foreign bonds named as Panda Bonds.

Eurobonds

Such bonds which are issued in the currency, which is not the local currency of the country where they are issued are called Eurobonds. For example, Hong Kong has the Eurobonds which are denominated in Renminbi (RMB). One may confuse the definition of Eurobonds with the name of them as they may think that they are the bonds either issued only in Europe or denominated in Euro, while reality is totally opposite to it, eurobonds are not issued in Euro.