Humankind has experienced lending, earning interest on debt and borrowing for ages. Even the Holy Bible is not against the act of borrowing. What it prohibits is not paying back debt and usury. In the modern world also, borrowing either directly through the bank or in the form of debt securities, or bonds is a good source of raising capital.
Corporations, government, and even individuals rely on various sources of funding to meet their capital needs. They may use either internal or external sources of capital to finance their businesses. Funds can come from external sources either in the form of equity or debt instruments. The capital raised by companies through equity instruments is called stock or share, and the money raised by firms using debt securities is corporate debt, also named a corporate bond.
Governments and companies can issue bonds. The Great Ethiopian Renaissance Dam (GERD) project bond being issued by the government is one example we may cite here. However, the author's focus in this article is on corporate bonds and analysis of the legal framework for bonds issued by companies in Ethiopia.
It is evident that shares are now becomning popular in Ethiopia, particularly, in the urban centres. The attitude of the public towards share investment is also increasing. However, when it comes to debt instruments, the concept is still unaccustomed to among companies and traders, let alone among the public.
A bond is a document written and sealed containing a confession of debt. What makes a bond different from a bank loan is that it is issued for more than one year; maybe for decades in the case of government bonds. A bank loan, on the other hand, is mainly a short means of debt.
A bond is a contract between two or more parties whereby the issuer is obliged by contract to pay the holders of the bonds or notes, on a certain specified date, with a repayment of, usually, interest and principal.
A corporate bond is just an instrument in writing acknowledging indebtedness to be paid to the holder of a sum of money stated there in the instrument.
A corporate bond comes in the form of a certificate, as a share certificate. It differs from a share in that first bondholders are creditors of the company. Those who subscribe to shares during the formation of the company or later and contribute to the capital of the enterprise are shareholders. Also, bond or debenture holders should not take part in the management of the company. They carry no voting rights at any meeting of the company whatsoever, unlike shareholders.
Corporate bonds are issued to the public (similar to equity instruments). They can be listed on stock exchanges and traded in secondary markets. Bonds are transferable and can be owned jointly. A bond is transferable in the secondary market, redeemable, can generate interest, and is saleable through physical market arrangement or electronically.
All bonds have a coupon interest rate, sometimes referred to as coupon rate or simply coupon, which is a fixed annual interest paid by the issuer to the bondholder. Coupon interest rates are determined as a percentage of the bond's face value but differ from interest rates on other financial products because it is the amount, not the percentage of transparency over time.
Think of it this way: a bond with 1,000 Br face value and a 5pc coupon rate is going to pay 50 Br in interest even if the bond price climbs to 2,000 Br or drops to 500 Br. It is crucial to understand the difference between a bond's coupon interest rate and its yield.
Accordingly, the coupon rate of a bond is the amount of interest paid per year as a percentage of face value of the principal, whereas the yield of a bond is the overall return an investor would realise on the date of maturity of a bond.
The commercial code of Ethiopia governs the issuance of debentures (the commercial code of Ethiopia uses 'debentures' to describe debt securities). It allows a company to issue debentures but at a limit not exceeding the amount of its paid-up capital. The law also acknowledges the applicability of several provisions of shares to debentures.
Once a company issues a bond, it can make an offer to the public via direct promotion and sale or through stock markets trading. The latter mechanism is absent in today's Ethiopia.
The relationship between the company and the holders of the instrument will be as of a debtor and a creditor. However, in an exceptional situation, Ethiopian company law allows convertible bonds. This means bondholders have a chance to take part in the managerial activities of the concerned corporation as shareholders.
The company's bondholders also acquire rights of transferring their bond and attending shareholders meetings. They can also take legal action against the company through their representatives when their rights are infringed. Moreover, they are entitled to claim yield of the bond on the date of maturity.
Although the commercial code recognises corporate bonds as such, Ethiopian companies are reluctant to raise their funds through debt instruments. The debt market is almost non-existent. Undeniably, the legal coverage for corporate bonds and the bond market might be insufficient. However, compared to share issuance and the share market in the country, debt instruments in corporate business are still at an infant stage.
Factors like the absence of a legal and institutional structure for a stock market, lack of corporate governance skills regarding bond market and portfolio investment and lack of public awareness have their contribution to the problem. Of course, the weak saving habit among the public, lack of transparency and accounting issues in corporate management and the existence of affiliated companies, are also a few among many, which have an effect.
To highlight the importance of corporate bonds and popularise the debt market, however, may require the state to improve its regulatory capacity; take initiatives to structure the capital market legally and institutionally, promote corporate bond issuance via securities and financial sector regulation.
Companies also need to make their corporate finance and governance structure transparent to avoid insider trading and price manipulation. They need to realise that in addition to stocks, corporate bonds are an option for capital raising.
In parallel, raising the level of awareness of the public about saving and investment in the bond market would help. Investing money in debt instruments is better than depositing cash in banks.
Not to forget that the role of institutions, such as an independent press, an efficient and independent judicial system, professional corporate lawyers and accountants, is extremely relevant to improving the situation.