Most financial markets have been more open throughout time, moving away from their tradition of catering to the wealthy and powerful and allowing regular people to purchase and sell stocks, ETFs, and other popular products at low costs and with ease. Massive institutional investors, on the other hand, continue to play an important role in the financial system behind the scenes, and one SEC rule allows them to conduct large trades among themselves in investments that ordinary people cannot buy. Rule 144A has gotten a lot of press for supporting a “shadow market,” and efforts to shed light on trades made under the rule have had some early success. Let’s take a closer look at Rule 144A and what it entails for financial institutions.
Rule 144A was created to give an exception to the normal rule that all securities must be registered with the Securities and Exchange Commission (SEC) before being sold. The regulation explicitly addresses the resale of shares among what the rule refers to as qualified institutional buyers, which includes the vast majority of organizations that meet the securities laws’ definition of accredited investors. Individual investors do not qualify as qualified institutional buyers under Rule 144A; only institutions do.
The rule’s overall goal is to allow institutions to do transactions that the SEC would consider too risky for the broader public. Even if the underlying issuer hasn’t given all of the information required for SEC registration, institutions can still make trades. In contrast to individual investors, who often lack the means to check claims by issuers without the help of the SEC, major institutions are assumed to be knowledgeable enough to undertake their own due diligence without the agency’s help.
Furthermore, Rule 144A has increased the liquidity of the markets for privately issued restricted securities. Under SEC Rule 144, institutions that purchase restricted securities from issuers must keep them for two years. Rule 144A provides for shorter-term investing in these assets by enabling exchanges between eligible institutions.
One issue with the Rule 144A regulatory structure is that, while the trades sanctioned by it were a significant part of trading in some issuers’ shares, the reporting restrictions made it difficult for regular investors to observe what was going on in the 144A market. Last year, the Financial Industry Regulatory Authority estimated that the total number of 144A transactions in the corporate bond market was over 20% of the overall average daily volume for the entire bond market. That amount was even greater in the high-yield debt market, at over 30%.
Who is eligible to purchase Rule 144A securities?
Rule 144A, also known as the Private Resales of Securities to Institutions, was established in 2012 and allows qualified institutional buyers to trade these investments (QIB).
What is a 144A Bond Offering?
“Rule 144A” governs 144A bonds. The 144A is a 1990 SEC rule that allowed QIBs to trade privately placed securities among themselves, removing the requirement for a two-year holding period. Previously, there existed a different holding period for such private stock. A 144A bond offering is a U.S.-based offering that is frequently used as an alternative to the time-consuming and expensive initial public offering.
Bonds and Notes
There are two popular terminology used to denote debt securities issuance, a “bond, and a “note. A bond’s maturity date the date on which the bond expires or ends is generally set at ten years. The average length of a note is up to ten years. Thus, if a corporation issues a 144A bond, by the standard definition the 144A bond will last for longer than 10 years. If a firm issues a 144A note, the notes will typically mature within 10 years of the date of issue. While the semantics of bonds and notes are unimportant in the business world, they are significant to people in the know, and it is critical to be accurate when presenting your debt offering.
A 144A bond offering is a private placement conducted in the US for US investors that clears through DTCC (but not always). In Europe, 144A offerings and their Reg S component clear and settle through Euroclear or Clearstream. In the vast majority of circumstances, a 144A is a debt issuance. While only a small fraction of issuers choose to issue a 144A equity security, the majority of firms and governments choose to issue 144A debt, with practically all 144A issues being notes or bonds.
Is it possible for an individual to qualify as an institutional buyer?
Qualified Institutional Buyers: An Overview (QIBs) Due to their experience, assets under management (AUM), and/or net worth, these persons or companies are regarded not to require the same level of regulatory monitoring as typical retail investors when purchasing stocks.
How can I obtain 144A?
Given the low interest rate environment, investment managers must be able to utilize techniques that optimize portfolio income while staying within the parameters of their customers’ mandates. 144A private placement concerns are a market category that is frequently overly limited. While not all investors are eligible to buy 144A issues, the increased opportunity offered by these securities creates a strong case for raising 144A restrictions for those who are.
What are 144A securities?
The Securities Act of 1933 mandates that when a bond issuer distributes a security to the investing public, the issuer registers the bonds with the Securities and Exchange Commission (SEC). This procedure necessitates a great deal of documentation, scrutiny, and repeat disclosures. Bonds issued under Rule 144A, which permits privately placed securities to be sold and traded to Qualified Institutional Buyers (QIBs) without requiring SEC registration, are an exception. Under Rule 501 of the SEC’s Regulation D, QIBs are described as institutions (not individuals) that are considered a “accredited investor.” An insurance business must have a minimum of $100 million in unaffiliated invested assets on a discretionary basis to qualify as a QIB under Rule 144A. Because QIBs are seen as having more resources and access to information than smaller institutions, an exception is created for them. As a result, despite potentially having less information and continuing mandated reporting from securities registered with the SEC, it is assumed that individuals can make sound investment judgments.
It is possible to issue 144A securities with or without registration rights. The issuer has not yet filed for registration with the SEC for those issued with registration rights, but plans to do so within a defined time period following issuance. Once they are registered, the 144A securities are then exchanged for freshly generated public securities. The securities will remain unregistered until maturity if they were issued without registration rights.
What are the benefits for an issuer of 144A securities?
There are several advantages to issuing bonds under Rule 144A from the standpoint of the issuer. First, sensitive material is not required to be made public, there is no SEC review process, and continuous reporting requirements are lowered. Second, 144A issuance reduces the possibility of Securities Act liability. Third, because the procedure of registering a bond with the SEC might delay the timing of an offering, issuers can gain access to the market more quickly. Finally, the issuers’ costs are reduced since they can avoid pre-issuance registration, hefty underwriting fees, and post-issuance reporting.
What are the benefits of buying 144A securities for QIBs?
The key benefit to the investor is access to a larger supply of bonds, while the benefits to the issuer are quite straightforward. The quantity of 144A issuance has increased at a significantly quicker rate than public bond issuance during the last decade. Since 12/31/08, the outstanding issuance of investment grade 144A (excluding structured sectors: asset backed securities, commercial mortgage backed securities, and non-agency residential mortgage securities) has increased from $341 billion to $1,637 billion (a 380 percent increase), compared to a $11,430 billion increase in the Barclays Aggregate (82 percent growth).
Since the financial crisis, the growth of 144A issuance in the structured industries has been even more pronounced. Over half of the bonds issued in the Asset Backed and Commercial Mortgage Backed sectors in 2018 were issued under Rule 144A. (Exhibit 1). Almost all securitizations in the Non-Agency Residential Mortgage Backed Sector have been issued under Rule 144A in recent years.
Exhibit 1
The fundamental benefit of 144A offerings to investors is a larger supply of bonds, but it isn’t the only one. 144A structured securities underwriters generally give more specific loan level data than is accessible for public issuers. This capability enables investment management research teams to better comprehend the underlying collateral’s characteristics, model cash flows, and forecast deal performance.
While some 144A issues may provide a yield advantage, raising the ceiling on 144A issued securities isn’t always a yield-enhancing approach. Because the market recognizes that public vs 144A issuance are almost identical, there is little or no yield premium for a given issuer whether they issue a 144A or a public transaction. Increasing 144A restrictions is all about broadening the opportunity set, especially in the ABS, CMBS, and Non-Agency RMBS markets. Outside of prime auto deals and credit card transactions, the entire single-property CMBS industry and practically the entire ABS market are 144A.
Given that the pool of possible 144A investors is limited to individuals with QIB status, 144A issues are likely to be less liquid than public bonds. Liquidity for fully registered and 144A securities, on the other hand, is primarily influenced by issue features such as issue size and credit quality. For similar tenor public and 144A bonds, bid side indicators are often the same. Exhibit 2 provides an example.
Conclusion
As 144A private placements become a larger part of the bond market, QIB investors should consider including them as a higher share of their portfolios. In today’s market, limiting 144A to a small fraction of a portfolio’s holdings is an antiquated restriction that limits managers’ investment options and doesn’t always reduce a portfolio’s risk profile. If your investment rules limit your exposure to 144A securities, ask your investment manager if raising those limits might improve the diversification and opportunity set of your portfolio.
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is a Securities and Exchange Commission-registered investment adviser that specializes in fixed-income asset management for insurance companies. Registration does not imply that you have a certain degree of knowledge or experience. This data was compiled with the help of publicly available data, domestically created data, and trusted outside sources. While every effort has been made to ensure that the facts stated and the opinions expressed are accurate, comprehensive, and reasonable, AAM and its affiliates (collectively known as “AAM”), and their representative officers and employees expressly disclaim liability. This research is provided for informative purposes only and does not attempt to be a comprehensive examination of any security, company, or industry mentioned. Any expressed opinions and/or recommendations are subject to change without notice and should only be used as part of a well-diversified portfolio. Our judgment is expressed in any thoughts or remarks made here about financial market developments based on market conditions. This information may include projections or other forward-looking statements about future events, goals, or expectations, and it is only current as of the date indicated. There is no guarantee that such events or targets will occur, and they may differ dramatically from those outlined here. The information offered, including any assertions about financial market trends, is based on current market conditions, which are subject to change and may be overtaken by subsequent market events or other factors. Although the assumptions underlying any forward-looking statements herein are thought to be reasonable, they can be influenced by erroneous assumptions or known or unknown risks and uncertainties. AAM makes no commitment to provide updates to any of the analyses presented here. On request, a complete list of investment suggestions given in the previous year is accessible. Past performance does not guarantee future results. This information is distributed to a variety of recipients, including AAM, who may have acted on the basis of the information or who own securities to which the information relates. It may also be sent to AAM clients and other receivers with whom AAM does not have a client relationship. The provision of this information does not constitute an endorsement by AAM, nor does it imply that the purchase or sale of any security is appropriate for the receiver. Market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment, and extension are all risks associated with bond investing. Without prior written permission, no part of this content may be duplicated in any form or referred to in any other publication.
Is it possible for a non-US investor to purchase 144A?
If the buyer proves that it is not a U.S. person and the sale otherwise conforms with Regulation S, Rule 144A securities can be resold to non-U.S. individuals. If the resale complies with Rule 144A, the Regulation S securities can be resold to QIBs in the United States.
Who is authorized to issue 144A?
Who is eligible to use Rule 144A? Rule 144A can be used by someone who isn’t an issuer. For the offer and sale of unregistered securities, issuers must find another exemption. Typically, issuers depend on the Securities Act’s Section 4(a)(2) (typically in conjunction with Regulation D) or Regulation S.
A vs. Regulation S
ISIN’s 144A or Regulation S (Reg S) advice and consulting can aid your organization, regardless of country or jurisdiction.
What is the difference between a 144A offering and a Regulation S offering? This is a question that we are frequently asked. With your Reg S and 144A products, we can help.
Regulation S
Regulation S bonds and stocks are bonds or stocks that cannot be offered, sold, or delivered in the United States. Furthermore, they may not be made on behalf of, or for the account or benefit of, U.S. citizens, unless they are made pursuant to an exemption from, or in a transaction not subject to the Securities Act’s registration requirements. As can be seen, Reg S imposes a slew of restrictions on residents of the United States.
Previously, bonds traded under Regulation S (Reg S) could only be sold to qualified institutional buyers (QIBs) in the United States under Rule 144A. In fact, QIBs are one of the few organizations allowed to invest in Reg S offerings.
Who is eligible to purchase regs bonds?
Corporate and governmental issuers continue to use the debt capital markets to fund big transactions at this moment of exceptional market turmoil.
Resilience in time of uncertainty
Throughout H1 2020, the Eurobond market has demonstrated to issuers and investors that its depth and stability set it apart from other markets in times of uncertainty, as it continues to provide large-scale finance and stable investment possibilities around the world.
Reg S and Rule 144A bonds
Reg S and Rule 144A bonds are forms of bonds that do not require the issuer to register the securities under the Securities Act of 1933. The following are the two rules:
- Qualified Institutional Buyers (QIBs) can trade debt securities without having to register or be reviewed by the Securities and Exchange Commission under Rule 144A. (SEC).
- The Reg S bond type is accessible for offers and sales of securities to U.S. and non-U.S. QIBs outside of the United States.
Issuing Reg S and Rule 144A securities to global investor base
Clearstream’s AA-rated infrastructure is ideally suited to facilitate the issuance of Reg S and Rule 144A securities, as it provides direct access to a large number of worldwide intermediaries while also broadening the scope of post-trade connection, securities lending, and collateral management options.
Facilitating efficient funding
Clearstream enables full USD cash clearing for Reg S and Rule 144A securities via internal DVP settlement of cash and securities. Furthermore, by centralizing the issue and storage of both note forms, Clearstream can drastically minimize the time required for conversion via secondary market trade.
Reg S and Rule 144A securities with a common depositary
In a bifurcated structure, Clearstream supports the issuing of Reg S and 144A securities:
- Two independent global notes in registered form that are lodged directly with a single depositary, one Global note evidencing the Reg S portion and the other the 144A portion, are held via Clearstream and Euroclear.
- Both worldwide securities are registered in the common depositary’s nominee name.
- The Global notes have two different ISIN codes: one XS ISIN for the 144A and another XS ISIN for the Reg S.
Under Rule 144A, what is a qualified institutional buyer?
In US law and finance, a qualified institutional buyer (QIB) is a buyer of securities who is considered financially knowledgeable and is legally recognized by securities market regulators as requiring less protection from issuers than ordinary public investors. Typically, an investor’s total assets under management and specific legislative requirements in the country where the fund is domiciled are used to determine eligibility for this classification. To be classified a QIB, an institution must manage at least $100 million in securities from non-affiliated issuers, according to Rule 144A. If it’s a bank or a savings and loan cooperative, the net worth must be at least $25 million. If the institution is a registered dealer operating for its own account, it must own and invest at least $10 million in securities from non-affiliated issuers on a discretionary basis.
To limit regulatory constraints and public filing requirements, many private placements of stocks and bonds are made accessible only to qualified institutional buyers.