How to Map the Creditor Protections a Bond Actually Gives

A creditor protection is a term in a bond's documents that limits what the borrower may do, gives the holder a claim on something, or requires the borrower to report. Mapping them means walking a fixed set of categories in a fixed order, recording what the document says in each one, and writing an empty category down as EMPTY rather than reading it as satisfactory.

A holder of a bond's documents wants to know what they promise beyond the payments. Working out what they promise is a reading job, and reading jobs go wrong in a particular way: the interesting term is found first, an impression is built around it, and everything read afterwards is measured against that impression rather than against a fixed list. The whole of this procedure is a device for fixing the list before the document is opened. A list fixed in advance means the document cannot decide what the reader looks for.

A rough version of this already runs in most households. A lender who advances Rs 50,000/- to a cousin opening a tea stall usually writes something down: the purpose of the money, the date it comes back, and perhaps a promise that the cousin will not take a second loan from anyone else while the first is outstanding. A Rs 2,000/- deposit paid to the electricity utility is written down nowhere at all, and nobody offers a term either. Two loans, two documents, one of them nearly empty. The empty one is not the frightening one, and working out why not is most of the work below.

The shape of the walk below is the shape this sequence uses everywhere: fixing the frame, applying it once, applying it again to something different, then setting the two results beside each other and saying only what the comparison supports. A completed map is not a judgement about a borrower. A completed map is a record of what two documents say and a record of what they do not say, kept in a form that a second person can check line by line.

What is a creditor protection actually protecting against?

A creditor protectionA term in a bond's documents that limits the borrower, gives the holder a claim on something, or requires the borrower to report. addresses one narrow set of worries: that the borrower does not pay, or pays late, or does something between now and maturity that leaves less behind for the holder than there was on the day the money was lent. Payment, timing and what is left behind are the whole of its territory. A creditor protection has nothing to say about the number on the screen next Tuesday.

A fall in a bond's price after a rise in the yield is not a protection failing, and a bond with a full set of protections can lose a great deal of price without anything at all having gone wrong with the borrower. How far a price moves for a given move in yield is a property of the dates, the amounts and the discounting, and it is settled earlier in this sequence. No term in any document changes it. Two bonds with identical dates and identical amounts move identically on a rise in the yield whether one of them carries thirty printed sides of terms and the other carries none.

Merging the two is the commonest confusion in this area, and it runs in both directions. A reader who has just learned about protections starts reading price falls as breaches. A reader who has just learned about price sensitivity starts treating a document full of terms as a cushion against a rise in the yield. Neither is true.

Which categories does the walk cover, and in what order?

Six categories, walked in the same order on every document, decided before any document is open. Fixing them in advance is what makes two maps comparable at all: if the categories came out of the document, then the frame would be shaped by whichever document was read first, and a second reader working from a second document would produce something that could not be laid beside the first.

The order is not alphabetical and it is not arbitrary. Each later category is worth less when an earlier one is empty. Remedy sits at the bottom rather than the top for exactly that reason: a remedy without anybody appointed to act for holders is a right that nobody is placed to exercise. Walked upwards, the categories produce rights written down with no machinery behind them, and a reader reassured by them.

Written out as a walk, the procedure is eight moves. Six of them are the categories; the first sets the frame and the last states what the finished sheet is for. Nothing in the list calls for a view.

1. Write the six category names down before opening anythingRanking, security, restrictions, reporting, representation, remedy, in that order, on a blank sheet, along with the name of the issuer, the maturity and which document each answer will be taken from.
   Checking: are all six on the sheet before a single line of the document has been read?
2. Row one, rankingWrite down where this claim stands relative to the borrower's other claims, in the document's own words, or write EMPTY.
   Checking: is the entry what the document says, rather than what the reader understood it to mean?
3. Row two, securityWrite down what specific thing has been pledged against this claim and where it is described, or write EMPTY.
   Checking: does the row name a specific thing, or does it only say the borrower is substantial?
4. Row three, restrictionsWrite down what the borrower has agreed not to do while the bond is outstanding, one line per restriction, or write EMPTY.
   Checking: is each line something the borrower agreed to, rather than something the reader expects of it?
5. Row four, reportingWrite down what the borrower has agreed to tell holders and how often, as a term of this bond, or write EMPTY.
   Checking: is the entry a term of this bond, rather than something the borrower publishes anyway?
6. Row five, representationWrite down who acts for holders collectively and under which document they are appointed, or write EMPTY.
   Checking: does the row name the appointing document, or only a job title?
7. Row six, remedyWrite down what may be done if a term is breached and who may do it, or write EMPTY.
   Checking: does row five carry somebody who could actually use what row six describes?
8. Write the line stating the purpose of the sheetOne line at the foot: this sheet records what the document says and does not say, and it is a description of terms rather than a measure of risk.
   Checking: does the line travel on the sheet, where the next reader cannot miss it?

What goes in a category the document leaves empty?

The row reads EMPTY. Not a dash, not a blank, not a note saying that the document appears comfortable on this point, and not what similar documents usually say. An empty categoryA category the document says nothing about, which is recorded as empty rather than as satisfactory or skipped. is recorded as empty, and that single rule decides whether a completed map is worth anything at all.

Here is the failure it prevents, and it is a failure of the eye rather than of the reasoning. A sheet with four entries and two blank lines reads, at a glance and at speed and a week later, as a sheet with four entries. The blanks disappear. The blanks vanish most completely for the person who wrote them. The writer remembers reading the document and remembers finding nothing, and remembering that nothing was found feels a great deal like knowing there was nothing to worry about. The word EMPTY written in the row survives all of that. The word is still there when somebody else picks the sheet up, and still there when the writer picks it up again in March.

There is a second reason, and it concerns the temptation that comes next. A blank row invites completion. Somebody will fill it, and the thing they fill it with will be drawn from what documents of this kind usually contain rather than from this document. Once written, that entry travels exactly as far as the entries that were actually read, and it carries no mark distinguishing it from them. The category name goes down, EMPTY goes beside it, and the walk moves to the next row.

What does the walk produce on an invented government bond?

Take an invented government bond, five years to maturity, of the kind this sequence has been working with throughout, and run the six rows. Nothing below is quoted from any real document, and none of it is a statement of what any authority requires.

Row one, rankingWhere a claim stands relative to the borrower's other claims.. The claim ranks alongside the government's other borrowing of the same kind, and the document says no more than that. One clause is the entry, and a short one.

Row two, securityWhether anything specific has been pledged against a particular claim.. Nothing specific is pledged against this claim. EMPTY.

Row three, restrictionsSomething the borrower has agreed not to do while the bond is outstanding.. There is nothing of the kind a lender writes into a corporate document, no promise about what else may be borrowed and no promise about what may be sold. EMPTY.

Row four, reporting. A government publishes a great deal about its finances, and it publishes all of it for reasons that have nothing to do with this bond. As a term of this bond, agreed with these holders, there is nothing. EMPTY.

Row five, representationWho acts for holders collectively, and under what document they are appointed.. No trustee is appointed to act for the holders of this instrument. EMPTY.

Row six, remedyWhat may be done, and by whom, if a term of the bond is breached.. The document does not say what a holder may do. EMPTY.

Five of the six categories come out empty, and the sheet says so in five places rather than looking tidy in five places. The result is worth reading slowly, and it is the opposite of what most readers predict. The instrument that everything else in this sequence is measured against produces the emptiest map in this guide. Protections and safety are two different questions, and this is the moment the difference stops being a slogan.

If the map is nearly empty, what is the holder relying on?

Not a term in a document, because there are almost none. The honest answer is that a holder of that bond is relying on the identity of the borrower, and the identity of the borrower is the one thing the map cannot record. The government is the borrower whose cost of money every other borrower in the market is measured against, and that is why the invented SPOT curve this sequence works from is the reference schedule for everything else in this record.

The invented SPOT curve, stated as invented, carries six recorded points: a one year SPOT rate of 5.90 per cent, a two year SPOT rate of 6.25 per cent, a three year SPOT rate of 6.55 per cent, a five year SPOT rate of 6.90 per cent, a ten year SPOT rate of 7.35 per cent and a thirty year SPOT rate of 7.60 per cent, all compounding annual. The six recorded points are the rates at which the market lends to this borrower for those six horizons, and every other price in this sequence is set against them.

The claim is narrow and it is worth saying twice: the protections are not in the document, so a reader who has mapped only the document has mapped nothing of what actually protects this holder and must write that down rather than writing in a reassurance. Neither the claim that a government bond is beyond loss nor the claim that the borrower is beyond failure is supported by anything in this record, and putting either into an empty row would be a worse outcome than the empty row. A written-in reassurance looks like a finding.

How does the same walk run on a borrower that is not the government?

Palash Cements Limited, invented, is the one non-government issuer this record carries and the only instrument in it that carries a spreadThe amount a borrower pays above the government rate for the same horizon.. Palash Cements Limited borrows for five years at 9.10 per cent a year. The five year government SPOT rate on the invented curve is 6.90 per cent a year. Take the difference before touching the document. The difference is the one number that will still be comparable at the end.

Walking the six rows on that document shows what changes. On this borrower every one of the six is a category that can carry content, and the content of most of them is not decided by whoever drafted the document. The Securities and Exchange Board of India (SEBI), at sebi.gov.in, sets what an issuer of corporate debt must disclose in the terms it offers, what a trust document must contain, who must be appointed under it, and the security, covenant and reporting duties such an issuer carries.

The requirements move, so naming the source is the right answer rather than a dodge. A recital of them is wrong from the day they change rather than merely old. A sheet with a route in the row can be brought up to date by one person in one afternoon. A sheet with a recited requirement in the row cannot be brought up to date at all. Nobody looking at it can tell which year it was true in.

How are two completed maps compared without inventing a score?

Put them side by side and go down the rows together. Row one against row one, row two against row two, saying for each whether it is filled and what it says. The two sheets read together are the comparison, and the comparison is a description rather than a result.

Do not add the rows up. Adding requires weights, weights require a view about which protection is worth more than which, and no such view exists in this record or anywhere in the arithmetic. Is a pledge over specific property worth two restrictions or half of one? Nothing in this record answers that, and a number that comes out of a sheet without an answer to it is a number somebody invented while adding.

There is one comparison that does put both bonds on a single scale, and it is a price rather than a score. Rs 1,000.00/- promised in five years costs Rs 716.327252/- at the five year government SPOT rate of 6.90 per cent a year, and the same Rs 1,000.00/- promised in five years by Palash Cements Limited at 9.10 per cent a year costs Rs 646.958238/-, both with one discounting period a year. The difference is Rs 69.369015/- on every Rs 1,000.00/- of five year face.

The gap is what somebody is charging for every difference between the two bonds at once, protections included, and the gap arrives as a single number that cannot be split across six rows. Nothing in it says how much of the Rs 69.369015/- is being charged for the empty security row, how much for the empty representation row, and how much for things this map never touches at all. Read it as the one figure both bonds can be quoted on, and stop there.

Who actually walks a protections map, and when?

Three people, at three different moments, and none of them is doing it out of curiosity.

A lender walks it before the money leaves. Not to score the borrower, a job the lender does separately and with entirely different material, but to work out which rows are empty and whether the terms on offer should be argued about while there is still leverage to argue. The empty rows are the agenda for that conversation. A row that stays empty after the conversation is a row the borrower refused, and knowing that is worth more than any total the sheet could carry.

An analyst walks it after a price arrives and before an opinion is written. The value of the walk here is that it is fixed: the same six rows on every document means that six documents read across three weeks produce six sheets that can be laid on one desk. Without a fixed frame, the third document gets read against the impression left by the second, and a run of documents turns into a mood.

A holder who has nothing beyond the bond itself walks it when something changes. A borrower announces something, and the only useful question is whether it touched a row. If the restrictions row was EMPTY, then there was nothing there to breach, nothing was breached, and the holder's position is exactly what it was yesterday with different news attached. The sheet earns its place at that moment. A holder learns what the document never promised before anybody has to work out whether a promise was broken.

The household version is close enough to be useful. The cousin with the tea stall took the Rs 50,000/- and agreed not to borrow from anybody else while that loan was outstanding, and the lender wrote it down. Six months later news arrives that he has taken a second loan. The paper comes out, the row is found, and the restriction is in it: a term was breached, and the lender has something to say. Had the row been empty, the same news would have arrived with nothing to say at all, and knowing which of those two situations holds, before the news arrives, is the entire practical value of writing the rows down in the first place.

What can a completed map never tell?

Four things, and they are the four things a reader most wants when the sheets are finished.

A completed map cannot give the chance that anybody fails to pay. No default study, no recovery study and no loss distribution appears in this record, so any probability produced from it would be produced from nowhere and would then be quoted by somebody who did not watch it being produced.

A completed map cannot give either issuer a credit assessment. The scale such an assessment is expressed on, and what each step of that scale means, belong to an authority. Palash Cements Limited has no assessment in this record.

A completed map cannot say what the 2.20 percentage point difference, equal to 220 basis points, implies about expected loss. The arithmetic exists and is covered separately in this sequence. Here the difference is used for one purpose only, as the single scale both bonds can be quoted on.

And it cannot say whether the protections on either document are enough. Enough is a judgement about a borrower, and this record does not describe either borrower beyond the rate each one pays. The sheet answers a smaller question completely: what does this document say, and what does it not say. Answer that one well, write the empty rows as EMPTY, and put the purpose line at the foot where the next reader will see it.