Collecting entitlements
The way you receive the payments due on strip bonds and strip bond packages depends on whether you hold the strip bonds and packages through a financial institution or yourself.
For callable residuals, some special procedures may apply if the underlying bond is not called.
If the underlying bond has a fundamental change affecting the bond (e.g., a default or restructuring), there are some additional provisions that investors should consider.
Holdings through a financial institution
In today's world, almost all investors hold strip bonds and strip bond packages through a financial institution (bank, trust company, investment dealer, or other financial institution).
On the payable date, or possibly when the institution receives the payment (depending on the arrangements you have with the institution), your account will be credited with the proceeds automatically. If the payable date is not a business day for the financial institution, the payment normally will be made on the next business day.
If the institution holds the strip bonds or strip bond packages through a securities depository, they will receive the payments from the depository. If the institution holds the strip bonds in certificate form, the institution will make the necessary arrangements to collect from the paying agent. Fees may apply, depending on your individual arrangements with the financial institution.
These processes apply to all forms of strip bonds (depository book-entry, receipt security, and physical strip bonds) and strip bond packages held through a financial institution.
Holdings in your possession
If you hold the strip bonds yourself (which is not possible for depository book-entry strip bonds and strip bond packages), you can collect the payment only by presenting the certificate for payment, on or after the payable date. Because of the high risk in handling physical strip bonds, you may wish to consider special arrangements and insurance for transporting the strip bonds to the paying agent.
Most certificates will state where the certificates may be redeemed at maturity. You will have to deliver the certificates (at your expense) to the paying agent (normally a bank, a trust company, or the issuer), as stated on the certificate. If using mail or a courier service to deliver the certificates, you may wish to consider
- insuring the envelope against loss, and
- potential delays in receiving the maturity payment.
If you fail to present the certificates, you will not receive the maturity payment.
NOTE: When deciding how to submit the strip bonds for payment, remember that physical strip bonds are payable to the bearer and cannot be replaced if loss.
Callable residuals
In Canada, a number of callable bonds have been stripped to the next call date. If the bond is called on the call date, the holders of the residuals receive the full amount of the principal payment (excluding the final interest payment due on that date). If the bond is not called, the residual becomes equivalent to the underlying bond. If you hold the residual through a financial institution, you will see an exchange of the position from the residual to the underlying bond.
Special situations
For some issuers (e.g. corporations), the strip bonds may be subject to changes in the terms due to corporate restructuring, defaults, or other fundamental situations that could affect the payments to the holders of the strip bonds. Holders should inquire about the provisions for events of this nature before purchasing these strip bonds, if they believe that this risk may apply to the strip bonds being purchased.
In Canada, the approach used for receipt security strip bonds since the early 1990's is the concept of proportionate economic interest. This approach uses the yields on Government of Canada bonds of similar maturity for each of the remaining strip bonds. These yields are used to calculate a price for each of the strip bonds and then the total value for each of the strip bonds. The value for each strip bond is then divided by the total of all the values, to give a percentage of the total value. The holders of each strip bond then receive their calculated percentage of the total value. The same approach also is used for the allocation of proxies.
Receipt security strip bonds issued prior to 1990 generally were backed by government or government agency bonds and therefore typically do not have similar provisions. If such a situation arose, holders of the receipt securities may be limited in their right to enforce the terms of the underlying bond directly against the issuer.
This approach is not perfect, but it does provide a reasonably equitable allocation of the entitlements.
The Canadian Depository for Securities (CDS) introduced this process in 1993 for its depository book-entry strip bonds, primarily to support the stripping of corporate bonds. The arrangements also apply to the federal, provincial, municipal, and other bonds, with the exception of five corporate issues. These five issues were stripped using special arrangements with a trustee, who follows the original approach for calculating the proportionate economic interests. CDS has flagged these strip bonds by including "TR" in the security description.
NOTE: These include issues from Bell Canada. The only way to find out the exact issues is to purchase a copy of the CDS strip bond reports and search through the security descriptions, since CDS does not publish a list of these issues. For a simplified overview of the processing for Bell Canada strips, please see Bell Canada strips.
CDS modified the formula used for the allocation of entitlements in 2001, to address a perceived inequity in the previous formula. The change ensures that the proportions are aligned more closely with the actual market values prior to the event. Under the new approach, instead of using yields from federal government securities, CDS uses recent market prices for the strip bonds involved and then calculates the estimated market value for the strip bonds. The proportionate economic interest is calculated based on these market values.
CDS has published detailed information on its handling of special situations on its web site.
For depository book-entry strip bonds in countries other than Canada, the risk is probably very low, since these depositories strip only bonds issued by or guaranteed by the federal government or agencies. Some countries have enacted legislation and/or regulations so that the strip bonds created from government bonds represent direct obligations of the issuer. This reduces the need for a process such as the one in Canada, but still leaves open questions about the treatment of the strip bond holders if there is a fundamental change affecting the underlying bond(s).
For physical strip bonds, the rights of investors in this type of situation are not at all clear. It is quite probable that the bond trustee will require that the residual and the unmatured coupons for each certificate be presented before making any payments.
Since the strip bonds from each certificate typically were sold to different investors, there is a risk that the holders of physical strip bonds may have difficulties in collecting any such payments.
NextCopyright Keith Campbell ©2002-2008. All rights reserved.