Perpetual bonds, often referred to as "perps," stand at the intersection of debt and equity, offering unique advantages and risks for both issuers and investors. Unlike traditional bonds with fixed maturity dates, perpetual bonds have no set repayment date—making them an intriguing instrument in corporate finance and investment portfolios. This guide explores the structure, market dynamics, accounting and tax treatment, risks, and investment strategies related to perpetual bonds, with a focus on the Chinese market context.
What Are Perpetual Bonds?
Perpetual bonds are debt securities without a fixed maturity date. Instead of repaying principal on a specific date, the issuer retains the right to extend the bond indefinitely. These instruments typically feature high coupon rates, call or extension options, interest step-up mechanisms, and deferral rights. While they resemble equity in some aspects—especially in accounting treatment—they are generally viewed as debt by investors due to their fixed-income nature.
In China, three primary types of perpetual instruments exist:
- Extendable Enterprise Bonds (approved by NDRC)
- Long-Term Callable Medium-Term Notes (registered with the Trading Association)
- Extendable Corporate Bonds (approved by CSRC)
Despite their name, most perpetual bonds include embedded call or extension options that allow issuers to redeem or prolong the term after an initial period—commonly structured as “3+N” or “5+N” years.
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Key Features and Clause Design
1. Indefinite Maturity: The Core Trait
The absence of a fixed maturity is achieved through extension clauses, which grant issuers the option to renew the bond for additional periods. Two common structures include:
- No stated maturity, but with a call option allowing redemption.
- A defined maturity, but with an issuer’s right to extend.
For example:
- 18 Wuhan Guozij MTN001: Long-dated until redeemed; no fixed term.
- 17 Wutie Y1: 3-year repricing cycle with issuer’s choice to extend or repay every 3 years.
This flexibility benefits issuers seeking long-term funding while managing leverage ratios.
2. Interest Step-Up Mechanism (Coupon Reset)
To discourage indefinite rollover, many perpetuals include an interest step-up clause. If the issuer chooses not to redeem, the coupon rate increases significantly—typically by 300 basis points (bps)—making continued issuance costlier than refinancing.
Three common reset models:
- Benchmark + Spread + Step-Up: Most common in China; reset based on current benchmark rates.
- Previous Coupon + Fixed Bump: Leads to compounding increases if extended multiple times.
- Delayed Step-Up: No increase in early cycles—creates potential "traps" where extending is cheaper than refinancing.
Example: 17 Wutie Y1 has no step-up in the first nine years; only from year 10 onward does the rate rise by 200–400 bps.
Investors should be cautious about delayed step-up structures, as they may incentivize issuers to avoid redemption even when market conditions favor refinancing.
3. Interest Deferral Rights
A defining feature of perpetuals is the issuer's ability to defer interest payments without defaulting. Unless a mandatory payment event occurs (e.g., dividend distribution), interest can be postponed indefinitely.
Some bonds impose penalties:
- Accrued interest earns additional interest during deferral.
- Spread increases until deferred amounts are settled.
This clause strengthens the "equity-like" nature of perpetuals, particularly under accounting standards.
4. Cross-Default Clauses
Over 5% of outstanding perpetuals now include cross-default provisions, meaning default on other debts triggers default here too. This protects investors amid rising credit stress and reflects improved market discipline since 2016.
Example: 17 Liuzhou Dongtou MTN001 triggers cross-default if any debt over RMB 100 million or 5% of net assets remains unpaid.
5. Bankruptcy Subordination
While most corporate perpetuals rank pari passu with senior debt, some—especially financial perpetuals—are structurally subordinated. Their claims come after depositors and general creditors but before equity holders.
Example: 19 Hongdou MTN002 ranks behind ordinary debt but ahead of equity—enhancing its equity classification potential.
Market Overview: Corporate and Financial Perpetuals
Corporate Perpetual Bonds
As of early 2025, there are 1,489 outstanding corporate perpetuals totaling RMB 2.1 trillion:
- Mid-term notes (MTNs) dominate (~70% share).
- Over 82% rated AAA, indicating strong issuer quality.
- State-owned enterprises (SOEs) account for 96.6% of issuance volume—driven by deleveraging needs and investor preference.
- Top sectors: Urban investment platforms, utilities, construction, and conglomerates.
From a yield perspective:
- Average yield premium over non-perpetual peers: +125 bps since 2014.
- Lower-rated issuers command higher spreads: AA-rated perpetuals trade at ~190 bps above benchmarks vs. AAA at ~25 bps.
- Non-SOEs face significantly wider spreads (~196 bps) compared to SOEs (~90 bps).
Despite hybrid features, most corporate perpetuals behave like debt due to strong redemption incentives and equal recovery rankings.
Financial Perpetual Bonds
Financial institutions issued 33 perpetuals worth RMB 628.3 billion, primarily:
- Commercial bank AT1 bonds (92%): Launched in 2019 to boost Tier 1 capital.
- Securities firm perpetuals (15 issues): All privately placed; mostly AAA-rated.
- One-off institutional issue: 19 Zhongzeng Financial Perp 01.
Bank perpetuals exhibit stronger equity characteristics:
- No interest step-up.
- Discretionary coupon cancellation.
- Subordinated claim in liquidation.
- Principal can be written down if capital ratios fall below thresholds.
The People’s Bank of China introduced the Central Bank Bills Swap (CBS) in 2019 to enhance liquidity for bank perpetuals—supporting market development and confidence.
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Accounting and Tax Treatment
Accounting Rules (2019 Guidance)
In January 2019, China’s Ministry of Finance issued Accounting Treatment for Perpetual Bonds, clarifying when these instruments qualify as equity rather than liability.
Key criteria for equity classification:
- Issuer can unconditionally avoid cash outflows.
- No mandatory redemption date (unless linked to liquidation).
- Interest deferral without penalty.
- No investor put options or guarantees.
- Subordination in bankruptcy strengthens equity case.
- Interest step-ups must not create an “implicit obligation” (e.g., cap rate ≤ industry average).
If all conditions are met, perpetuals can be recorded as equity—helping firms reduce leverage ratios without diluting ownership.
However, only 12 perpetuals have been classified as liabilities post-guidance—five issued after 2019—indicating conservative application so far.
Tax Policy (2019 Announcement No. 64)
The tax treatment depends on whether the instrument is treated as debt or equity:
- If deemed equity: Interest paid is not tax-deductible; received interest qualifies for inter-corporate dividend exemption.
- If deemed debt: Interest is tax-deductible for issuers; taxable income for investors.
The tax authority allows flexibility: companies can choose different treatments across accounting and tax frameworks, provided they meet at least five of nine criteria—including repayment obligation, fixed interest, subordination, etc.
Most corporate perpetuals meet enough criteria to justify tax-deductible interest expense—enhancing their attractiveness.
Extension and Deferral Risks
Although rare, some issuers have chosen to extend or defer:
- 29 perpetuals from 19 issuers have experienced non-redemption or interest deferral (~1.64% of total outstanding).
Causes fall into two categories:
- Structural traps: Delayed step-up clauses make extension cheaper than refinancing.
- Credit stress: Cash flow issues force continuation despite higher coupons.
For instance, 16 Guangzhou Metro Perp 03 had no rate hike until year 18—leading to extension at a lower effective rate than new issuance.
Deferring interest usually signals distress—it offers no strategic benefit beyond temporary liquidity relief.
Investment Strategy and Screening Tips
Watch Out for No Step-Up Clauses
There are currently 27 perpetuals (RMB 42.77 billion) with no initial interest bump upon extension. All that reached their first call date have been extended—highlighting high roll-over risk.
Monitor upcoming maturities in 2025 with similar structures closely.
Evaluate Subordinated Perpetuals
Among 39 subordinated perpetuals (RMB 76.26 billion), analysis shows:
- In 11 out of 13 dual-track issuers, subordinated paper carries a spread premium of 5–30 bps over senior counterparts.
- Higher yields compensate for lower recovery priority—justifying inclusion in diversified portfolios if credit quality remains strong.
Target High-Yield Quality Issuers
We screened for issuers with implied ratings of AA or higher and identified those offering spreads above 150 bps—representing attractive risk-adjusted opportunities in the current environment.
Frequently Asked Questions (FAQ)
Q: Can perpetual bonds really last forever?
A: Technically yes—but practically no. Most include call options every 3–5 years. High step-up rates typically prompt redemption unless structural or financial constraints prevent it.
Q: Why do companies issue perpetual bonds?
A: To raise long-term capital without increasing leverage (if classified as equity), support deleveraging goals, and lock in favorable rates amid volatile markets.
Q: Are perpetual bonds riskier than regular bonds?
A: Yes—due to extension risk, deferral risk, and subordination in some cases. However, strong issuers with transparent terms offer acceptable risk-return profiles.
Q: How do investors get protected?
A: Through step-up clauses, cross-default triggers, subordination clarity, and monitoring issuer behavior around call dates.
Q: Can retail investors buy perpetual bonds?
A: Mostly institutional; retail access is limited in China, though some exchange-listed versions exist.
Q: What happens if a company goes bankrupt?
A: Depends on subordination terms. Most corporate perps rank equally with other debt; bank perps rank below deposits and senior debt but above equity.
Final Thoughts
Perpetual bonds are powerful tools blending debt stability with equity flexibility. For investors, understanding clause design—especially step-up timing, deferral terms, and subordination—is key to assessing risk. For issuers, these instruments support capital management under evolving regulatory frameworks.
As accounting standards tighten and market discipline grows, expect more nuanced designs aimed at balancing investor protection with issuer flexibility.
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