So, what happens to companies with outstanding capital markets debt, or equity-linked capital markets debt, when a worsening economic environment puts pressure on their ability to adhere to the provisions of such borrowings?
Liability Management
Liability management is the collective name for techniques companies employ to restructure their capital markets debt before any terms are breached. Broadly, there are four main techniques:
- open market purchases
- consent solicitations
- tender offers
- exchange offers
The market for liability management is big business. To use a European example, from a base of approximately Ç10 billion ($14.3 billion) of debt restructured using these techniques in 2000, the market grew to deals with a value of in excess of Ç70 billion in 2006. With global investment banks expanding their capability in this area, expect to see volumes of liability management deals in Asia grow.
Open market purchases:
A programme of open market purchase occurs when an issuer of bonds either goes into the market itself, or instructs a bank to do so, to buy back bonds of a certain series within certain price parameters by individual negotiation with each existing bondholder. Bonds may be purchased from different bondholders at different prices and at different times. Open market purchases are most effective when the issuer perceives his debt to be cheap and wishes to reduce that level opportunistically.
Consent solicitations:
A consent solicitation is an approach by an issuer of bonds to bondholders requesting their consent to an amendment in the terms and conditions of the bonds. Usually this is done by convening a meeting of the bondholders to consider and pass a relevant resolution. This technique is used, for example, where an issuer recognises the risk of breaking financial covenants in an existing bond issue.
Tender offers:
This is an offer from the bond issuer to the bondholders to buy back some or all of the bonds for cash. Unlike a programme of open market purchase, a tender offer is made to all bondholders alike and on the same terms, although it may be used in similar circumstances.
Exchange offers:
This is an approach by an issuer of bonds to the bondholders requesting them to exchange the existing bonds for a new series of bonds with different terms. We have seen this technique used effectively to extend the maturity of existing bonds or to move debt to a different level in the group structure.
An issuer may combine any or all of the above techniques in order to achieve its commercial objectives. For example, in certain circumstances an exchange offer may be combined with a bondholdersÆ meeting to alter the terms of the bonds that are not exchanged by incorporating a call option allowing the issuer of the bonds to ôsqueeze outö minority holders that do not accept the exchange offer.
Why would you want to use these techniques?
Companies will always have a range of different commercial objectives.
However, the most common reasons to use these techniques are to:
- reduce indebtedness
- reflect a change in corporate structure following a corporate restructuring
- cater for regulatory change
- allow extra flexibility in financing structures
- substitute high yielding debt for cheaper debt, or
- remove restrictive terms.
To use some common examples, we have seen situations related to takeovers where the new holding company offers to exchange bonds issued by it as a replacement for bonds issued by an acquired company that has become its new subsidiary. This will be done in order to avoid structural subordination within the holding companyÆs consolidated balance sheet.
We have also seen them used by convertible bond issuers that have experienced a fall in their share price such that bondholders are unlikely to convert, and where these companies won't easily be able to fund the cash redemption cost of the bonds. In this scenario, techniques such as an exchange into a new convertible bond or an adjustment to the existing conversion price allied to an extension of the maturity may be used to manage the liabilities on the balance sheets.
Is there any legal risk?
While the concepts of liability management may seem clear, they can give rise to a number of difficult legal issues. At the outset, these may be driven by the law governing the bonds that are the subject of the exercise. Legal documentation and regulatory concerns may dictate a different approach to managing risks for a New York law-governed high-yield debt issue sold to qualified institutional buyers (QIBs) under Rule 144A compared with an English or Hong Kong law-governed convertible bond issued on an accelerated book build basis under Reg S.
The location of the investor base may also be key to determining what, if any, local law and regulation is relevant. Different stock exchanges on which the bonds are listed may have different rules on matters such as disclosure.
Over and above these concerns, an exchange offer involves a new issue of securities, necessitating an analysis of relevant securities laws in relation to the offering. In some cases, significant amendments to the terms of a bond may be so fundamental as to constitute an offer of a new security, although this is rare.
Outlook
The change in the current economic climate from the last few yearsÆ benign environment, coupled with an increased interest of global investment banks in bringing advanced liability management techniques to Asia as a product in its own right, will likely lead to an increase in the volume of these types of deals in the region going forward.
Watch this space.
Linklaters has a wealth of experience in all liability management techniques and has most recently advised the solicitation agent on the consent solicitations resulting from the KCRC/MTRC merger in Hong Kong. This exercise involved consent solicitations and noteholders meetings for a wide range of note issues, including Yankee, Eurobonds and Hong Kong retail notes.
If you would like further information on any of the issues raised in this article, please contact:
Nigel Pridmore
Capital Markets Partner, Hong Kong
tel: +852 2901 5373
email: [email protected]
Jeremy Webb
Capital Markets Partner, Hong Kong
tel: +852 2842 4870
email: [email protected]
Patrick Sheil
Partner and US Practice Head (Asia), Hong Kong
tel: +852 2842 4124
email: [email protected]
Kevin Wong
Managing Partner, Singapore
tel: +65 6890 7333
email: [email protected]
Dean Lockhart
Capital Markets Partner, Singapore
tel: +65 6890 7388
email: [email protected]
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