Published 18 November 2020 by Audra Oliver
LIBOR is the reference interest rate for millions of contracts worth more than $240 trillion — ranging from complex derivatives to corporate bonds. And it ends abruptly on December 31st, 2021.
Issuers are running out of time and options for transitioning their existing LIBOR contracts. Amending the Terms and Conditions of a bond (as one would need to in the event of changing the benchmark reference rate) usually requires bondholder consent, which seems like a daunting and impractical process (even though it is easier than many believe).
As such, US law makers have considered legislating a solution that would theoretically swap all LIBOR contracts governed by NY state law to a new rate without the explicit consent of the bondholders. And in the UK, the Bank of England has considered legislation that would create a synthetic LIBOR rate for tough legacy contracts. But legislation has yet to come to fruition in either jurisdiction.
Enter the latest idea: bond swaps.
A bond swap consists of selling one debt instrument and using the proceeds to purchase another debt instrument. Investors engage in bond swapping with the goal of improving their financial positions in the context of their overall fixed-income portfolio. Bond swaps can be used to achieve tax benefits, known as a tax swap, or be used to take advantage of changing market conditions. They are also done to shorten or extend maturities of a bond security, known as a maturity swap. But in the context of LIBOR, they would not be swapped to improve a financial position or achieve tax benefits. Nor would they be used to take advantage of new market conditions or change the maturity of their bond. Bonds would be swapped purely so that the holder retains a note based on a reference rate that is not about to go extinct.
In order for bond swaps to work as a LIBOR transition instrument, the issuer would purchase the existing LIBOR bonds from the holders and sell them new bonds with the same terms except with new language in the fallback provisions that applies in the event of the discontinuation of LIBOR. Which makes sense—sort of. While Exchange Offers such as this would help with some of the bonds, it would not solve the LIBOR problem for the bonds that aren’t exchanged. Bond swaps therefore are not a total solution unless 100% of the bondholders swap. Some would argue it makes it even more complicated as you are likely to end up with two sets of bonds.
The Federal Farm Credit Banks recently executed a swap deal which is being viewed as a trial to see if bond swaps might actually work as a LIBOR transition solution. Last week the bank announced the results of the deal: there was NOT unanimous participation in all but one of the bonds. Therefore bond swapping was not a full solution, but a mere partial fix.
In order to get more bondholders to swap, Federal Farm Credit Banks, or any LIBOR issuer, has to approach the Exchange Offer in the most comprehensive way possible—first by performing a bondholder identification, and then going carefully through the information agent and exchange agent process in which bondholders are contacted, and each is made aware of what was happening and what action they needed to take.
This is the same process that an issuer would go through for a consent solicitation, in which bondholders agree to change the terms and conditions of the bond to a new rate at an AGM or EGM. But the advantage to this method of transition is it is simpler. There is no exchange, just a change in the fallback language of an existing contract.
The major benefit however of going through the consent solicitation process rather than an Exchange Offer, is that in most jurisdictions (except New York) you only need a portion of bondholders to agree to change the reference rate – not everyone. Moreover, you only need a certain percentage to achieve quorum for the meeting, making the consent solicitation process a far more achievable endeavour.
In addition to consent solicitation being the easier route, it is also the recommended route, and is the safest way to avoid the economic, reputational and legal risks associated with the transition.
What is the first step?
The first step is to perform a forensic bondholder identification, using an issuer agent experienced in identifying bondholders in what is a large and opaque secondary bond market. Without knowing who most of your bondholder are, it is difficult to get them to agree to anything. Once they are identified however, the process of informing them and mobilising them to vote can commence, and if executed properly, is likely to lead to a passed resolution.
All in all, it is safe to say issuers will continue to pursue ideas that may appear to be a relatively easy fix to the big LIBOR problem. Afterall, this is a truly daunting challenge—perhaps the most daunting the capital markets has ever seen. But like the trialling of bond swaps, we believe most issuers will eventually come back to the only recommended, safe option for transitioning their LIBOR contracts: a consent solicitation.
Written by Audra Walton
CMi2i is a leader in capital markets intelligence, specialising in the world’s most accurate Equity & Debtholder identification service. As an issuer agent, CMi2i supports issuers and their advisors with investor relations, M&A, shareholder activism, capital restructuring and reputation management goals. The company has supported more than 1000 corporate transactions, 1200 AGMs and has over 500 clients worldwide. CMi2i’s LIBOR Solution provides an end-to-end service for issuers wishing to identify bondholders and solicit their approval for the new rate.