As we approach the end of 2022, the international debt capital markets continue to remain challenging due to the successive shocks of the COVID-19 pandemic and ongoing supply chain disruptions, the war in Ukraine and associated disruptions to the global energy and other commodity markets and elevated inflation twinned with a historically strong U.S. dollar. In these precarious and unpredictable times, issuers with securities outstanding should:
- Review the terms and conditions of their outstanding securities as market conditions change to determine whether the circumstances trigger an event of default or a cross-default. In particular:
- Financial Covenants. Loss of income, higher commodity expenses and deterioration in asset values are likely to negatively affect issuers’ compliance with their financial covenants. Issuers, together with their auditing partners, should continue to monitor compliance with financial covenant packages and, if a breach has happened or looks likely, issuers should quickly look at mitigation strategies, whether to try to cure the breach (e.g., by way of a capital increase or asset sale), seek the consent of the holders of securities to amend the financial covenant package prior to any potential breach, or seek waivers from the holders of any breach.
- Rating Agencies. With the credit environment deteriorating globally, ratings agencies are taking action, with a number of ratings agencies issuing downgrades in both ratings and outlooks in recent months. Issuers should consider whether there is a requirement included in the terms and conditions that they retain a certain rating and the potential impact of a downgrade or a deteriorating outlook (or both). Issuers that may have a refinancing need who have a ratings concern should also consider the impact of any ratings changes on planned transactions, whether to budget for higher interest costs or reconsider the form, structure and strategy of a new transaction.
- Cross-default. Most debt capital markets instruments contain a cross-default provision that is triggered when another instrument or financing by the same issuer or within the same group moves into default. These provisions often extend beyond non-payment (see below) and can cover “softer” events of default, such as a relatively minor covenant breach. The effect of this can be to imperil a company’s entire capital structure due to a minor event that can be immaterial to the ability of the issuer to meet its obligations. Accordingly, issuers should carefully monitor all of their financings and keep an eye on the potential effects that they may have on other financings.o Insolvency. Issuers should also carefully review the applicable provisions for an event of default triggered by insolvency as there may be circumstances other than an actual insolvency proceeding that could cause there to be an event of default, such as an issuer- or government-level moratorium on payments, or loss of license.
- Access to Currency. Instruments denominated in a currency (usually the U.S. dollar or euro) that is different from the issuer’s own currency require access to foreign currency. In some economies, access to foreign currency has become increasingly constrained, as central banks direct foreign currencies first to essential commodity purchases (principally, energy and food). Accordingly, issuers should keep an eye on their access to foreign currency and their legal ability to deploy their own foreign currency to make international payments.
- Guarantees. Guarantors should also enquire as to the financial health of issuers for whom they have issued guarantees in order to be able to plan for future issues. Guarantees often trigger the same event of default and cross-default concerns as direct issuances.
- Non-payment. Any potential short-term cash flow issues could make it difficult for some issuers to pay interest as it falls due. Such non-payment would trigger an event of default. Issuers should start considering now how to raise any additional funds required to ensure compliance.
Applicable grace periods would need to be considered for all events of default. In some cases, the event of default may have no grace period, most often with respect to payments. Issuers should also be aware that notification requirements may be triggered when the issuer becomes aware of an event of default (or potential event of default), which would be when any grace period would be ordinarily expected to begin.
- Consider if now is the time to repurchase outstanding securities by way of either a private buyback or a tender offer. There may be benefits in doing so: (i) outstanding securities are likely to be trading below par value and, following such repurchase, an issuer may be permitted to recognize a profit in its balance sheet (the difference between par and the price paid); and (ii) securities repurchased by the issuer by way of a tender offer or private buyback will be cancelled, which will also reduce interest payment amounts. However, if a repurchase will result in higher interest costs, which is likely at the moment, most issuers will only benefit from a repurchase if another objective can be met, such as extending out an issuer’s maturity profile.
While debt capital markets deal flow decreased during the first half of 2022 due to market conditions, some issuers were able to come to market. Issuers considering a deal in the coming months should:
- Attempt to differentiate their offering. Pools of capital remain available for investment in ESG and other non-traditional categories of securities. In particular:
- Consider a green, blue, social or sustainability bond. Many investors, including asset managers, increasingly operate with a mandate or preference for sustainable assets and central banks have been taking further steps to incorporate climate considerations into policy (in the first half of 2022, the European Central Bank announced measures to incorporate climate change into monetary policy, including tilting corporate bond holdings). A green, blue, social or sustainable label can also communicate a strong overarching approach to environmental, social and governance issues, which can provide assurance to investors reticent to invest in a challenging jurisdiction.
- Consider issuing a Sukuk. The Islamic finance market has risen in prominence over the last decade, as demand for Islamic financial products and services has increased globally.
- Be ready to take advantage of market windows that may be fleeting.
- Diligence and Disclosure. Issuers should start gathering all materials to be reflected in their offering document. Issuers should be prepared to discuss the impact of the global spike in commodity prices inflation and increases in interest rates with the banks advising on the issuance and should consider the type of information that may be required to be included in the offering document. The impact of COVID-19, although increasingly in the past, will also be a point of inquiry, as it will impact the issuer’s 2020, 2021 and, to a lesser extent, 2022 financial statements.
- Financials. Conversations should be held with auditors to confirm when the relevant financial statements will be ready as this may have an impact on timing. Any future issuance should include a recent development section setting out trends or uncertainties that have impacted the issuer’s financial position. This should include detailed discussion of the expected impact of the rise in global inflation and the related increase in interest rates.
- Rating Agencies. Issuers may need to discuss the impact of the current global economic climate with the rating agencies. Again, consideration should be given as to the effect of a downgrade or negative outlook if such action is likely