Account banks, swap counterparties and liquidity facility providers getting downgraded is now the new norm. Not being able to locate replacements with the requisite ratings and/or the appetite to take on these roles on substantially similar terms is also passé. In reality, it is frequently the case that nothing changes. These entities are still performing their obligations and from an operational standpoint, the deal functions as it should. But the problem arises because of the by now oft used phrase “in breach”. The transaction documents oblige either the servicer or the issuer to search for replacements who hold the requisite ratings. Every day that an entity that is “in breach” of the rating triggers remains on the deal is a day where the issuer and/or the servicer is “in breach” of its obligations. This is despite the fact, that the deal may still be performing as it should!
To cure this breach, the issuer will have to seek the trustee’s consent to either waive the offending breach or to give its blessing to an amendment of the trigger ratings to ensure that the existing entities involved meet such rating requirements. Understandably, trustees often decline to exercise the discretion to grant such consents and/or waivers but may instead either seek, or direct the issuer to seek, noteholder direction to grant such waiver or amendment.
While workable on paper, this process of seeking noteholder approvals is in practice a minefield. The most common way of seeking a noteholder direction is to convene a noteholder meeting. For most of these waivers or amendments to be approved, each class of noteholders will have to vote in favour of the extraordinary resolution. That is hard in itself as different classes of noteholders may have conflicting concerns. Take the issue of liquidity for instance – senior noteholders may well be happy to be rid of a liquidity facility as opposed to bearing the costs of seeking a replacement or amending the ratings triggers. Junior noteholders may on the other hand, feel very differently if they are benefitting from the liquidity. Or it could be the other way around if the junior will bear the costs and never realistically see the benefit or their notes aren’t rated highly enough to be affected by the liquidity provider’s ratings.
The second hurdle comes in the form of convening quorate meetings. In our experience, this has proven to be challenging (to say the least). Noteholders are frequently indifferent to these issues, especially if their notes’ ratings will not likely be affected in any event.
To compound matters, the notes in question are held through the clearing systems and traded. This means that the issuer does not know who the noteholders are and cannot be sure that they even receive the noteholder notices requesting the meeting.
There is no straightforward solution perhaps but if I were running the world, I would suggest that we should write provisions into our documents that make clear that the results of a quorate meeting of the most senior class of noteholders will prevail in circumstances where no other classes are quorate at their adjourned meetings. So as long as no one has clearly voted against the proposal and a failure would occur solely because of the lack of quorum, then it seems to me that the results of the quorate meeting of the most senior class of notes should reign supreme; this seems only fair as they have chosen to exercise their vote and their voice. And after all, all the other noteholders have had their chance. Noteholders who have proven that they “care” about the deal should have the right to chart the direction of the transaction.
So in my view, the old adage of “you snooze you lose” should apply and I dare say the trustees, issuers, account banks, swap counterparties or liquidity facility providers would agree with me on this one. We may not like the result but at least we would have one!
