Summary of model provision
The Securities Industry and Financial Markets Association (SIFMA) investment-grade bond optional redemption model provision was recently published. Following the assembly of a working group of investment banks operating in the United States and global capital markets to agree on general principles and proposed language, a model provision was developed that promotes consistency and clarity while removing the ambiguity found in historical provisions. This model provision provides issuers, investment banks, investors and other market participants with certainty and specificity in the calculation of the redemption price of bonds. The new language is expected to be introduced throughout the industry starting in the fourth quarter of 2021 and into 2022.
Links to the model provision forms and a presentation providing further detail on the provision can be found here:
- SIFMA Model Provision – Investment-Grade Bond Optional Redemption (with Par Call);
- SIFMA Model Provision – Investment-Grade Bond Optional Redemption (without Par Call); and
- SIFMA Model Provision – Presentation – Investment-Grade Bond Optional Redemption.
This article provides a summary of the provision.
Investment-grade bond optional redemption provisions, and the calculation of the make-whole redemption price, can vary by issuer and by the methodology used by the investment bank assisting with such calculation. This variation in language and calculation results in a lack of standardisation in the manner of calculating the redemption price. As a result, market participants have expressed the desire for standardised language in investment-grade bond optional redemption provisions.
In many make-whole calculations, a reference US treasury security is selected by the issuer with the assistance of an investment bank. In others, a US treasury constant maturity, as published by the board of governors of the Federal Reserve System (known as a "treasury constant maturity") is used. In both cases, a make-whole spread that was established at the time of initial pricing of the issue is added to the yield of the selected treasury security or treasury constant maturity, and the resulting yield is used to discount the sum of the present values of the applicable remaining scheduled payments of principal and interest to the redemption date. The yield of the reference US treasury security or treasury constant maturity is most commonly referred to as the "treasury rate".
In existing optional redemption provisions, there are variations in the method for selection of the US treasury security or the treasury constant maturity and the related yield. Many current provisions use a comparable treasury issue selected by an independent investment bank in accordance with customary financial practice in pricing new issues of corporate debt for determining the treasury rate. Ambiguity over which treasury is comparable and what is customary may result in different investment banks selecting different reference treasuries and yields.
To promote consistency and clarity for the benefit of both issuers of corporate debt as well as the holders of such debt, the SIFMA working group focused on the treasury rate definition, and considered, among other things, the optimal source and method of selecting and calculating the treasury rate, including the role of the independent investment bank. The SIFMA working group also considered additional changes to existing provisions.
The resulting model provision provides issuers, investment banks, investors and other market participants with certainty and specificity in the calculation of the redemption price of bonds being redeemed.
Below is a summary of key aspects of the model provision:
- The general principles of the make-whole calculation are unchanged. Payments of principal and interest are discounted to the redemption date using a treasury rate determined at the time of the redemption plus the make-whole spread that was determined at pricing of the issue.
- The calculation of the treasury rate and redemption price are done by the issuer. It is no longer necessary for an independent investment bank to select a United States treasury security or perform the make-whole calculation.
- The primary method of calculating the treasury rate will be done using the most recent statistical release published by the board of governors of the Federal Reserve System designated as "Selected Interest Rates (Daily) - H.15" or any successor designation or publication (H.15) as of quarter past four in the afternoon (New York time) on the third business day preceding the redemption date and choosing the relevant treasury constant maturity or treasury constant maturities. This is published by the Federal Reserve on a daily basis.
- Applicable calculations use the period from the redemption date to the maturity date (or, if the notes have a par call date, the par call date), with such period being referred to as the "remaining life".
- In the majority of redemptions, two yields are selected – one yield corresponding to the treasury constant maturity on H.15 immediately shorter than the remaining life, and one yield corresponding to the treasury constant maturity on H.15 immediately longer than the remaining life.
- The two yields are interpolated to the maturity date, or par call date, as applicable, on a straight-line basis using the actual number of days. To calculate the actual number of days, the applicable treasury constant maturity on H.15 is deemed to have a maturity date equal to the relevant number of months or years, as applicable, of such treasury constant maturity from the redemption date. Other than for maturities of less than one year, this means that a treasury constant maturity will be deemed to have a maturity date with a month and day the same as the redemption date, and the applicable year matching the selected treasury constant maturity. For example, if the redemption date is 15 November 2021 and the par call date is 15 April 2027, and the period from the redemption date to the par call date is five years and five months, the issuer will select the yield corresponding to the five-year treasury constant maturity and the yield corresponding to the seven-year treasury constant maturity on H.15 (there is no six-year treasury constant maturity). The yields will be interpolated on a straight-line basis using the actual number of days. For this interpolation calculation, the five-year treasury constant maturity will be deemed to have a maturity date of 15 November 2026, and the seven-year treasury constant maturity will be deemed to have a maturity date of 15 November 2028.
- In more limited circumstances, only one treasury and yield will be used. This happens when:
- the remaining life matches exactly a treasury constant maturity (for example, if the period from the redemption date to the par call date is exactly five years, the yield for the five-year treasury constant maturity on H.15 will be the treasury rate); or
- if there is no treasury constant maturity on H.15 immediately shorter or immediately longer than the remaining life, as applicable (for example, if the period from the redemption date to the maturity date, or par call date, as applicable, is less than one month or greater than 30 years).
- If H.15 or any successor designation or publication is no longer published, the model provision provides a backup that calculates the treasury rate using the yield of the US treasury security maturing on, or with a maturity that is closest to, the maturity date, or par call date, as applicable.
- Subjective determinations such as the comparable treasury or what is consistent with customary financial practice in pricing new issues have been eliminated.
- Notice of redemption must be mailed or electronically delivered at least 10 days but not more than 60 days before the redemption date. While this period is shorter than the historical 30-day notice period, 10 days has become customary in current debt issues and should provide investors with sufficient notice of the redemption.
- After all calculations are completed, the treasury rate is rounded to three decimal places.
For further information on this topic please contact Jonathan DeSantis, Lisa Jacobs, Robert Giannattasio or Richard Alsop at Shearman & Sterling by telephone +1 212 848 4000) or email ([email protected], [email protected], [email protected] or [email protected]). The Shearman & Sterling LLP website can be accessed at www.shearman.com.