Since the dawn of the structured products industry, issuers and underwriters have entered into license agreements with index sponsors. These agreements enable the parties to the offering to use the index and its levels in connection with the offering of these products.
A number of developments in the area have made the drafting and negotiating these license agreements a bit more time- intensive. For example, issuers are linking to an increasing number of new indices. In addition, market participants are increasingly interested in the extent to which an index and its methodology are transparent.
In this article, we discuss a variety of items to consider in preparing these agreements.
Which Entities Should Be Covered?
Depending upon the circumstances, the issuer or the underwriter may be party to the license agreement. But no matter which entity is the contracting party, the entities entitled to rely on the agreement must be considered. For example, will an affiliate of the licensee, such as a finance subsidiary or a new trust entity, be the actual issuer of the product? Or if the underwriter is the licensee, will that underwriter seek to use the index with more than one issuer? The agreement must be prepared to ensure that the relevant entities will have the right to use the license in connection with an offering. (And of course, from the perspective of the index provider, the relevant revenue stream under this agreement may depend upon which parties, and how many parties, are entitled to issue products in reliance upon it.)
What Products Are Covered?
At the time a license is first granted, an issuer may have a specific product in mind, such as an ETN. However, if the product is successful, the licensee may wish to use the index for other products, such as other types of structured notes, CDs, structured warrants or OTC derivative instruments. The scope of the license agreement should be considered in connection with the licensee’s future issuance plans.
Similarly, a product may be initially planned for offering under a specific “wrapper,” such as a U.S. MTN. That being said, the licensee should be careful about limiting the scope of the license solely for use in, for example, the U.S. and its territories. Many U.S. registered offerings, and other types of offerings, involve a certain number of offerees outside of the United States. And it is always possible that if an offering is successful in one jurisdiction, a broker may seek to extend its use in other markets that it serves as well.
Obtaining an exclusive right to use an index for a particular type of structured products may provide a competitive advantage to the licensee. On the other hand, the licensor is likely to charge increased license fees for this privilege. A licensee seeking an exclusive license may also wish to have the option to convert the license to a non-exclusive license, at a lower cost.
Licensees may wish to negotiate agreement terms that help ensure that the index will remain a suitable reference asset over time, and in a variety of regulatory environments. Accordingly, the licensee may request the index provider to:
- Maintain at all times a publicly available index methodology, and to update it on a timely basis if there are any changes to the methodology;
- Publish on a daily basis (or other agreed basis) the current level of the index, its historical performance and its constituents;
- Agree that it will not receive any payments or other consideration from any potential index components or other third parties as an inducement to include (or exclude) any component from the index;
- If it provides “preinception performance information,” to prepare that information using the same index methodology that is currently in effect;
- Provide advance notice of any expected changes in the index methodology;
- Maintain appropriate index governance, supervisory and audit mechanisms; and
- Source pricing information from index components solely from independent third party providers.
- Maintain information walls that separate the individuals and divisions calculating and maintain the index from any other groups within the entity that could have an incentive to manipulate the index, such as trading or investment banking groups.
Training and Support
In the case of a new index, the licensee may wish the index provider to supply training sessions for the relevant salesforce as to the nature of the index, its construction and any risks that arise from the use of the index. Of course, the scope of any such training will depend upon the relative needs of the licensee, and the capabilities of the licensor.
Avoiding Burdensome Document Approval Obligations
An index provider may wish to approve any prospectuses or market materials relating to its index prior to their use. While that may not be an unreasonable concept, any such provisions in a license agreement have to be drafted in light of the speed at which structured product offerings are conducted. For example, the 2-day window for filing a final pricing supplement under SEC Rule 424(b) may be inconsistent with a 30-day advance approval requirement for an index provider of any materials, if the index provider is insistent on reviewing all these documents. In that regard, a provision may be drafted so that, once a description of an index is approved for use by the index provider, the licensee may continue to use it in other similar offering documents with receiving further approvals from the index provider.
Required Index Disclaimers
It is usually fair for an index provider to require the issuer to state the limited obligation of the index provider in connection with the structured product. This is usually done through required disclaimer language. However, any such language should be carefully considered so that (a) in connection with any short term sheets or FWPs, the required disclaimer isn’t three times the size of the other disclosures and (b) the language can be modified a bit to reflect the circumstances of the offering. (Notes vs. CDs, etc.) This can be accomplished through provisions that allow a shorter disclaimer to be used for shorter marketing materials, and provisions that permit required disclaimers to be stated with minor modifications.
Depending upon its planned use of the index, the licensee may wish to have a license agreement that automatically continues at the end of one or more terms, if not previously terminated by one of the parties.
License Agreement Administration
Frequent issuers should maintain a readily available “library” of their index licenses agreements, together with a list of their inventory and any relevant expiration dates. Calendar reminders can also be implemented as to any key dates. Having these mechanisms in place will often make it easier to launch new offerings, as the status of any required licenses, and any required license agreement language, will be easier to obtain.
Intellectual Property Issues
And of course, no discussion of license agreements would be complete without a discussion of IP issues…
The provisions granting the relevant license should be carefully reviewed to make sure that they grant a license to use the index data and the licensor’s trademarks as intended in connection with the offering of the relevant products. The index provider should ideally indemnify the licensees, without any limitation on dollar amount, for any damages caused if the licensee’s use of the index or the trademarks is challenged by a third party.