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The development of contingency clauses: appraisal and implications for financial stability

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  • Levy, S.
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    Abstract

    The sustained growth in corporate debt over the past decade has led to an increasingly widespread use of contingency clauses. These clauses, also known as “triggers”, are written into bond issue contracts or bank loan agreements, and aim to facilitate borrowers’ access to financing by offering a certain degree of protection to creditors. They result in a tightening of the company’s borrowing conditions (for example an increment in the coupon or an early repayment), should its financial situation deteriorate. These clauses may have significant effects on the functioning of financial markets. First, because they complicate both credit risk analysis and the valuation process of debt securities with such triggers embedded. Second, because they complicate credit rating agencies’ task of rating debt-security issuers. And lastly, because their triggering could result in the opposite effect to that sought, that is to say, instead of protecting the creditor, they may cause a sharp deterioration in the borrower’s financial position. At the same time, they may also result in a series of destabilising effects for financial markets, exacerbated by the fact that investors are often unaware of their existence. While these clauses must be used with caution by borrowers, adequate transparency is also essential so that rating agencies, analysts and investors might fully understand their potential effects.

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    File URL: http://www.banque-france.fr/fileadmin/user_upload/banque_de_france/publications/Revue_de_la_stabilite_financiere/et5_1102.pdf
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    Bibliographic Info

    Article provided by Banque de France in its journal Financial stability review.

    Volume (Year): (2002)
    Issue (Month): 1 (November)
    Pages: 103-115

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    Handle: RePEc:bfr:fisrev:2002:1:4

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    Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
    Web page: http://www.banque-france.fr/
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    Cited by:
    1. Fernando Gonzalez & François Haas & Ronald Johannes & Mattias Persson & Liliana Toledo & Roberto Violi & Martin Wieland & Carmen Zins, 2004. "Market dynamics associated with credit ratings - a literature review," Occasional Paper Series 16, European Central Bank.

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