Exchange Offer

An exchange offer is a corporate action in which holders of a security are invited to give it up in return for another security. The consideration is new bonds, shares or a mix of securities and cash, in contrast to a cash tender offer, where holders are simply bought out. Participation is voluntary: each holder decides whether to accept, and those who decline keep their existing securities, although the terms are often designed to make holding out unattractive.

Exchange offers are used in three main situations. Issuers use them to restructure or refinance debt, including the case described under bond exchange. Bidders use them to acquire companies by offering their own shares in a takeover offer. And parent companies use them to separate a subsidiary by letting shareholders swap parent shares for subsidiary shares, a transaction called a split-off.

A company or government may offer to replace outstanding bonds with new ones for several reasons.

• Liability management. A healthy issuer extends its maturity profile by exchanging bonds that fall due soon for longer-dated ones, usually at market value and often with a small premium.
• Distressed exchange. An issuer in difficulty asks holders to accept new bonds with a lower principal amount, lower coupon or later maturity, or to take equity, as an alternative to default or formal insolvency. This is a form of debt restructuring. Rating agencies generally treat an exchange that reduces what holders are owed, made to avoid default, as a default in itself.
• Registration exchange. In the United States, bonds first sold by private placement to institutions are often later exchanged for identical registered bonds that can be freely traded.

To discourage holdouts, a distressed exchange is commonly paired with a consent solicitation. Holders who tender also vote to strip protective covenants from the old bonds, leaving anyone who stays behind with a weaker instrument; these are known as exit consents. The new bonds may also rank ahead of the old ones in debt seniority. Offers usually carry a minimum participation condition, so that the deal proceeds only if enough holders accept.

Governments have no bankruptcy court, so an exchange offer is the standard tool for restructuring after or before a sovereign default. Argentina's exchanges in 2005 and 2010 and Greece's in 2012 are the best-known examples. Because holdout creditors can sue for full payment, most sovereign bonds now contain collective action clauses, which allow a qualified majority of holders to bind all holders to the new terms. The vote may be taken at a bondholder meeting or by written consent alongside the offer.

In an acquisition, the bidder may offer its own shares to the target's shareholders at a fixed exchange ratio, alone or with cash. The result resembles a stock-for-stock merger, but the offer is made directly to shareholders and can complete faster than a merger that requires a shareholder meeting. In a split-off, a parent offers shares of a subsidiary in exchange for its own shares, usually at a discount to encourage acceptance, which reduces the parent's share count in the same way as a buyback.

Because new securities are being offered, an exchange offer is both a tender offer and a securities offering. In the United States, the new securities must be registered with the Securities and Exchange Commission unless an exemption applies; a commonly used one covers exchanges by an issuer with its own existing holders where no one is paid to solicit acceptances. Tender offer rules require the offer to stay open for at least twenty business days and to be extended after certain changes in terms. In Europe, prospectus rules, takeover codes and market abuse rules apply according to the type of security.

The offer document sets out the exchange ratio or price, any early participation premium, conditions, withdrawal rights, the timetable and the risks of accepting or declining. Dealer managers advise on terms and contact holders, and an exchange agent receives the tenders.

For custodians and brokers, an exchange offer is a voluntary corporate action. Holders are notified of the terms and must submit a corporate action election before the intermediary's election deadline, which falls ahead of the offer's expiration date. Tendered securities are blocked in the holder's account. On settlement the old securities are debited and the new ones credited, with cash for accrued interest or fractions. Restrictions on who may participate, for example qualified institutional buyers only, or holders outside certain countries, must be checked for each account, and tax teams determine whether the swap is a taxable disposal. The workflow follows that of tender offer processing.

A holder weighing an exchange compares the value and terms of the new security with those of the old, the likelihood that the offer succeeds, and the position of non-participants afterwards: reduced liquidity, weaker covenants and possibly lower ranking if the exchange goes ahead. In distressed cases, bondholders often form committees to negotiate with the issuer before the offer is launched, since coordinated creditors can obtain better terms than individuals responding alone.