6 steps for implementing a deal-contingent hedge

Assess the need for a deal-contingent hedge

Banks have increased the scope of contingencies (take-private, IPO, financial close) and associated asset classes (foreign exchange, interest rate, commodities) they can underwrite. However, not all transactions are created equal. Before implementing a deal-contingent hedge, you should conduct a cost-benefit and feasibility analysis comparing the costs of the hedge with the potential financial protection it offers, but also against other hedging products. Because confidentiality is key to a successful M&A, partnering with a hedge advisor early in the process can help to assess potential feasibility without involving multiple hedge counterparties.

Consider engaging an advisor

Due to the complexity involved in structuring an appropriate deal-contingent solution, it is common to engage hedge advisors to coordinate and run a streamlined implementation process. Deal-contingent hedging processes typically start a few days or weeks before deal signing, during a period when time and resources for all the parties involved are both critical and highly constrained.

Determine the hedge structure

An advisor will ensure the specific terms of the hedge align with the transaction's timeline and conditions for closing. While deal-contingent features can be added to most hedging products, they are most often associated with forwards, swaps, and options. Some transactions may require tailor-made structures, such as flexible hedge notional for a tender offer, or the hedge must stay in place post-closing, as with an interest rate swap. An advisor will help to independently assess the costs, benefits, pricing, and documentation for these solutions.

Ensure an effective process

In addition to structuring the hedge, there are several parallel workstreams required to trade a deal-contingent hedge. Despite a larger number of deal-contingent hedge providers, there are significant differences in terms of offering, pricing, and legal terms. Selecting the right number of counterparties is critical to achieving the efficient speed and competitive pricing necessary for a successful deal-contingent process. An advisor with expertise in deal-contingent hedging will add significant value by providing transparency to an opaque “over-the-counter” market and running a streamlined and efficient implementation process.

Execute the hedge

Hedge execution should be carefully planned. Market liquidity, volatility, and economic events must be considered to ensure optimal execution. In addition, there are a range of execution methods, which can lead to different market risk impact depending on the trade parameters and number of counterparties. Having a clear understanding of the costs and benefits of each alternative is critical.

Monitor and settle the transaction

Once the hedge is executed, hedge providers will regularly ask for the progress of the underlying transaction. In some circumstances, the hedge must be adjusted or restructured. If the deal successfully closes, the hedge becomes effective and settles. If the deal does not go through, the hedge falls away at no cost, according to the terms of the agreement.