On Nov. 21, 2024, S&P Global Ratings published a request for comment (RFC) on its proposed criteria for controlling shareholder financing (see "Request For Comment: Methodology For Assessing Financing Contributed By Controlling Shareholders"). This methodology describes how S&P Global Ratings treats financing, other than common equity, that is contributed by a company's controlling shareholder. Examples of this type of financing can include preferred shares, shareholder loans, Class A units, or convertible debentures, among others.

Questions And Answers

Why are we changing the criteria now, and what are the key changes?

Controlling shareholder financing (CSF) is an evolving aspect of the capital markets. In keeping with this, we are updating and simplifying our approach to evaluating these instruments. The proposed criteria for assessing CSF focus on examining the contractual terms to evaluate if the CSF effectively behaves in a manner akin to equity capital. We grouped these contractual terms into three categories of provisions:1) those that require cash payments, 2) those that provide typical lender rights, and 3) those that may incentivize redemption of the CSF in advance of stated debt maturities and, potentially, cause a deterioration in creditworthiness. We also considered situations where the issuer may receive significant support from the broader group, in which case an abbreviated analysis of the financing is allowed under the proposed criteria.

This proposal adopts many of the same key factors of the existing criteria but simplifies our approach. (Please see the RFC for details.)

Why do we request all related controlling-shareholder financing documentation?

The proposed criteria place a greater emphasis on assessing the contractual terms of the CSF and the only way our analysts can do this is by reading specific sections within the documents. In addition, our assessment of how to treat the CSF is based on a holistic view of its terms and conditions. Our analysts will review all related CSF documents to evaluate whether the CSF contains any debt-like provisions. Without this documentation, we are unable to assess whether the CSF meets the conditions for exclusion from our leverage and coverage metrics.

Why do we include the CSF included in our adjusted debt metrics unless the conditions for exclusion are met?

CSF typically takes the form of preference shares or shareholder loans. The nature of these types of investments is structurally different from common equity. The use of CSF typically involves an expectation of repayment and, thus, cash outflows from the issuer. Our treatment of the CSF depends on our view of whether the instrument will be available to absorb losses or conserve cash in times of stress. We include the CSF in debt if the documents do not provide sufficient provisions to ensure that that would be the case. That is, we look for the documentation to ensure that, in challenging scenarios, the investor will act as a shareholder rather than a creditor.

How do we consider debt-like provisions in this type of financing?

Typically, debt instruments impose a contractual obligation on an issuer to pay cash, while equity instruments do not. Therefore, if the shareholder financing requires the issuer to pay cash at some point or could require the issuer to pay cash due to an event beyond its control (e.g., payment acceleration due to an event of default, put, or required call), we would include it in our adjusted debt metrics, regardless of how likely or unlikely it is that this would occur. For example, an instrument with guarantees or security pledges increases the likelihood of a required cash payment in a distribution waterfall. Equity instruments do not impose such an obligation and give the issuer discretion to either pay cash (e.g., declare a dividend) or not.

We do not take into consideration the potential ability of a shareholder's to change the instrument's contractual terms at a future date. We determine our treatment based on the contractual rights and obligations within the existing legal documents. Changes to the legal documents are inherently unpredictable and viewed as an event risk that may require us to reassess our treatment of the instrument.

The third debt-like provision is more subjective than the first two: What is the rationale behind this?

Structures involving CSF can be complex and are subject to continued evolution. As a result, we wanted to make sure the methodology would capture any future clause or condition that would cause (or incentivize) the CSF to be unavailable to absorb losses or conserve cash in stress scenarios. In addition, we would include the CSF as debt in our adjusted leverage and coverage metrics if we believed it would not act as a loss absorbing/cash conserving cushion, regardless of what the terms and conditions in the documentation might otherwise indicate.

For example, this provision may apply when we believe the CSF terms and conditions incentivize its redemption and negatively impact the issuer's creditworthiness. It could also be used if the instrument includes provisions that make it onerous to keep it outstanding, for instance, very large interest rate step-ups or interest margins that would result in principal owed doubling within a short to medium term period.

Why do we treat CSF more favorably when provided by a group parent or government and where there is a high expectation of support?

When we assess a subsidiary as 'core' or 'highly strategic' to a parent under our Group Rating Methodology (GRM) or we assess that the likelihood of support from government-related entities (GRE) is 'almost certain' or 'extremely high' we apply an abbreviated list of conditions to judge whether to include or exclude the CSF from our leverage metrics. This is because we expect the government or parent to support the entity and thus believe there is a lower likelihood that the controlling shareholder providing the financing would enforce their creditor rights or trigger cash payments affecting the issuers creditworthiness without compensating measures.

How do the proposed CSF criteria interact with the hybrid capital methodology? Have we ensured that our treatment of CSF is consistent with our views and treatment of hybrid securities?

The proposed CSF criteria apply to financing provided by a controlling shareholder, while the hybrid capital criteria apply to hybrid instruments issued to third-party investor(s). Both criteria are based on the principle that an instrument can be excluded from our debt metrics if it is equity-like in nature, i.e. able and available to absorb losses or conserve cash in times of stress. However, because the motivations of controlling shareholders and third-party investors differ, we have consistent, but different, approaches to how we evaluate the instruments they provide. Third-party investors are principally focused on the timely payments to their invested capital, whereas controlling shareholders are focused on maintaining control over the company as well as obtaining a return on their CSF. The controlling shareholder may be willing to make some concessions on their CSF payments in order to preserve their controlling stake in the company.

In the proposed CSF criteria, we evaluate the possibility that a controlling shareholder would be able to use their controlling position to exercise creditor rights. The provisions included in the proposed criteria are common sense mitigants to the risks that could arise in these situations while ensuring consistency with the hybrid capital criteria. In rare cases where both hybrid and CSF instruments exist, the proposed CSF criteria can be used together with the hybrid capital criteria, and both criteria consistently analyze the risks posed by different types of investor capital.

When we add controlling shareholder capital to our adjusted debt metric, won't our ratios appear out of alignment with the markets?

Our adjusted debt metric doesn't always align with the views of market participants. Under our debt principle (in Ratios And Adjustments), we include other liabilities such as underfunded pensions, asset retirement obligations, or litigation awards where we expect no other offsetting cash inflows that will benefit the issuer. The inclusion of the CSF in our adjusted debt metrics, when it does not meet the conditions for exclusion, more accurately reflects the risk to higher ranking instruments when we view the CSF as a debt-like instrument. We may also include payments to the CSF in our earnings forecast to account for whether we believe the CSF may be redeemed in the foreseeable future.

Secondly, Debt-to-EBITDA or FFO-to-Debt are not the only credit metrics we can use to analyze an issuer's financial profile, and our supplemental ratios can often better assess credit risk. For example, as an issuer becomes less creditworthy (i.e., 'B' issuers or lower), credit measures such as payback and coverage ratios, might provide an improved characterization of an issuer's credit quality. Our supplementary coverage and payback ratios provide for the ability to differentiate between issuers through financial cycles, interest rate environments, and industries. When we write our rating reports or establish rating thresholds, we may emphasize unique characteristics of the issuer's cash flow and our supplementary ratios.

When financial sponsors control companies, we assess their financial policy and assign a financial sponsor (FS) designation. When we also include the CSF as debt in our leverage metrics, aren't we double-counting the risk?

No, our treatment does not double-count the impact of a financial sponsor. Our assessment of financial policy provides a broader view of the expected aggressiveness of a financial sponsor towards an issuer's capital structure and investments. This differs from our assessment of whether to include the CSF in our leverage metrics, which focuses on the CSF's contractual attributes, and whether the controlling shareholder intends to use the CSF consistently with common equity, i.e. in a loss-absorbing or cash-conserving manner. We do not automatically include the CSF as debt just because it is provided by a financial sponsor. To the extent the CSF meets the conditions listed in the criteria proposal and acts as a cushion to conserve cash or absorb losses, we would exclude it from our coverage and leverage ratios.

Related Criteria

• Request For Comment: Methodology For Assessing Financing Contributed By Controlling Shareholders, Nov. 21, 2024
• Hybrid Capital: Methodology And Assumptions, March 2, 2022
• Group Rating Methodology, July 1, 2019
• Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
• The Treatment Of Non-Common Equity Financing In Nonfinancial Corporate Entities, April 29, 2014