“Seeking out companies at risk from PRS” ... Signs of growth in the financial restructuring advisory market [fn Market Watch]

[Financial News] Potential financial risks at companies using Price Return Swaps (PRS) are emerging as a new business opportunity for investment banks (IB) and the mergers and acquisitions (M&A) advisory industry. Some advisory firms are analyzing potential financial risks before companies face a liquidity crisis and proposing proactive measures to improve their financial structures, such as asset sales or attracting outside investment. In particular, given that early settlement or the burden of providing additional collateral under PRS contracts could worsen companies’ financial positions, there are signs that demand for restructuring advice may grow, especially among companies with limited capacity to generate cash internally.■ M&A advisers set out to identify companies at risk from PRSAccording to the investment banking (IB) industry on the 22nd, some M&A advisory firms have begun identifying companies with potential financial risks related to PRS contracts and reviewing ways to improve their financial structures over the past two months. This marks a shift away from the traditional approach of seeking advice only after a company faces a liquidity crisis, toward identifying risk factors in advance and proposing responses.
An M&A advisory firm representative said, “Advisory firms like ours, once we learn that there may be potential risks, sometimes go to the companies first and suggest, ‘How about trying to resolve it this way?’” Asked about the possibility that financial risks related to PRS could lead to growth in the advisory market, the representative explained, “I think that market will open up considerably,” adding, “There are advisory firms actively seeking out companies because of this.”
A PRS is a contract under which a company sells shares it holds or transfers newly issued shares in a subsidiary to an investor, while settling gains and losses based on subsequent share-price movements. Companies can secure large amounts of funding by using their equity stakes, but if the value of the underlying assets falls, they may face obligations such as paying a settlement amount or providing additional collateral, depending on the contract terms.
According to Korea Investors Service (KIS), domestic PRS contracts outstanding exceeded 20 trillion won as of last September. Among major groups, SK Group had the largest cumulative contract value, at approximately 7.3 trillion won, followed by Hanwha Group at 3.6 trillion won, POSCO Group at 2.5 trillion won, LG Group at 2 trillion won, and Lotte Group at 1.8 trillion won.■ Early settlement and margin-call burdens ... Liquidity risks vary by companyCredit rating agencies are also examining the impact of PRS on companies’ actual financial burdens. One analysis says the credit risk of PRS depends not only on the contract size but also on the liquidity of the underlying assets, early settlement clauses, and a company’s financial buffer. Investors can sell publicly listed shares on the market to recover their investment, but valuing and selling shares in unlisted or overseas subsidiaries may be relatively difficult. In such cases, as investors find it harder to recover their investment, a company could end up shouldering a repayment burden equivalent in effect to borrowing, depending on the contract structure.
A credit rating industry representative explained, “Investors may not be able to easily sell shares in unlisted or overseas subsidiaries, which could result in the related burden being passed on to the company,” adding, “In such cases, a considerable portion of the funds raised through PRS could effectively function like debt.”
The obligation to settle early following a credit rating downgrade is another factor. Some PRS contracts may include clauses requiring settlement before maturity if a company’s credit rating falls to a certain level or below. A decline in the value of the underlying assets could also trigger margin-call obligations if the contract requires the provision of additional collateral. The weaker a company’s existing financial structure, the more these clauses could add to its liquidity burden.
The representative said, “Even if a PRS has an early settlement trigger, the burden may be limited if the company has a sufficient financial buffer,” adding, “Conversely, the same clause could pose a greater risk for companies already facing significant liquidity pressures.”
An IB industry representative said, “We are watching to see whether potential financial burdens related to PRS lead companies to sell non-core assets, attract outside investment, or strengthen their capital.”
[email protected] Kim Hyun-jung Reporter