Index-linked products are a mainstay of the structured products market, and issuers routinely negotiate and enter into license agreements with index sponsors in connection with these products. Given recent regulatory attention to indices and the increasing use of proprietary indices, we revisit below key considerations when preparing or negotiating index license agreements.
SCOPE OF LICENSE AGREEMENTS
Parties. Either the issuer or the issuer's affiliated broker-dealer may enter into the license agreement with the index provider, and often multiple affiliates may be a party to the license agreement. The potential use of the index should be considered to determine which entities will need to be party to the agreement: Will the issuer distribute notes linked to the index through several underwriters? Will the underwriter distribute notes linked to the index issued by several different issuers? Which parties will need index data in order to make payment or pricing calculations?
Products. A license agreement will specify the products that may be issued referencing the index. A license agreement may cover a single issuance, a particular product type (e.g., multiple issuances based on a specified structure), or it may cover an entire product line (e.g., notes, CDs, etc.). A license agreement may also specify a geographic limit on use (usually determined based on the offering wrapper). The same license agreement may also cover OTC derivative instruments, which may be used for the issuer's hedge. Parties should consider their potential future issuance plans in determining the desired scope of a license agreement.
Indices. An index provider may license either a single index or it may prefer "bundling" several indices together. Where a license agreement contemplates multiple indices, it is common to use a schedule to allow indices to be added or removed during renewals without renegotiating the main agreement.
Data. In addition to licensing the use of an index and the related trademarks, an index provider may also provide data related to the index, including component information and real time index levels. Data provisions may also include back-tested data, especially with respect to newly launched indices, or the right to publish or disclose the index data that is provided to the licensee in connection with the products that are issued. The right to use derived data can also be included in a license agreement where the licensee wishes to design a product using its own modified index or strategy based on the licensed index.
Exclusivity. Index license agreements for novel indices may also include exclusivity provisions, granting the licensee the exclusive right to use an index or the exclusive right to use the index for a particular category of structured products. These provisions may also include a convertibility feature wherein the licensee may choose to waive exclusivity in exchange for reduced licensing fees.
License agreements will outline the required statements regarding the ownership of the index and the index trademarks that will appear in the offering documentation as well as required statements disclaiming liability of the index provider. Some license agreements will include specific language, while others will include only the substantive requirements for the disclosures. Regardless of whether the disclosure requirements are outlined or specific language is provided, licensees should consider the planned offering documentation and whether any short "quick glance" marketing documents or term sheets will be used. Important negotiation points, depending on the planned offering documentation, include both the ability to use a shortened version of extensive required disclosures and the ability to make minor modifications to conform the required disclosures to the applicable documents (i.e., modifying language to reflect defined terms or multiple product types).
A license agreement should clearly outline the liability of both parties, including the related indemnity, with respect to any index-linked products.
Indemnification of the Index Provider. The index provider is generally indemnified for any suits brought by investors in the applicable index-linked products. However, suits where the investor damages are related to index data or calculation errors or corrections may be carved out from the general indemnity.
Indemnification of the Licensee. The index provider is responsible for the ownership of the intellectual property that it is licensing under the agreement. Accordingly, a licensee should negotiate for indemnification in the event of any suits from third parties regarding the use of the index or related trademarks.
It is not uncommon for index providers to request prior review of any offering documents. However, licensees should consider whether this will be feasible in the context of the planned issuance timing. Form language that is approved prior to the first issuance (or contained within the license agreement) is often an acceptable alternative to prior review of offering documents, though some index providers may request that they are also provided the relevant offering documents for subsequent review to ensure compliance with the agreed language.
ONGOING REPRESENTATIONS AND REGULATORY CONCERNS
As mentioned in the introduction, there has been increased regulatory attention on reference indices. Europe's Benchmark Regulation is now effective, and, while the United States has not implemented any similar comprehensive rules, there have been calls for additional SEC regulation (discussed in greater detail here). Accordingly, new license agreements will include clauses related to maintaining the regulatory status of the index. These clauses include, depending on the circumstances, provisions related to index provider compliance with applicable regulatory requirements and limiting licensee use to activities which will not result in the index becoming subject to additional regulatory requirements or oversight. These provisions are in additional to the standard representations regarding maintaining the independence of the index by maintaining appropriate index governance, oversight and audit procedures and using third party pricing information.
Index licensees should also consider ongoing representations from the index provider regarding the publication of an updated methodology in the event of any changes to the calculation of the index and notice requirements regarding any such changes or methodology updates or disruptions or corrections to previously published levels.
Various fee arrangements are used in connection with index licenses depending on the provider and the planned use by the licensee, including both flat fee and volume-based fee models. Flat fee arrangements, which allow unlimited use for a specified period of time, are more likely to be available for custom or less-frequently used issuances. Most of the frequently used benchmark indices are only available to license under volume-based fee structures. Volume based fee arrangements can be based on either the number of issuances or the total notional, and break-points or an initial flat fee are also common in such arrangements. Depending on the licensee's future plans, the licensee may want to consider building in the ability to renew at the current fee arrangement to lock-in their current licensing rates.
Originally published in REVERSEinquiries: Volume 3, Issue
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