Exchangeable Bond vs Stock Loan: What’s the Difference?

An exchangeable bond is issued by a company or holding vehicle that owns shares in a different listed company, and it can be exchanged for those shares at a fixed exchange price. The terms set a principal amount, a coupon, a maturity, often of several years, and an exchange price fixed at a premium to the share price when the bonds are priced. Each bond is exchangeable for a set number of the underlying shares, and the terms commonly let the issuer settle an exchange in cash instead of delivering shares.

The buyers are institutional: convertible-bond funds, other bond and equity investors, and hedge funds that buy the bonds and hedge by short-selling the underlying shares, a strategy known as convertible arbitrage. Bookrunning banks prepare an offering document, the bonds are often listed, and the deal itself is usually launched and priced within a day, much like an accelerated bookbuild.

At maturity there are two outcomes. If the share price is above the exchange price, investors exchange and the issuer parts with the shares, in effect selling them at the exchange price. If it is below, investors are repaid in cash and the issuer keeps the shares. A variant, the mandatory exchangeable, must be exchanged at maturity and works more like a deferred sale. An exchangeable also differs from a convertible bond, which converts into shares of the issuer itself rather than of a company the issuer holds.

Under an exchangeable bond the issuer keeps the downside and gives away the upside above the exchange price; under a stock loan the owner keeps the upside and, on non-recourse terms, can cap the downside at the shares. With an exchangeable, gains up to the exchange price stay with the issuer, but any rise above it goes to the bondholders, who will exchange. If the shares fall, the issuer still owns them, has lost the value and must repay the bonds in full.

With a stock loan the owner keeps every rise in the share price, because the shares come back on repayment. The downside depends on the recourse. Under full recourse the borrower owes any shortfall after the shares are sold. Under non-recourse, the lender can look only to the pledged shares: there is no call for a top-up, and if the loan is not repaid the lender’s remedy is the collateral, so the borrower’s loss is capped at the position, as explained in why non-recourse matters in a sell-off. That protection is priced in through a lower advance.

An exchangeable bond is a public transaction, while a stock loan is a private contract, although the pledge behind it may have to be disclosed. An exchangeable is launched and priced with announcements and sold under an offering document, and the hedging that comes with it shows up in the market for the underlying shares, through short selling and stock borrowing. The issuer, and in some markets investors holding instruments referenced to the shares, may also have holding notifications to make.

A stock loan is negotiated between borrower and lender and is not announced. Whether the pledge must be disclosed depends on the market of listing and on who the borrower is: substantial shareholders and directors face pledge-reporting rules in several markets, and the timing and wording are best settled before the shares move. The position in each market is summarised on the markets pages.

An exchangeable bond tends to suit an institutional or corporate holder with a credit investors accept, a large stake in a liquid company, a willingness to part with the shares at a premium later and comfort with a public process. Investment holding companies, listed groups with stakes in other listed companies and other large strategic holders use them to monetise stakes at a low coupon, accepting that a strong share price means the stake is eventually sold.

A stock loan tends to suit a founder, family office or holding company that wants to keep the shares and their upside, wants the financing kept private, or holds a stake whose size or market would not support a public bond. Non-recourse terms add a defined worst case. The two sit in a wider set of options, alongside sales and hedges, compared in how to raise cash from a large listed stake. This guide is general information; the accounting, tax and disclosure consequences of either route depend on the holder and the market, and independent advice should be taken.