eScholarship provides open access, scholarly publishing services to the University of California and delivers a dynamic research platform to scholars worldwide. Berkeley Program in Law and Economics UC Berkeley Title: Managing Liquidity Risk in a Changing Debt Environment: The Issuers Perspective Author: Gabilondo, Jos, Florida International University, Miami, Florida Publication Date: 05-08-2007 Series: Latin American and Caribbean Law and Economics Association (ALACDE) Annual Papers Publication Info: Latin American and Caribbean Law and Economics Association (ALACDE) Annual Papers, Berkeley Program in Law and Economics, UC Berkeley Permalink: http:/escholarship.org/uc/item/2gr584st Abstract: Some trends in global funding markets are leading to a new paradigm about liquidity risk in issuers: increased cross-border debt and equity flows; the growth of equity intermediaries like private funds, sovereign wealth funds, and “club” consortia; and the use of financial products which embed contingent liabilities in firms, liabilities which “spring” into maturity in market downturns. Working together, national regulators are moving towards an enterprise rather than entity view of liquidity risk and making clearer distinctions between market liquidity risk (to assets) and funding liquidity risk (to obligors). Current surges of commercial liquidity make this a timely issue for issuers (liquidity consumers), prospective investors and creditors (liquidity providers), and national regulators with system responsibilities for financial public goods, like the funding markets. Creative conflicts between the interests of issuers, investor and lenders, and regulators are a healthy part of a financial system, but this paper argues for more financial literacy about funding liquidity risk. After explaining this concept, the paper situates “event risk” in the context of funding liquidity. Recent bondholder losses in leveraged restructurings of firms (“event risk”) have raised questions about whether bond indenture covenants provide adequate protection against the risk of these losses. This paper argues that funding liquidity risk and its management are important aspects of event risk, which liquidity covenants might help to mitigate for issuers and others. MANAGING LIQUIDITY RISK IN A CHANGING DEBT ENVIRONMENT: THE ISSUERS PERSPECTIVE Associao Latino-Americana e do Caribe de Dirieto e Economa Brasilia, Brasil, May 25-26 Jos Gabilondo, Assistant Professor, Raphael Daz-Balart Hall College of Law, Florida International University Miami, Florida 33139, jose.gabilondofiu.edu1 ABSTRACT Some trends in global funding markets are leading to a new paradigm about liquidity risk in issuers: increased cross-border debt and equity flows; the growth of equity intermediaries like private funds, sovereign wealth funds, and “club” consortia; and the use of financial products which embed contingent liabilities in firms, liabilities which “spring” into maturity in market downturns. Working together, national regulators are moving towards an enterprise rather than entity view of liquidity risk and making clearer distinctions between market liquidity risk (to assets) and funding liquidity risk (to obligors). Current surges of commercial liquidity make this a timely issue for issuers (liquidity consumers), prospective investors and creditors (liquidity providers), and national regulators with system responsibilities for financial public goods, like the funding markets. Creative conflicts between the interests of issuers, investor and lenders, and regulators are a healthy part of a financial system, but this paper argues for more financial literacy about funding liquidity risk. After explaining this concept, the paper situates “event risk” in the context of funding liquidity. Recent bondholder losses in leveraged restructurings of firms (“event risk”) have raised questions about whether bond indenture covenants provide adequate protection against the risk of these losses. This paper argues that funding liquidity risk and its management are important aspects of event risk, which liquidity covenants might help to mitigate for issuers and others. 1 I am very grateful for the opportunity to participate in the Associao Latino-Americana e do Caribe de Dirieto e Economa. Before teachin, most my professional experience consisted of service in the U.S. Securities and Exchange Commission (trading market structure), the U.S. Comptroller of the Currency (national bank trading book and treasury management), the World Bank (legal aspects of administration), and the U.S. Department of the Treasury (legal section for credit transactions, public debt issuance, and domestic credit and capital markets law). This paper draws on insights from government practice in order to disseminate some analytical perspectives of potential interest to both private and sovereign issuers, especially those in the region. Let me note that this is the first draft of thi