We suggest setting the expected value (the discounted value of the stepped coupon payments) to be at least $1 (“greenback”), which allows us to infer a lot on the required structure of the SLB with regards to step up sizes and pay-out terms. In order for an SLB to reach the “greenback” threshold, the expected pay out and materiality needs to be meaningful, likely above what is perceived as the current market convention.
Importantly, the compensation to the issuer for material steps and ambitious performance targets should be a significantly lower cost-of-capital/fixed coupon on the SLB. This can be derived directly from a no-arbitrage condition.
We also propose to standardise SLB pay-out periods to the points on the CDS curve, as this could allow for forward credit-risk hedging.