Money market investors have conservative risk profiles and typically require high ratings to buy X-notes. Issuing institutions normally have A-1/P-1 short-term ratings. They also are limited to an initial tenor of 13 months the maximum that US-regulated funds can legally invest for. However, these 2a7 accounts are able to buy a note that can extend.
In April 2005, Royal Bank of Scotland issued a $4 billion X-note. The initial coupon paid one-month Libor minus three basis points. Investors were incentivized to extend the bond by modest annual increases in the coupon. So in the second year the yield steps up to minus 1bp, in year three to plus 1bp and plus 3bp in years four and five.
These modest coupon step-ups give the investor a pick-up over traditional money market instruments such as commercial paper, while theoretically the borrower gets five-year money at a rate substantially below a true five-year floating-rate note. In this instance, RBS would have received a blended cost of one-month Libor plus 0.5bp in contrast to a five-year FRN, which would have cleared at somewhere in the region of 12bp over Libor.