Welcome to Collateral, MJ Hudson’s quarterly newsletter focusing on the latest restructuring, turnaround and debt matters with insight aimed at institutions at all levels of the capital structure.
Interest rates remain low, the global economy continues to grow and liquidity is abundant which means the show goes on in the lending market. But while deal flow remains positive, it is important that lenders and borrowers alike carefully monitor their loan documentation to ensure it keeps pace with legal and regulatory developments and other changes in the market.
In this latest edition of Collateral, we look at 5 significant loan market developments and summarise how the relevant issues are currently being managed.
The long period of stable- and for borrowers at least – favourable loan pricing has led borrowers to look for ways of ensuring that well priced facilities remain at current rates for as long as possible. Similarly, many borrowers whose financing needs might increase over the term of their facilities have tried to include “accordion” rights to increase initially agreed facility amounts within the framework of existing documentation.
Through an extension option, the borrower is given the right to ask for a twelve month extension to the duration of the loan. There is normally no obligation on the lender to agree to the extension, so whether the extension is available will depend on the borrower’s commercial relationship with its lender at the time it wishes to exercise the option. Fees are often paid to lenders that do extend. These are either specified in the loan or left to be agreed as and when the extension is exercised.
Accordion facilities allow the borrower to add a new term loan, tranche, or increase the revolving credit loan commitments under an existing loan facility up to a specified amount. This provides access to additional funds which are available to meet increased working capital needs or, for example, to take advantage of an investment opportunity. The attraction for the borrower is usually the means to access further funds from its relationship lender without paying arrangement fees.
The accordion mechanism is usually incorporated into the existing facility agreement but is occasionally structured as a separate facility on new commercial terms to be agreed when the accordion is exercised. The conditions under which the borrower may utilise the accordion vary, although access to both extension options and accordion facilities is usually subject to repeating representations and the absence of any continuing events of default.
Reforms to LIBOR and other loan benchmarks have led to a number of amendments to the provisions catering for the use of benchmarks in loan documentation and for the consequences if a chosen benchmark is not available during the life of the facility.
It is important to note that the FCA’s view – articulated as far back as 2017 – that it is unable to support the use of LIBOR indefinitely does not necessarily mean LIBOR will be discontinued on the specified cut-off date (currently anticipated to be the end of 2021).
However, the Loan Market Association (LMA) has taken steps to “future-proof” the benchmark provisions in its templates and to address a variety of contingencies. If LIBOR ceases to be available completely, current LMA terms contain an extensive fallback rate regime and market disruption provisions. However, fallback rates are not intended to be used forever and the parties would need to agree a replacement rate. The question of what rate the market might adopt to replace LIBOR or even if LIBOR is adapted in some way is still an open one and appropriate provisions that effect a transition to a new rate will only be developed when consensus as to the shape of any new rate emerges.
Sanctions can take many forms, including trade restrictions and financial sanctions intended to freeze the assets of the sanctioned entity or block access to capital markets and financial services.
Historically, thorough due diligence and contractual assurances addressing illegality and unlawfulness in loan documentation were considered sufficient to address sanctions risks in lending transactions. But increasingly aggressive enforcement action, especially by the US authorities, has prompted lenders to seek contractual assurances on these topics.
In terms of the key risks, lenders’ proposals often include assurances in relation to the following:
Another important issue to consider in a loan context is whether an event of default is the most appropriate consequence of a breach of any sanctions representations. Lenders may take the view that they would prefer to determine themselves whether to exit the deal in the event of a sanctions breach. Accordingly, a mandatory prepayment right may be more suitable than an event of default. If the borrower is concerned about the possibility of wide‑ranging representations and undertakings giving rise to events of default, they also may prefer a mandatory prepayment right.
In general terms, contractual provisions relating to anti‑corruption laws tend to be less controversial than provisions relating to sanctions because they are often more limited and less complex in structure.
Most borrowers should be fine to give lenders comfort with regard to their compliance with anti‑corruption laws, subject to appropriate materiality qualifications. Likewise, borrowers should also be comfortable offering assurances regarding policies and procedures given criminal proceedings for failure to prevent bribery under the Bribery Act can be defended if the company has adequate procedures in place to prevent bribery.
Article 55 of the BRRD requires EU firms and other entities to include in a very wide range of non-EU law governed contracts a contractual recognition of “bail-in” enabling the relevant regulator to write down and/or convert the “liabilities” of a failing institution into equity.
The concept of “liability” for this purpose is quite broad. As applicable to UK institutions in a lending context, it potentially includes obligations in loans such as lending commitments, indemnity obligations and any notification obligations under the agreement. Accordingly, it has generally been concluded necessary to include a contractual bail‑in clause in any loan documentation entered into by an EEA financial institution which is subject to the BRRD, and which is governed by the law of a non‑EEA country.
Given that Article 55 clauses respond to a regulatory obligation with which financial institutions within the scope of the BRRD are required to comply, whether or not to include an Article 55 clause is not generally up for negotiation. However, the prospect of a counterparty’s liabilities being disrupted or converted into a different security due to a regulatory intervention is equally a concern. The existence of the BRRD bail‑in powers and any other legal and regulatory powers to disturb lending relationships if an institution gets into financial difficulty are an important counterparty risk factor for borrowers to consider.
It is difficult to avoid the subject of Brexit and the impact it may have on loan market is of course the risk factor that has recently received the most attention from loan market participants.
Areas of focus include:
Although these topics (and others) have been analysed in some detail, in general, none have prompted
changes to current standard documentation terms because an answer on many of these points is currently pending further information on the detail of the UK’s exit. As a result, the need for and extent of any Brexit‑related adjustments is likely to be a continuing question in most loan transactions for some time to come….
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