Between late November 2016 and the end of January 2017, the ECB engaged in a public consultation on the draft guidance on leveraged transactions (the "Guidance"). The Loan Market Association ("LMA"), the trade body for the syndicated loan markets in EMEA, participated in the consultation process and published a written submission on 26 January 2017. We examine the scope of the Guidance and its potential impact. We also look at the LMA's submission, as part of the public consultation.

Why was the Guidance issued?

In 2015, the ECB surveyed a number of credit institutions. The results revealed that globally, leveraged finance markets have recovered well since the crisis. The EU has enjoyed a long period of low interest rates resulting in strong competition in the search for yield and increased new business by credit institutions. In addition, the prevailing market conditions appear to have translated into less stringent covenants and the introduction of "covenant-lite" borrower-friendly structures into European markets. All of these factors have elicited specific attention from the ECB and given cause for it to consider affording closer supervisory scrutiny to leveraged transactions.

Who does the Guidance apply to?

The Guidance, when finalised, will apply to all "significant credit institutions" supervised by the ECB under Article 6 (4) of the SSM Regulation. The ECB determines a credit institution to be "significant" based on, amongst other factors, the following:

  • the total value of assets;
  • its importance for the economy of the country in which the credit institution is located or the EU as a whole;
  • the scale of its cross-border activities; and
  • whether it has requested or received public financial assistance from the European Stability Mechanism (ESM) or the European Financial Stability Facility (EFSF).

The significant supervised entities regulated in Ireland by the Central Bank of Ireland currently are:

  • Allied Irish Banks plc 
  • Permanent TSB
  • Bank of Ireland
  • Ulster Bank Ireland DAC

What is leveraged finance?

The Guidance states that each credit institution should have a unique and overarching definition of what it regards as a leveraged transaction. Notably, the Guidance does not provide a precise definition, other than to state that a leveraged transaction should meet at least one of the following conditions:

  • 4x test: All types of loan or credit exposure where the borrower's post financing level of leverage exceeds a 'Total Debt to EBITDA' ratio of 4.0;
  • Sponsor test: All types of loan or credit exposure where the borrower is owned by one or more financial sponsors. In this context, a 'financial sponsor' means an investment firm that undertakes private equity investments in and/or leveraged buy-outs of companies, with the intention of exiting those investments on a medium-term basis, beyond 6 months.

The definition of a leveraged transaction is to be left to each credit institution. Helpfully, the Guidance contains a list of transactions which are not leveraged transactions. They are:

  • loans with natural persons, credit institutions and investment firms;
  • loans where the consolidated exposure of the credit institution is below €5 million;
  • loans secured by an asset that pertains to asset-based loans;
  • commercial real estate financing;
  • project finance loans; and
  • trade finance.

Guide or rule?

The language and content of the Guidance suggest that it will not, when finalised, have the force of law. However, in the context of the ECB supervisory role, the Guidance cannot be ignored. It is the ECB's stated aim that the Guidance be incorporated into credit institutions' internal policies, although there is some discretion as to the implementation of each aspect of it.

Summary of the ECB proposals

Credit institutions are required:

  • to define their appetite for underwriting and syndicating transactions. They should set an overall limit and establish a detailed set of sub-limits for the quantum and nature of leveraged transactions.
    • ​​Six Times: a transaction presenting a ratio of total debt to EBITDA exceeding 6.0 times at closing should "remain exceptional", with any potential exception to be duly justified.
  • to ensure that the credit approval process is aligned with risk appetite of the credit institution. A new transaction, renewal or a refinancing of an existing leveraged transaction will require in-depth due diligence and critical review to be performed by an independent risk function.
  • to implement policies and procedure to ensure adherence of secondary market transactions with regulations on market conduct.
  • to provide regular comprehensive reports to management on the trends in the leveraged market and on characteristics of its own leveraged transactions.

LMA response – 26 January 2017

Nicholas Voisey, Managing Director of the LMA welcomed the ECB's efforts to level the playing field for financial institutions by aligning supervisory expectations and practices. He also recognised the value and merit of ensuring banks conduct leveraged activities in a safe and sound manner with an emphasis on regular monitoring and reporting of risk and credit quality of leveraged exposures.

The LMA suggested changes to the Guidance in order to align it closer with the US Guidance on Leveraged Lending, first published in 2013 (the "US Guidance").

Summary of LMA concerns

The Guidance refers to "significant" credit institutions. There is a concern that, this means that the Guidance shall not apply to:

  • banks based in the EU which do not participate in the SSM; 
  • banks which are not regarded as 'significant' by the ECB; and/or
  • banks outside the supervisory scope of the ECB.

This could result in an unlevel playing field in the leveraged finance market and a risk that institutions not regulated by the Guidance will undertake higher leveraged transactions.

Definition of leveraged transactions

  • The Guidance refers to non-investment grade corporate bonds in the context of monitoring transactions which generate settlement risk. It's not clear if the Guidance will apply to corporate bonds and this should be clarified.
  • Definitions of key terms such as "Total Debt" and "EBITDA" should be consistent with the definitions in the US Guidance.
  • Six Times test. This should not trigger referral to the highest level of credit committee within a credit institution but rather require additional scrutiny as part of the standard credit approval process for such loans.

Exclusions to the definition of leveraged transactions

  • The exclusion for loan exposure below €5 million should be increased to €10 million.
  • Lending to SMEs should be excluded from the concept of leveraged finance
  • Borrowers engaged in a restructuring or workout negotiations should be excluded from the concept of leveraged finance.

Status of the Guidance

  • The Guidance is stated as being non-binding in nature and shall not be a rule or regulation. The Guidance should clarify that it does not constitute a "pass or fail test" such that transactions may be prohibited to the extent that they do not meet the Guidance requirements.


The EU's efforts to achieve a uniform global regulatory standard is a positive development. However, it has to be balanced against increased regulation, monitoring for credit institutions and additional internal reporting and administration. For credit institutions operating globally in this market, there is the obvious advantage in having the same criteria for US and EU credit institutions. For UK banks participating in the LMA who may be assessing the impact of Brexit, regulatory variance between EU and US guidelines may be a factor for further consideration as they assess their internal compliance resource requirements.

In recent years there has been a substantial increase and enhancement of the internal credit risk process within credit institutions. This has included close monitoring and evaluation functions and rigorously managed budget allocation across all sectors; client businesses and geographic risk. The Guidance may prove not to be as onerous as it first appeared, but may indeed require a slight change of emphasis and content in reports and updates to senior management.

Notwithstanding the competitive market, in Ireland, there continues to be a reliance on traditional debt by corporates and SMEs. If the LMA recommendations are accepted, SME lending may be excluded from the Guidance. However, exclusion is likely to apply to leveraged finance in excess of €5 million, which is a reasonably low threshold particularly when the Guidance applies to the 'significant' banks that originate but also simply participate in syndicated loans.

The ECB has acknowledged that all credit institutions operate in a competitive arena. For institutions to which the Guidance applies, the issue and focus has to be on implementation cost and the associated cost of on-going reporting and compliance. Where the Guidance and the associated work streams do not apply to competitors, i.e. non-significant credit institutions or non-traditional lenders, inequality of treatment will need to be considered. This is necessary to ensure that the Guidance is proportionate and reasonable, having regard to the volume of leveraged finance conducted by the 'significant' credit institutions. The consultation phase ended at the end of January 2017 and we will continue to monitor developments in this area.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.