Ireland: Financial Services Update: ECB Suggests Closer Scrutiny Of Leveraged Transactions

Last Updated: 16 February 2017
Article by Christine O'Donovan

Most Read Contributor in Ireland, February 2017

Between late November 2016 and the end of January 2017, the ECB engaged in a public consultation on the draft guidance on leveraged transactions (the "Guidance").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.

Comment 

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Events from this Firm
28 Mar 2017, Conference, Dublin, Ireland

We are delighted to sponsor the IWEA Spring Conference "Your Power, Your Energy, Your Future" which will take place in the Clayton Hotel, Dublin on 28 & 29 March 2017.

 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.