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

Between late November 2016 and the end of January 2017, the ECB engaged in a public consultation on the draft guidance on leveraged transactions (the "Guidance").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
14 Nov 2018, Seminar, Dublin, Ireland

We will host our commercial litigation seminar on Investigations and White Collar Crime on Wednesday 14 November in our offices on Barrow Street, Dublin 4.

 
In association with
Related Topics
 
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions