Market disruption clauses are playing an increasing role in lending transactions in the South African market. The purpose of such clauses is to protect a lending bank when the so-called "base rate" (generally a publicly quoted screen rate such as "JIBAR"), which forms the cost of funding component of variable interest rate funding, does not represent its true cost of funding. This situation would typically occur when there is a lack of liquidity in the inter-bank lending market, which results in a bank's cost of funding rising above the publicly quoted screen rate.
In certain lending transactions, especially more heavily leveraged transactions, lenders may consider whether their ability to rely on a market disruption clause should act as a draw stop event. For example, if there is a significant change in the liquidity premium (ie the cost to the bank of obtaining funds) as it applies on the date of the term sheet produced for a certain transaction versus the liquidity premium as it applies immediately before the date on which funds are due to be advanced, could this act as a type of pre-advance material adverse change which would allow the lenders not to advance the funding?
To answer this question we need to distinguish between transactions which fall under the supervision of the Securities Regulation Code (the "Code") under the Companies Act, 1973 (so called "affected transactions") and transactions which do not fall under the Code ("public to private" transactions where bank financing is required are typically subject to the Code). Where a deal falls under the Code and a cash confirmation letter is required by the Securities Regulation Panel ("SRP") it is unlikely, based on our experience of the local market up to now, that the SRP will accept a cash confirmation letter which includes the occurrence of a market disruption event as a draw stop event, even if the market disruption event is objectively defined. The reasoning behind this is the SRP's strict application of certain provisions of the Code which require that, unless otherwise permitted by the SRP, when an offer is for cash or includes an element of cash, confirmation is required by the financial advisor, or by another appropriate third party, that resources are available to satisfy the full acceptance of the offer, either in the form of the issuance of an irrevocable guarantee or some other form of proof that the cash will be available. The view of the SRP is that, although the offer itself may be subject to objectively formulated conditions, one of those conditions cannot in effect be the raising of funding.
In forming the view set out above, we understand the SRP has investigated international markets and the practice in those jurisdictions for assistance. This is not surprising given that the South African Code is based to a large extent on the City Code on Take-overs and Mergers issued by the London Panel on Take Overs and Mergers. From our interaction with UK and European law firms, we understand that the securities regulation panels in those jurisdictions do not accept market disruption wording in cash confirmation letters. Therefore, when entering into transactions where the Code applies and a cash confirmation letter is required to be issued to the SRP, lenders wishing to rely on market disruption as a draw stop event need to consider alternative approaches.
In lending transactions where the Code does not apply and no cash confirmation letter is required, it is submitted that it is a matter for negotiation between the borrower and the lenders as to whether the borrower (and the target for that matter) is prepared to live with the risk of a market disruption event acting as a draw stop event to the funding. In the local market we have seen borrowers accepting market disruption draw stop events in certain private deals. This is not to say however that it has become market practice, and each deal would need to be approached on its own merits.
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