The hot topic of Brexit is one of a range of regulatory and legislative issues being discussed in syndicated loan markets across Europe.
Others include the end of the Libor era, the new EU directive on non-performing loans, ESG lending and whether the interest in blockchain will fizzle out, or not.
Syndicated loans in the real estate world have grown in importance over recent years, attracting a wider variety of institution types as lenders, and hence boosting liquidity.
To discuss how these topics are affecting the syndicated loan market in Europe, Global Real Estate Experts caught up with Amelia Slocombe, Director & Head of Legal at the Loan Market Association (LMA), the EMEA syndicated loan trade body, and her colleague Senior Associate Director Gemma Lawrence-Pardew.
How is a deal on Brexit – whatever shape or form that may take – likely to affect the syndicated loan market?
Amelia Slocombe: The syndicated loan market is largely unregulated, so it is difficult to know precisely how it would be treated in a no-deal Brexit scenario. Essentially, it would require a country-by-country analysis of how lending is handled in each country: for new and existing lending, and for primary lending and secondary trading.
In a worst-case scenario, if it were to become illegal for a UK-based lender to lend to a borrower in a particular EU country, that borrower might be required to repay its entire loan. The treatment of existing loans is therefore likely to be one of the biggest concerns.
The effect of Brexit also goes wider than this. The fact that the UK will be treated as a ‘third country’ post Brexit poses the possibility that lending from the UK to the EU will no longer be practical or cost effective, even if it is legal. This could mean lending to EU borrowers becomes less competitive.
Moving on from Brexit, the UK’s Financial Conduct Authority has set a 2021 transition date to close the chapter on the Libor interest rate benchmark. How is this affecting the syndicated loan market?
AS: A replacement benchmark for Libor has yet to be agreed and, at present, nothing being discussed replicates its key components. Fundamentally, this relates to its forward-looking term structure: i.e. the borrower knowing on day one how much interest it will need to pay at the end of the interest period it has selected. This is essential from a cashflow management perspective.
The new benchmarks currently being proposed for the loan market are overnight rates. Putting aside the fact that Libor compensates lenders for an element of credit and term risk and overnight rates do not, from a pure borrower perspective, overnight rates would require compounding, also meaning that the borrower would not know the final payable rate under the end of the relevant period. In addition, from an operational perspective, this would be a much more onerous process to calculate and verify.
What is currently happening on an EU level?
AS: One of the main regulatory proposals is a directive relating to non-performing loans (NPLs), issued by the European Commission earlier this year, in March.
The purpose of the directive is help develop a transparent secondary market for NPLs, which in itself we would support.
However, the overarching issue is that the wording of the legislation is not restricted to NPLs. Instead it applies to all credit purchases from banks by non-bank investors, and therefore has significant implications for both the primary and secondary syndicated loan markets.
In addition, it requires banks to disclose information to purchasers to enable them to assess the value of the credit agreement and the likelihood of recovery. This cuts across generally accepted disclosure arrangements, as well as the more general ‘buyer beware’ principle.
We are lobbying hard to reduce the scope of the directive to loans below a particular threshold, so that at least this would exclude the majority of the wholesale loan market. Unfortunately, it remains a bit of a wait-and-see at the moment.
And UK legislation – such as the draft Registration of Overseas Entities Bill from the Department for Business, Energy & Industrial Strategy (BEIS)?
AS: This bill, from the BEIS, requires registration at HM Land Registry of any overseas entities owning property in the UK. A key area of concern for a security agent or secured lender will therefore be to ensure that its options for enforcement against an overseas borrower remain fully available, even if the borrower itself has failed to comply with the bill.
From an enforcement and security perspective, the bill is too narrow and does not cover off a broad enough range of situations for lenders. As an example, if a non-compliant borrower subsequently becomes compliant, the borrower can register its ownership at the Land Registry but the security interest itself cannot. We have responded to the consultation and intend to follow up with the BEIS.
How is blockchain set to change the syndicated loan market?
Gemma Lawrence-Pardew: A real buzz exists around blockchain and distributed ledger technology (DLT) in the financial services sector at the moment, with market participants looking for safer, more efficient means of transacting.
In the syndicated loan markets, there are clear efficiencies to be gained through more accurate record keeping as well as process and workflow improvements. For example, DLT should remove the need for all aspects of data and systems reconciliation taking place during the lifecycle of a loan; in turn taking away the reliance on manual reconciliation systems and freeing up the time of operations professionals to focus on other tasks.
From a documentation perspective, the adoption of legal contract automation technology could substantially speed up the drafting process, allowing a template to be tailored to the specific transaction quickly and easily, with the final ‘finessing’ done ‘by hand’.
It will be interesting to see to what extent the market adopts this technology and puts it to use.
Where are we at with the emergence of ESG (environmental, social & governance) lending?
GLP: Having garnered the support of the borrowing and lending communities, the ESG lending market has developed rapidly over the past few years. This has, no doubt, been assisted by global climate change initiatives, such as the UN’s 2030 Agenda for Sustainable Development and the European Commission’s action plan on sustainable finance.
Going forward, it is necessary to ensure the development of a united classification system. In May 2018, the EU Commission presented a package of measures as a follow-up to its action plan on financing sustainable growth.
These included proposals to establish a taxonomy for climate change and environmentally sustainable activities, which could be used to set standards for financial investments across Europe.
The aim of the EU Commission’s taxonomy is to create a harmonised set of criteria to be used in different areas, such as labels, standards and benchmarks, with the end goal of being embedded into EU law. Ideally this taxonomy would be adopted on a global basis, allowing for the development of a common language.
At the LMA, we have initially focused on the development of green loan principles (GLP), which seek to provide a high-level framework of market standards and guidelines, and allow for consistent methodology to be applied across the whole green loan market.
These GLP set out a clear framework of recommendations to be applied by market participants on a deal-by-deal basis, depending on the underlying characteristics of the transaction, and based on four components: Use of Proceeds; Process for Project Evaluation and Selection; Management of Proceeds; and Reporting
Looking to 2019, we will be seeking to produce a set of principles that apply to sustainability improvement loans – those loans that incentivise a borrower to achieve predetermined sustainability performance targets.
All in all, there is a bright future for the ESG loan market, with plenty of opportunities available to both lenders and borrowers.