LMANews Dec09 Final

Inside this issue…

2 View from the market A cross-section of LMA members answer topical questions about the state of the loan market.

5 New LMA Debt Trading Documentation A summary of the key changes due to the merger of the Par/Distressed documentation.

7 Current themes in European restructurings A review of the trends arising from cross-border restructurings.

11 Europe in 2010 S&P review market trends and forecast the outlook for Europe next year.

15 A new regulatory landscape What are the possible changes to come in the lending market as a result of new regulations imposed on banks?

18 New trading desksUnderstanding their role in the secondary loan market.

21 The South African and Sub Saharan Africa syndicated lending marketAn overview of how the loan market is evolving in this developing region.

Plus LMA Committee Update and contributions from the LSTA and APLMA.

LMANEWSIssue 25 December 2009

Time to look to the futureClare Dawson, Managing Director, Loan Market Association

Towards the end of another difficult year for the loan markets, sentiment appears to be improving, particularly in the investment grade corporate market. Banks appear to be looking forward more to what business can be done, rather than focusing solely on capital and the state of their balance sheets.

working on a new issue, to widen the investor base for loans. Given the complexities of legislation in the European market that affects the lender base, considerable thought will have to be given as to the best approach to increasing the pool of liquidity without the risk of unintended consequences for the product.

With all these very substantial projects to complete, as well as maintaining our growing education programme and, of course, keeping the now very large library of documents up to date, resources at the LMA are becoming increasingly stretched. The Board has therefore decided that, for the first time in 10 years, subscriptions will have to be increased, details of which are being sent out to all members. Despite this increase, LMA membership remains remarkably good value, and the Board looks forward to the continuing support of our members.

Against that backdrop, the LMA has continued to work on the many issues that the difficulties in the market over the last 18 months have highlighted. Significant milestones in the last six months include; completing the new single set of trading documents for both par and distressed trades; producing a revised version of the Intercreditor Agreement, as a result of constructive discussions with a group of mezzanine investors; submitting a response to the UK Insolvency Service’s consultation, much of which was reflected in the resulting proposals for change to the UK insolvency regime; and holding our second annual conference to an even larger audience than last year. For more information on LMA initiatives see page 28.

For 2010, the LMA has identified a number of priorities, many of which continue work already started this year. We will continue to focus on improving operational efficiency in the loan market, and carry on with our work on reviewing what works – and what doesn’t – in an insolvency regime. Despite the seemingly endless list of reviews, statements and draft proposals from regulators, so far there have been relatively few firm outlines for legislation, so monitoring and commenting on proposed changes to regulation will continue to be an essential part of the LMA’s remit next year. We will also be undertaking further work to ensure transparency of information in the loan market, in particular as it relates to information about the composition of the syndicate that may be significant to the lenders. Finally, we will be

LMA contact: T: +44 (0)20 7006 6007F: +44 (0)20 7006 [email protected] www.lma.eu.com

View from the marketAt the end of another challenging year, we invite a cross-section of LMA members to answer some pertinent questions about the outlook for the loan market in 2010.

2 Loan Market Association LMA News December 2009

Jeremy Selway, Director Leveraged Syndicate – Barclays Capital

Q: HY bonds dominated the leveraged debt market during 2009. Do you see this being repeated in 2010?A: HY issuance in 2009 has been driven by the return of investor demand for riskier fixed income assets in a low interest rate environment. This demand has been met with ample supply from leveraged borrowers needing to term

out existing syndicated loans, and corporates diversifying sources of financing away from the liquidity constrained loan market.

2010 is likely to see continued strong HY issuance for refinancing purposes, with ongoing development of an active leveraged corporate HY market. In addition, bonds are expected to be an important source of funding as M&A activity picks up.

Growth of the HY market should help facilitate the recovery of the leveraged loan market, as bond issuance, together with repayments from the IPO or trade sale of private equity portfolio companies, will result in the release of existing institutional funds for reinvestment.

The return of this liquidity will be a very positive development for financing new sponsor driven buyouts, particularly as these funds can be invested in non or lightly amortising debt structures. Barring an economic downturn, the overall leveraged debt market should therefore be larger and more balanced between bonds and loans in 2010.

This trend is already clear in the US market, where a high level of bond issuance since the summer has been followed by the reopening of the primary leveraged loan market over the last quarter. Europe is 3-6 months behind, but with an increasing number of potential buyouts in discussion, issuance could start picking up from Q2 2010.

Julian van Kan, Global Head, Loan Syndications & Trading – BNP Paribas

Q: How do you see the wider investment grade loan market in Europe developing over the coming year?A: With more than US$1 trn in each of the bond and loan EMEA markets coming up for maturity in 2010, one can be certain that bank lenders will have as important a role to play as the bond markets.

This volume is in addition to any new issuance, which we are already starting to see pick up in the last weeks of 2009. One tends to focus attention on volumes coming from event driven transactions; however, one should not ignore the absolute demand coming from real economy related borrowers, such as traders and commodity companies, which continues to rise.

Despite the pressures from respective central banks, lending volumes are still substantially off their peaks of 2007/8 – borrowers have sought comfort from the bond and equity markets, managing their own working capital, and making better use of existing facilities to fulfil their needs. As we start to experience the effects of a recovering economic environment, we should expect to see an increased demand for general working capital financing.

We cannot ignore the debt volumes that have been impacted by failures in the Gulf and other regions, namely Russia, Ukraine etc – this will continue to prevail in 2010 and will subdue lender appetite there for a little while to come, with some areas returning quicker than others.

Q: Bank and Bond lending in 2009 – a rare event, or to be a continuing trend?A: Often it has been reported that the loan market is dead, and this is the first time we have seen bond issuance eclipse loans. Rubbish! One should look to history – this shows that the loan and bond markets have oscillated with each other, the last times being 1998, 1991 and 1984

just to quote more recent dates. If one examines these dates carefully, each one reveals that there were credit events prevailing in the market (Russian crisis, bank failures) and this would indicate that bond investors are more able to price and provide liquidity through these crises than the traditional bank market. This analysis is a shallow and simple one and does not give any credit to the severity of the 2007/2009 crisis, which has been affected by so much more.

What we have seen leading up to this crisis has been an over reliance by borrowers on the loan market, given its flexibility and relative cost of funds. What this crisis has shown us is the ability of the two markets to work together and show the true form of a debt continuum.

Such oscillation will continue provided we have separate debt markets and differing liquidity providers – continued capital adequacy pressures on bank lenders will also have an impact, and the true extent of this will only be seen once we have a universal approach from the regulators.

Loan Market Association LMA News December 2009 3

Jeremy Selway continued

Q: It has been suggested that big inflows of investment into the HY debt market has resulted in a return to looser covenants. Would you agree with this assertion and how do you foresee the trend developing?A: It is generally acknowledged that strong fund inflows may lead to a relaxation of lending criteria. Investors become more concerned about being invested today rather than losing money tomorrow. This can result in a transition to more highly leveraged capital structures, tighter pricing, issuance in ‘difficult’

sectors, more aggressive use of proceeds such as acquisitions or dividends, and potentially looser covenants.

This overall trend is evident in both the US and the European markets. For example, the US market has already seen a number of dividend recapitalisations, and new issue pricing has tightened significantly.

In Europe much of the new BB corporate issuance (including unrated but with an implied BB rating) has come with investment grade style covenants. Some traditional HY investors have shown resistance, but the deals have generally been successfully placed, with strong

demand from investment grade accounts looking for yield evident. A return to weaker economic conditions or a drop in investor demand would be likely to lead to a return to tighter covenants in this segment of the market.

For lower rated credits there has not yet been significant loosening of terms. A B rated LBO issuer would typically still need a traditional HY covenant package, and European leveraged loan investors are likely to hold firm on covenants and other documentary protections for the foreseeable future. Investors will remain mindful of the key lessons of the last 24 months.

Alon AvnerExecutive Vice President – Sankaty Advisors

Q: If you were a new investor researching entry to the European loan market, what would you list as the major attractions and what would be the major barriers?A: We see several attractions in the European loan market. First, parts of the loan market offer strong value relative to the US. Although areas of relative value change over time, in the main, large European LBOs and levered corporates are #one or #two leaders in their markets and thus provide better credit quality for similar leverage to the US.

Secondly, as funds and other collective investment vehicles seek to diversify their investor bases, having a sizeable presence in the European loan market will allow such funds to attract European and global investors.

Lastly, many LBO targets are multi-national. Having a dedicated team in Europe is required in order to understand these businesses and assess investments even when investment decisions are made outside of Europe.

New investors may be deterred by a number of barriers. The limited liquidity in the European loan market is often the

first issue noted by investors. This is caused by the relatively small number of institutional lenders, exacerbated by multiple currencies and numerous jurisdictions. Liquidity is not helped by the lack of public ratings and limited availability of public information. The liquidity issue results in difficulties in building meaningful position sizes and negatively affects relative value due to constrained ability to exit positions if the credit view changes.

Another key barrier is the lack of a predictable (let alone unified) restructuring regime. Many European restructurings involve multiple jurisdictions, are more complex, take longer (potentially resulting in greater value destruction) and can result in outcomes that do not necessarily reflect levels of seniority (e.g. need for equity consent in some jurisdictions).

Lastly, the European market is still relationship-oriented. Building the right set of relationships with banks, funds, sponsors and advisors takes a significant effort. This also manifests itself in some troubled companies situations where the incentives of relationship banks may be very different from those of institutional investors.

Q: Given the variance of insolvency laws throughout Europe, to what extent has ‘jurisdiction risk’ moved up the priority list when conducting an investment assessment?A: Jurisdiction as well as legal documentation and capital structure risks have always been high up the priority list

in investment considerations at Sankaty. When we started investing in Europe we devoted resources up front to understand these jurisdictions and the various rights of different debt classes. We avoided companies in countries in which we were not comfortable investing or where we were not paid for the additional risk.

An area where jurisdiction risk has moved up the priority list recently is the relationship between senior and junior capital. The use of COMI shifts as well as junior capital cram-downs in certain jurisdictions would make these countries more difficult for new junior capital issuance.

Jurisdiction risk will continue to be a major consideration going forward. Interestingly, the current distressed cycle will provide much needed clarity since many of the restructurings will set a precedent or at least help to clarify the 2004-2007 reforms in insolvency laws. This new knowledge will then help investors quantify and price the risk more accurately.

We hope the work being taken by the LMA with regard to European jurisdictions and recent intercreditor changes will lead to improvements in legal regimes and ultimately benefit recoveries for all parties.

Our view is that the market is now ready to distinguish between jurisdictions, which should lead to differential pricing, capital structures and legal documentation. ‘One size fits all’ will not be welcome anymore.


News in Brief

In September 2009, the LMA held its second Syndicated Loans Conference in London attracting 700 delegates. This impressive turnout reinforces its position as one of the biggest and most significant events in the loan industry calendar. The conference is, without doubt, a must-attend event for all major organisations and industry professionals operating in the syndicated loan market.

In 2010, the conference will be held at the Queen Elizabeth II Conference Centre on 30 September. Ideas for possible speakers and enquiries regarding sponsorship can be sent to Melanie Hutchings on [email protected].

LMA membership

Unsurprisingly, there has been considerable turnover during the year, but the membership has held up very well with 399 members currently compared to 404 as at the beginning of the year. There continues to be a strong international interest; the membership covers 40 nationalities and the new members included institutions from Austria, Czech Republic, Denmark, Germany, Ghana, Ireland, Italy, Netherlands, Norway, Oman, Portugal, South Africa, Switzerland, UAE, UK and the USA. Anyone wishing to know more about LMA membership should refer to the LMA website – www.lma.eu.com or contact Mike Johnstone on +44 (0) 20 7006 2267 or at [email protected]

LMA Board

A number of new directors were elected at the 2009 AGM namely, Charles Bennett (Credit Suisse), Roland Boehm (Commerzbank AG), Edward Brown (ING), Francesco Carobbi (Bank of Tokyo-Mitsubishi UFJ), Justin Conway (Goldman Sachs International) and Zak Summerscale (Babson Capital Europe).

More recently, David Fewtrell (HSBC Bank) and Eric Capp (Royal Bank of Scotland) retired from the Board and their respective institutions are now represented by Andrew McMurdo and Rachel Manuel. Many thanks to both with special thanks to David who has worked tirelessly for the LMA virtually from its inception.

From left to right: Matthew Sabben-Clare, Partner – Cinven; Richard Munn, Head of European Investments – Oak Hill Advisors (Europe); Paul McKenna, Head of Structured Acquisition Finance Advisory – ING; Charlotte Conlan, Head of Leveraged Syndications, EMEA; and Paul Watters, Head of Corporate Research – Standard & Poors.

2009 LMA Syndicated Loans Conference

Charles Bennett

Francesco Carobbi

Roland Boehm

Justin Conway

Edward Brown

Zak Summerscale

LMA Syndicated Loans Conference


New:LMA Debt Trading DocumentationThe LMA has completed its review of its recommended secondary loan trading documentation and has released the new LMA Combined Par/Distressed Terms and Conditions and related documents as ‘Pending Documentation’. The intention is that the new documents will be officially launched as formal LMA documents as at 25 January, 2010. In the meantime, the documents will remain in the ‘Pending Section’, giving members the opportunity to become familiar with them.

Given that the revisions are major, in the sense that we have moved to a single set of documents for par and distressed trades, we held a training day on the documents in early December, and the intention is to hold a repeat event on 8 January, 2010 (see adjacent Event Alert).

New LMA default positionsIn drafting the documents, two major changes have been made to the LMA default positions as formerly related to par trading. These are:

– the default position is that break funding DOES NOT APPLY; and

– the concept of ‘a trade is a trade’ WILL APPLY to all trades – this default position emphasises the strict requirement for absolute clarity at the time the trade is struck.

In due course the LMA will issue a list of points that should be addressed at the time of agreeing the contract.

Key changesSingle Set of Terms and ConditionsThe new Terms and Conditions will apply to all trades and, as the current distressed terms were used as the ‘starting point’, the former par terms will move closer to the current distressed terms, but certain existing conditions applicable to par trades will continue to be allowed for, namely:

– ability to settle by way of risk participation;– ability, re treatment of accrued interest,

to trade on paid on settlement and discounted from next rollover date basis;

– using upfront fees as part of the pricing matrix; and

– ability to provide for break funding compensation.

The introduction of a ‘trade is a trade’ will prevent parties from walking away from trades if borrower consent is not forthcoming, with the result that the parties will have to agree a suitable way of settling the trade on a mutually agreed basis that reflects the economic reality, including, possibly, cash settlement.

There are differences between some specific terms applicable to par trades as compared to distressed trades, which include the fact that Delayed Settlement Compensation (if selected) accrues from T+10 in par and T+20 in distressed; there are slightly different representations and warranties; BISO only applies to par trading; and par includes an option to apply break funding compensation in the trade terms.

The current distressed terms and conditions allow parties to trade on the basis of the seller assigning its rights under its Predecessor Transfer Agreements (‘upstreams’), but the new terms and conditions do not include this framework. All distressed trades will be assumed to be traded on the basis of predecessor-in-title representations and warranties.

Termination on insolvencyA new provision has been introduced allowing for termination of a trade should one of the parties become insolvent between Trade date and Settlement date. The definition of ‘insolvency’ is based on the Bankruptcy event of default definition in ISDA (International Swaps and Derivatives Association) documentation and closely matches the similar concept already introduced into LMA primary documents.

The default position is that the trade is terminated upon service of a notice by the non-insolvent party following the insolvency of the other party, but this can be altered by

Event AlertRevised Secondary Documentation Training8 January, 2010

Target AudienceAimed at anyone who is involved in secondary debt trading or settlement.

ProgrammeThe training will focus on the new Terms and Conditions, the Trade Confirmation and Participation Agreements. Presentations in the morning will be delivered by senior bankers and lawyers working in the UK loan market who are active members of the Secondary Documentation Committee. The afternoon will comprise a workshop exercise run in small groups to cement understanding.

Please note this is a repeat of the training day held on 1 December, 2009.

To register visit the LMA website:www.lma.eu.com

LMA Revised Secondary Documentation Training held on 1 December, 2009

The new combined trading documents represent a major departure for the secondary loan trading market in Europe, but the LMA is confident that they will bring a marked improvement.


each party either by (1) notifying the other party at any time prior to that other party becoming insolvent that automatic termination will apply instead, should that other party become insolvent or (2) including this as a specific term of the trade in the ‘Other Terms of Trade’ section in the Trade Confirmation. Following the termination, the non-insolvent party obtains quotes and calculates the Early Termination Payment Amount following a specific procedure set out in the Terms and Conditions.

Buy-in/Sell-out (BISO)The BISO clause in the current par documents has been revised for inclusion in the new revised Terms and Conditions. BISO will only apply to par trades and will automatically apply to trades unless specifically disapplied under the terms of trade. The non-defaulting party is not obliged to exercise its rights under the BISO provisions.

The outline BISO provisions are:

– the non-defaulting party has the BISO rights after T+60 for unsettled trades;

– the defaulting party has a 15 day Cure Period;

– if the trade is not resolved during the Cure Period, the non-defaulting party has the right to enter into a substitute transaction; and

– if the defaulting party disputes the substitute transaction price, the price will be determined by the LMA Pricing Panel.

It is important to recognise that BISO is not in any sense a replacement settlement mechanism. Parties continue to have all the legal remedies previously available to them – BISO is aimed at encouraging parties to settle trades as quickly as possible.

Representations and WarrantiesThe new Terms and Conditions now include all representations and warranties given by the Buyer and the Seller, and the representations and warranties previously given in the freestanding Standard Representations and Warranties documents are now incorporated in the Combined Terms and Conditions.

The representations given by both Buyer and Seller for all trades are those currently applicable in the distressed documentation to the effect that no broker, finder or other person is acting on the instructions of one party for which the other may be responsible for the payment of a broker’s fee or commission and that no approval by any Governmental Authority is needed to enter into the transaction.

A number of representations are given by the Buyer only and the Seller only, as set out in the new Terms and Conditions.

Combined Trade ConfirmationThe approach taken in drafting the Combined Trade Confirmation was to use the current Distressed Trade Confirmation (Bank debt) as the basis and amend as required. The key points are:

– parties will identify whether the trade is par or distressed by using the appropriate tick-box;

– there is an assumption in the Combined Terms and Conditions that trades will settle on an ‘as soon as reasonably practicable’ basis, so the tick-box for Settlement Date has been removed. If parties wish to agree a different timing, this should be added to the confirmation as a trade specific term;

– the tick-boxes for allocation of stamp duties, transfer taxes and costs attributable to the transfer of security have been removed and would have to be dealt with as trade specific terms to the extent they are to be payable other than by the Buyer;

– combined forms of purchase agreement (Transfer Agreement, Assignment Agreement and Funded Participation) have been produced and the current master participation agreements and risk participation agreements have been amended to accord with the combined form of Funded Participation;

– the only conditionality envisaged is that of third party consents, which has been incorporated into the new Terms and Conditions. Any other conditionality will have to be dealt with as trade specific terms;

– the required options re settlement as a risk participation are not covered in the Combined Trade Confirmation and so a separate confirmation has been produced; and

– the Combined Trade Confirmation does not deal with claims trades and a separate confirmation has been produced.

SummaryThe new combined trading documents represent a major departure for the secondary loan trading market in Europe, but the LMA is confident that they will bring a marked improvement. Their introduction will largely eliminate the basis risk associated with buying an asset under par terms and conditions and then being required to sell under distressed terms and conditions. They will also address a number of aspects which had previously been seen as barriers to a liquid market.

This article is an abbreviation of the Explanatory Memo posted on the LMA website and members are urged to read that more comprehensive write-up.

New:LMA Debt Trading Documentation Continued from page 5

Current themes in European restructuringsAdrian Cohen, Partner – Clifford Chance; Mark Hyde, Partner and Global Head of Insolvency & Restructuring – Clifford Chance and Malcolm Sweeting, Partner – Clifford Chance

In recent months, a spate of cross-border restructuring transactions have been implemented. These restructurings have taken many forms and have cut across many sectors, including financial services, automotive, construction and chemical industries, in addition to the retail and commercial property sectors. The restructurings have also crossed many jurisdictional borders, as exemplified by cases such as Lyondellbassell, Monier, Vita Group and Sanitec Oy, to name but a few. The nature of the restructurings has varied from the refinancings of ‘fallen angels’ to the comprehensive restructuring of private equity owned global groups with over-leveraged balance sheets. Upon a close examination of the recent examples, developing trends become apparent. In this article we consider some of these trends. In particular we will look at:

– the importance of valuation in a distressed situation;

– creditor priority and intercreditor agreements;

– the use of security enforcement and the developing role of the security agent in restructurings; and

– the increased use of schemes and arrangement or other similar composition procedures.

ValuationThe starting point in any restructuring is to determine from an early stage, who has an economic stake in the business concerned. As a result of the significant leverage and multiple debt layering that took place in the leveraged buyout (LBO) market immediately prior to the current recession, there are often complex debt structures that require unravelling. The issue of which stakeholders still have an economic interest is often allied to the question of the ability of certain stakeholders to extract some ‘hold out’ or nuisance value in the context of a restructuring, with a view to being offered some incentive in exchange for their cooperation. Valuation

of the business is therefore a key factor, not only at an early stage in the negotiation of any restructuring but also, potentially, with the implementation of a restructuring.

There is no statutorily-imposed method of valuation in the context of a restructuring. Much will depend upon the nature of the business and the particular circumstances of the debtor and the timing of any realisations. Different methodologies may be appropriate, which will normally be determined by an expert valuer. Even then, the values will not be certain or exact and may fall within a wide range.

In two recent cases, one in England and the other in the Netherlands, the issue of how a distressed debtor was valued was fundamental to the success of the restructuring.

Restructurings have taken many forms and have cut across many sectors, including financial services, automotive, construction and chemical industries, in addition to the retail and commercial property sectors.


Adrian Cohen

Mark Hyde

Malcolm Sweeting

In the first case, Re Bluebrook [2009] EWHC 2114 (Ch), a dispute arose between IMO (UK) Limited (IMO) supported by its senior lenders, and the mezzanine lenders, in relation to how it ought to be valued for the purposes of the restructuring. The restructuring of the group, which boasts 900 sites in 14 different countries, involved senior creditors writing off a significant part of their debt, in exchange for an equity stake in a new company, to which all the value in the business was being transferred. This had the effect of leaving the mezzanine lenders with claims in the old companies, which were effectively empty shells. The mezzanine creditors were excluded from the restructuring on the basis that when valuing the business, it was clear that there would be insufficient assets to cover even the senior creditors’ claims. As such, the mezzanine creditors no longer had any economic interest in the group, and it was entirely appropriate not to include them in the restructuring. IMO’s own assessment of value was based upon three separate valuation methodologies. Each of these valuations found value breaking well into the senior debt; a conclusion which was bolstered by the fact that IMO’s debt was trading at a substantial discount. The mezzanine lenders argued that the valuations were too low and that they failed to take into account the fact that IMO did not suffer from any liquidity issues. In this case the judge was very critical of the mezzanine lenders’ ‘Monte Carlo simulation’ valuation technique. The case illustrates the importance of companies undertaking a rigorous valuation exercise, especially when pursuing a restructuring which excludes certain stakeholders on the basis that they lack an economic interest. It also confirms that English law has a mechanism for dealing with out-of-the-money creditors by way of a scheme of arrangement, which we discuss later.

The second case, which is indicative of the importance of valuation in a restructuring, was a decision from a Dutch Court, in relation to the restructuring of the Schoeller Arca Systems group. The structure and complexity of the group made it unsuitable for a sale of the company by way of public auction. Therefore

the restructuring plan took the form of an enforcement of a Dutch share pledge by way of private sale of the group to a new company established by the existing owners, but which needed the approval of the Dutch Court. The valuations submitted showed value breaking in the junior facility, but the key from the Court’s perspective was the value that was actually deliverable at the time. The junior creditors, like those in the IMO case, were concerned that they would be left only with a claim in a shell company. The Dutch Court, however, considered that since the junior creditors had agreed to a subordination of their claims, and given the fact that a private sale was likely to deliver a better offer than a public auction, their objections should be overridden by the restructuring plan.

Once the appropriate valuation for a distressed business is assessed, it is then important to ascertain creditor priorities to determine whether any given creditor should be invited to the restructuring table, or in cases where valuation could lead to junior creditors asserting some ‘hold out’ value, identify and deal with those creditors as soon as possible.

Creditor priority and intercreditor agreementsCreditor priority is our next theme and is inextricably linked to valuation. In the present market there are a number of LBO restructurings for which the priority arrangements between the multiple creditors is key. Creditor priority is documented at the outset by an intercreditor agreement. The intercreditor agreement normally prohibits junior creditors from taking enforcement action until the senior creditors’ liabilities have been discharged. Junior creditors will also be unable to make a demand, accelerate, sue for payment, or enforce any security or guarantees before the senior creditors have been satisfied. The intercreditor agreement will also usually contain provisions and set out the circumstances in which the security agent may release security and liabilities in connection with a sale. In addition, the security agent may be given the ability to effect a disposal, sale

In two recent cases, one in England and the other in the Netherlands, the issue of how a distressed debtor was valued was fundamental to the success of the restructuring.

Once the appropriate valuation for a distressed business is assessed, it is then important to ascertain creditor priorities.

Current themes in European restructurings Continued from page 7



or transfer of liabilities as well as a release of liabilities, that may be particularly useful in a restructuring context, to avoid incurring unnecessary tax liabilities that may be triggered on the release of a liability. In March this year, the LMA launched its new recommended form of intercreditor agreement, together with a guidance note to assist lenders in agreeing intercreditor arrangements, so that they may be better prepared for the event of a borrower becoming financially distressed in the future. The new recommended LMA form of intercreditor agreement develops the ability of the security agent to exercise its powers of release in distressed and non-distressed disposals, which can be crucial in the restructuring context. It also enables the security agent to release or transfer liabilities, without the requirement to seek further consent from the individual lenders. From a practical perspective, this may prove to be an extremely useful mechanism, as a common feature of the current round of restructuring is the vast number of disparate lenders involved.

Role of the security agent and security enforcementAs already discussed, when most of the financing arrangements were put in place a couple of years ago, the focus of the parties to many of these transactions was very different. The role of the security agent, who would usually represent both the senior and junior

creditors, although fundamental to the structuring of the deal, was often perceived as a fairly administrative role, for which a modest fee was received. In the current climate however, the security agent is now being asked to take on the role of enforcer or to become heavily involved in the restructuring process itself. This is at odds with the anticipated administrative nature of the role and the often understandably cautious and conservative approach taken by security agents. In our experience, when security agents are asked to ‘roll up their sleeves’ in the context of a restructuring, they are advised to seek independent advice from professionals on their specific role and duties as security agent in a restructuring environment. Restructurings have the potential to become adversarial, and although contractually the security agent may be entitled to act upon the instructions of the senior creditors alone until their liabilities have been discharged, the security agent does owe a fiduciary duty to the junior creditors. It should also be borne in mind that a cautious approach, often adopted by a security agent, may not sit well with the restrictive timetable required to push through a restructuring. The role of the security agent is particularly crucial in cases where the restructuring takes effect by way of a controlled enforcement of the security. This has been a trend in some very recent high profile restructurings, such as those of Monier and the Vita Group, which recently concluded by way of enforcing share pledges at a holding company level. In these cases, the security agent has had a prominent role in achieving a successful outcome. In cases which may involve the transfer of all of the borrower’s assets or business to a senior creditor-owned vehicle for the sole benefit of those creditors, the security agent needs to be particularly careful to avoid any potential conflicts of interest.

Schemes of arrangements and similar composition proceduresOur final theme is the use of schemes of arrangement as a restructuring tool, which has become increasingly common over the last few months. For example, in the context of the IMO case referred to above, a scheme was used to write off part of the senior debt, in exchange for equity in the newly-formed company. The nature of a scheme of arrangement is such that it allows a company to agree to a statutory compromise or arrangement with its creditors (and/or members), which can include (amongst other things) the rescheduling of debt, the writing off of debt and the swapping of debt for equity. Provided the requisite majority of creditors affected by the scheme vote in favour (75 percent in value and a majority in number

The new recommended LMA form of intercreditor agreement develops the ability of the security agent to exercise its powers of release in distressed and non-distressed disposals, which can be crucial in the restructuring context.


in each class of creditor) and the Court sanctions the scheme, it takes effect and binds those who either abstained from voting or voted against the scheme. As such, it has proved to be a very useful and flexible tool in the current round of restructurings, where a scheme can be used (or threatened to be used) to bind creditors, who otherwise would need to unanimously approve a restructuring. The ability to bind creditors in this way is often referred to as ‘cram down’.

We are also seeing the development of the use of schemes for debtors not incorporated in England and Wales. The Court’s jurisdiction for sanctioning a scheme is based on whether an entity is ‘liable to be wound up pursuant to the Insolvency Act 1986’, which includes foreign companies. Case law relating to whether a company may be liable to be wound up, suggests that the English Court will exercise its jurisdiction provided a sufficient connection to England can be evidenced. This may include assets being available in England, or a debt being incurred in England. It may even extend to circumstances where the only connection to England is the fact that the debt is governed by English law. This has not yet been tested by the courts, although the purpose for which the scheme was being propounded and its ability to be recognised and respected in other jurisdictions would no doubt be taken into account by the court when considering whether to exercise its discretion. The ability to use a scheme in this way has the potential to make a huge impact on the restructuring market, particularly in cases where complex cross-border group structures are in distress.

In addition, the Insolvency Service in the UK announced on 11 November, 2009, its intention to extend the moratoria for companies contemplating a company voluntary arrangement, which will further enhance the current tools available to encourage company rescue. (A company voluntary arrangement is another mechanism which enables the ‘cram down’ of creditors, by way of a compromise reached with a 75 percent majority of creditors, and has the effect of binding all creditors. However unlike a scheme of arrangement,

it cannot be used to bind secured creditors without their consent.)

Procedures in other European jurisdictionsSimilarly, in other European jurisdictions the ability to invoke a composition procedure as a way of ‘cramming down’ non-consenting creditors is becoming more common. In France for example, the ‘Safeguard’ procedure made famous by the Eurotunnel restructuring a few years ago and sometimes referred to as the ‘French Chapter 11’, provides a debtor with the ability to restructure on the basis of the agreement of a two thirds majority of the requisite creditor constituents. Even in the absence of the requisite majorities being achieved, the French Court can also impose a rescheduling of debt for a period of up to 10 years on creditors. This has been used most recently in the case of Coeur Défense, a property company which owns the famous La Défense business district in the centre of Paris. In Spain and Italy over the last couple of years, there has also been a developing trend in adopting a legislative framework to support the increasing demand for pre-insolvency composition arrangements. Equally in Germany, the use of the Insolvenzplan in the context of restructurings is being promoted by a suspension of the statutory obligation imposed upon directors to file for insolvency proceedings within 21 days of becoming aware that a company is balance sheet insolvent (i.e its assets no longer cover its liabilities) as long as they can demonstrate that the company will be able to survive for the current and following business year.

Over the next few months, it is inevitable that there will be more cross-border restructurings that illustrate these themes. It is also likely that more innovative restructuring solutions will develop to assist distressed businesses and put them firmly back on the road to recovery.

Current themes in European restructurings Continued from page 9

Clifford Chance’s market leading Restructuring team brings together a large dedicated team of top ranked lawyers who can draw upon a broad range of expertise in areas such as finance, M&A, tax, pensions, capital markets, regulation and real estate, to deliver practical and commercially sound solutions for our clients. Our Restructuring team frequently partners with clients through all stages of the transaction – strategic planning, negotiation and implementation – and, where required, uses our cross border expertise to give practical guidance on jurisdictional variances and issues. Our overall depth, scope, experience and detailed understanding means we are well placed to provide proactive legal and technical advice of a consistently high quality, irrespective of the scale and complexity of the transaction.


Standard & Poor’s 2010 OutlookLeverage still burdens recovery prospects in EuropePaul Watters, Head of Corporate Research and Taron Wade, Senior Research Analyst

+74%increase in default rate in Q1 2009 compared to the end of 2008.

96companies in our dataset have defaulted over the past 12 months.

While the worst of the recession may be behind us, thanks to the positive impact of fiscal and monetary stimulus packages, higher costs of capital and the unwinding of excessive leverage burden recovery prospects as Europe emerges from recession. Standard & Poor’s Ratings Services currently expects the path to recovery will be long and narrow. Weak capital spending prospects by European companies, coupled with expectations for a further rise in unemployment, continued weakness in regional housing markets, ongoing tight lending conditions by banks, the threat of rising interest rates and taxes, and a strengthening euro, we believe paints a challenging picture for corporate credit quality in 2010.

What are the trends we are seeing for defaults in 2009? For the third quarter of 2009, Standard & Poor’s announced its speculative-grade default rate (by number) among Western European companies had increased further to a preliminary rate of 13.1% for the 12 months to end-September 2009. This is higher than our 11.7% base case but lower than the 14.7% downside scenario that we projected for the end of 2009.

While the default rate has continued to rise thus far, we believe an important observation is that the pace of increase has slowed over

successive quarters through 2009. The default rate accelerated to 9.2% in the first quarter of 2009, from 5.3% at the end of 2008, representing a 74% increase. Subsequently it rose by 24% to 11.4% at the end of the second quarter, and then only by a further 15% to reach 13.1% in quarter three.

This means that 96 companies in our dataset, with total outstanding funded debt of €68.9 bn, have defaulted over the past 12 months. This breaks down into 15 publicly rated companies, with total outstanding debt of €36.4 bn, and 81 private companies with credit estimates, whose outstanding funded debt amounted to €32.5 bn.

The default rate as we calculate it for the third quarter combines that of our public speculative-grade companies (those companies with long-term ratings of ‘BB+’ and below) of 10.4% with the 13.8% rate for those private companies for which we provide credit estimates.

What are your current expectations on how defaults could play out in 2010?While we believe that the speculative grade corporate default rate in Europe may have reached a cyclical peak, at around 13.1% in the third quarter of this year, we expect that it will remain substantially above its long term trend average of about 4.5% in 2010, before returning to a more subdued level in 2011. Our current projections suggest that the 2010 full year default rate may fall between 8.7% and 11.5%, which if correct, would still make next year the third worst year on record. We estimate that this may translate into between 55 and 75 Western European firms with speculative grade corporate ratings and credit estimates that could default in 2010.

Are capital structures of restructured credits sustainable for the long-term or are we in for a second round of defaults? It is certainly true that the great majority of balance sheet restructurings that we have reviewed in 2009 have failed to lift the corporate rating out of the B- or CCC rating category. In our opinion this means that these credits remain vulnerable to default over the

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Paul Watters

Taron Wade

next two years. There are two main reasons for that. The first is that, in our view, the degree of leverage even after a restructuring is in many cases difficult to justify given the likely free cash flow that the company could generate over the next few years. We believe this is a view that is widely shared with market participants, who recognise that their priority for now is to focus on near term interest service, given the low level of interest rates and that the bulk of refinancing for LBOs in Europe doesn’t begin until 2013. The second reason is that, in our view, the economic dislocation has severely impacted confidence in the ability to deliver on business plans of many companies. This uncertainty and lack of visibility is incorporated into our assessment of credit prospects.

How would you summarise leveraged loan market activity in 2009? In our view 2009 has been a very testing year where the challenge has been to maintain cordial intercreditor relationships in the face of extreme uncertainty. Not only has visibility over future business prospects been uncertain, but also the preferences of different stakeholders when a renegotiation of covenants or restructuring of the balance sheet has been required.

The market environment started to improve after the end of the first quarter, reflected in the steady recovery in secondary market prices through the year. The behaviour of lenders (banks and non-banks) in response to short term underperformance by portfolio companies certainly appears, to us, to have become more lenient as the year has progressed.

Unsurprisingly, activity in the primary leveraged loan market has been almost non existent, amounting to only about €1 bn per quarter between Q1-Q3 2009, comprising small relationship club deals for the most part. We believe that the lack of lending appetite from banks and non-banks has been one key reason and that this is reflected in the total absence of underwriting capacity within the arranging bank community.

How would you assess prospects for 2010?We anticipate that several themes may play out in 2010 – a year where we expect growth to be lacklustre. First, we think that liquidity is key. Those companies not able to generate operating cash flow, and with little prospect of doing so, are likely to remain in the distressed category, and at some point may be candidates for restructuring.

Second, we anticipate overlevered companies with a profitable underlying business and adequate near term liquidity will pursue one of two alternative financial strategies. The first may be to refinance senior secured loans in the high yield bond market to pre-empt rising interest rates and to partially alleviate refinancing risk. This also may have the potential benefit of derisking banks (and investors) and may provide additional financial flexibility to the company by making financial covenants less restrictive. Examples of companies that have used this strategy include Ardagh Glass, Smurfit Kappa and CEVA. The second alternative, in our view, would be a solution where new equity is provided. This could include when an existing or new equity investor, or indeed a trade buyer, acquires the company and essentially redeems a portion of the debt at (or close to) par. For example, Baxi senior creditors and mezzanine noteholders recently approved a merger with De Dietrich Remeha Group, a company also in the heating industry. The merger included an injection of €100 mn in additional equity from Baxi’s private equity shareholders. This route may become more feasible as the year progresses to the extent that valuations recover – possibly to the point of breaking well within the subordinated debt category – which might make current debt investors more likely to agree a sale price.

Standard & Poor’s 2010 OutlookContinued from page 11


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In our view 2009 has been a very testing year where the challenge has been to maintain cordial intercreditor relationships in the face of extreme uncertainty.

An important variation on this route may be LBOs seeking public listings. Companies such as Elster, Amadeus and Brenntag have been reported in the press to be seeking to (at least partially) exit by floating the companies to pay down debt in Q1 2010. This could potentially improve market confidence and increase liquidity in the leveraged loan market, to the extent that investors and banks could recycle the capital from existing debt financing into new transactions.

However, we remain cautious about prospects for new LBO transactions of any material size, as we anticipate that bank lending capacity will remain very restricted for this asset class. In our view, this is in large part due to the high capital intensity of on balance sheet leveraged loan assets and the limited ability to distribute leveraged loans to third party investors.

What types of companies will provide new sources of lending business, and what is your expectation for capital structures?We anticipate that new leveraged loan transactions may be sourced from crossover credits in the BB/BB+ rating categories, either from companies that previously held investment grade ratings looking to refinance or from spin-offs of non-core businesses from larger corporations that fall into this category. However, in our view, there is a chance that crossover credits like Fiat (BB+), which have raised €4 bn through the bond market in recent months, will bypass the loan market and seek to refinance mainly through the high yield bond market.

For spin-off companies purchased by private equity firms, we expect that capital structures are likely to remain highly conservative and in line with structures put in place during 2009. Leverage multiples in 2009, albeit derived from only a small number of deals, have reverted back towards 2001-2003 levels, at around an average of 4.3x according to S&P Leveraged Commentary & Data, significantly lower than the average of 5.1x total debt/EBITDA that prevailed in 2008. In this context, we expect that equity contributions are likely to remain close to 2009 levels of 50% of company enterprise value on average.

Given what we have observed as the relatively low level of recoveries achieved to date for subordinated debt in Europe, and given our observations of market activity as to the relative reduction in bank lending capacity in Europe, we would not be surprised to see investors seeking to negotiate stronger intercreditor positions and security rights relative to senior bank lenders going forward. We expect that this may also include strengthening ongoing reporting and disclosure standards.

From a credit perspective are there particular sectors that are likely to perform well or poorly in 2010?Despite some expected improvement in the macro-economic outlook in 2010, we still believe that credit quality among rated corporates will continue to deteriorate, albeit at a slower pace. The main reasons why, in our view, negative ratings pressure is expected to persist include:

– Output is expected to continue at well below capacity, which is likely to weigh on margins and cash flow metrics.

– Upward pressure on working capital is expected to build on the back of restocking as modest growth returns.

– Rising (commodity) input cost pressures are a widespread concern across many sectors as competition and excess capacity limits the ability for companies to pass them through to customers.

– Companies are expected to continue to implement cost-cutting programmes and to continue to limit capital expenditures.

Despite some expected improvement in the macro-economic outlook in 2010, we still believe that credit quality among rated corporates will continue to deteriorate, albeit at a slower pace.



Overall, ratings prospects for 2010 across corporate sectors in Europe are currently evenly balanced between stable and negative outlooks. Summarising the rating outlook and key drivers for particular sectors:

– Negative rating trends are expected to persist in retail as rising unemployment encourages ongoing consumer down-trading that is likely to keep margins under pressure.

– Media industry earnings are expected to begin to rebound in 2010 as cost adjustment efforts take full effect and the top line stabilises. The risk of further downgrades we believe stems mainly from the advertising markets, if they do not improve as expected in the second half of 2010.

– In chemicals, negative rating trends are expected to improve relative to 2008/09, although under-utilisation of assets and increasing working capital requirements as demand picks up will, in our view, be likely to maintain pressure on cash flow measures.

– Ratings prospects for capital goods producers is in our opinion likely to remain negative overall through most of 2010, reflecting relatively low demand and excess capacity.

– Forest product companies’ rating outlook continues to be driven by a combination of weak economic conditions, poor demand, and pricing pressure. We believe prospects appear relatively better for packaging companies than for forest producers.

– Challenges, we believe, will continue in the automotive and auto components sectors, as European car sales are expected to fall in 2010 following the phasing out of various government sponsored sales incentive schemes. Business prospects for light and heavy commercial vehicle production appear relatively worse, in our view, compared to auto manufacturers.

– The utility sector, we believe, is exposed to the execution risk of planned corporate disposals, continuing cost cutting programmes, and their commitment to longer term capital investment. On balance, this leaves the overall rating outlook for the sector negative, in our view.

– Greater ratings stability is anticipated in the building material sector following downgrades in 2009 as low construction volumes (particularly for commercial property) are expected to be mitigated by the full year impact of recent severe restructuring programmes.

– Other sectors expected to be stable, reflecting the combination of what we view as relatively more resilient business conditions, low cyclicality, and/or generally significant headroom for key financial ratio targets, are aerospace and defence, pharmaceuticals, investment grade telecom, consumer goods, transportation, infrastructure, mining and food retailers.

Standard & Poor’s 2010 OutlookContinued from page 13

If you would like to know more about the issues discussed in this article then please talk to your usual contact at Standard & Poor’s or:

Taron Wade E: [email protected] T: + 44 (0)20 7176 3661

Paul Watters E: [email protected] T: +44 (0)20 7176 3542

We believe prospects appear relatively better for packaging companies than for forest producers.

In chemicals, negative rating trends are expected to improve relative to 2008/09.

Negative rating trends are expected to persist in retail.

A new regulatory landscape How can the loan market survive?Barbara Ridpath, Chief Executive – International Centre for Financial Regulation

The loan market prides itself on being largely unregulated. This is likely to remain the case. However, this does not mean that the loan market will remain untouched by regulatory changes to the banking industry. The search for enhanced safety in the banking market means many of the regulatory changes imposed upon banks are likely to have direct effects on the capacity and pricing of loans in the future. However, potentially even more dangerous, will be the secondary effects of regulations. It is often these ‘unintended consequences’ that are the true legacy of regulatory reform.

After a brief reminder of some of the key lessons of the 2007-08 financial crisis, this article will explore the possible changes to come in the lending market.

Lessons from the financial crisis: the four ‘Cs’Connectedness The interconnections among market participants have multiplied exponentially over the last lending cycle.

This is as true in the syndicated loan market as anywhere else in the market, perhaps even more so. Between origination, sales, hedging with credit default swaps or their indices, and creation of collateralised loan obligations (CLOs), and synthetic CLOs, it is arguable that counterparty exposure to all these borrowers – and certainly to the lenders involved – was dramatically increased, not decreased in the run up to the crisis. But, surely that’s not the effect these techniques were supposed to have? The problem was rather that there weren’t enough sales to genuine third parties, as people assumed there were, particularly when the now extinct structured investment vehicles (SIVs) are included in the game. The whole set-up began to look a little like one of those shell games on the streets of Manhattan.

Correlation This was another ruse. No one in the financial sector had good data for correlation, so there was some significant guesswork in CLO modelling on correlation across countries and industries for loan portfolios. Suffice it to say that these loans were far more correlated in a downturn than the numbers suggested. Clearly there is a huge risk of correlation among all financial products when faced with a liquidity squeeze and a downturn combined. Models will, therefore, need to be rebuilt, and their assumptions reconsidered to reflect these facts.

Confidence Like credit, confidence is most readily available when you need it least. It is based entirely on sentiment, not fact, and – in a world of globalised communications – its disappearance moves at Google speed. Its reappearance is far more gradual, but an absolute necessity to the strength of not only the financial system, but of the economy as a whole.

And, finally, cyclicality The next time you hear anyone say that an end has come to banking and credit cycles, that ‘boom and bust’ is history, or that we have entered a ‘paradigm shift’, you will know that it is time to exit the market.

All four of these issues will be factors to be aware of in future cycles for the wise lender.


The next time you hear anyone say that ‘boom and bust’ is history, or that we have entered a ‘paradigm shift’, you will know that it is time to exit the market.

Barbara Ridpath

What does it mean for the loan market?Figure 1 may have an uneven scale, but that should not obscure the basic point it demonstrates. The loan market needs to be aware that, in relative terms, the capacity squeeze in bank lending is taking its toll on the industry, and that borrowers are now going straight to end investors.

What is harder to fathom than these basic volumes, however, is what is happening on the structuring side. This is clearly a more complex and subtle area, where effects may be more qualitative than quantitative. Figure 2, for example, shows hardly any change in the number of covenants since the crash, which is counter-intuitive. This is a rough measure, but it paints a very different picture from a recent survey by Allen & Overy of their partners that suggests a significant tightening of financial covenants, events of default and non-financial covenants. What seems likely, therefore, is that attention is being paid to the substance, and not the number, of the covenants.

It is interesting – and surprising – that some of the ‘covenant lite’ transactions appear to have held up well, when it is quite certain that those are the ones that most worried the bankers.

This is because private equity investors have had strong incentives, based on their own equity and debt positions, to keep the companies in the working capital they need to stave off insolvency. It will be interesting to see how the lessons of this experience work their way through the next cycle. For the moment – not surprisingly – while private equity transactions are just beginning to reappear and gain pace again, the share of equity in the overall financing of the transactions has risen dramatically.

What to look out for on the regulatory agendaWhatever the outcome of regulation now under discussion, the consequences, intended or unintended, for bank behaviour are important to consider. The following four business issues will depend crucially on the outcome of current regulatory debates:

1. Convergence of regulation across borders is desirable for the large multinational players in the industry. This can help ensure there is no risk of disadvantage based on jurisdiction – such as the risk that foreign competitors, who could have lower regulatory capital costs, may have a clear pricing advantage.

2. Pricing will need to change to cover potentially higher costs of capital, and other increased charges and operating costs resulting from changes to regulation. This will be one significant input into the relative competitiveness of the loan market vs. the bond market.

3. As pricing changes, including some specific charges for trading books and securitisation, the relative profitability of different banking business areas is likely to change. Senior bank management will have to make hard choices about which businesses remain attractive and which to exit.

4. Unless the regulatory net is drawn very widely to encompass all potential players in the financial services market, it is extremely likely that new (non-bank) competitors will emerge to do some of these businesses without the compliance and capital costs.

In addition to bank capital and potential leverage ratios, the loan market will also be affected by changes to the treatment of securitisation, the future of OTC derivatives as it affects credit derivatives, changes to the treatment of the banking versus trading book, fair value accounting changes, and – in the UK – changes to liquidity requirements.

However, this litany of changes may not be as daunting as it first seems. Initial research suggests that, given the highly levered nature

Senior bank management will have to make hard choices about which businesses remain attractive and which to exit.

The loan market needs to be aware that, in relative terms, the capacity squeeze in bank lending is taking its toll on the industry, and that borrowers are now going straight to end investors.

A new regulatory landscapeContinued from page 15


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of the loan industry, pricing may not need to change dramatically to meet new capital guidelines. However, while this is not a problem in the current market, which has seen many players at least temporarily withdraw, it may become an issue as competition returns to the market.

Second, the rules will change only gradually. These negotiations take time, and – especially with public and political pressure likely to recede – it may be some time before guidelines are finalised. Also, all regulators recognise that too quick an imposition could choke off any recovery – given the direct impact of the changes on credit growth – and thus GDP growth.

In order to think about potential changes in composition and distribution as a function of changed regulation and the speed of recovery, it is worth looking at the case of the United States in particular. It is well known that America is the most ‘disintermediated’ market in the world, with bonds and commercial paper finance making up a far larger share of corporate funds than in Europe. It is also true that, for as long as the Euromarkets have existed, some have expected the same phenomenon to occur in Europe, but it has not.

However, corporate treasurers’ current concerns about the reliability of their bankers suggest that just such a change may be approaching in Europe as well. Borrowers have found themselves increasingly dependent on a smaller and smaller handful of banks, which withdraw credit when it is needed most. Unsurprisingly, such borrowers are not happy. In addition, given proposed bank capital guidelines, it is quite possible at the least that the share of bonds and notes compared with loans in a corporation’s funding arsenal may become increasingly significant, as a result of the new regulatory framework.

This restructuring of the financial system may also bring new competition for the banks. Will the Barclays vehicle, Protium 45, just close when it runs down its asset book? What about the backward integration of the private equity and venture capital houses? The loan market’s new competition may look very different from the traditional competition, and the institutions which the LMA represents may be very different in a few years’ time.

The extent to which these effects end up being felt by the industry depends largely on the regulators’ ability to widen their net to prevent a re-establishment of the shadow banking system. Market participants are quick and nimble, especially when it comes to seizing opportunities, and the regulators, absent a step change in resources, will be constantly playing ‘catch-up’, as they are now.

Transparency in the loan marketAnother key issue of concern, and one which is being targeted across financial services, is transparency. Every regulator will say they are for transparency. But it is much less clear what transparency means in practice. Transparency reduces the ability to make a margin on a transaction, and limits the ability of the intermediary to profit. There are important debates to be had on secondary pricing of loans, disclosure of trades, changes in voting rights, and negotiations between lenders and bond investors.

Add to this question the issue of information movement between the public – trading – side of the bank, and the private –lending – side of the bank. Perhaps, fortunately for the loan markets, most regulators have more pressing matters to decide in the near term, but these are issues that will be coming back, again and again, as the loan market regains some momentum.

The reputations of traditional corporate lenders have taken a bashing. It is not clear that their clients still trust them, and some of those clients will decide to limit their use of banks as much as possible. Nevertheless, one unintended consequence of the market meltdown has actually been a reduction in the competition, which should help banks’ market share and pricing power. On the other hand, it is clear that an entire new class of competition may be under development. It would be wise for those in the loan market to continue to scan the landscape for potential new entrants in guises that might be unexpected. Also, for some time, the relative costs of lending will remain higher if the regulators have their way. Watching where the pricing equilibrium between the bond and credit markets settles will be a key determinant to future volumes.

The key to success for the loan market will, therefore, be getting the balance right between client service and good old-fashioned credit skills, so that banks can once again be seen as a valued partner by clients. It may not be an easy task.

Initial research suggests that, given the highly levered nature of the loan industry, pricing may not need to change dramatically to meet new capital guidelines.


One of the affects of the recent turmoil in the credit markets has been the changing landscape of the secondary trading market. Several former players have disappeared, almost all that remain have changed their modus operandi and several new platforms have entered the market. These new businesses have come in a variety of shapes and sizes, with different approaches to filling in some of the void created by the reduction in secondary trading services historically provided by a small number of banks. Some are trying to rebuild the old model, others are focusing on a simplified broker model, and a few are crafting businesses based on what they believe to be the right combination of both models.

Look to the origins To understand some of the new trading desks it is important to look at where the traditional dealing desks started. Most secondary loan trading desks were born out of an expansion of the primary syndication teams, as a way to facilitate the odd transfer of a position between members of a bank loan syndicate, including increasing or decreasing the bank’s own hold position. As additional leverage entered the system, for example in the form of total return swap (TRS) programmes, investors with more frequent trading needs, such as CLOs and hedge funds, became active investors in the loan market. This increase in secondary

trading volumes created a boom for the trading desks but masked the fact that many remained as warehouses for large inventories of loans bought in primary. Evidence of the large books came about when, despite increases in bid/offer spreads through 2008, many of these desks posted losses for the year due to mark downs of their inventories.

With the turmoil in the credit markets that ensued, much of the personnel from these desks moved to other banks or to new ventures, taking with them a large part of the sourcing and distribution capability. As with the bond market, new platforms sprang up to provide secondary brokering of loans using that sourcing and distribution capability on an agency basis. In the bond market, settlement of trades with an agency broker does not need to differ in most instances from those with a larger financial institution, due to the public nature of the securities and the existence of clearing houses. However, the private and bespoke nature of loans has resulted in a wider variety of trading platforms. In its simplest form, the model that involves the least infrastructure and investment is to effectively act as ‘introducing broker’. In this format, the trading desk uses its sourcing and distribution knowledge to line up a buyer and seller, and then takes a fee while stepping out of the trade so that the seller settles the transaction directly with the buyer. Proponents of this strategy would argue that by removing the investment in a settlements team

Stuart Levett

New trading desksUnderstanding their role in the secondary loan marketStuart Levett, Managing Director, HY & Loan Trading – Cantor Fitzgerald


There are a few differences that arise from the true agency broking platform in loans that can cause issues for some clients.

and the capital required by the trading desk to settle the trades as principal, the business can operate on the smallest margin, which should result, at least in theory, in the lowest bid/offer spread and therefore highest level of price efficiency.

Client concernsThere are a few differences that arise from the true agency broking platform in loans that can cause issues for some clients. The first is the concept of ‘name give-up’. Due to the direct settlement between buyer and seller, each party knows the other’s identity. For some trades and counterparties this disclosure is not a major issue, but for many situations and clients, there is significant concern with entering into a trade knowing that someone with whom they do not have a trusting relationship will know their trading activities. The second issue that comes up is the potential lack of legal expertise to process all of the documents required to settle a loan trade, such as trade confirmations, transfer certificates, etc. While there are standard templates for many of the documents, the bespoke nature of each individual loan results in variations from these templates that require a certain amount of legal expertise to navigate. Some entrants into the loan trading market have attempted to address these two issues by enlisting a third party to settle their loan trades. Sometimes this only addresses

the latter concern by using outside counsel to handle the documentation while still allowing the trade to settle directly from seller to buyer. A few desks have managed to involve a separate entity through which the trades can also settle, thereby addressing the name give-up issue, but creating some challenges around KYC and resulting in counterparties facing a shell settlement entity instead of the trading desk with which the trade was executed.

The third issue arising from agency trading of loans surrounds the concept of trading ‘as principal’. Part of a loan trade involves making various representations and warranties to the counterparty and having the capital base to stand up to those representations, and also being able to settle a trade without the need to close both pieces of the trade at the same time. This aspect of loan trading is not entirely addressed by direct settlement between ultimate buyer and ultimate seller away from the trading desk that put the two together. In the opinion of Cantor Fitzgerald at least, in this aspect the more traditional principal loan trading platforms provide a higher level of service to their trading clients, certainly of settlement, and an overall ease to execution. For this reason, and as it already had the stable capital base required (evidenced by the recent investment grade bond issue), rather than simply hiring loan salespeople to build an agency business, Cantor Fitzgerald brought in veteran loan trading, legal and operations experts from

The first half of 2009 provided ample opportunity for fledgling businesses to grow as the liquidity provided by existing trading desks essentially dried up, but as the markets stabilise and banks address their issues, trading desks will need to establish their roles in the market for the long haul.

the largest banks to build a loan trading platform to trade as principal with its clients.

Different platforms will continue to exist because there is a significant investment associated with the build out of a principal loan trading platform. As a result, it becomes imperative to extract as much value as possible from that investment by providing additional services to clients relating to loans and leveraged finance, for example, at Cantor Fitzgerald, a full service capital markets and investment banking platform (with origination and bank loan agency capabilities). Providing these services, as well as other bespoke products such as strategic sub-participation arrangements, are just some of the ways in which the full suite of loan trading capabilities can be harnessed and platforms such as that being built at Cantor Fitzgerald can be of far more value to loan market participants.

The other differences among secondary loan trading platforms will be similar to the differences between secondary trading platforms for other types of investment products, namely in the level of research provided. As with the settlement infrastructure, some businesses will keep their investment in research to a minimum to remain as low-cost sourcing and distribution houses. Others will follow a similar strategy to Cantor Fitzgerald, making the investment to build out both investment banking and a significant research product to complement their loan trading services, as has been done with their trading desks across other investment products.

What the future holdsSo where will these various trading platforms fit into the secondary loan market going forward? The first half of 2009 provided ample opportunity for fledgling businesses to grow as the liquidity provided by existing trading desks essentially dried up, but as the markets stabilise and banks address their issues, trading desks will need to establish their roles in the market for the long haul. The trading desks of banks will garner a large portion of the market due to their infrastructure and ability to trade as principal, but they will inevitably be more focused on the loans in which they retain a significant hold position through the primary syndication. Some will trade on a private basis and others will decide to combine their secondary trading with their public security trading businesses to maintain greater flexibility to achieve a market-neutral business.

There also will likely be room in the market for a few boutique agency brokers, although it will be interesting to see how many of the new agency brokers survive. The further removed from origination business the trading desks

remain, the more they will have to focus on off-the-run or complicated credits where volatility and illiquidity take away a bank’s ability to trade it simply as an extension of its own position, particularly as investors view the trading desk as potential competition or conflicted parties due to their banks’ lending relationships with an issuer. There is certainly room for the boutique agency broker with a particular edge in a sector to flourish, but one would have to question whether there is enough business to support the rapid growth of these businesses without providing all of the principal services investors have come to expect from their trading desk counterparties.

Outlook for 2010The beginning of 2010 should bring additional change to the secondary loan trading market as the differences between the haves and have-nots manifest themselves into year-end compensation figures. There is likely to be an additional round of movement, particular among salespeople, as many will want to bring their sourcing and distribution capabilities back to larger, full-service investment banking operations.

Traditional loan secondary trading desks were developed as add-ons to the corporate lending businesses of commercial and investment banks. The financial crisis has caused some to grow and some to shrink. New businesses, such as Cantor Fitzgerald, a name historically known to many from 9/11 or its minority ownership of interdealer-broker BGC, have used the dislocation of the crisis to grow an investment bank out of their secondary trading expertise. And yet others have grown niche agency brokers. All of these trading desks have their primary focus on providing sourcing and distribution of loans for their clients, but each with its own take on the best way to add value and with its focus on the market. Time will tell which businesses thrive and are preferred by the client base and more importantly, whether or not there is room in the market for a number of different approaches.

New trading desks Continued from page 19


If you would like to know more about the issues discussed in this article then please talk to your usual contact at Cantor Fitzgerald or:

Stuart Levett E: [email protected] T: + 44 (0)20 7894 8565


Syndicated lending is a reasonably new phenomenon in the South African market, which dominates activity in sub Saharan Africa (SSA). Due to the limited number of lenders and available assets, borrowers have most often funded themselves through the use of bilateral loan facilities. The syndicated lending market is however gaining greater acceptance by local borrowers as they are seeing stronger liquidity and pressure from lenders to be on equal terms and economics.

Transactions on the African continent also tend to be quite bespoke, as much of the economic activity on the continent is driven by infrastructure development and resource based projects. In addition to the bespoke nature of lending in the region, deal volumes are not as robust as in Europe, and one often finds that transactors and lawyers work on a wide range of transactions, bringing their unique influences and experiences to each transaction.

African markets tend to be more private than the international markets; a quick glance through a dealogic generated list of transactions in the region will show that deals, margins, fees and participation levels are seldom made public.

The pricing processWith fewer deals and little public information, the pricing discovery process is a little more complicated in the region. This is further amplified by the market having a wider range of

costs and varying interpretations of capital treatment and allocation under Basel II.

To further complicate matters, most companies in the region do not have credit ratings; for example, only 25 companies in South Africa are rated by Moodys, Fitch or S&P.

With poor market liquidity, sparse information, differing costs and difficulties in getting a coherent view on risk across the market, lenders become quite reliant on return models such as Return on Risk Weighted Assets (RORWA) and Return on Economic Capital (ROEC). Two key variables in the returns modelling are Probability of Default (PD) and Loss Given Default (LGD). PD is often calculated off the Estimated Default Frequency (EDF) parameter produced by Moodys KMV. A key driver to the EDF parameter is a measure of asset volatility. With limited liquidity in the equity markets and under current macroeconomic conditions, one finds that PD’s are volatile, introducing further complexity as returns vary between lenders and over the course of the transaction.

Due to the private and new nature of the syndicated lending market, borrowers in the region are often wary of the way deals are priced. There is often a wide view on what the appropriate price is on a transaction, introducing further stress, as lenders will often push to the higher end of the range and borrowers will want to push to the lower end. This dynamic has actually resulted in a number

Crofton McLaughlin

Rudy Wuite

The South African and Sub Saharan Africa syndicated lending market Crofton McLaughlin, Director, Head of Distribution CIB SA and CIB Africa – Standard BankRudy Wuite, Senior Manager, Loan Syndication and Sales – Standard Bank


of transactions in South Africa where borrowers have managed to get participants into a syndicated loan on a bilateral pricing basis but using a common terms agreement within the syndicate.

Cost of fundsWith fallout from the global financial crisis, local banks have seen significant volatility in costs of funds. In South Africa a reasonably good publicly available indicator of the banks’ marginal wholesale cost of funds is the difference between the rates on Negotiable Certificates of Deposit (NCD’s) and the appropriate point on the swap curve. The graph below illustrates evolution of the swap rates (Bloomberg : SASW1 Curncy), average NCD rates (Bloomberg : SADR3 Curncy) and the difference between them.

The red line in the plot above, read off the right hand y-axis, shows the significant current level of volatility and steady increase in the banking sector wholesale cost of funds.

Local lenders have been using the difference between NCD rates and the swap curve in loan documentation to protect themselves from significant changes in their funding costs. Borrowers have been quite understanding of lending conditions and within reason have been willing to accept these risks.

Documentation precedentsDue to the historic bilateral nature of the regional loans market, in house loan documentation standards have been preferred by local lenders and legal counsel. With institutions like Standard Bank expanding its international footprint, Absa having Barclays as a majority shareholder and use of international markets by borrowers, documentation standardisation and convergence to LMA standards is gaining significant traction. The South African banking sector is currently

in the process of formulating its own association and is already discussing draft documentation based on the LMA.

Most of the banking and finance lawyers representing both borrowers and lenders across the region are becoming more and more familiar with LMA documentation and practice notes. International loan documentation courses such as those hosted by Euromoney are seeing strong attendance by delegates across the region, and there are courses hosted in Johannesburg a number of times in a year.

A key element to transactions in the region is the lender mix: to achieve maximum liquidity borrowers often need to turn to institutional investors such as Old Mutual and Sanlam, which are insurance companies. Having a mix of insurance companies and banks in a single syndicate and facility can post significant challenges, as one ends up with a bank market deal with strong USPP characteristics. For example, the R6.45bn deal done for Vodacom (subsidiary of Vodafone) had terms and conditions specific to the life insurance companies separately tranched. The insurance companies also have limited treasury capacity and find it difficult to fund transactions that are not fully drawn with bullet repayment profiles.

Key areas of difference between LMA and local documentationLMA documentation precedents are formulated with large syndicates in mind. Many of the administrative clauses and voting mechanics are well suited to the smooth functioning of an expansive syndicate. African deals by contrast have fewer lenders with a broader mix of institutions and are more like club transactions. As a result, many of the divergences off the LMA standards are related to deal mechanics and voting procedures. Minority pari passu lenders will often insist on a range of protections, extended rights to vote, and sometimes will insist on rights particular to a class of lenders. For example, the insurance companies will often have a differing view to the banks and will often seek enhanced voting rights to ensure that they are not dictated to by the banks.

Many banks in the region do not have dedicated agency teams and transactors often wear a deal until its final maturity date. This dynamic can pose challenges given provisions of the Competitions Act and Chinese wall constraints.

Regional lenders will also often insist that agents have very limited powers and will not allow the agent to do anything (even if only administrative in nature) unless the agent has the prior written consent of the requisite majority.

The South African and Sub Saharan Africa syndicated lending marketContinued from page 21

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Source: Bloomberg


Market disruption and lender/agent default is a current hot topic in the local market. Over the last few months many deals have taken the form of recent LMA precedent even though one could argue that the precedent and differing interbank mechanics probably do not work all that well in the regional market. The market is still bedding these ideas down and will soon establish its own more relevant precedents.

Black Economic Empowerment (BEE)In South Africa and countries such as Namibia, various pieces of legislation exist that are aimed at correcting socioeconomic imbalances that have arisen due to inappropriate policies of prior political administrations. As a result of this legislation, companies need to have appropriate shareholding structures and policies such as affirmative action to ensure that they are BEE accredited. For companies that are strongly reliant on government contracts and licences for their business, lenders will require significant protections against loss of, or changes to, BEE credentials.

The business requirements of the BEE process find their way into loan documentation through a combination of information requirements, undertakings, covenants and representations. Enforcement of security is often also further complicated by the BEE process, as the validity of licences and other contracts can be affected by lenders exercising step in rights.

Corporate financeIn a similar fashion to recent trends in Europe there have been a limited number of leveraged and acquisition finance deals coming to market. The local markets are however still open and liquid to provide replacement and new capital to high quality corporates. An interesting and apt illustration of this is recent activity of multinational corporates in the debt markets. Corporates with treasuries outside of Africa are increasingly using local markets for additional group liquidity and to achieve a lower overall cost of debt.

Acquisition and leveraged finance Activity in the leveraged and acquisition finance space has been limited in the region over the period of the economic downturn. Due to sparse deal flow, trends and precedents in this sector are difficult to distil at this point in time.

An interesting trend to note is that many financiers that cover this space have been looking at a broader range of transactions whilst the market has been relatively quiet. This has resulted in this particular sector becoming more familiar with the LMA precedents.

Project FinanceAfrican infrastructure development has been a substantial driver of transactions on the continent. With various projects gaining the backing of international Developmental Financial Institutions (DFI) and Export Credit Agencies (ECA), documentation and deal precedents track international best practise. Both local and international banks are re-establishing their appetite for underwritten transactions but are certainly lending more cautiously.

Looking forward, lenders are likely to require more substantial feasibility studies, increased equity contributions and competitive technology.

Concluding remarksLocal markets have not been as severely impacted as their foreign counterparts over the period of the latest credit crunch. Lending conditions have tightened but the markets have generally speaking been open for business, especially for the right names.

The LMA is starting to become an influential part of the region’s thinking around the loan product and the continent’s strongest local banks are currently in the process of forming their own very similar association.

Even though the LMA standards are not always followed closely, legal and banking professionals are increasingly consulting LMA documentation and practice notes to broaden their thinking, understanding and applicability to the local markets.

The LMA is becoming increasingly relevant in the region as Africa modernises and starts becoming more relevant globally. African banks are becoming members of the LMA with banks such as Standard Bank, Investec and Absa (through Barclays) all being current members.

The LMA is becoming increasingly relevant in the region as Africa modernises and starts becoming more relevant globally.


Regulatory update

US Loan MarketMeredith Coffey, Senior Vice President, Research and Analysis – LSTA

Though it seldom captures the headlines of popular newspapers, the syndicated loan market is extremely important to companies; in the US alone, syndicated loans supply almost US$2.9 trn of financing to corporates. However, this could change. A number of regulatory reform initiatives have the potential – however unintentionally – to profoundly disrupt the syndicated loan market.

A particular threat arises from legislation that would require securitisers to keep ‘skin in the game’. There are two securitisation reform proposals being developed: The US House of Representatives Finance Committee’s Draft Bill (which would impact both syndicated loans and possibly CLOs) and the Senate Banking Committee’s Draft Bill (which probably would not affect loans, but would impact CLOs). While undoubtedly well-intentioned, the

unintended consequences of these reform proposals could hamstring the recovery of both the syndicated loan market and the CLO market. The result would be i) reduced credit availability for US companies and ii) banks with more concentrated portfolios.

House of Representatives: Syndicated LoansThe Draft Bill from the US House of Representatives would “require creditors to retain 10% or more, of the credit risk associated with any loans that are transferred or sold including for the purpose of securitisation”. This position cannot be hedged. Similar to the EU’s risk retention proposal in 2008, this language is so sweeping that it would likely capture syndicated loans as well as securitisations.

The LSTA has argued this sweeping language is inappropriate for several reasons. First, syndicated loans are very different from the securitisations that the House Bill is trying to capture. In particular, the LSTA has noted that syndicated loans are relationships between borrowers and lenders, that borrowers provide on-going information to syndicate members, that borrowers will return to the bank group for amendments periodically (allowing the loan terms to be reset to market terms), and that US syndicated loans borrowers are usually rated (providing transparency). Second, the LSTA noted the proposed language is very broad, perhaps capturing all primary market lenders to a borrower. This, theoretically, could restrict a bank group to just 10 lenders – a situation that is highly problematic for large borrowers. As an example, ThomsonReutersLPC’s DealScan database tracks more than 500 US loans of US$1 bn or more that were arranged 2007. Under the House Bill, these loans could theoretically be restricted to 10 lenders, and each lender would hold (unhedged) at least US$100 mn. Even if this were feasible, it would create bank portfolios with large exposures to just a few individual borrowers. In the end, banks would end up with more concentrated exposures, and borrowers would end up with smaller and more expensive loans. This is not a good solution for anyone.

Meredith Coffey


Aligning this legislation to reflect the reality of the loan market …will ensure the loan market remains a vital and vibrant source of financing.

Even if the House language were confined to requiring only the originator to hold 10%, the amount of available financing would still be reduced. With many large US loans boasting five or more arrangers, the lead group might need to hold 50% or more of a jumbo loan. This would again lead to large, unhedged exposures and smaller, more expensive loans. The LSTA has noted it is market practice for lead lenders to retain some exposure on revolvers; however enshrining a fixed number – like 10% – does not take into account different situations. For instance, a bank may be quite willing to hold 30% of a US$100 mn loan (or US$30 mn), while holding 5% of an US$8 bn loan (US$400 mn) could be bad risk management policy.

In turn, the LSTA has urged the US government to follow the lead of the EU Capital Requirements Directive and exempt syndicated loans from its securitisation ‘skin in the game’ legislation.

Senate: CLOsWhile the House Bill is so broad it may capture syndicated loans, the Senate’s Bill specifically targets Asset Backed Securities (ABS) and CDOs. CLOs are likely to be captured under the CDO definition.

Due to the way the risk retention language is written, it would likely cripple the re-emergence of the CLO market. As CLOs provided the bulk of institutional demand in 2002-2007 and currently hold some US$250 bn of outstanding leveraged loans, anything that hinders the recovery of the frozen CLO market could also hamper the recovery of the leveraged loan market.

The Senate’s proposed securitisation Bill probably means to target ABS and mortgage securitisations in particular. However, the LSTA argues that the sweeping language will pick up CLOs – a product that has many characteristics that make it particularly safe and transparent. First, most cash flow CLOs are actively managed by experienced, well-known and well-trusted asset managers. Second, CLOs have a number of tests that require managers to maintain the quality and diversification of their loan portfolio. Third, most CLOs have pieces of just 100-200 large corporate loans in them; the CLO managers know each of the loans, and make daily decisions on whether to buy or sell these loans. Fourth, the underlying US corporate loans are large (over US$100 mn), transparent, publicly rated and publicly priced. Fifth, the investors in these CLOs receive monthly trustee reports that detail the performance of the portfolio – and the performance of each individual loan. Sixth, the CLO managers don’t get paid unless the CLOs perform. There’s very little that is mysterious, opaque or nefarious about CLOs.

Next, the role of the ‘securitiser’ is very different for CLOs than for many other securitisations. The Senate presumes that securitising banks simply package their assets up and sell the resulting ABS (or CDOs of ABS) to investors that might not know what they’re buying. In contrast, for cash flow arbitrage CLOs, the structuring bank works as an agent for experienced and trusted asset managers. An asset manager will engage a structuring bank to go out and actively buy loans for a new CLO. Some of these loans might have been originated by the structuring bank, but most of them are originated by other banks. Most importantly, the asset manager tells the structuring bank which loans to buy.

Finally, considering the magnitude of the financial crisis, CLOs have performed remarkably well. It is true that Moody’s did downgrade roughly 71% of CLO Aaa notes. However, almost 70% of the downgraded Aaa notes remained rated Aa. This is the second highest rating category that Moody’s offers. So, despite suffering through the worst financial downturn since the Great Depression, nearly 80% of CLO Aaa tranches remain rated Aa or better. In less contentious times, this would be considered a remarkably good performance.

For all these reasons, CLOs should not be seen as a problem to be solved. Moreover, subjecting CLOs to legislation meant to fix other market problems will penalise leveraged companies that need financing. Requiring the structuring bank to retain a 10% risk position of every CLO they structure would simply make CLOs uneconomic. Thus, it would create yet another hurdle to the return of the CLO market, the return of loan securitisation – and the return of credit to US companies. Because of all these factors, the LSTA is arguing that CLOs should be exempted from the risk retention plank in the securitisation Bills.

OutlookSecuritisations are just one regulatory reform impulse that will affect the loan market; OTC derivatives reform may hamstring the loan TRS market and Private Fund registration might quash any recovery of smaller CLO managers. However, it’s the ‘skin in the game’ legislation that could smother a recovery in the overall US leveraged loan market. In turn, aligning this legislation to reflect the reality of the loan market – that originators usually do keep skin in the game (but that one size does not fit all), that CLO structuring banks simply act as agents, and that CLO managers already have interests aligned with their investors – will ensure the loan market remains a vital and vibrant source of financing for companies.


Spotlight on:

The Australian loan marketInterview with APLMA Board member and Chairman of their Australian Branch, Gavin Chappell, Executive Director, Head of Loans and Syndications NSW – Westpac Banking Corporation

Q: The Australian market has largely avoided the worst consequences of the economic crisis and the ‘credit crunch’. To what do you attribute this?A: As I am sure that you are aware, the Australian economy has avoided recession and performed above the expectations of most economic forecasts. Several factors have contributed to Australia’s resilience, including consumer and government spending, Australia’s sound banking system and the ongoing demand for commodities.

Australia also went into the economic crisis with considerable momentum, particularly in the mining sector, and with significant pent up demand in the housing sector and a labour market that was overstretched in early 2008.

Government incentives for first time homebuyers have also supported an upswing in building activity. Prudent fiscal policy of prior years has also left Australia with no net public debt, allowing the government in part to spend its way out of the crisis. Cash transfers to the household sector, the A$14 bn school building spend and business investment incentives have assisted in supporting disposable incomes, non-residential construction and business investment respectively.

Our banking system has remained sound and profitable, and in conjunction with relatively high pre crisis interest rates, this has allowed monetary policy to be effective.

The other key ingredient is that Australia, as a significant commodity producer, is benefiting from the resurgence of China. The policy stimulus measures of the Chinese have had a significant impact on Australian exports. With the rebound in Chinese commodity demand, our exports increased during the first half of 2009, at a time when global trade was contracting.

Q: To what extent will the focus of Australian banks shift towards Asia and away from Europe as the balance of economic power changes between the continents?A: I certainly wouldn’t go as far as saying there has been a shift away from Europe, although I wouldn’t expect significant new investment

A$ spent in the region in the near term. I would probably best describe the Australian banks’ presence in Europe as stable.

That said, Asia is most definitely gaining greater attention from each of the four key Australian banks, not least because of our proximity to Asia and the greater reliance that Australia has on the region for the country’s growth moving forward. Australian export growth to the region in recent years has been significant and as a result the region is gaining more attention from not only the financial sector but equally a significant proportion of Australian businesses. The result of this is that the Australian banking community all wish to be in a position to support both our key clients and other potential target customers offshore.

Q: Can you provide a brief overview of current loan market conditions in Australasia, looking at corporate, leveraged and project finance. A: Like everyone, we went through a period post Lehman’s collapse of significant market uncertainty, with limited deal flow. Since this time, developments or improvements in the market have been occurring at a faster (or slower) pace depending on which of these sectors that borrowers find themselves in.

Corporate BorrowersRated investment grade corporates now have the greatest flexibility in the market they can approach, as most have access not only to the bank market but also domestic and offshore bond markets. Rating is one factor that is impacting bank loan market liquidity, with investment grade borrowers in non-cyclical sectors having a reasonable level of liquidity, such that anything other than the really large deals of a few years ago can now be accommodated.

The market is more challenging for unrated borrowers or those in cyclical sectors, although deals are getting done. Deals do obviously need to be considered on a case by case basis and we are starting to see the return of underwriting in a measured way even for some of the slightly more challenging transactions.

Gavin Chappell


Asia is most definitely gaining greater attention from each of the Australian banks, not least because of our proximity to Asia and the greater reliance that Australia has on the region for the country’s growth moving forward.

We are also starting to see the early signs of downward movements in pricing since the peak in around May this year, with Australia currently being one of the higher priced loan markets globally.

Project FinanceThe project finance market arguably has the greatest amount of liquidity at present, demonstrated by the highly successful Victorian Desalination Project syndication for approximately A$4 bn. This deal has demonstrated strong liquidity for an appropriately structured deal with the right sponsors and at the right price.

While this transaction met many of the lending criteria of a number of banks globally that may not be available on all transactions, it has demonstrated that big volume deals can again be considered and underwritten in this market.

Project Finance is dominated at present by PPP’s, with a significant number of transactions likely to occur over the next 12 months.

Leveraged FinanceThe Leveraged Finance market has been the slowest market to recover, not only because of a lack of liquidity, but also because of the time it has taken for vendor and bidding expectations on price to become more closely aligned, and existing portfolio stress to be worked through.

Over the coming year we do expect to see an increase in M&A related activity, which will provide a boost in activity for the mid-cap leveraged market, where sufficient liquidity in the loan market exists to get deals done. However, market conditions remain such that it will be quite some time before the large A$1 bn plus debt syndications start occurring again.

Q: In Europe we are seeing corporate bond issuance significantly overtake syndicated corporate loan volumes. To what extent are you seeing a similar trend, and if you are, do you see this as a long term change in the dynamic between the products? A: We have similar dynamics here as in Europe, although there are additional factors in play.

Corporate borrowing in Australia has historically largely been dominated by the bank market, with domestic corporate bond issuance a relatively small proportion of the overall funding mix for the corporate sector. The larger borrowers have also historically accessed the offshore bond markets (particularly the US), where diversification, volume and tenor was sought, as the market for corporate borrowers in the bank market was, pre global financial crisis (GFC), effectively capped at five years.

Post GFC the size of deal that is now achievable in the domestic loan market has fallen for a number of reasons, including:

– Banks either exiting the Australian market or refocusing their business to a narrower range of key customers;

– Lower overall hold sizes driven by not only GFC related issues, but also the relative strength of the A$ impacting the size of a commitment in a bank’s home currency.

Why this is important is that an overall smaller loan market capacity will increase the importance of the domestic bond market.

Another important point is that while banks have ample access to funds, the cost of these funds is still relatively high, especially for longer terms. In contrast, bond investors are willing to buy corporate paper with longer dated maturities than seen previously; we are currently seeing a willingness in Australia to move out to 7 and 10 years – maturities that have not been well bid in the past.

Whether this results in a long term shift in the market will depend on the ability of each market to adapt on a long term basis to the competitive pressures that each face over the next three-five years.

Committee Update

Following an approach to the LMA at the beginning of the summer from a group of mezzanine investors, we held a number of discussions with them about intercreditor issues of particular importance to this investor base, and as a result, have published a revised edition of the Intercreditor Agreement and User Guide. Most of the changes take the form of options/provisions in the Intercreditor Agreement, or notes in the Agreement or User Guide, highlighting areas which are likely to be negotiated on a case by case basis. These include:

Restructuring Issues– Controls on Security Agent’s powers

to release Transaction Security and Creditors’ claims when making a disposal as part of an enforcement

– Payment of professional adviser fees in the context of a restructuring

Mezzanine Payment Stops– Trigger for service of a Mezzanine

Payment Stop Notice– Maximum number of Mezzanine

Payment Stop Notices– Illegality

Restrictions on Senior Lenders’ ability to defer or capitalise interest or fees

Ability of Mezzanine Lenders to agree changes to Mezzanine Interest and to agree deferral of repayment under the Mezzanine facility.

Cross-default provisions in Mezzanine facilities

For a full description of these changes, see the explanatory memo on the LMA website.

InsolvencyOur Insolvency Working Party has continued to work on producing a template for what is desirable in a successful insolvency regime. However, over the summer, work focused on producing a response to the UK Insolvency Service’s consultation paper – Encouraging Company Rescue. Whilst welcoming any efforts to improve the UK insolvency regime, we communicated our concern that the initial proposals looked to alter the existing priority of security.

The uncertainty this could have created would have been likely to result in an increase in the cost of loans and a reduction in the availability of credit. We have subsequently maintained contact with the Insolvency Service, and will be involved in the further consultation on their proposals to extend the availability of CVA’s to all corporates and the extension of moratoria.

TaxThe Tax Committee has also commented on a number of issues. We have continued to press HMRC to move forward with improvements to the UK treaty clearance procedures – preferably by introducing a ‘passporting’ system for lenders. There have, in addition, been several recent changes of tax law that have had a potentially deleterious effect on our members’ activities. For example, we made representations to government noting that the initial form of Clause 59 to last year’s Finance Bill would have imposed a punitive tax liability on UK banks, and were pleased to see that this provision was subsequently amended. Another more recent example is the legislation relating to buy-backs announced in a Ministerial statement of 14 October. This, whilst targeted at certain arrangements HM Revenue & Customs regard as avoidance, may in practice make it considerably more difficult to restructure companies that are in financial difficulty, and we have sent a comment in to government to this effect.

Legal ForumFinally, the Legal Forum has continued to press for a resolution of Brussels I, an issue which continues to create uncertainty around choice of jurisdiction in contracts.

We would like to thank all our volunteers for their contribution this year. We look forward to working with them on our busy agenda for 2010.

Documentation work in the last six months has been mainly focused on the secondary trading documents (see article on pages 5-6) and the Intercreditor Agreement.


A number of banks have satisfactorily resolved the confidentiality issue and are now actively using loan ID numbers in their systems for position reconciliation purposes. Also, at the time of writing, one bank had successfully generated an FpML message and others are anticipated to follow suit rapidly.

However, despite the rapid pace of ongoing development and implementation, the reality is that the wider market has yet to fully come to grips with the issue.

It is fully recognised that incorporation of system solutions into existing IT platforms, aligned with extraction of relevant data from internal systems, will take time and require resources and investment. Nevertheless, given the increased pace of development and the interest among regulators in settlement delays in the loan markets, the LMA urges all market participants to initiate research into what is available by way of system assistance and evaluate what would best suit their requirements.

So what are the issues, and why has momentum built up?

Unique Identification NumbersClearly, the first, essential step in using system solutions is the application of unique ID numbers for both loans and market participants, and it is vitally important that the market adopts a standard, global approach.

CUSIP numbers for loans have been in use in the US for some years but it is only very recently that some banks have begun allocating ISIN ID numbers to European

loans. We recommend that market participants visit the ANNA website for information on the use of internationally accepted ISIN/CUSIP numbers1.

With regard to ID numbers for participants, Markit and Standard & Poor’s CUSIP Service Bureau are collaborating on building a global database of Market Entity Identifiers (MEIs) and, while there are likely to be different series of ID numbers for participants in use, the LMA recommends application of Markit MEIs as the global solution in line with the LSTA’s previous recommendation2.

Position reconciliation/Delivery-v-PaymentDifferences between positions in the agent

bank’s records and those of lenders frequently result in delays to settlement, and a number of banks have been working closely with vendors in developing position reconciliation platforms. Obviously, the LMA does not endorse or recommend any particular vendor or platform, but we strongly recommend that all loan market participants investigate what is available by way of reconciliation platform. Both DTCC and Euroclear are developing systems, which are fully explained on their respective websites under their respective Loan/SERV3 and LoanReach4 products.

A functioning reconciliation platform of this nature intuitively leads to the concept of trade matching and

During much of the summer, the banks most actively engaged in working with vendors in the development of position reconciliation and other platforms have been researching legal issues around the questions of provision of data to numbering agencies, but there is now a real sense of momentum on the loan operations/settlement front, with much progress being made.

Loan Operations Update

Time for Action


Loan Operations Update continued LMA Education and Events Programme 2010

8 January Revised Secondary Documentation TrainingDe Vere VenuesCanary Wharf, London

20 January Early Evening SeminarClifford Chance Auditorium, Canary Wharf, London

21 January Loan Operations Afternoon SeminarClifford Chance AuditoriumCanary Wharf, London

22-26 February LMA Certificate CourseCass Business School, London

February Early Evening SeminarDate and venue to be confirmed.London

3 March Madrid Afternoon SeminarOccidental Miguel Angel Hotel, Madrid

16 March Intercreditor Agreement TrainingDe Vere VenuesCanary Wharf, London

28-29 April Syndicated Loan Course for LawyersHolborn Bars, London

17-21 May LMA Certificate CourseCass Business School, London

9 June Frankfurt Afternoon SeminarHotel Maritim, Frankfurt


delivery-versus-payment, and vendors are actively working with market participants on such systems, which we understand will become available in early 2010.

E-messagingThe LMA has been working closely with the LSTA for some time in establishing agreed standard formats for a range of typical agent banks to lender messages5. Currently, the market relies almost entirely on faxes for Agent-to-Lender messages and the intention is that FpML messages will, over time, replace faxes as the method whereby agent banks transmit information. Whilst only a few agent message types are agreed, these represent 80% of all agent messaging, so material benefits exist in accelerating widespread implementation in the market. There will be considerable benefits in making this change, primarily standardisation and speed/certainty of delivery and, again, rapid progress is now being made. In Europe, several banks are testing sending/receiving such messages, with one European bank having successfully sent an FpML message to a US bank, a first in the market.

There are potentially a variety of ways of sending/receiving E-messages, and it is not practical for all these possibilities to be commented on here in a meaningful way. However, it seems certain that the use of E-messaging in the loan market will expand rapidly and, in the not too distant future, lenders will be expected to be able to receive such messages and, inevitably, faxes will be phased out.

SummaryWhile it is fair to say that progress in introducing system assistance to the European loan market has taken time, real progress is now evident, and the LMA has an important role to play in terms of promotion/education. Introduction of the type of systems and messaging capability discussed above are not only vital in terms of operational efficiency but also in relation to counterparty credit exposure and related capital requirements.

For banks and funds interested in finding out more about these initiatives, the LMA will be holding an afternoon seminar in London on 21 January, 2010, at which vendors will explain their platforms and plans, and a panel of banks will talk about their actions and aims.

There is no doubt that the incorporation of systems assistance in the loan operations/settlements space will evolve very rapidly over the coming months, and this will have a major impact on how the business is managed. Introducing changes on this scale will be complex, and we urge all market participants to initiate their own research and hold conversations with in-house IT departments as soon as possible.

We recommend that market participants talk directly to vendors about the current platforms and likely developments but, for more general queries or information on the LMA January event, please contact Mike Johnstone on +44 (0) 20 7006 2267 or at [email protected].

There is no doubt that the incorporation of systems assistance in the loan operations/settlements space will evolve very rapidly over the coming months, and this will have a major impact on how the business is managed.

1. Visit www.anna-web.com for a detailed explanation of ISIN/CUSIP numbers.

2. Visit http://indentifiers.wsodata.com. 3. Visit www.dtcc.com – Asset Services/

LoanSERV. 4. Visit www.euroclear.com – Euroclear Bank/

Services/LoanReach. 5. Visit www.lma.eu.com Members/Market

Information/Loan Operations for FAQ on this topic.


A must-attend event for all major organisations and industry professionals operating in the syndicated loan market.

From left to right: Julian van Kan, Global Head of Loan Syndications & Trading – BNP Paribas; Richard Basham, Co-Head of European Loans & Leveraged Finance – Citi; Marco Antonio Achón, Head of Credit Markets, Europe – Santander; David Bassett, Global Head of Syndicate – The Royal Bank of Scotland; Oliver Duff, Global Head of Leveraged & Acquisition Finance – HSBC; and Nick Jansa, Head of European Loan & High Yield – Deutsche Bank; and Tim Ritchie, Head of Global Loans – Barclays Capital.

Robert McAdie, Global Co-Head of Credit Strategy – Barclays Capital

Thomas Mirow, President – European Bank for Reconstruction & Development

Barbara Ridpath, Chief Executive – International Centre for Financial Regulation

Ian Fitzgerald, Chairman – LMA & Head of Loan Syndicate – Lloyds TSB Corporate Markets

The London Conference in pictures

LMA Syndicated Loans Conference Cocktail reception

The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual, organisation or entity. There can be no guarantee that such information is accurate as at the date of publication or that it will continue to be accurate in the future. No-one should act upon such information without independent professional advice. The views and opinions expressed in any article in this publication are those of the author of such article and do not necessarily represent the views and opinions of the Loan Market Association. Publication of an article does not constitute an endorsement by the Loan Market Association of the author, their organisation or any product or service mentioned therein.

© 2009 Loan Market Association. All rights reserved. Printed in the United Kingdom.

The authoritative voice of the loan market

LMA Achievements in 2009The projects undertaken by the LMA in 2009 were again heavily influenced by the ongoing challenging economic climate. LMA documentation held up well, but in response to evolving market conditions, revisions have been made to ensure it continues to meet the needs of members and the wider loan market. The LMA’s Events and Education programme was also revisited to reflect the issues impacting loan market participants, with several new courses successfully introduced. And, as always, the Association continued its general lobbying activities, reaching out to regulators and government in its role as the voice of the loan market.

February 2009New guidelines introduced for MLAs and recommendations on the Syndication Timeline.

March 2009New recommended form of Intercreditor Agreement launched.

April 2009LMA began dialogue with Insolvency Service concerning changes to UK insolvency regime.

June 2009Revised leveraged primary documents launched, including clauses addressing issues arising in light of the recent market turmoil.

UK Takeover Panel issued guidelines on disclosure of information to potential lenders following discussions with the LMA.

July 2009LMA launched guidance to market participants on amendments & waivers.

September 2009LMA hosted its second UK conference attracting 700 delegates, distinguishing it as one of the largest loan events in Europe.

November 2009Revised secondary trading documents completed, merging par and distressed.

LMANews Dec09 Final

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