Insights

From the inception of the secondary market for syndicated bank loans some 35 years ago, we have seen continuous movement in the direction of increased liquidity for the asset, but recent developments in this market point toward a reversal of this trend.

The Directive on Credit Servicers and Credit Purchasers was adopted by the EU in 2021 (the Directive) and the implementing technical standards (ITS) relating to the Directive have also been adopted by the European Commission. Member states (of the EU) were required to implement the Directive into local law by the end of 2023 and notably France, Luxembourg, Ireland and Germany have now passed laws implementing the Directive.

In the ever-evolving landscape of English law credit agreements in the European leveraged loan market, the dynamics of lending have undergone significant transformations in the last few years. One issue that has gained prominence is the increase in limits on the ability of lenders to transfer their loans and the associated restrictions imposed on potential new lenders. European syndicated loan agreements have historically included a standardised and expected set of transfer restrictions applicable to prospective lenders, reflective of the market guidance and templates issued by the Loan Market Association (“LMA”). Certainty of terms and the capability of an existing lender to sell out of a loan position have been the hallmark (and expectation) of the LMA loan market. However, trends in the drafting of credit agreements have contained a concerning increase in limitations on loan liquidity. As a result, many lenders are finding it difficult to sell their distressed loans. This article explores these trends, as well as their implications on the secondary loan trading market.

On 29 June 2023, the long-awaited Financial Services and Markets Act 2023 (the “Act”) received Royal Assent, clearing the Act’s final hurdle prior to its implementation. The Act is the framework for the UK’s post-Brexit financial legislative and regulatory landscape.  Focusing on the promotion of competition, innovation and investor protections, it hopes to ensure the UK’s continued leadership in the global economy by providing “a smarter financial services framework”. While the Act is 349 pages in length, we have set out some of the key themes and regulations currently making headlines.

In continuing with its efforts to promote greater liquidity and certainty in the U.S. secondary loan trading market, on July 21, 2023, The Loan Syndications and Trading Association, Inc. (the "LSTA") officially released a revised suite of secondary market loan trading forms, which revised forms are effective for LSTA trades entered into on or after such date. 

Participation agreements, in the form promulgated by The Loan Syndications and Trading Association, Inc. (LSTA), are widely regarded as dependable vehicles for conveying loan ownership interests from a lender to a participant as “true sales” in the United States.  But what if the underlying credit agreement describes the participation as a financing relationship between a lender, as debtor, and participant, as creditor?  The answer is unclear as a legal matter, and the existence of such language should give market participants pause if encountered in the loan origination or secondary trading contexts.

As debt issued by oil and gas exploration and production companies continues to trade at distressed levels, the secondary loan market has again focused on unique issues presented by the distinct lending structures developed to finance the exploration and production of energy — “reserve-based financing,” under which a lender’s commitment to lend is based on the predicted future value of the oil and gas reserves of the borrower that serve as collateral for the loan.

As the economic impact of COVID-19 continues to unfold, opportunities to purchase debt and claims at attractive prices from sellers who may be starved for liquidity have started to increase. In such periods of market dislocation, even good-faith purchasers may risk claims of “constructive fraudulent transfer”, “constructive fraudulent conveyance”, or a similar “claw-back” suit if the seller was (i) insolvent at the time of the transaction, or (ii) rendered insolvent as result of the transaction. Claw-back causes of action are typically asserted by spurned creditors of the seller that have unsatisfied debts, or by bankruptcy trustees or official committees of unsecured creditors if the seller subsequently files for bankruptcy.

Investment funds often need additional liquidity, particularly in a volatile market. If permitted under governing documents, they naturally try to leverage their investment portfolio. Finance providers, for their part, may hesitate when the portfolios consist of distressed loans, insolvency claims, high yield bonds and other illiquid financial assets. This note outlines structuring considerations and techniques for both sides in this situation.

Settlement certainty is a required feature of any global credit market. The secondary loan market aspires to that goal; however, ensuring absolute certainty of settlement has proven elusive due to several reasons, including the complexity of the underlying loan product. There are no robust electronic settlement platforms, transfer documentation is negotiated between counterparties, definitions of “eligible assignee” vary by credit agreement, and borrower-generated confidential lists of disqualified lenders, pre-qualified “white-listed” lenders and ineligible competitors further confuse the overlapping sets of entities that can or cannot become members of the lending syndicate. Numerous consents to transfer a loan may be required, including consents from the borrower, the administrative agent, the letter of credit issuer and other interested parties. And even if these hurdles are overcome, transfers of loans may be arbitrarily “frozen” by a borrower or administrative agent during a lengthy reorganization or restructuring.

Selling a “loan participation” is a common form of ownership transfer in the secondary loan market. What is being sold? The legal answer is that the seller (or “grantor”) sells, and the participant buys a “beneficial interest” in the loan. Who owns the loan? The answer is in two parts: the grantor continues to hold legal title to the loan, but the economics of the loan are now owned by the participant.

The secondary loan market uses a variety of transfer structures and settlement conventions to move the risk of owning a commercial loan from a seller to a purchaser. The widely-used distressed purchase and sale agreement (currently published in the U.S. by The Loan Syndications and Trading Association, Inc.) is derived from asset sale and assignment templates used by private law firms in the 1990’s. This article briefly describes the purpose and function of a purchase and sale agreement (a “PSA”) tailored for distressed loans.

Illiquid assets that trade in the secondary credit markets are often difficult to value. Calculating economic loss when a counterparty defaults on a trade requires a comparison between the original trade price and the fair market value of the asset on the date of breach. That poses a challenge for traders and their in-house counsel when deciding whether it makes economic sense to pursue litigation against a defaulting counterparty. Valuable time may be wasted if there is a singular focus on liability, rather than damages, during the initial sparring. Understanding how much money is at stake can lead to sound decisions as to whether to litigate, and ultimately, the best path forward.

Any party active in the global secondary loan market will, at some point, come across questions or concerns involving the formation of a binding contract. These may be questions regarding whether an agreement to trade was made, what terms of the trade had been agreed, or even how the rules of contract formation apply to a telephone call, email or instant message conversation. In this global market the first question is: which country’s law governs contract formation? The second question is whether oral trades are enforceable in that jurisdiction. 

In today’s distressed global financial markets, the emerging focus is once again on counterparty credit risk, as it was in the aftermath of the Lehman Brothers collapse a decade ago. The European secondary loan market uses a standard form “loan participation” to transfer borrower risk and the economics of a loan in the secondary market. Several forms of loan participations are published by the London-based Loan Market Association (the “LMA”). For those investors holding loan participations under the LMA Funded Participation, a particular topic of concern, in addition to the credit risk of the underlying borrower, is the credit risk a of the lender selling the loan in the market. The seller is called the “grantor” of the participation.