The International Comparative Legal Guide to: Lending & Secured Finance 2019 - 7th Edition - Allen & Overy
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The International Comparative Legal Guide to: Lending & Secured Finance 2019 7th Edition allenovery.com
ICLG The International Comparative Legal Guide to: Lending & Secured Finance 2019 7th Edition A practical cross-border insight into lending and secured finance Allen & Overy LLP Haynes and Boone, LLP Norton Rose Fulbright US LLP Anderson Mori & Tomotsune Hogan Lovells International LLP Orrick Herrington & Sutcliffe LLP Asia Pacific Loan Market Association (APLMA) Holland & Knight Pestalozzi Attorneys at Law Ltd Astrea HSBC Pinheiro Neto Advogados Baker & McKenzie LLP IKT Law Firm PLMJ Advogados Bravo da Costa, Saraiva – Sociedade de Jadek & Pensa Ploum Advogados JPM Janković Popović Mitić Proskauer Rose LLP Cadwalader, Wickersham & Taft LLP Kelobang Godisang Attorneys Rodner, Martínez & Asociados Carey King & Wood Mallesons Sardelas Liarikos Petsa Law Firm Carey Olsen Jersey LLP Latham & Watkins LLP Seward & Kissel LLP Cordero & Cordero Abogados Lee and Li, Attorneys-at-Law Shearman & Sterling LLP Criales & Urcullo Lloreda Camacho & Co. Skadden, Arps, Slate, Meagher & Flom LLP Cuatrecasas Loan Market Association Škubla & Partneri s. r. o. Davis Polk & Wardwell LLP Loan Syndications and Trading SZA Schilling, Zutt & Anschütz Debevoise & Plimpton LLP Association Rechtsanwaltsgesellschaft mbH Dechert LLP Loyens & Loeff Luxembourg S.à r.l. Trofin & Asociații Dillon Eustace Macesic & Partners LLC TTA – Sociedade de Advogados Drew & Napier LLC Maples Group Wakefield Quin Limited E & G Economides LLC Marval, O’Farrell & Mairal Walalangi & Partners (in association E. Schaffer & Co. McMillan LLP with Nishimura & Asahi) Fellner Wratzfeld & Partners Milbank LLP Weil, Gotshal & Manges LLP Freshfields Bruckhaus Deringer LLP Morgan, Lewis & Bockius LLP White & Case LLP Fried, Frank, Harris, Shriver & Jacobson LLP Morrison & Foerster LLP Gonzalez Calvillo, S.C. Nielsen Nørager Law Firm LLP
The International Comparative Legal Guide to: Lending & Secured Finance 2019
Editorial Chapters:
1 Loan Syndications and Trading: An Overview of the Syndicated Loan Market – Bridget Marsh &
Tess Virmani, Loan Syndications and Trading Association 1
2 Loan Market Association – An Overview – Nigel Houghton & Hannah Vanstone,
Loan Market Association 6
3 Asia Pacific Loan Market Association – An Overview – Andrew Ferguson,
Contributing Editor Asia Pacific Loan Market Association (APLMA) 12
Thomas Mellor, Morgan,
Lewis & Bockius LLP
General Chapters:
Publisher
Rory Smith 4 An Introduction to Legal Risk and Structuring Cross-Border Lending Transactions –
Sales Director Thomas Mellor & Marcus Marsh, Morgan, Lewis & Bockius LLP 15
Florjan Osmani
5 Global Trends in the Leveraged Loan Market in 2018 – Joshua W. Thompson & Korey Fevzi,
Account Director Shearman & Sterling LLP 20
Oliver Smith
6 Developments in Delayed Draw Term Loans – Meyer C. Dworkin & Samantha Hait,
Senior Editors
Caroline Collingwood Davis Polk & Wardwell LLP 26
Rachel Williams
7 Commercial Lending in a Changing Regulatory Environment, 2019 and Beyond –
Editor Bill Satchell & Elizabeth Leckie, Allen & Overy LLP 30
Sam Friend
8 Acquisition Financing in the United States: Will the Boom Continue? – Geoffrey R. Peck &
Group Consulting Editor
Alan Falach Mark S. Wojciechowski, Morrison & Foerster LLP 34
Published by 9 A Comparative Overview of Transatlantic Intercreditor Agreements – Lauren Hanrahan &
Global Legal Group Ltd. Suhrud Mehta, Milbank LLP 39
59 Tanner Street
London SE1 3PL, UK 10 A Comparison of Key Provisions in U.S. and European Leveraged Loan Agreements –
Tel: +44 20 7367 0720 Sarah M. Ward & Mark L. Darley, Skadden, Arps, Slate, Meagher & Flom LLP 46
Fax: +44 20 7407 5255
Email: info@glgroup.co.uk 11 The Global Subscription Credit Facility and Fund Finance Markets – Key Trends and Forecasts –
URL: www.glgroup.co.uk
Michael C. Mascia & Wesley A. Misson, Cadwalader, Wickersham & Taft LLP 59
GLG Cover Design
F&F Studio Design 12 Recent Developments in U.S. Term Loan B – Denise Ryan & Kyle Lakin,
Freshfields Bruckhaus Deringer LLP 63
GLG Cover Image Source
iStockphoto 13 The Continued Growth of European Covenant Lite – James Chesterman & Jane Summers,
Printed by Latham & Watkins LLP 70
Stephens & George
Print Group
14 Cross-Border Loans – What You Need to Know – Judah Frogel & Jonathan Homer,
April 2019 Allen & Overy LLP 73
Copyright © 2019 15 Debt Retirement in Leveraged Financings – Scott B. Selinger & Ryan T. Rafferty,
Global Legal Group Ltd. Debevoise & Plimpton LLP 82
All rights reserved
No photocopying 16 Analysis and Update on the Continuing Evolution of Terms in Private Credit Transactions –
Sandra Lee Montgomery & Michelle Lee Iodice, Proskauer Rose LLP 88
ISBN 978-1-912509-65-2
ISSN 2050-9847 17 Secondments as a Periscope into the Client and How to Leverage the Secondment Experience –
Alanna Chang, HSBC 95
Strategic Partners
18 Trade Finance on the Blockchain: 2019 Update – Josias Dewey, Holland & Knight 98
19 The Global Private Credit Market: 2019 Update – Jeff Norton & Ben J. Leese, Dechert LLP 104
20 Investment Grade Acquisition Financing Commitments – Julian S.H. Chung & Stewart A. Kagan,
Fried, Frank, Harris, Shriver & Jacobson LLP 109
21 Acquisition Financing in Latin America: Navigating Diverse Legal Complexities in the Region –
Sabrena Silver & Anna Andreeva, White & Case LLP 114
22 Developments in Midstream Oil and Gas Finance in the United States – Elena Maria Millerman &
PEFC Certified
John Donaleski, White & Case LLP 121
This product is
from sustainably
managed forests and
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23 Margin Loans: The Complexities of Pre-IPO Acquired Shares – Craig Unterberg &
PEFC/16-33-254 www.pefc.org
LeAnn Chen, Haynes and Boone, LLP 127
24 Credit Agreement Provisions and Conflicts Between US Sanctions and Blocking Statutes –
Roshelle A. Nagar & Ted Posner, Weil, Gotshal & Manges LLP 132
25 SOFR So Good? The Transition Away from LIBOR Begins in the United States –
Kalyan (“Kal”) Das & Y. Daphne Coelho-Adam, Seward & Kissel LLP Continued Overleaf 137
Continued Overleaf
Further copies of this book and others in the series can be ordered from the publisher. Please call +44 20 7367 0720
Disclaimer
This publication is for general information purposes only. It does not purport to provide comprehensive full legal or other advice.
Global Legal Group Ltd. and the contributors accept no responsibility for losses that may arise from reliance upon information contained in this publication.
This publication is intended to give an indication of legal issues upon which you may need advice. Full legal advice should be taken from a qualified
professional when dealing with specific situations.
WWW.ICLG.COMThe International Comparative Legal Guide to: Lending & Secured Finance 2019
General Chapters:
26 Developments in the Syndicated Term Loan Market: Will Historical Distinctions from the High-Yield
Bond Market Be Restored? – Joseph F. Giannini & Adrienne Sebring, Norton Rose Fulbright US LLP 141
27 Green Finance – Alex Harrison & Andrew Carey, Hogan Lovells International LLP 144
28 U.S. Tax Reform and Effects on Cross-Border Financing – Patrick M. Cox, Baker & McKenzie LLP 149
Country Question and Answer Chapters:
29 Angola Bravo da Costa, Saraiva – Sociedade de Advogados / PLMJ:
Bruno Xavier de Pina & Joana Marques dos Reis 159
30 Argentina Marval, O’Farrell & Mairal: Juan M. Diehl Moreno & Diego A. Chighizola 165
31 Australia King & Wood Mallesons: Yuen-Yee Cho & Elizabeth Hundt Russell 174
32 Austria Fellner Wratzfeld & Partners: Markus Fellner & Florian Kranebitter 183
33 Belgium Astrea: Dieter Veestraeten 193
34 Bermuda Wakefield Quin Limited: Erik L Gotfredsen & Jemima Fearnside 199
35 Bolivia Criales & Urcullo: Andrea Mariah Urcullo Pereira &
Daniel Mariaca Alvarez 207
36 Botswana Kelobang Godisang Attorneys: Wandipa T. Kelobang &
Laone Queen Moreki 214
37 Brazil Pinheiro Neto Advogados: Ricardo Simões Russo &
Leonardo Baptista Rodrigues Cruz 221
38 British Virgin Islands Maples Group: Michael Gagie & Matthew Gilbert 230
39 Canada McMillan LLP: Jeff Rogers & Don Waters 237
40 Cayman Islands Maples Group: Tina Meigh 247
41 Chile Carey: Diego Peralta 255
42 China King & Wood Mallesons: Stanley Zhou & Jack Wang 262
43 Colombia Lloreda Camacho & Co.: Santiago Gutiérrez & Juan Sebastián Peredo 269
44 Costa Rica Cordero & Cordero Abogados: Hernán Cordero Maduro &
Ricardo Cordero B. 276
45 Croatia Macesic & Partners LLC: Ivana Manovelo 284
46 Cyprus E & G Economides LLC: Marinella Kilikitas & George Economides 292
47 Denmark Nielsen Nørager Law Firm LLP: Thomas Melchior Fischer & Peter Lyck 300
48 England Allen & Overy LLP: David Campbell & Oleg Khomenko 307
49 Finland White & Case LLP: Tanja Törnkvist & Krista Rekola 316
50 France Orrick Herrington & Sutcliffe LLP: Emmanuel Ringeval & Cristina Radu 324
51 Germany SZA Schilling, Zutt & Anschütz Rechtsanwaltsgesellschaft mbH:
Dr. Dietrich F. R. Stiller & Dr. Andreas Herr 335
52 Greece Sardelas Liarikos Petsa Law Firm: Panagiotis (Notis) Sardelas &
Konstantina (Nantia) Kalogiannidi 344
53 Hong Kong King & Wood Mallesons: Richard Mazzochi & Khin Voong 352
54 Indonesia Walalangi & Partners (in association with Nishimura & Asahi):
Luky I. Walalangi & Siti Kemala Nuraida 360
55 Ireland Dillon Eustace: Conor Keaveny & Richard Lacken 366
56 Israel E. Schaffer & Co.: Ehud (Udi) Schaffer & Shiri Ish Shalom 375
57 Italy Allen & Overy Studio Legale Associato: Stefano Sennhauser &
Alessandra Pirozzolo 381
58 Ivory Coast IKT Law Firm: Annick Imboua-Niava & Osther Tella 390
59 Japan Anderson Mori & Tomotsune: Taro Awataguchi & Yuki Kohmaru 396
60 Jersey Carey Olsen Jersey LLP: Robin Smith & Laura McConnell 404
61 Luxembourg Loyens & Loeff Luxembourg S.à r.l.: Antoine Fortier-Grethen 414
62 Mexico Gonzalez Calvillo, S.C.: José Ignacio Rivero Andere &
Jacinto Avalos Capin 422
63 Mozambique TTA – Sociedade de Advogados / PLMJ:
Gonçalo dos Reis Martins & Nuno Morgado Pereira 430
Continued OverleafThe International Comparative Legal Guide to: Lending & Secured Finance 2019
Country Question and Answer Chapters:
64 Netherlands Ploum: Tom Ensink & Alette Brehm 437
65 Portugal PLMJ Advogados: Gonçalo dos Reis Martins 445
66 Romania Trofin & Asociații: Valentin Trofin & Mihaela Atanasiu 452
67 Russia Morgan, Lewis & Bockius LLP: Grigory Marinichev & Alexey Chertov 462
68 Serbia JPM Janković Popović Mitić: Nenad Popović & Nikola Poznanović 470
69 Singapore Drew & Napier LLC: Pauline Chong & Renu Menon 477
70 Slovakia Škubla & Partneri s. r. o.: Marián Šulík & Zuzana Moravčíková Kolenová 487
71 Slovenia Jadek & Pensa: Andraž Jadek & Žiga Urankar 494
72 South Africa Allen & Overy LLP: Lionel Shawe & Lisa Botha 504
73 Spain Cuatrecasas: Manuel Follía & Iñigo Várez 514
74 Sweden White & Case LLP: Carl Hugo Parment & Tobias Johansson 525
75 Switzerland Pestalozzi Attorneys at Law Ltd: Oliver Widmer & Urs Klöti 532
76 Taiwan Lee and Li, Attorneys-at-Law: Hsin-Lan Hsu & Odin Hsu 541
77 UAE Morgan, Lewis & Bockius LLP: Victoria Mesquita Wlazlo &
Amanjit K. Fagura 549
78 USA Morgan, Lewis & Bockius LLP: Thomas Mellor & Rick Eisenbiegler 564
79 Venezuela Rodner, Martínez & Asociados: Jaime Martínez Estévez 576
EDITORIAL
Welcome to the seventh edition of The International Comparative Legal Guide to: Lending &
Secured Finance.
This guide provides corporate counsel and international practitioners with a comprehensive
worldwide legal analysis of the laws and regulations of lending and secured finance.
It is divided into three main sections:
Three editorial chapters. These are overview chapters and have been contributed by the LSTA,
the LMA and the APLMA.
Twenty-five general chapters. These chapters are designed to provide readers with an overview
of key issues affecting lending and secured finance, particularly from the perspective of a multi-
jurisdictional transaction.
Country question and answer chapters. These provide a broad overview of common issues in
lending and secured finance laws and regulations in 51 jurisdictions.
All chapters are written by leading lending and secured finance lawyers and industry specialists
and we are extremely grateful for their excellent contributions.
Special thanks are reserved for the contributing editor Thomas Mellor of Morgan, Lewis &
Bockius LLP for his invaluable assistance.
Global Legal Group hopes that you find this guide practical and interesting.
The International Comparative Legal Guide series is also available online at www.iclg.com.
Alan Falach LL.M.
Group Consulting Editor
Global Legal Group
Alan.Falach@glgroup.co.ukChapter 7
Commercial Lending in a Changing
Regulatory Environment, Bill Satchell
2019 and Beyond
Allen & Overy LLP Elizabeth Leckie
While the Trump Administration’s deregulatory initiatives continue In May 2018, Comptroller of the Currency, Joseph Otting, observed
apace in many areas, change in the banking area in the US remains that the Leveraged Lending Guidance was just “guidance” and banks
comparatively modest. Although the banking agency Leveraged could occasionally operate outside those parameters, but would still
Lending Guidance has ceased to be central to the debate about bear the burden of demonstrating that their loans are prudent.
that market, the banking agencies and other policy makers and Banks continue to be involved in this market and, as is reflected in
commentators continue to express concerns about potential risk in the recent Shared National Credit Program 1st and 3rd Quarter 2018
the leveraged loan market, particularly in the event of a downturn Examinations Review,6 the Agencies are still troubled, observing that
prompted by other structural challenges. At the same time, it is far the “[r]isks associated with leveraged lending activities are building
less clear than it might have been before the 2008 financial crisis in contrast to the portfolio overall. Leveraged loans with supervisory
that those risks are predominantly faced by banks. Non-bank ratings below pass typically reflect borrowers with higher than
participants are ever more important as investors in those markets average leverage levels and weaker repayment capabilities”.7 The
and may, at least indirectly, be responsible for the decline in the SNC 2018 Review found that many leveraged loan transactions had
rigour of covenants. Further, such market participants – and even weaker transaction structures and increased reliance upon revenue
many of the banks – may not have the incentive or resources to growth or anticipated cost savings and synergies to support borrower
engage with borrowers in restructuring efforts, instead leaving that repayment capacity. The agencies also point to the anomalous
role to relatively more aggressive late stage investors with a greater influence that borrowers in this market possess over lending
inclination to pursue extreme tactics. However, many commentators relationships, noting that this too is likely a factor contributing to
have been careful to draw distinctions between concerns about the growing risk in the sector.
increasing potential for credit losses and other vulnerabilities of the The SNC 2018 Review did, however, conclude that agent banks’
loan market and broader systemic risks, noting in particular that risk management and underwriting practices have improved in
banks generally have a smaller share of the market and better pipeline some respects since 2013 and that agent banks are better equipped
management than in years past. to assess borrower repayment capacity and enterprise valuations,
In a somewhat challenging economic environment, the Federal as well as having developed other risk management processes that
Reserve has chosen to taper down the balance sheet normalisation better align with safety and soundness principles. But at bottom,
process, not only with a view to mitigating deflationary pressure, but the SNC 2018 Review indicates that the Agencies do not think that
in an effort to right-size the availability of reserves necessary to help these improvements are in themselves sufficient to address changing
banks satisfy applicable liquidity requirements by ensuring a stable conditions and increased layering of risk.
source of reserve, as well as helping the Federal Reserve to ensure A number of commentators, including the FRB, have cited Moody’s
emergency liquidity needed by banks facing potential distress. Investors Service research as a validation that, although spreads
remain at the lower level of their range since the end of the financial
crisis, the covenant quality of North American leveraged loans
Leveraged Lending After the Leveraged is close to its all-time record worst and is continuing to weaken.
Lending Guidance Moody’s Loan Covenant Quality Indicator (LCQI), which tracks
the degree of overall investor protection in the covenant packages of
In October 2017, the federal Government Accountability Office individual speculative-grade leveraged loans issued in the US and
(GAO) confirmed Senator Pat Toomey’s view that the Leveraged Canada on a two-quarter rolling average basis, measured on a scale
Lending Guidance1 (adopted by the key federal banking agencies of 1 to 5 (with 5 denoting the weakest from investor protections),8
who share responsibility for supervision of the banking sector: the ended the second quarter 2018 at 4.09,9 against 4.05 at the end of the
Board of Governors of the Federal Reserve System (FRB)2; the first quarter. The following quarter was just one basis point away
Office of the Comptroller of the Currency (OCC)3; and the Federal from its lowest point, reached in the third quarter of 2017.10
Deposit Insurance Corporation (FDIC,4 and together with the FRB Even the IMF, in its Global Financial Stability Report 2018, cites
and the OCC, the Agencies)) is potentially subject to legislative the risk of reduced spreads and a higher LCQI as a source of risk
repeal under the U.S. Congressional Review Act.5 Senior House that could result in an untoward market adjustment.11 Echoing the
Financial Services Committee member Blaine Luetkemeyer reacted findings of the FRB Report with respect to the US market, the IMF
to the GAO’s conclusion by writing to the Agencies to inquire as Report highlights that origination of the share of leveraged loans of
to their plans with respect to the Leveraged Lending Guidance. It total corporate origination in Europe is now rivalling levels in the
was widely reported that the Agencies responded to Representative US, with a relatively higher percentage of loans evidencing leverage
Luetkemeyer by suggesting that the Guidance would be revisited. multiples of 5 or more.12
30 WWW.ICLG.COM ICLG TO: LENDING & SECURED FINANCE 2019
© Published and reproduced with kind permission by Global Legal Group Ltd, LondonAllen & Overy LLP Lending in a Changing Regulatory Environment
The SNC 2018 Review evidences the Agencies’ continuing focus The SNC 2018 Review confirms the changing character of investors
on assessing the impact of these layered risks of weaker transaction in the market, noting that non-bank entities have increased their
structures and covenants and their belief that a downturn in the participation in the leveraged lending market via both purchases
economy could result in a significant increase in classified exposures of loans or direct underwriting and syndication of exposure. Thus,
and higher losses. In the SNC 2018 Review, the Agencies enjoin the SNC 2018 Review concludes that more leveraged lending risk
banks engaged in originating and participating in leveraged loans to is being transferred to these non-bank entities, a factor that some
ensure that risk management processes keep pace with changes in associate with declining market discipline.
the leveraged lending market and ensure that their risk management The inference that weaker covenants are a product of the increased
processes and limits fully consider the potential direct and indirect
participation of relatively passive investors has an empirical
risks associated with these loans. In particular, the Agencies have
foundation. And while the FRB observes that levels of non-agency
said that they expect lenders:
securitisations (instruments not guaranteed by a government-
(i) To understand and reasonably support the borrowers’ ability sponsored enterprise or by the federal government) have been rising
to achieve revenue growth or anticipated cost savings and
in recent years, the FRB notes that gross issuances of CLOs, which
synergies when underwriting and risk rating these credit
are predominantly backed by leveraged loans, hit $71 billion in the
facilities.
first half of 2018, an increase of one-third compared to the preceding
(ii) To ensure that planned and permissible incremental facility use
year, and that CLOs now purchase about 60 percent of leveraged
is fully incorporated into measures that control origination and
participation activities, recognising that usage of incremental loans at origination.16
facilities shortly after funding may materially alter repayment While not so large a contributor to non-bank holdings of leveraged
capacity estimates and could adversely affect facility risk loans, according to the FRB Report, loan mutual funds purchase
ratings. about one-fifth of newly originated leveraged loans. Because the
(iii) To ensure that stress testing models account for market changes holders of such funds are ordinarily entitled to redeem on one-day
as recovery rates may differ from historical experience. notice and loans may require longer periods for sales, mutual funds
A blog posted on the IMF website highlights some of the specific are conceivably subject to runs. A race to redeem shares could lead
risks associated with weaker covenants: to large sales of relatively illiquid loans, exacerbating price declines
For example, weaker covenants have reportedly allowed and run incentives.17 The FRB Report expresses concerns that such
borrowers to inflate projections of earnings. They have also valuation pressures may make large price adjustments more likely,
allowed them to borrow more after the closing of the deal. potentially motivating investors to quickly redeem their shares.
With rising leverage, weakening investor protections, and
In a credit crunch, not only are weaker covenants likely to delay or
eroding debt cushions, average recovery rates for defaulted
loans have fallen to 69 percent from the pre-crisis average of impede the workout process, but the investors holding such loans are
82 percent. A sharp rise in defaults could have a large negative likely to flee the credit in favour of participants who may be more
impact on the real economy given the importance of leveraged aggressive in the workout process as a result of having purchased
loans as a source of corporate funding.13 exposures at significant discounts. It is unlikely that mutual funds will
Weaker covenants and creditor protections are expected to have the continue to hold leveraged loans issued by borrowers experiencing
effect of delaying defaults and therefore inhibiting lender efforts to distress – and there may be powerful incentives for CLOs to exit from
intervene earlier to try to remediate troubled credits. Specifically, their exposure to deteriorating credits by selling out. Even banks,
borrowers commonly have opportunities to incur additional debt which already have a relatively low exposure to such credits, may
without lender consent, through incremental facilities, and to inflate also be more likely to sell out than engage in the resource-intensive
EBITDA (earnings before interest, tax, depreciation and amortisation, workout process, particularly since regulators are likely to force
used as a measure of cash flow potentially available for debt service aggressive mark-downs on troubled loan exposures. While banks at
and as a basis for calculating leverage and covenant baskets) by one time played a significant role in the workout process, not only
incorporating adjustments or “addbacks” for items such as cost has the share of leveraged loans held by banks declined, but banks
savings and synergies, leading to additional debt capacity. As has have also become more likely to join passive investors in selling
been demonstrated in credits such as J. Crew, PetSmart, and Neiman down their exposures. All of these factors, together, reinforce the
Marcus, looser covenants may give the Borrower the freedom, in a expectation that such loans are likely to offers recoveries that are less
tactic colloquially referred to as “collateral stripping”, to weave a good than historic norms, and that workouts of leveraged loans may
path through the exceptions to the restricted payment and investment be increasingly dominated by aggressive private funds.
covenants to move assets out of the restricted group of guarantor
subsidiaries free of lien – and out of the collateral package that the
lenders had expected to be able to rely on for credit support. Federal Reserve Balance Sheet
As noted in the paper Covenant-Light Contracts and Creditor
Normalisation Policy: Response to the
Coordination, “financial covenants are intended to serve as triggers Expanded Demand for Federal Reserve
to renegotiation: covenant violations shift control toward creditors”,14 Bank Reserve Balances
but fail to serve this function adequately when borrowers are able
to implement tactics such as those described above. But the paper There has been considerable discussion since enactment of Dodd-
suggests that, more than evidencing the influence that borrowers in Frank of the impact on bank balance sheets and the propensity of
this market possess over lending relationships, weaker covenants banks to engage in credit creation as a result of the Basel III Liquidity
may reflect the increasing involvement in the leveraged loan market Coverage Ratio (LCR) and inhibitions on the power of the Federal
of comparatively passive investors resembling the holders of public Reserve System to grant short-term credit to banks in distress. As the
bonds. In the hands of such investors, the authors suggest, “loan Federal Reserve System weighs whether and how much to downsize
contract covenants intended to lead to renegotiation become less its balance sheet in the wake of substantial quantitative easing in
attractive, and one should expect more bond-like (cov-lite) contracts, response to the financial crisis, it has moderated its earlier guidance
as well as a lower cost of such features”.15 Implicitly, such investors regarding the conditions under which it could adjust the details of
would rather sell the exposure than engage in relatively costly its balance sheet normalisation program. While the reserves have
negotiations with borrowers designed to remediate any distress. already declined appreciably from their peak, falling by $1.2 trillion
ICLG TO: LENDING & SECURED FINANCE 2019 WWW.ICLG.COM 31
© Published and reproduced with kind permission by Global Legal Group Ltd, LondonAllen & Overy LLP Lending in a Changing Regulatory Environment
to the current level of around $1.6 trillion, the Federal Open Market This approach would be operationally convenient but would
Committee (FOMC) announced on January 30, 2019, that: also leave the size of the balance sheet and reserves larger
The Committee intends to continue to implement monetary than necessary most of the time. In my view, it might be
policy in a regime in which an ample supply of reserves ensures appropriate for us to operate somewhere in between these two
that control over the level of the federal funds rate and other extremes, with a sizable quantity of reserves large enough
short-term interest rates is exercised primarily through the to buffer against most shocks to reserve supply. On those
setting of the Federal Reserve’s administered rates, and in which few days when that buffer is likely to be exhausted, we could
active management of the supply of reserves is not required. conduct open market operations to temporarily boost the
supply of reserves.
The Committee continues to view changes in the target range
for the federal funds rate as its primary means of adjusting The FOMC’s substantial reduction in the pace of the decline in
the stance of monetary policy. The Committee is prepared reserves will allow a gradual convergence to the optimal level of
to adjust any of the details for completing balance sheet reserves.
normalisation in light of economic and financial developments. By providing assurance that an ample supply of reserves will remain
Moreover, the Committee would be prepared to use its full available to the banking system, the Federal Reserve not only
range of tools, including altering the size and composition
softens the potentially depressing effect of potentially costly LCR
of its balance sheet, if future economic conditions were to
warrant a more accommodative monetary policy than can be requirements, but reduces the likelihood of possibly destabilising
achieved solely by reducing the federal funds rate.18 liquidity shortages in the banking sector, while possibly mitigating
deflationary tensions and dampening the disincentives on credit
In 2014, the Agencies jointly adopted a final rule implementing a
creation.
“liquidity coverage ratio” (LCR) applicable to large, internationally
active banking organisations, certain designated non-bank financial
companies, and certain consolidated subsidiary depositary institutions Endnotes
thereof (LCR Rule). The LCR Rule is expressly patterned on the
international standard established by the Basel Committee, albeit 1. FDIC, FRB, OCC, Interagency Guidance on Leveraged
with some adjustments to reflect the unique characteristics of the US Lending, 78 Fed. Reg. 17766 (March 22, 2013).
market and US regulatory scheme. Thus, the LCR Rule imposes a 2. The FRB is the central bank of the United States and also
somewhat more stringent requirement than the Basel Committee’s has supervisory and regulatory oversight of bank holding
framework. In broad strokes, the LCR Rule requires subject entities companies, their non-bank subsidiaries, state banks that are
to maintain a minimum LCR, defined as the ratio of unencumbered members of the Federal Reserve System, state regulated
“high-quality liquid assets” (HQLA) to “total net cash outflows”, branches and agencies of foreign banks, and foreign banking
over a prospective period of 30 calendar days, a form of standardised organisations that are treated as bank holding companies as
stress test scenario. The question posed by the LCR Rule to subject a result of having a branch, agency or commercial lending
institutions is as follows: Assuming that cash outflows over the subsidiary.
coming period are large and cash inflows are weak, does the bank 3. The OCC, an independent division of Treasury, has supervisory
have sufficient readily liquefiable assets to weather the storm? and regulatory oversight of national banks, which includes
many of the Nation’s largest banks, and federal branches of
Depending on the size and activities of the subject entity, the LCR foreign banks.
Rule imposes two distinct requirements, referred to herein as the
4. The FDIC insures the deposits of FDIC member banks and
“Full LCR”, applicable to large, internationally active banking
has supervisory and regulatory oversight with respect to state
organisations, and the “Modified LCR”, applicable to other large banks that are not members of the Federal Reserve System.
bank or savings and loan holding companies that in the Agencies’
5. Title II, Subtitle E. of the Contract with America Advancement
view pose less severe systemic risks. The LCR Rule became effective
Act of 1996, Pub L. 104–121, creates a mechanism through
on January 1, 2015. which an agency statement of general or particular applicability
The LCR improves the liquidity resilience of banks by requiring and future effect designed to implement, interpret, or prescribe
them to hold sufficient high-quality liquid assets to cover potential law or policy is subject to review and possible disapproval by
outflows during times of stress, but has a high opportunity cost. Congress and the President. At the request of Senator Toomey,
Reserves held with Federal Reserve Banks, along with Treasury the GAO concluded that the “[t]he Interagency [Leveraged
securities, are favoured under the LCR. Firms currently meet a Lending] Guidance is a general statement of policy designed
sizable fraction of their LCR requirements by holding reserves. The to assist financial institutions in providing leveraged lending
to creditworthy borrowers in a sound manner. As such, it is
Federal Reserve manages the level of the federal funds rate and other
a rule subject to the requirements of [Congressional Review
short-term interest rates primarily through the use of administered Act].” GAO, Applicability of the Congressional Review Act
rates, including the rate paid on reserve balances and the offered rate to Interagency Guidance on Leveraged Lending (October 19,
on overnight reverse repurchase agreements. 2017), avail. at https://www.gao.gov/products/D17915.
In a speech on The Future of the Federal Reserve’s Balance Sheet 6. FDIC, FRB, OCC, Shared National Credit Program 1st and
given by FRB Vice Chairman for Supervision Randal K. Quarles,19 3rd Quarter 2018 Examinations (January 2019) (SNC 2018
Vice Chairman Quarles observed that the Federal Reserve would Review), avail. at https://www.occ.gov/news-issuances/news-
work to maintain a quantity of reserves necessary to remain reliably releases/2019/pub-snc-review-2018.pdf.
on the flat portion of the reserve demand curve. This amount would 7. SNC 2018 Review, at 3.
likely reflect a balance somewhere between the industry’s expected 8. Id.
demand for reserves in the neighborhood of $800 billion and an
9. The LCQI measure is a somewhat challenging basis for
average supply of reserves large enough to keep the federal funds assessing a broad market, because a decline in lending to
rate determined along the flat portion of the reserve demand curve the very worst leveraged credit borrowers, resulting in an
even with an unexpected shift in the supply of or demand for reserves. improvement of the overall credit quality of originations, could
In the Vice Chairman’s view: result in an increase in the LCQI because the relatively stronger
credits are able to negotiate comparatively weaker covenants.
32 WWW.ICLG.COM ICLG TO: LENDING & SECURED FINANCE 2019
© Published and reproduced with kind permission by Global Legal Group Ltd, LondonAllen & Overy LLP Lending in a Changing Regulatory Environment
10. FRB, Financial Stability Report (November 2018), at 12 with a 3.2% increase in the likelihood of cov-lite structures
(FRB Report), avail. at https://www.federalreserve.gov/ (about half of the unconditional average); a 2.0% drop in the
publications/files/financial-stability-report-201811.pdf. likelihood that the loan amortizes before maturity (about half
11. IMF, Global Financial Stability Report: A Decade After the of the unconditional average); and a 0.2-year increase in loan
Global Financial Crisis, Are We Safer? (October 18, 2018), maturity (the mean maturity is around 4.5 years)”.
at 11 (IMF Report). 16. FRB Report, at 29.
12. Id., at 8. 17. Id., at 34.
13. Tobias Adrian, Fabio Natalucci, and Thomas Piontek, 18. https://www.federalreserve.gov/newsevents/pressreleases/
Sounding the Alarm on Leveraged Lending, avail. at https:// monetary20190130c.htm.
blogs.imf.org/2018/11/15/sounding-the-alarm-on-leveraged- 19. Vice Chairman for Supervision Randal K. Quarles, Speech,
lending/. The Future of the Federal Reserve’s Balance Sheet (February
14. Becker & Ivashina, Covenant-Light Contracts And Creditor 22, 2019) at the 2019 U.S. Monetary Policy Forum, sponsored
Coordination (2016), at 3, avail. at https://www.hbs.edu/ by the Initiative on Global Markets at the University of
faculty/Publication%20Files/SSRN-id2756926_fccde84f- Chicago Booth School of Business, New York, New York,
d333-4569-8fb1-2aa387a2e403.pdf. avail. at https://www.federalreserve.gov/newsevents/speech/
15. Id., at 4. The author’s research suggests that “[a] 5% increase quarles20190222a.htm.
in the ownership stake of mutual funds and CLOs is associated
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