LONDON (Reuters) - The effects of Brexit are starting to be felt in the syndicated loan market as lenders seek greater flexibility on where and how they book loans to deal with the potential loss of passporting rights in a hard Brexit, a move that could cause operational problems for banks’ agency functions.
Loan bankers are also grappling with the full range of issues affecting the wider capital markets, ranging from governing law to jurisdiction and enforcement, how existing and new agreements are interpreted, Article 55 BRRD and withholding tax.
The potential loss of passporting rights is, however, the most serious issue facing lenders. Corporate loans are an unregulated product in the UK and Ireland but operate in some EU countries including France, Italy and sometimes Germany.
“Where banks are most focusing their concerns from a legal perspective is France and Italy and possibly Germany,” Simon Fisher, a partner in Mayer Brown’s banking and finance practice said.
UK and Irish banks may be unable to fund or participate in some loans if they do not have licenses or local regulation recognised through a European passport that allows them to provide loans and take security.
This is a big problem for cross-border lending as large European blue-chip companies, such as Swiss food and drink company Nestle, often have multi-billion euro loans which can be used by multiple subsidiaries in the different countries that they operate in, which can draw and repay the loans to the parent company.
At least one global investment bank, which has advanced loans through its UK entity, is considering no longer booking loans through its English booking hub and booking through single market entities, sources said.
“This institution is saying that it is considering dropping the English entity from the selection of booking entities. Loans are currently booked through the English entity, but it looks like the writing’s on the wall and that may cease,” a senior source said.
The loss of English booking hubs is not expected to diminish the importance of English law for the loan product or English courts for hearing disputes, however.
“Just because the booking hub’s not in England, that doesn’t diminish the importance of English law for financing products? or the English Courts for hearing disputes,” said Alex Dell, partner and co-head of asset based lending at Mayer Brown.
The Loan Market Association, which represents EU lenders including UK banks, has been educating the UK government, including the Treasury and the FCA, and the EU about licensing requirements and importance of the loan market and its EU operations.
The Loan Market Association has come up with a fix that gives comfort to lenders doing business under its documentation and English law that buys time until the outcome of the complex Brexit negotiations are known, which will avoid cross-border loans from being changed or structured to accommodate any possible changes as a result of licensing arrangements for now.
The LMA has introduced a new Designated Entity Clause that is designed to ‘slot in’ to the existing documentation of investment grade or leveraged loans which allows banks to nominate designated entities or affiliates who meet regulatory requirements to book assets and make loans.
“I haven’t yet seen any real live deals or transactions structured specifically on the basis that the UK may lose its passporting license,” Dell said.
The DEC gives lenders more flexibility to change where loans are held in a changing regulatory system. Commitments will be made by a central lender, which will be able to designate an affiliate – for example a French affiliate to lend to a French borrower.
The clause will make it easier for lenders to determine or allocate lending duties to entities in its group without having to do a formal transfer and works rather like an informal sub participation.
This has significant implications for banks’ capital and how affiliates are capitalised, and will see lenders changing their lending arrangements. Banks may be booking business through parts of the bank that have not had big flow before and will need to have appropriate capital in place to back their lending activities.
“It will make it easier for lenders to determine or allocate lending duties to entities in its group at a later date without having to do a formal transfer and has the benefit of allowing banks to better manage their exposure in different jurisdictions,” Fisher said.
The lending affiliate will take over specified lending obligations and rights, while the central lender will retain the commitment and all other obligations and rights, including remaining in charge of communications and voting.
“It’s helpful if you’re a big bank and have got more than one passported entity, less so if you haven’t,” Dell said.
While the DEC gives lenders extra flexibility, the extra layer of complexity with affiliates could cause significant operational problems, particularly for agent banks that administer loans, which is likely to be expensive and time consuming, several sources said.
Several issues have yet to be resolved, including how repayments work under the affiliate structure – whether repayments go to the affiliate or central lenders - and whether or not there will be a limit on the number of affiliates.
Banks will also have to complete “Know Your Customer” work, which identifies and verifies clients, on lending affiliates. This will create extra work for agent banks, which have to monitor all lending entities and could also affect secondary trading by delaying the close of transfers.
Editing by Christopher Mangham