Offering an alternative form of debt financing to bilateral lending or corporate bonds, the syndicated loan market is a critical source of capital in Europe. However, as Ocorian's Director - Transaction Management, Chris Wilson explains, the secondary market's capital flows are under threat from increasingly stringent transfer restrictions and active market participants need to be fully aware of the terms to which they are agreeing.

The syndicated loan market plays a major role in financing the capital markets of Europe, providing an important source of large-scale lending. In 2017 alone, € 720 billion was raised across all of Europe according to the European Commission (EC). Of that figure, almost 60 per cent was used for corporate purposes such as refinancing, M&A, leveraged buyouts, project and infrastructure financing.

In the immediate aftermath of the financial crisis, when bank lending all but dried up, the secondary markets displayed highly standardised loan transfer provisions. In the intervening years, as the loan markets recovered and demand began to outstrip supply, an increasingly diverse population of participant entities have entered the market, causing sponsors and borrowers to impose even more transfer restrictions in a bid to retain control of the lender group. Such restrictions on the transfer of interests in loans can slow down secondary market settlement and introduce settlement risk, as recognised by the EC's April 2019 report, "EU loan syndication and its impact on competition in credit markets".

Restricting market efficiency

Transfer restrictions in the EU have primarily focused on industrial competitors, "loan-to-'own'-investors" (or "debt-for-control-lenders"), distressed debt investors and "approved lender lists"; whereas US transfer restrictions target "disqualified lender lists".

In isolation, the transfer restrictions slow down local trade and settlement but also raise questions over the viability of cross-border EU/US structures. It is now common place for documentation to have numerous combinations of transfer restrictions on amount, currency, borrower and/or lender, requiring protracted approvals and consents, thereby impeding efficiency in the secondary market.

These inefficiencies have a direct impact on liquidity and on a sponsor or borrower's ability to manage its relationship with lenders. Generally, more constraining transfer restrictions reduce liquidity (and thereby marketability of loans), but also give sponsors better control over the lenders (and thereby more protection from industrial competitors, "loan-to-own-investors" and distressed debt investors). Recent documentation has also begun to try to further restrict - the historically less restricted - sub-participations by imposing further contractual obligations on lenders.

Mitigating a breach

In order to avoid a breach of established transfer restrictions, active participants within the secondary loan market need to be fully aware of the terms to which they are agreeing. A failure to prevent a breach of transfer restrictions can lead to significant reputational damage, a loan trade that might need to be unwound between buyer and seller and, in a worst case scenario, litigation attempting to enforce untested and potentially weak restrictions. Participants in a typical syndicated loan transaction include:

  • Facility agents

Facility agents need to be extremely conscious of transfer restrictions when they execute transfer certificates for secondary market loans, including whether necessary consents were obtained.

  • Sponsors and borrowers

Because transfer restrictions impact both the liquidity of outstanding loans and how ongoing relationships with lenders are maintained, sponsors and borrowers need to be aware of the implications of limiting transfer restrictions before agreeing to them.

  • Lenders and subsequent purchasers

Lenders, including subsequent purchasers, find that their ability to later transfer previously acquired loan positions is impacted by knock-on effects that transfer restrictions have on liquidity.

  • Buyers and sellers

Both buyers and sellers might also find that strict legal provisions in some documentation could mean that a breach in the transfer process means the transfer (i) is not legally binding (ii) causes the new lender to be disenfranchised and (iii) gives the parent of the borrowers legal remedies.

Although flagged as an issue limiting secondary market efficiency, the EC's April report did not propose a solution to the problem of ever tightening transfer restrictions. Therefore, all parties, including facility agents, should ensure that they fully understand the transfer terms to which they are agreeing. They should also ensure that they have the administrative infrastructure in place to monitor compliance with such restrictions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.