King & Spalding LLP | Amin Doulai and Patrick Schumann
Capital and liquidity requirements
Describe how capital and liquidity requirements impact the structure of loan facilities, including the availability of related facilities and the differing impact of such requirements on different types of investors.
The capital, leverage and liquidity requirements associated with the implementation of Basel III (ie, part of the international regulatory framework for banks) has had a significant impact on the banking sector in the United Kingdom, and fundamentally changed the leveraged lending landscape in the United Kingdom and Europe. Most obviously, these stricter prudential standards have directly impacted the ability of bank lenders to underwrite and hold leveraged loans, and loans to certain riskier credits and sectors, by increasing their internal costs for holding such riskier loans on their balance sheets.
In turn, this has facilitated both the growth of private credit lending in the leveraged loan space, as well as entrenching the originate-to-distribute model that is intrinsic to the large-cap syndicated loan market. As these stricter prudential standards do not apply to private credit funds, they have been able to fill the gap left by the retreat of traditional banks and take market share, particularly for leveraged acquisition loans in the mid-market space and other riskier types of lending, such as recurring revenue loans and growth financing.
These capital and liquidity requirements have driven banks to seek new sources of business, including establishing their own direct lending businesses, which seek to compete directly with traditional private credit funds.Disclosure requirements
For public company debtors, are there disclosure requirements applicable to loan facilities?
Yes, UK-listed companies are subject to continuing disclosure obligations imposed by the London Stock Exchange and the Financial Conduct Authority. Such companies must provide periodic financial reports, including comprehensive notes on their financing activities, including the terms of new debt issuances.Use of loan proceeds
How is the use of loan proceeds by the debtor regulated? What liability could investors be exposed to if the debtor uses the proceeds contrary to regulations? Can investors mitigate their liability?
Under English law, the parties to a loan agreement are free to negotiate the purpose for which the loan proceeds may be applied. The loan agreement in the case of a leveraged acquisition loan will typically stipulate that the term loan proceeds shall be applied towards paying the consideration for the target company and associated transaction costs, while the revolving facility may be used for working capital or general corporate purposes.
The loan agreement will also invariably stipulate that, as a condition to the utilisation of any loan, the making of the loan (or any lender’s participation in the loan) must not be unlawful in any relevant jurisdiction, and that no default is continuing or would result from the proposed loan, which will usually include a breach of applicable sanctions, anti-corruption and anti-money laundering regulations in the jurisdictions of the lender and relevant obligors. Where such a breach occurs after the loan has been drawn, an event of default would occur allowing the lenders to accelerate any outstanding loans, terminate unused commitments, exercise remedies against the borrower, and commence enforcement of the security package.Cross-border lending
Are there regulations that limit an investor’s ability to extend credit to debtors organised or operating in particular jurisdictions? What liability are investors exposed to if they lend to such debtors? Can the investors mitigate their liability?
Yes, lenders will not extend credit to borrowers incorporated or operating in a sanctioned territory. The specific applicable regulations (and relevant exceptions) will also depend on the jurisdiction of incorporation of the lender itself.
In any case, most commercial loan agreements will be drafted broadly to cover all economic and financial sanctions and measures administered by a wide variety of sanctions authorities in various jurisdictions, including the United Kingdom, the United States, the European Union and the respective governmental institutions that administer such applicable sanctions law (eg, the US Department of State and the Office of Foreign Assets Control of the US Department of the Treasury).Debtors’ leverage profile
Are there limitations on an investors’ ability to extend credit to debtors based on the debtors’ leverage profile?
The Bank of England has written extensively regarding leveraged lending in the UK market and has publicly expressed some concerns about the management of leverage levels in both bank lending and private credit lending contexts. The Prudential Regulation Authority of the Bank of England has issued leveraged lending guidelines in a similar fashion to guidelines previously published by the European Central Bank and the US Federal Reserve. However, these are guidelines only, and emphasise the importance of the relevant institutions themselves having appropriate internal controls and procedures for managing the risks associated with leverage loans, as opposed to mandating specific lending thresholds or limits on leverage.Interest rates
Do regulations limit the rate of interest that can be charged on loans?
Under English law, there is no express regulation or usury law that limits the rate of interest that may be charged for commercial loans, and commercial parties are generally free to negotiate the economic terms of their loan arrangement as between themselves, including as regards interest and reasonable default interest for overdue amounts. However, an English court may apply equitable principles to prevent a lender enforcing an unconscionable bargain, or from enforcing a provision that requires payment upon breach of the contract on grounds that it would amount to a penalty, if it was found that such payment did not represent a genuine estimate of loss arising from the breach. Note that usury laws applicable in the jurisdiction of incorporation of the lender or the financier might also be relevant and could apply, notwithstanding that the loan agreement itself might be governed under English law.Currency restrictions
What limitations are there on investors funding loans in a currency other than the local currency?
None. There are no foreign exchange or currency controls applicable in the United Kingdom.Other regulations
Describe any other regulatory requirements that have an impact on the structuring or the availability of loan facilities.
In the case of loan facilities provided to commercial loan parties incorporated in the United Kingdom, there is no requirement to obtain a banking licence or other regulatory approvals for such activity. However, to the extent the loan is made under an English law facility to a party incorporated or located outside the United Kingdom, there may be regulatory or licensing issues to consider in that jurisdiction.
Certain lending activities are regulated in the United Kingdom, including consumer credit and mortgage lending.
This article first appeared on Lexology | Source
