April 2019 – On 5 April 2019 the European Commission published a much-awaited report on loan syndication and its impact on competition in EU credit markets (the "Report"). This multidisciplinary research was undertaken for the Directorate-General for Competition of the European Commission by external consultants and focuses on syndicated loans connected with leveraged buyouts (“LBOs”), project finance (“PF”) and infrastructure finance (“INFRA”) in six Member States (France, Germany, the Netherlands, Poland, Spain and the United Kingdom), which together account for approximately three-fourths of the EU's syndicated lending in these segments in Europe.
Based on the analysis of the loan syndication market contained in the Report, it appears that there are certain areas where the loan syndication process could raise certain risks under Article 101 of the Treaty on the Functioning of the European Union (“TFEU”), i.e., where agreements between lenders have, as their object or effect, the prevention, restriction or distortion of competition, or Article 102 of the TFEU regarding the abuse of a dominant position. The Report identifies two major causes for such risks: the manner in which lenders typically cooperate, and the wider contextual factors of the market. While some potentially competition risk-generating features may benefit from the exemption under Article 101(3) of the TFEU by virtue of being efficiency enhancing and indispensable to the pro-competitive benefits of the agreement, others may not.
I. IDENTIFIED RISKS
The Report identifies the following main risks to competition, observed throughout the lifecycle of syndicated loan transactions:
- Market soundings: The Report contends that market soundings undertaken by mandated lead arrangers (“MLAs”) prior to the formation of the lending group are a key market feature capable of facilitating collusion. The solution seems to reside in drawing a non-ambiguous distinction between generic and specific market soundings, coupled with an efficient functional separation of the origination and syndication desks. The authors of the Report conclude that interactions in the PF/INFRA segment give rise to a higher degree of risk than the LBO segment.
- Non-disclosure agreements (“NDAs”): Although the bidding process is set up to avoid contact among lenders, the prevention of information sharing is governed by NDAs, which the Report contends can be difficult to enforce.
- Single mandated lead arranger (“MLA”), who may also act as an advisor: The Report emphasises that the use of a single MLA to set up a syndicate and to negotiate with other banks, while not yet common, is more likely to take place in PF/INFRA loans. While the borrowers/sponsors appear to retain control of this process, the possibility remains that information sharing may occur such that the negotiations of the syndicate may be coordinated and the price and terms of the loan moved against the borrower. Therefore, the Report identifies this as a risk-prone area.
- Post-mandate collusion by lenders discussing loan terms: The risk for lenders discussing loan terms so as to move against the borrower at the post-mandate stage is low, given that, as a rule, the loan terms are agreed bilaterally between the borrower/sponsor and individual lenders. The Report concludes nonetheless that joint discussions between lenders post-mandate should be limited to agreeing on the loan documentation and syndication strategy. However, two specific risks are acknowledged: negotiations resulting in an agreement on the highest common denominator (whether in respect of price or other terms), and the practice in some PF/INFRA deals to bring lenders together at an earlier stage to discuss terms. The risk of collusion may be higher where the borrower is relatively unsophisticated, e.g., a municipal authority.
- Tying of ancillary services to MLA services: The Report notes that, generally speaking, ancillary services are agreed as part of the initial agreement or post-closing, ensuring competitive pressure by enabling the borrower/sponsor to choose between competing bank offers. However, in a few cases, the provision of a loan was conditional upon ancillary services, and the Report suggests that such tying raises the risk of sub-optimal outcomes.
- Advisors belonging to the syndicate: The Report acknowledges the practice of using advisors who are also part of the syndicate (particularly in the PF/INFRA segment) and emphasises that adherence to protocols around keeping this role functionally separate from lending should mitigate the potential risks of sub-optimal outcomes for borrowers. Additionally, the Report manifests concerns for cases when an advising bank attempts to influence the borrower/sponsor towards a strategy or debt structure that suited its lending strategy (thus subverting the firewall between advisory and lending functions).
- Advisors influencing borrowers in respect of transaction structure and terms: The Report highlights the separate risk of the potential of advisor MLAs to influence borrowers to adopt a transaction structure or terms suitable to the advisor's lending practice. This area is of even more concern if control mechanisms (such as internal protocols) are weak and ineffective.
- Coordination of lenders when restructuring upon default: While in normal circumstances restructuring discussions between lenders are only to be held with the borrower's consent, discussions and negotiations regarding restructuring in the event of a default occur collaboratively among the syndicate members. The effects of this practice are twofold, the Report cautions, as this can enhance efficiency while at the same time increasing the risk of coordination. The Report qualifies this area as one “deserving future monitoring.”
- Tying ancillary services to refinancing: In conditions of default, lenders may have the opportunity to condition the refinancing upon contracting certain ancillary services. Akin to refinancing in general, the anti-competitive risks are exacerbated where the negotiations are held only with the existing members of the syndicate.
- Coordination by lenders on the sale of the loan on the secondary market: The Report found no evidence of coordinated activity to manipulate prices in the secondary market, finding that certain characteristics of the secondary market, such as the degree of buyer sophistication, should limit the ability of sellers to collude on the debt price. The economic benefit to lenders from any coordination may therefore be limited, reducing the probability of this risk.
- Other market failures: The Report also discusses competition-related inefficiencies on the market, particularly around “know your customer” rules and settlement processes. The report contends that blockchain technology may have the capacity to improve efficiency by redefining the loan as a digital asset, automating the allocation of collateral, expediting the clearing and settlement process, and speeding up the approval time for including additional investors (i.e., on the secondary loan market). However, further technical advancements are needed.
II. POTENTIAL SAFEGUARDS AND SUGGESTED SOLUTIONS
The Report defines certain safeguards aimed at securing pro-competitive outcomes in the loan syndication mechanism, such as:
- Training and policies: The Report identifies two key solutions: (i) competition law guidance or training for banks about information exchange issues, and (ii) adequate training and policies for relevant staff at MLAs (in particular regarding the duty to provide neutral advice to clients and to identify and manage conflicts).
- Ensuring that alternative options are presented to the borrower: The Report holds MLAs responsible to ensure that alternative options are presented to the borrower prior to agreeing on the loan terms, including pricing.
- Promoting competition between lenders: The Report suggests that borrowers should themselves ensure a competitive bidding process by approaching more potential lenders and maintaining bilateral negotiations with each of them prior to mandate, etc.
- Putting in place effective safeguarding protocols on information sharing between a lender's syndication and origination functions: The Report emphasises that a viable degree of separation between syndication and origination must function, such that syndication desks provide only consolidated anonymous views to origination desks and, consequently, reduce the risk that information about other lenders’ interest is unduly passed to the origination team.
Promotion of unbundled price competition: Ancillary services not directly related to the loan (e.g., future M&A advisory services) can be negotiated as part of the loan negotiation, with both “right of first refusal” and “right to match” clauses being used, the Report contends. The expert authors also advise that syndicates limit the cross-sale of ancillary services in order to avoid the risk of impairing competitive conditions in neighbouring markets to syndicated loans. Moreover, these practices should be kept outside the loan syndication process when these services are not directly linked to the loan.