The European Commission (EC) has published a report prepared by Europe Economics on the impact of loan syndication on competition in EU credit markets (Report). The EC requested the study in view of the perception that loan syndication exhibited “close cooperation between market participants in opaque or in-transparent settings…which are particularly vulnerable to anticompetitive conduct”.
Listen to our accompanying podcast on the report
The Report covers loans in the context of leveraged buy-outs (LBOs), project finance (PF) and infrastructure projects (INFRA) and focuses on six EU Member States (France, Germany, the Netherlands, Poland, Spain and the UK). The goal of the study is ambitious: to provide an assessment of the functioning of the loan syndication market in the EU and to identify aspects which may give rise to competition law risk.
The Report does not identify any intrinsically anti-competitive market features, but points to features that may facilitate competition law problems in individual cases. This includes features that may facilitate:
- collusion (including use of market soundings by Mandated Lead Arrangers (MLAs));
- tying of ancillary services (hedges, other lending services) to the syndicate;
- the potential for tacit reciprocity where bookrunners are dealing with competing lenders; and
- curtailed borrower/sponsor bargaining power where the borrower is in financial difficulty and faces default.
We summarise the key competition risk areas identified in the Report at each stage of the syndication process below.
1. Competitive bidding process for appointing individual banks to the lead banking group
The Report identifies market soundings by MLAs prior to the formation of the lending group as a key market feature capable of facilitating collusion. It stresses the importance of having a clearly defined distinction between generic and specific market soundings (the latter requires explicit borrower/sponsor consent), and functional separation of the origination and syndication desks. In particular, soundings with other MLAs (as opposed to exclusively with institutional investors without connections to MLAs) could be abused to facilitate collusion.
Additionally, although the bidding process is set up to maintain competitive tension (by keeping lenders separate and through use of NDAs), there is a risk that lenders engage in anti-competitive information exchange in breach of those arrangements.
2. Post-mandate to loan agreement
Post-mandate, the scope for lenders to discuss the loan terms (to the borrower’s detriment) is considered to be limited given that the general process is for the loan terms to be agreed on a bilateral basis between the borrower/sponsor and individual lenders. The Report concludes that joint discussions between lenders post-mandate should be limited to agreeing the loan documentation and syndication strategy.
The Report also notes that given the multiple interactions between lenders on transactions over time, this gives rise to some risk that lenders can observe each other’s behaviours and strategies which may enable coordination on future transactions. However, no direct evidence of this was identified in practice.
3. Allocation of ancillary services across banks, and the pricing of such services
The Report notes that ancillary services are predominantly agreed as part of the initial agreement or post-closing, ensuring competitive pressure by enabling the borrower/sponsor to choose between competing banks’ offers. However, in a small minority of cases, ancillary services were provided as a condition of the loan and although, for example, the Spanish competition authority has recently considered this is not unlawful in relation to hedging services, the Report suggests such tying raises the risk of sub-optimal outcomes.
In the PF/INFRA segment, restrictions by lenders on who can provide the hedge can be problematic, especially in smaller markets where borrower/sponsor choice is limited (e.g. in Poland). In the UK, the FCA has prohibited restrictive contractual clauses which prevent effective competition in subsequent transactions, although their use may be continued outside the UK.
4. Use of debt advisors which are also involved in the syndicated loan
The use of advisors which form part of the lending syndicate is widespread amongst borrowers/sponsors. The Report points to limited evidence that some lenders do bundle the advisory role with a lending role but notes that this can increase the risk of sub-optimal outcomes, especially if the advisor is appointed without a competitive process. Additionally, there would be a significant concern if an advising bank attempted to influence the borrower/sponsor towards a strategy or debt structure that suited its lending arm (subverting the Chinese wall between advisory and lending functions). However, it is noted that this would represent a significant breach of banks’ internal protocols.
5. 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 the features of the secondary market (and in particular the degree of buyer sophistication) should limit the ability of sellers to manipulate the price of debt. The Report also found widespread evidence of borrower / sponsor restrictions on secondary trading (e.g. no small transfers, or transfers subject to borrower approval) which it considered may, to some extent, limit efficiency of the secondary market as well as having some minor potential knock-on effects on the primary market.
6. Refinancing in conditions of default
Discussions and negotiations regarding restructuring in the event of a default occur collaboratively amongst the syndicate members. The Report cautions that this can enhance efficiency but also increases the risk of coordination. In the majority of cases examined in the course of the study, refinancing discussions involved lenders from outside the original syndicate, indicating market discipline and limiting the market power of existing lenders. However, the Report points to a number of instances where the existing syndicate was the only option, creating an opportunity for lenders to price ancillary services in distressed circumstances on non-competitive terms. The Report’s finding is that this is an area which “deserves future monitoring”.
The Report identifies a number of different features of the market and syndication process which may give rise to increased competition law risk as outlined above, although it does not include evidence of specific competition law infringements. However, it also highlights certain countervailing safeguards which can help ensure competitive outcomes (e.g. banks’ duty of care to clients, protocols to limit information exchange), underlining again the importance of properly implemented compliance training on these complex issues. Furthermore, the Report does not identify the market segments looked at as being highly concentrated.
More generally, we should expect the EC (together with the national competition authorities) to carefully consider the findings set out in this Report. The competition authorities can be expected to continue to focus on financial services, including loan syndication, with this Report potentially being a catalyst for detailed regulatory scrutiny and/or enforcement action.
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