Finance Insights - Spring 2019

1 Welcome to the spring 2019 edition of our semi-annual newsletter for corporate treasurers, chief financial officers and corporate general counsel in which we highlight key topical issues in the financial markets and explore their implications from a corporate perspective. In this edition, we continue our series examining global interest rate reform. Momentum is building in the steps being taken to transition away from LIBOR, with a number of key developments over the last six months. €STR, the recommended euro risk-free rate, is set to be published from 2 October 2019, prompting activity in preparation for this. Staying abreast of these developments is of growing importance. Regulatory change also continues to evolve. A new prospectus regime will apply in full from 21 July 2019, introducing key changes relevant to issuers. Changes to EMIR are set to come into force in late June or July 2019, with the intention of making compliance with EMIR easier for corporates and other non-financial counterparties. We revisit the development of green finance, discussing new regulatory initiatives in relation to environmental, social and governance issues. Lastly, we consider the release of preliminary panda bond guidelines by the People’s Bank of China and their potential impact on the viability of panda bonds as a source of funding. We hope you find this edition helpful in considering the implications of these key developments in practice. We would be pleased to discuss further any queries or comments which any of the articles may raise. Finance Insights | Spring 2019 LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N EMIR REFIT PAN DA B O N DS REGULATION ESG €STR 2 The last six months have seen continued momentum in the steps being taken to transition away from LIBOR across financial products. With just over two and a half years until the end of 2021, we take stock of recent developments and the critical next steps in supporting a market-led transition. The regulatory emphasis is on transition to new RFRs, rather than reliance on fallbacks. Bold strides into the new world of risk-free rates have been seen in both the bonds and derivatives markets, with continued issuance of bonds referencing SONIA and SOFR as well as increased liquidity in the RFR derivatives market. The March 2019 publication of a discussion paper by the Working Group on Sterling Risk Free Reference Rates (“Sterling RFR WG”) on SONIA conventions is expected to inform use of SONIA in other products, including loans. The Sterling RFR WG has concluded that an overnight SONIA rate, compounded, may be appropriate for some currently using term LIBOR in the cash markets, but that a risk-free term rate would be helpful for some parts of the cash markets. Development of liquidity in underlying markets to support such a rate ahead of end-2021 is likely to be challenging and regulators have urged market participants not to delay transition. However, fallbacks do have an important role to play ahead of transition. Fallbacks contemplating the permanent cessation of LIBOR have been developed for the bonds and derivatives markets. The ISDA consultation on fallbacks has yielded clear responses on favoured methodology for the adjustment of SONIA in the derivatives context and a similar credit adjustment spread consultation is expected to be launched shortly by the Sterling RFR WG for cash products. The LMA expanded replacement of screen rate provisions intended to facilitate transition are now commonplace in the loan market. Effective fallbacks depend on a clear understanding of what the end may look like for LIBOR. This too is developing. Edwin Schooling Latter of the FCA noted in January 2019 that a decrease in submissions due to departure of panel banks post end-2021 could result in an announcement by the FCA that LIBOR is no longer representative. In these circumstances, it is possible that publication of LIBOR, at least in certain currency tenors, may continue for legacy deals, a scenario contemplated by ICE Benchmark Administration, the current LIBOR administrator, in its recent survey to identify the most widely used LIBOR settings for use in certain legacy contracts. Whilst this could be helpful, particularly in the bond market where amending legacy contractual references to LIBOR may not be practicable, it also highlights the need to consider pre-cessation triggers when developing fallbacks. The ARRC in the US has contemplated such triggers and ISDA has just launched a consultation on pre-cessation events. The authorities have continued to make clear that the need to manage transition falls on all market participants. This is the time to accelerate preparations for the end of LIBOR, including identifying exposures, developing appropriate transition plans, participating in the numerous consultations that are now open and maintaining awareness of their progress. Finance Insights | Spring 2019 LIBOR Recent developments in transition from LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N EMIR REFIT ESG PAN DA B O N DS €STR LIBOR 3 The ECB’s September 2018 announcement of ESTER, now referred to as €STR, as the recommended euro risk-free rate, prompted a flurry of activity in preparation for its arrival. €STR is set to be published for the first time on 2 October 2019, reflecting the trading activity of 1 October 2019. The working group on euro risk-free rates (the “Euro RFR WG”) published in January 2019 a set of guiding principles for fallbacks in euro-denominated cash products. These principles are intended to assist market participants in developing more robust fallback language to address the permanent alteration or cessation of a euro benchmark such as EURIBOR or EONIA. They recommend market participants consider incorporating a fallback to €STR, even ahead of its first publication, and an adjustment spread that may in future be recommended by a relevant body. In addition, the principles state that new contracts should include permanent cessation triggers and consideration should be given to pre-cessation triggers as well as including provisions which may make it easier to amend the rate in future, for example by using the LMA’s expanded replacement of screen rate provisions. Following its consultation on the development of an €STR-based term rate, in March 2019 the Euro RFR WG recommended a methodology based on OIS tradeable quotes for calculating an €STR-based forward looking term rate that could be used as a fallback in EURIBORlinked contracts. The Euro RFR WG has also made recommendations, following public consultation, that the European Money Markets Institute (“EMMI”), the administrator of EONIA and EURIBOR, should modify the current EONIA methodology to €STR plus a spread for a limited period to assist transition to €STR. For its part, EMMI has been working towards authorisation under the EU Benchmarks Regulation (“EBR”) and has consulted on a new hybrid methodology for EURIBOR. EMMI recently announced that it has applied for authorisation as an administrator under the EBR and has started to transition panel banks from the current EURIBOR methodology to the new hybrid methodology. In recent months, there has been considerable progress to support use of €STR in the future. However, notwithstanding the anticipated extension of transitional provisions under the EBR to end-2021, maintaining momentum will be important as timing for transition, to a rate that has yet to be published, is tight. Finance Insights | Spring 2019 €STR The way forward for euro interest rates LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N EMIR REFIT ESG PAN DA B O N DS €STR 4 The provisions of the Prospectus Regulation (EU) 2017/1129 (the “PR”) will apply in full from 21 July 2019, at which time the existing Prospectus Directive (“PD”) regime will cease to have effect. The PR has been developed from the existing PD regime and is the third iteration of securities disclosure regulation in Europe. It forms a major part of the EU’s Capital Markets Union initiative. We outline here the headline changes introduced by the PR of which issuers should be aware. The existing wholesale disclosure regime will be broadened to include debt that is admitted to a specific segment of a regulated market to which only qualified investors have access. Risk factors must be limited to those that are material and specific, and they must be categorised with the most material risks listed first in each category. The concept of an EU Growth prospectus will be available for SMEs. A Universal Registration Document (similar to a shelf registration document) will be available for regular issuers and may facilitate faster access to the capital markets. More relaxed disclosure requirements will be in place for secondary issuances (where an issuer is already admitted to a regulated market or SME growth market). The format of prospectus summaries will be changed, there will be a maximum limit imposed of seven sides of A4 and the maximum number of risk factors that can be included in the summary will be 15. In addition to the PR itself, other pieces of legislation and guidance are key to the new prospectus regime. A delegated regulation on form and content is a level 2 measure setting out the content requirements for prospectuses relating to different types of products and different types of issuers. These content requirements are set out in a number of annexes to the delegated regulation. Regulatory technical standards relating to key financial information for prospectus summaries, publication of prospectuses, data and machine readability, advertisements and when a supplementary prospectus is required, have recently been published by the European Commission. At level 3 ESMA has published guidelines for competent authorities to consider when reviewing risk factors as part of the prospectus approval process. Although addressed to competent authorities, these guidelines will be of much interest to issuers as they set out in detail what competent authorities will expect in terms of the content and presentation of risk factors in prospectuses. Grandfathering is available for those issuers who have a PD-compliant base prospectus approved before the PR fully applies on 21 July 2019. Issuance under such a PD-compliant base prospectus will be possible until its date of expiry. Finance Insights | Spring 2019 Prospectus Regulation New EU prospectus regime is nigh LIBOR Click on icons to view the related article EMIR REFIT ESG PAN DA B O N DS €STR PROS P ECTUS REG U L AT OI N 5 EMIR is being amended as part of the European Commission’s REFIT programme, and the amending Regulation (the “REFIT Regulation”) is expected to come into force in late June or July 2019, with some of the changes taking immediate effect. While the EMIR REFIT changes are intended to make compliance with EMIR easier for corporates and other non-financial counterparties (“NFCs”), some of the changes require urgent action by NFCs. In particular, NFCs need to revise the way they calculate whether they are below the clearing thresholds, and therefore can be classified as NFC-s for the purposes of the clearing, margining and risk-mitigation provisions of EMIR. The new methodology requires the calculation (on a group basis) of all OTC derivative positions (excluding hedging transactions) based on aggregate month-end positions for the previous 12 months, instead of on a rolling 30 day basis. ESMA recently issued a statement noting that, to continue to be treated as an NFC-, these calculations must be conducted, using the new methodology, as at the date the REFIT Regulation comes into force. Where an NFC exceeds any of the clearing thresholds or fails to calculate its positions according to the new methodology by the time REFIT comes into force, the NFC must immediately notify ESMA and its national competent authority (“NCA”). If not already subject to the clearing obligation, it would become subject to that obligation four months later unless, in the meantime, it is able to demonstrate to its NCA that it does not exceed the clearing thresholds. Failure to calculate positions would also prejudice its status as an NFC- under the margining and risk-mitigation provisions in EMIR. In a significant change for NFC+s, such counterparties will only be required to clear OTC derivatives in an asset class where the threshold is exceeded. Further important changes for NFCs relate to reporting of derivatives. A new requirement that EU financial counterparties (“FCs”) entering into derivative transactions with NFC-s report the transactions on behalf of the NFC- will apply from 12 months after the REFIT Regulation comes into force. In addition, there will be a new exemption from reporting intra-group transactions in some cases, subject to notification to the NCA. As a result of these changes, FCs are likely to ask NFCs to confirm their status as an NFC- or, in the case of NFC+s, the asset classes for which the clearing threshold is exceeded, when the REFIT Regulation comes into force, possibly in the form of a new ISDA Master Representation Letter. Finance Insights | Spring 2019 EMIR REFIT An update for corporates LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N ESG PAN DA B O N DS €STR EMIR REFIT 6 Whilst the green bond and green lending markets continue to develop, regulatory changes are afoot which will more concretely define, expand and seek the disclosure of the risk management processes undertaken by banks on environmental, social and governance (“ESG”) issues. New regulatory initiatives proposed in the EU and UK seek to embed analysis of ESG risks and opportunities in corporate governance, strategy and risk management processes, with a particular focus on how climate change is addressed in the financial services sector. March 2019 saw the launch of a set of Sustainability Linked Loan Principles developed by the Loan Market Association, Loan Syndications and Trading Association and Asia Pacific Loan Market Association. These seek to measure a borrower’s performance against pre-agreed Sustainability Performance Targets which are specific to each financing and may include metrics such as key performance indicators or external ratings. Following publication in recent years of the Green Loan Principles and Green Bond Principles, these principles represent continuing development of the green finance market. Various new regulatory proposals are now also in play, seeking to ensure that ESG-related risks are actively considered, measured and managed by banks and financial institutions. The PRA has published policy and supervisory statements to regulate banks’ and insurers’ approaches to managing the financial risks from climate change through (i) effective governance, (ii) risk management, (iii) scenario analysis, and (iv) disclosures. Under the new regime, banks and insurers will be expected to assign responsibility for climate-related risk to a senior manager. Such a framework leverages off that put forward in a voluntary disclosure standard produced by the Task Force on Climate-related Financial Disclosures (“TCFD”), itself established under the auspices of the Financial Stability Board with the aim of standardising disclosures made by corporates relating to climate-related risks in order to facilitate transparency of information on the carbon intensity of different assets/ investments in order to smooth price adjustments. The EU Sustainable Finance package, currently subject to legislative review, requires institutional investors, insurance companies, private equity houses, pension funds and their advisers to disclose how sustainability risks are integrated into their risk management processes and the services provided to clients. If implemented, this would entail increased scrutiny of those companies and products in which they are invested. A Technical Expert Group will produce a taxonomy on ESG risks and opportunities will be developed which will seek to define the climate risks which form the subject of the disclosure obligations, with social risks being addressed at a later stage. The FCA is consulting on (i) how it can ensure that issuers of listed securities are meeting disclosure obligations on climate change risks, and (ii) whether greater consistency on climate-related disclosures would be achieved by requiring disclosure pursuant to the TCFD on a comply or explain basis and/or requiring a “climate risks” report. Disclosure obligations, and disclosure-related scrutiny by third parties, will be enhanced by these initiatives. Additionally, they may, in the medium to long term, impact access to capital depending on the effectiveness of the ESG risk assessment and management by corporates. They may also signal greater granularity in the nature of the ESG-related regulation, centred around the new taxonomy. Finance Insights | Spring 2019 ESG A stronger push towards a lower carbon economy LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N EMIR REFIT PAN DA B O N DS €STR ESG 7 Panda bonds have grown notably since the first panda bonds were issued in 2005. According to the People’s Bank of China (“PBOC”), the aggregate value of panda bonds issued in China’s Interbank Bond Market (“CIBM”) from 2005 to August 2018 is RMB178.16 billion (approximately US$26.47 billion). However, following a period of significant growth from 2014 to 2016, issuances of panda bonds decreased notably in 2017. In a move to encourage further issuance, the PBOC released the highly anticipated preliminary panda bond guidelines (the “Guidelines”) in October 2018. We consider here the Guidelines’ implications for the panda bond market. Panda bonds are renminbi denominated bonds issued by non-Chinese entities and sold to mainland Chinese investors. The Guidelines have codified the two methods by which panda bonds have traditionally been issued: (i) direct offers to qualified institutional investors (i.e. a form of private placement); and (ii) public offers to investors in the CIBM or on an Exchange-Traded Bond Market (e.g. the Shenzhen Stock Exchange). Panda bonds are typically favoured by entities requiring funding for operations in China, although other issuers may also benefit from the relatively inexpensive funding costs (particularly for those issuers who have renminbi built into their debt issuance programme documentation) and investor base diversification. Despite this, growth of the panda bond market has been erratic. Sovereigns, supra-nationals and financial institutions have traditionally been the main issuers, with corporate issuers few and far between. Traditionally, this is due to PBOC’s prior approval being required for all issues, a process which can be lengthy and often lacks transparency, and the difficulty with remitting the funds outside China due to capital controls. The Guidelines are China’s first step in trying to address these issues. For example, it appears that sovereigns, supra-nationals and corporates now only need to apply for registration with the National Association of Financial Market Institutional Investors (“NAFMII”). We expect NAFMII to provide further clarity on the process shortly and hope that this would lead to a shortened execution timeline. In addition, the Guidelines hint at the possibility that proceeds (or parts thereof) may be remitted outside China, although more guidance in this area would be welcome. Finally, the Guidelines’ codification of the criteria for a direct offer to qualified institutional investors through a private placement provides clarity for foreign issuers looking to access this market. Market participants will be keenly observing the impact of the Guidelines and considering panda bonds as a viable source of funding. Finance Insights | Spring 2019 Panda bonds The panda’s fluctuating fortunes LIBOR Click on icons to view the related article PROS P ECTUS REG U L AT OI N EMIR REFIT ESG €STR PAN DA B O N DS Olga Petrovic Partner, Banking Tel: +44 20 7456 4429 olga.petrovic@linklaters.com James Martin Partner, Banking Tel: +44 20 7456 4430 james.martin@linklaters.com Mirthe van Kesteren Partner, Banking Tel: +44 20 7456 5446 mirthe.van_kesteren@linklaters.com Christopher Williams Counsel, Banking Tel: +44 20 7456 5091 christopher.williams@linklaters.com 8 Finance Insights | Spring 2019 Contact us May 2019 Ben Dulieu Partner, Equity and Debt Markets Tel: +44 20 7456 3353 ben.dulieu@linklaters.com Elaine Keats Partner, Head of Equity and Debt Markets Tel: +44 20 7456 4441 elaine.keats@linklaters.com Paul Lewis Partner, Global Head of Finance & Projects Tel: +44 20 7456 4658 paul.lewis@linklaters.com Philip Spittal Partner, Head of Global Loans, Banking Tel: +44 20 7456 4656 philip.spittal@linklaters.com Ian Callaghan Partner, Banking Tel: +44 20 7456 5304 ian.callaghan@linklaters.com Pauline Ashall Partner, Derivatives and Structured Products Tel: +44 20 7456 4036 pauline.ashall@linklaters.com Oliver Edwards Partner, Banking Tel: +44 20 7456 4463 oliver.edwards@linklaters.com Toby Grimstone Partner, Banking Tel: +44 20 7456 4893 toby.grimstone@linklaters.com Carson Welsh Partner, Equity and Debt Markets Tel: +44 20 7456 4602 carson.welsh@linklaters.com Deepak Sitlani Partner, UK Head of Derivatives and Structured Products Tel: +44 20 7456 2612 deepak.sitlani@linklaters.com Richard Levy Partner, Equity and Debt Markets Tel: +44 20 7456 5594 richard.levy@linklaters.com Doug Shaw Counsel, Derivatives and Structured Products Tel: +44 20 7456 5081 doug.shaw@linklaters.com UK 9 Dario Longo Partner, Capital Markets Tel: +39 02 883 93 5219 dario.longo@linklaters.com Finance Insights | Spring 2019 Contact us 8458_SPRING_F/05.19 Belgium Andrea Arosio Managing Partner, Banking Tel: +39 02 883 93 5218 andrea.arosio@linklaters.com Italy France Kathryn Merryfield Partner, Banking Tel: +33 1 56 43 59 03 kathryn.merryfield@linklaters.com Véronique Delaittre Partner, Capital Markets Tel: +33 1 56 43 58 85 veronique.delaittre@linklaters.com Germany David Ballegeer Partner, Banking and Capital Markets Tel: +32 2501 9593 david.ballegeer@linklaters.com Luxembourg Nicki Kayser Partner, Banking and Capital Markets Tel: +352 2608 8235 nicki.kayser@linklaters.com Russia Dmitry Dobatkin Partner, Banking and Capital Markets Tel: +7 495 797 9733 dmitry.dobatkin@linklaters.com Spain Juan Barona Partner, Banking Tel: +34 91 399 6120 juan.barona@linklaters.com Jorge Alegre Partner, Capital Markets Tel: +34 91 399 6177 jorge.alegre@linklaters.com Sweden Patrik Björklund Partner, Banking and Capital Markets Tel: +46 8 665 41 30 patrik.bjorklund@linklaters.com Pim Horsten Partner, Capital Markets Tel: +31 20 799 6210 pim.horsten@linklaters.com Poland Jarek Miller Partner, Banking and Capital Markets Tel: +48 22 5265 048 jaroslaw.miller@linklaters.com Portugal Antonio Soares Partner, Banking and Capital Markets Tel: +351 21 864 00 13 antonio.soares@linklaters.com Netherlands Mees Roelofs Partner, Banking Tel: +31 20 799 6289 mees.roelofs@linklaters.com Christian Storck Partner, Capital Markets Tel: +49 69 710 03 531 christian.storck@linklaters.com Dr. Neil Weiand Partner, Banking Tel: +49 69 710 03 380 neil.weiand@linklaters.com May 2019