What has the U.S. Fish and Wildlife Service got in common with the U.S. banking agencies [1]?  Simple: the U.S. Government Accountability Office (the "GAO"), which investigates financial matters on behalf of Congress, has opined that both have wrongly published general statements of policy which are in fact rules under the Congressional Review Act (the "CRA").

The GAO issued an opinion on 19 October 2017 that the Leveraged Lending Guidance (“LLG”) [2] is a rule subject to the requirements of the CRA, meaning that it should have been submitted to each House of Congress before it was implemented, and opening the door for the possibility of it being overturned. This is notwithstanding that the LLG explicitly states that it is not a rule – the GAO has reiterated that an agency's characterization is not determinative of whether it is a rule under the CRA, and the LLG does not meet any of the CRA exceptions.

What does this mean? Senator Toomey's objection to the LLG is that it has effectively acted like law to alter the behaviour of regulated lenders whereas U.S. laws are supposed to be passed by Congress. He is especially critical of the regulatory power granted to various agencies.

Following receipt of the GAO's opinion, the LLG is no longer effective. To rectify this the U.S agencies would need to submit the LLG to Congressional review. Were it to be submitted to them, Congress will broadly have 60 days to determine what to do. Congress may disapprove the LLG by passing a resolution for the President to sign or they may work with the agencies to modify the LLG to address some concerns.  Congress may also decide to leave the LLG intact. At this point, no one knows for sure.

Senator Toomey is said to be exploring steps to hold the agencies responsible for not complying with the CRA.

This all comes at an interesting time.

The LLG was introduced back in 2013 in reaction to the impact of the last financial crisis to try to minimize the risk of excessive leveraged debt contributing to a future crisis. When proposing the guidance in 2012 the U.S. agencies said that since 2001 (when the previous guidance had been implemented) they have "observed tremendous growth in the volume of leveraged credit and in the participation of non-regulated investors". The agencies also noted that many agreements have more frequently included "features that provide relatively limited lender protection…"including cov-lite loans and PIK-toggle features in junior capital instruments…both of which lessen lenders' recourse in the event that a borrower's performance does not meet projections. "It was in the light of these developments, as well as the growing "pipeline of aggressively priced and structured commitments" that the agencies implemented the LLG in the first place.

While there were many reports that many lenders took a long time after the adoption of the LLG to comply with it, it is now clear that the guidance has moderated the lending behaviour of regulated banks. Despite this, S&P Global Market Intelligence for YTD 2017 Average Pro Forma Credit Statistics shows Total Debt/EBITDA at x5.0 in both the U.S. and Europe (compared to x5.9 and x4.9 respectively in 2007) and by the end of the third quarter this year, cov-lite deals comprised 74% of issuance syndicated in Europe in the year to date. According to the S&P Leveraged Loan Index as of the end of September 2017, 72.9% of all U.S. leveraged loans outstanding featured a covenant-lite structure, up slightly from the previous month, and representing approximately $690 billion of outstanding U.S. leveraged loan paper.

Given that the leveraged finance market is currently very active and competitive, many have argued that the LLG is, therefore, needed more now than ever. Indeed in Europe, only this year the European Central Bank (the "ECB") introduced very similar guidance [3] which to a large extent mirrors the US guidance, and which only entered into force this month.

It is fair to say that market reception of the LLG (and the ECB guidance for that matter) has not been altogether positive.  Views have been expressed that regulated banks are put at a disadvantage when compared to those banks not subject to similar guidelines (which includes UK, Japanese and other banks not subject to either the LLG or the ECB guidance) and compared to non-bank lenders who are not subject to regulation at all.

Overturning the guidance could transform the competitive landscape, as unregulated lenders have been able to win a larger piece of the market share than the banks subject to the LLG.  If Congress modifies or even ditches the LLG, European banks subject to the ECB guidance could find themselves even more disadvantaged if US lenders are set free from the U.S. agencies' guidance keep net.

With increasing globalization the uncertainty caused by the GAO's ruling is unsettling. We wait to see if Congress will decide to throw this fish back or not.  It is possible that they will come up with a new version of the guidance that will be less challenging for the banks, but the agencies have yet to comment publicly.