As some of you may have seen, Fitch helpfully issued a press release last week clarifying its position on providing rating agency confirmations (RACs) during the replacement of special servicers on EMEA CMBS transactions. Rather unhelpfully, however, the release stated they would not be providing any such RACs in the future. This policy, of course, applies to the very transactions that Fitch rated (in the majority of cases) at inception which contained (presumably, either at Fitch’s request or at the very least with their knowledge) the requirement that such RACs be obtained from the relevant rating agencies before any transfer of the special servicer function could occur.

The right to replace the special servicer of a particular loan in a CMBS transaction typically lies with party that is exposed to the first loss position in relation to that loan i.e. either the B-piece lender or the lowest ranked class of noteholders (usually labelled the ‘controlling party’ or ‘controlling class’). Such controlling party or controlling class therefore has a strong economic incentive to ensure that the maximum recovery from the loan is achieved by the special servicer.

The replacement (or indeed the threat of such replacement) of the special servicer is one of the, if not the, most important right of such controlling creditor. However, it is also usual for such right to be subject to certain conditions before it can be exercised or the replacement can be effected. For example, the requirements sometimes include: (a) the replacement special servicer will be required to accede to the servicing agreement and in many cases, the issuer deed of charge and cash management agreement; (b) the replacement special servicer will need to be approved by a number of the transaction parties (most commonly, the trustee and/or the issuer); (c) the replacement special servicer must have sufficient experience and capabilities to perform the function; (d) the replacement special servicer’s fees must not exceed those of the outgoing special servicer; (e) rating agencies must be notified or, more applicable to the recent announcement, rating agencies must confirm that the replacement will not lead to a downgrade or withdrawal of the ratings of the notes. Fitch’s announcement therefore makes the exercise of such right in transactions which have a requirement for RACs more difficult than it otherwise should be and may, depending on the wording of the underlying documents and the stance of the existing special servicer, take it away altogether.

Fitch’s concerns include potential conflicts of interest including “a connection between the controlling class (or its representative) and the prospective special servicer” and “conflicting preferences between the controlling class (or its representative) and other (in particular senior) noteholders”.  First, these concerns presume no such connection exists between the existing special servicer and a particular noteholder or class of noteholder and, secondly, they also presume that the replacement special servicer would disregard the ‘servicing standard’ (in accordance with which such special servicer has to act).  We would hope that Fitch in coming to this conclusion isn’t assuming that a replacement special servicer will breach the terms of the servicing agreement and if so, what of the transactions where multiple parties or affiliates act in different capacities, which might have different preferences?  The protection provided is that parties are contractually bound to perform their obligations and in most cases the issue of conflicts is specifically provided for in the realm of servicing obligations.

So what are the practical consequences of the Fitch announcement? Well, certainly a headache for lawyers advising issuers, trustees, servicers, controlling parties and noteholders or at the very least some delays in the replacement process, which will prove frustrating for controlling creditors attempting to exercise their rights. In reality, as with most securitisations, the devil will be in the detail of the documents, as the transaction parties will want to know, for example, if the RACs have to be in written form, whether the documents specify which party has to be satisfied that a RAC has been obtained, whether there is a fallback provision allowing a noteholder vote in the absence of a RAC or if Fitch are willing to provide a press release stating that the change of servicer will not impact the ratings of the notes once the change has occurred. Surely an outgoing special servicer wouldn’t object to the waiver of this rating confirmation requirement and the replacement if it is sanctioned by the noteholders or directed by its principal, the issuer or the trustee? 2013 looks like it’s going to be a fun year in CMBS for all sorts of reasons and Fitch have just given us another one.