One of the main developments of the recent unprecedented events witnessed in the credit markets has been lenders’ contemplation of using the rarely invoked market disruption clause. In the past few weeks we have seen contemplation turn into action as a number of lenders have sought to rely on the market disruption clause in existing loan agreements to pass on their actual costs of funding to borrowers.
This has arisen as a result of the apparent discrepancy between the screen rates normally used to determine the market rates of LIBOR and EURIBOR (the BBA LIBOR screen rate and the EU Banking Federation EURIBOR screen rate) and the true cost to all lenders of obtaining deposits in the inter-bank markets. Judging by the examples that have been reported to us, this surge of interest in market disruption is a global development1, affecting most lending sectors. This note is intended to set out some of the key issues agent banks have faced in dealing with an invoked market disruption clause2.
Another issue in relation to the recent crisis is lenders’ increased consideration of the market material adverse change (MAC) clause in syndicated lending arrangements, particularly relevant at the mandate/syndication stage. We have included a summary of the potential issues for Mandated Lead Arrangers at the end of this note.
Our summary of market disruption is based on the Loan Market Association standard form of this clause. As a result this note is not intended to be relied upon as general advice. Any party requiring guidance on any of the issues raised by this note should seek specific advice based on the best course of action to be taken given the individual circumstances. In particular, it is crucial in each case to read the documentation very carefully to determine (a) in what circumstances the clause can be invoked, (b) what steps need to be taken to invoke it and (c) what its effect will be.
When must market disruption be declared?
The agent must receive notification before the close of business in London on the relevant Quotation Day for the relevant Interest Period.
In practice the timing of notification to invoke the market disruption clause has been a significant issue. Agents have reported that they have not received notification from lenders within the deadline specified and as a result the relevant threshold required to trigger market disruption has not been met. Failure to meet the relevant threshold has meant that the borrower has continued to pay interest at LIBOR rates for the next Interest Period.
Does the notice have to be provided in writing and what should the notice say?
Any notice provided to the agent should comply not only with the requirements of the relevant market disruption clause but also the general notice provisions of the loan agreement.
Under the LMA, all notices are required to be made in writing. Having the notice in writing will enable the agent to determine whether the relevant requirements to invoke the market disruption clause have been complied with. It is also important that the notice is addressed for the attention of the relevant department or officer identified in the relevant notice provisions and complies with any delivery formalities. For example, under the LMA a communication or document to be made or delivered to the agent is only effective when actually received by the agent.
Finally, the notice should expressly refer to the fact that the cost to the lender of obtaining matching deposits in the relevant inter-bank market would be in excess of LIBOR for the relevant Interest Period.
We have seen recent examples of notices being rejected by the agent for failure to comply with the formalities of the relevant market disruption clause. The notice should refer explicitly to the relevant utilisation for the relevant Interest Period. The notice should also be dated.
Is the agent required to deliver the notices to all the lenders?
Under the terms of the LMA, the agent may disclose to any other party any information it reasonably believes it has received as agent under the loan agreement. However this is subject to the overriding right of the agent not to do or omit to do anything which would or might, in its reasonable opinion, constitute a breach of any law, regulation or duty of confidentiality.
The key competition law concern arising from the operation of a market disruption clause is that it could result in an exchange of competitively sensitive information between lenders, potentially leading to the coordination of their behaviour in the market in a way which would be considered anti-competitive. The problem arises if, in the notice to the agent, the individual lender provides competitively sensitive information (such as its cost of funds) and the agent passes this information to the other lenders in the syndicate. The lenders are likely to be competitors in the wider market, so receipt of this sort of competitively sensitive information has the potential to impact on their competitive behaviour in that wider market.
Competition law concerns can be mitigated if the agent keeps the competitively sensitive information to itself. Should an agent have any concerns relating to potentially confidential or competitively sensitive information, we recommend that the agent first seeks the instructions of the individual lender(s) providing the notice(s) and, as necessary, legal advice, before sharing any such information with the other lenders.
Is the agent required to deliver the notices and/or disclose the identity of each lender declaring market disruption to the borrower?
Under the terms of the LMA, the agent is under no express obligation to do so. However, the agent may find itself under pressure from the borrower to provide sufficient information to enable the borrower to verify that the relevant threshold has been reached and that the other notice formalities (discussed above) have been complied with. The disclosure duty of the agent to the borrower is one of the more difficult issues raised by market disruption and agents should ensure that they take no action without first seeking the instructions of the individual lender(s) providing the notice(s) to the agent and as necessary, legal advice.
What is the threshold to trigger market disruption?
The market disruption notices must be received from lenders whose participation in the loan agreement exceed the relevant threshold. Usually this has been 35 per cent or 50 per cent of the lenders participating in the relevant loan.
It would seem that lenders have sought to rely on the market disruption clause in numerous transactions over the past few weeks. However agents have reported that in many cases the relevant thresholds have not been met. Given the number of lenders who are reporting disruption issues, it is strange that this is the case. It may be that lenders have not been sufficiently aware of their rights in respect of market disruption or that lenders have as yet taken only a passive role in the process. The timing issues referred to above may also have contributed to the general failure to meet the threshold level before the end of the specified deadline.
When should the lenders notify the agent of their cost of funds?
The lenders are required to notify the agent “as soon as practicable and in any event before interest is due to be paid” in respect of the relevant Interest Period.
We understand that in practice some lenders have been reluctant to provide their cost of funds until the very end of the interest period, although some borrowers have started to push back on this.
How is the cost of funds to be calculated?
Under the LMA, following the successful invocation of the market disruption clause, each lender will calculate its own cost of funds as “the rate…to be that which expresses as a percentage rate per annum the cost to that lender of funding its participation in that loan from whatever source it may reasonably select”.
However, the LMA does also allow for a 30 day negotiation period (at the election of either the agent or the borrower) in which a substitution rate of interest may be agreed. Although finalisation of the substitute rate will require all lender consent, it may provide a good opportunity for the agent, the borrower and the lenders to enter into negotiations to fix a new point of reference to evaluate the cost of lender funding, for example relying on a Reference Bank rate instead of LIBOR . In the absence of an overriding agreement to the contrary, the revised rate will only be effective for the relevant interest period.
In the event that a substitute rate cannot be agreed by the end of this period, each individual lender will be entitled to recover its own actual costs of funding its participation in the next loan (as opposed to LIBOR), regardless of whether or not that particular lender invoked the market disruption clause.
Is the agent required to disclose each lender’s cost of funds to the borrower or can the agent provide a single blended rate?
There is nothing explicit in the LMA obliging the agent to disclose the lender’s cost of funds to the borrower. However, if the new pricing is based on the cost of funds to the lender from whatever source such lender may reasonably select, the agent may find itself under pressure from the borrower to provide sufficient information to enable the borrower to assess the basis of the cost of funds and determine how much it is required to pay each individual lender. The competition law and confidentiality issues raised above are equally relevant here. Can a single notice apply to all future Interest Periods or extend beyond a single Interest Period? No, not unless otherwise agreed. A separate notice will need to be delivered in respect of each Interest Period.
Can invoking the market disruption clause cause a breach of the financial covenants and thereby potentially trigger an Event of Default?
A further repercussion/unintended outcome of invoking the market disruption clause is the potential, in certain circumstances, for the borrower to find itself in breach of a financial covenant (such as a debt service cover ratio) as a result of higher interest repayments for the relevant interest period and therefore, the potential (depending on the formulation of the default provisions) for this to trigger an Event of Default. This situation may raise difficult issues for both the agent and the lenders and it is recommended that legal advice be sought in such circumstances.
What is a Market MAC provision?
Market MAC clauses are typically found in the mandate letter for a syndicated loan and provide the Mandated Lead Arrangers (MLAs) with a means to renegotiate, or step away from, the underwriting or syndication in the case of a change in events or circumstances which affect the international or domestic lending or capital markets.
Potential issues for MLAs?
The key question facing MLAs in the current market conditions is whether the current events and circumstances are sufficient to invoke the market MAC. The answer will depend on the particular drafting of the provision and the circumstances surrounding the deal (in particular whether the mandate agreement was signed before or after the start of the recent troubles).
MLAs may consider whether it is easier to rely on more objective clauses, such as a downgrade of credit rating, in order to achieve the same result.
Finally, in respect of current deals yet to reach the mandate stage, MLAs should pay close attention to the specific wording of the market MAC clause and consider whether the wording should be revised to take into account the poor current market conditions to ensure that even a small or minor deterioration in market conditions would be sufficient to trigger the provision.
We hope this note has addressed a majority of the key issues which have arisen or may arise in the future in relation to market disruption and/or the potential use of market MACs. Please do feel free to contact us with any questions or concerns.