A frequent area of focus for market participants in a restructuring, particularly those on a steering committee (often called the coordinating committee or CoCom), is the extent to which they can trade loans once they have come into possession of material non-public information. Those buying loans from CoCom members also worry over whether there is equality of information between buyer and seller.
In June this year, the LMA issued best practice guidelines (the Guidelines) promoting "high standards of integrity by loan market participants". This follows previously issued guidance by the LMA relating to the communication and use of material non-public information by loan market participants in connection with activities concerning securities, which are governed by the longstanding insider dealing and market abuse regimes. Loan trading, however, is not subject to similar regulation and for this reason the LMA has sought to identify best practice for the handling of information in the loan market.
In particular, the Guidelines provide guidance to CoCom members who have information which may not be available to the syndicate as a whole, but who want to trade debt to others. The Guidelines also encourage the prompt dissemination by the CoCom of such information to the rest of the syndicate, and the prompt disclosure by borrowers of all material information to all potential lenders during the life of the transaction. The requirements on loan market participants set out in the Guidelines have prompted a debate whether they are an attempt to bring the unregulated loan market closer to the regulated public securities market as well as, concerns that they discourage non-banks from becoming members of CoComs and do not, in any event, have the force of the law.
The Guidelines define two categories of information: "Syndicate Confidential Information" and "Borrower Confidential Information" (see box below), and set out guidance on permissible trading by parties in possession of these different categories of information.
Distinction between types of information
"Syndicate Confidential Information" is information which has been made available to the whole of the syndicate, including, for example:
- Financial reports
- Financial projections
- Covenant compliance reports
- Plans to dispose of or acquire assets
There may also be market participants who elect not to receive Syndicate Confidential Information because of their holdings of publicly traded securities issued by the borrower.
"Borrower Confidential Information" is material information which has not been made available to the syndicate as a whole. "Material" information is "typically considered material" where "if it were known to the entire syndicate, it would significantly impact the price of the relevant loan". It could include for example:
- Material information provided to a CoCom member
- Material information provided to a loan investor in their capacity as a board member and/or shareholder (for example following a debt-for-equity swap)
- Details regarding potential material amendments, waivers and refinancings
Best practice for loan trading when in possession of "Syndicate Confidential Information" or "Borrower Confidential Information"
The Guidelines identify best practice as follows:
Market participants may trade loans based on Syndicate Confidential Information.
- This statement of best practice is nothing new. A seller is currently free to trade with any party in possession of Syndicate Confidential Information and, with respect to any that are not, the seller should make information available so that each party enters the trade with the same level of information (subject always to relevant confidentiality obligations).
- A buyer may choose not to receive Syndicate Confidential Information if it wants to remain "public" on the name (i.e. where there are also securities in issue), in which case the seller may proceed with the trade, relying on Condition 20.5 (Material Information) of the LMA Standard Terms and Conditions for Par and Distressed Trade Transactions (Bank Debt / Claims). Under that Condition, the buyer and the seller each acknowledges and agrees that the other may possess material information not known to it and excludes any liability for the non-disclosure of such information (except to the extent that it renders inaccurate an express representation made in the trade documentation).
- The Guidelines define Syndicate Confidential Information as information which has been made available to the "whole" of the syndicate. If the CoCom posts Borrower Confidential Information on an Intralinks site to which the whole syndicate has access, then this information becomes Syndicate Confidential Information even where some syndicate members might have opted not to receive such information, and the syndicate lenders will then be able to trade on this information as outlined above.
Market participants (including the Borrower itself and its related parties) should not generally trade loans based on Borrower Confidential Information (including with counterparties who have access to similar levels of information).
The Guidelines include an exception that a CoCom member who possesses Borrower Confidential Information may trade that debt in circumstances where they may reasonably make a judgement "subject to applicable law" that (a) it is "consistent with appropriate standards of professional integrity and fair dealings" to trade; (b) the trade is with a counterparty who is also in possession of or has the ability to receive Borrower Confidential Information and (c) the transaction "will not adversely affect other members of the syndicate or the market".
- The Guidelines do not elaborate on the meaning of "appropriate standards of professional integrity and fair dealings" and nor do they make any direct reference to a particular set of standards. This requirement is not new and was referred to in the LMA’s paper dated August 2007. These standards would include those expected from all firms regulated under the Financial Services Authority (FSA) as stated in the general FSA Principles of Business (see box below). Under FSA Principle 1, a firm must conduct its business with integrity. A lack of integrity would clearly include fraud, intentional misrepresentation, breach of trust or deception. An example could be where a seller mistates that it has Borrower Confidential Information to a buyer.
- Neither do the Guidelines clarify when a trade would "adversely affect the syndicate or the market", although it is probable that this would catch any transaction which significantly affected the price of the debt. For example, a selling CoCom member in possession of Borrower Confidential Information selling its entire exposure in the loan to another CoCom member could breach the Guidelines if it misjudged whether there could be an adverse effect on syndicate members or the market in circumstances where the trade resulted in a significant price fall.
- In practice, many institutions will set up information walls or use broker-dealers to deal with the restrictions which would otherwise prevent them from trading loans whilst sitting on a CoCom. The Guidelines state that they only apply to the person in a financial institution who is making the decision to trade or effecting trades, so market participants can continue to trade loans if they have an information wall separating the traders and CoCom members. However, smaller market participants (such as hedge funds who trade secondary debt in a restructuring situation) may find it impractical to build information walls due to their lack of internal resources.
- Some market participants have concerns that the circumstances in which they can trade based on Borrower Confidential Information are too narrow and that this will lead to certain market participants being reluctant to join the CoCom. One concern is a situation where CoCom members are placed under specific higher duties of confidentiality than syndicate members in respect of information received in that capacity. If the CoCom member does not have established information walls, any trade would be contrary to the Guidelines unless the Borrower’s consent to disclose to a potential purchaser is obtained, which is likely not to be practicable in those circumstances.
CoCom’s obligation to disclose information as soon as possible
The Guidelines state that CoCom members should share Borrower Confidential Information with the broader syndicate as quickly as possible. In complex restructurings all information provided to the CoCom and its advisers cannot be provided to the rest of the syndicate until it has been fully digested and analysed and it may be that the information provided forms the basis of confidential negotiations for some time. However, the Guidelines will require CoComs to continually bear in mind when to deliver information to syndicates.
Disclosure obligations for borrowers
The Guidelines also provide that:
- Borrowers should undertake in writing to disclose promptly to lending syndicates all material information to all potential lenders prior to signing and/or during the syndication process and during the life of the transaction
- Borrowers and/or a related party should disclose any loan purchase which in the context of the relevant loan is material no later than close of business on the day following the trade(s)
A borrower may have many reasons for restricting the circulation of confidential information during a restructuring until the restructuring terms are close to being agreed. The Guidelines suggest additional disclosure obligations on the borrower with the aim of ensuring that all syndicate members have access to the same information at the same time, recognising that the lenders will usually be required to enter into confidentiality restrictions. It remains to be seen whether these recommendations for best practice will be incorporated into the contractual documentation itself.
The Eleven FSA Principles of Business:
- Integrity - A firm must conduct its business with integrity.
- Skill, care and diligence - A firm must conduct its business with due skill, care and diligence.
- Management and control - A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.
- Financial Prudence - A firm must maintain adequate financial resources
- Market conduct - A firm must observe proper standards of market conduct.
- Customers’ interests - A firm must pay due regard to the interests of its customers and treat them fairly.
- Communications with clients - A firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading.
- Conflicts of interest - A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.
- Customers: relationships of trust - A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgement.
- Clients’ assets - A firm must arrange adequate protection for client’s assets when it is responsible for them.
- Relations with Regulators - A firm must deal with its regulators in an open and co-operative way, and must disclose to the FSA appropriately anything relating to it of which the FSA would reasonably expect notice.
The Guidelines’s advice to borrowers to disclose material loan purchases is a response to the flurry of borrower buybacks that occurred since the LMA’s last paper on the subject of dealing with material non-public information by loan market participants.
The Guidelines also give guidance with respect to syndicate lists and provides that after the close of primary syndication facility agents should not disclose the list of the current syndicate to any party except if requested by a Borrower or a syndicate member in certain limited circumstances. These limited circumstances include:
- If requested by a borrower, to the borrower or a related party, or to a third party to facilitate a refinancing or material amendment or waiver
- Syndicate members may ask whether an institution which files for insolvency or is downgraded below investment grade is part of a syndicate and if so the amounts of its holding
- Between syndicate members if it has been agreed to be shared (and if holders of more than 15 per cent of a facility request the agent to seek a vote on this, the agent must do so)
Identifying the syndicate members can be a strategic importance in restructurings and if these provisions are incorporated in future loans it will be interesting to see how the documentation develops.
Is the unregulated loan market moving closer to the regulated public securities market?
The LMA makes it clear that the Guidelines do not address the laws relating to insider dealing or market abuse on securities trading. Those regimes only apply in circumstances where the information relates to an issue or issuer of securities admitted to trading on a regulated market. The LMA accepts that participants in the loan market may receive information about borrowers that could be classified as inside information in relation to the public securities market, in which case they will need to comply with those regimes.
Some market participants claim that the LMA are using the Guidelines to provide equivalent insider dealing rules in respect of the loan trading market. The recommendations for additional transparency by the borrower in particular could be perceived as a first step towards standardisation of disclosure practices. It might indeed be a welcome step for loan investors, if equivalent disclosure obligations were contractually imposed on borrowers. However, the private nature of the loan market is seen by the LMA and all participants as being important. Detailed business plans and financial covenant levels, for example, are typically not provided to bondholders.
The weight of the Guidelines
The Guidelines are voluntary and not binding. The LMA is not a regulatory body and has no powers of enforcement. Loan market participants are unlikely to change suddenly their current behaviour with respect to the use of information when trading loans. Nevertheless, the aim of the Guidelines is to promote a fair and competitive loan market, in which participants will be "expected to behave with integrity". They aim to provide advice as to best practice which is consistent with ethical business practices and with applicable laws and regulations and so exist very much along side and entwined with the law.
The FSA is the main regulatory body for loan market participants in the UK. With respect to hedge funds, although these are not regulated by the FSA since they are generally located outside the UK, the FSA has authority over hedge fund managers and the broker/dealers who provide prime brokerage services to the funds. Under FSA Principle 5, a firm must observe proper standards of market conduct. Until now, there has been very little advice as to the standard which this Principle imposes and not much enforcement precedent in this context. Accordingly the FSA’s approach in a situation involving the inappropriate use of information in connection with loan trading might be to take the Guidelines into consideration (but also their affect on the market), particularly since the LMA is the trade association for syndicated loan markets in Europe and carries considerable influence in the loan markets in Europe. Accordingly, flagrant breach of the Guidelines may also amount, depending on the circumstances, to breach of the FSA Principles.
The LMA also notes in the Guidelines that they will be incorporated into future standard documentation where applicable. The provisions of the Guidelines will then have contractual weight if the parties agree to incorporate the provisions in executed deals. The disclosure requirements for Borrowers, and the provisions regarding lists of syndicate members, under the Guidelines may well be the subject of specific suggested LMA standard clauses in the future.
The Guidelines develop upon prior publications by the LMA and expand upon the use of material non-public information in the loan market.
In particular, the Guidelines place stringent restrictions on trading loans if a lender has possession of Borrower Confidential Information, so that such a lender will only be able to trade with a party with the same level of information if the transaction does not adversely affect the syndicate or market.
Any lender considering becoming a member of a CoCom needs to consider the Guidelines carefully. The Guidelines aim to promote the quick dissemination of Borrower Confidential Information by the CoCom to the rest of the syndicate, enabling such information to be "cleansed" and turning Borrower Confidential Information into Syndicate Confidential Information, which then facilitates the trading of loans by the members of the syndicate with purchasers in the wider market. Investors without the ability to set up information walls will want to ensure the CoCom arrangements contemplate swift dissemination of confidential information as soon as possible. Whether CoCom members can provide information received in that capacity to potential buyers is also an important fact to determine.
Despite the publication of the Guidelines, institutions are likely to continue, for the time being, to have primary regard to their current internal policies and the FSA Principles. However, they should be mindful of the Guidelines as they constitute a move towards adopting certain practices with respect to the use of information that are prevalent in the bond market.
Some readers may be interested to know that the Alternative Investment Management Association (AIMA), the hedge fund industry’s global trade association, is setting up a working group to consolidate the views of any interested parties in response to the Guidelines with a view to discussing their conclusion with the LMA. Any interested parties should contact Matthew Jones at AIMA by email at firstname.lastname@example.org.