BONELLI EREDE PAPPALARDO BREDIN PRAT DE BRAUW BLACKSTONE WESTBROEK HENGELER MUELLER SLAUGHTER AND MAY URÍA MENÉNDEZ MAY 2015

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1 BONELLI EREDE PAPPALARDO BREDIN PRAT DE BRAUW BLACKSTONE WESTBROEK HENGELER MUELLER SLAUGHTER AND MAY URÍA MENÉNDEZ MAY 2015 LOAN DOCUMENTATION IN EUROPE: RECENT TRENDS AND CURRENT ISSUES WHAT S NEW? THE LMA S BENCHMARK CHANGES

2 INDEX RECENT TRENDS AND CURRENT ISSUES AFFECTING LOAN DOCUMENTATION IN EUROPE: WHAT S NEW? 1 THE LMA S BENCHMARK CHANGES: KEY FEATURES AND MARKET REACTION 2 OUR APPROACH 9 KEY CONTACTS 10

3 RECENT TRENDS AND CURRENT ISSUES AFFECTING LOAN DOCUMENTATION IN EUROPE: WHAT S NEW? Introduction Our booklet Loan Documentation in Europe: Recent Trends and Current Issues (the Booklet ), published in July 2014, contains a detailed commentary on a variety of topical issues affecting the loan market. These include the impact on loan documentation of certain legal and regulatory changes, such as Basel III and CRD IV, sanctions and anticorruption laws and the US Foreign Account Tax Compliance Act (FATCA) as well as other hot topics in documentation discussions. The Booklet describes in detail the various adjustments made to LIBOR and Euribor definitions by the LMA during the course of 2013/14 to reflect certain changes made to the administration of those rates as well as other benchmark-related provisions that were starting to creep into loan documentation. In 2014, the LMA undertook a more comprehensive review of the benchmark clauses in its various recommended forms of facility agreement, the results of which were published, following discussions with the Association of Corporate Treasurers, in November 2014 (the Benchmark Changes ). The Benchmark Changes feature in all of the LMA s template facility agreements and have quickly come into quite widespread usage. However they contain a number of options which may require discussion and there are certain aspects which require negotiation. This note, by way of update to the commentary on this topic in the Booklet, outlines the key features of the Benchmark Changes and the market s reaction to those changes. Capitalised terms used but not defined in this note refer to those terms as defined in the current version of the LMA s English law recommended forms of facility agreement for Investment Grade Borrowers (the Investment Grade Agreements ). BONELLI EREDE PAPPALARDO BREDIN PRAT DE BRAUW BLACKSTONE WESTBROEK HENGELER MUELLER SLAUGHTER AND MAY URÍA MENÉNDEZ MAY

4 THE LMA S BENCHMARK CHANGES: KEY FEATURES AND MARKET REACTION 1. Non-LIBOR Currencies The LMA templates historically provided for loans to be priced using only LIBOR or Euribor. The benchmark provisions therefore required adjustment for loans to be funded in non- LIBOR currencies; a need which has arisen more frequently since the number of currencies for which LIBOR is quoted was reduced in The Benchmark Changes include a new optional framework for Non-LIBOR Currencies to be priced off a Benchmark Rate to be agreed. The new provisions serve as a placeholder for the insertion of benchmark provisions for currencies for which LIBOR is not quoted. As noted in the Booklet, in many cases, parties to loans in non-libor currencies use locally published benchmarks for Non-LIBOR Currencies. Accordingly, it is helpful that the LMA has also produced some slot-in drafting, enabling the completion of the framework provisions for certain of the more commonly used benchmarks, namely: the Australian Bank Bill Swap Reference Rate (BID) (BBSY (BID)), the Australian Bank Bill Swap Reference Rate (BBSW), the New Zealand Bank Bill Buy/Sell Rate (Average Mid) (BKBM (MID)), the Canadian Dealer Offered Rate (CDOR), the Copenhagen Interbank Offered Rate (CIBOR) and the Stockholm Interbank Offered Rate (STIBOR). 2. Screen Rates Intra-day rate re-fixing Reform efforts in relation to the calculation of benchmarks are focussed on ensuring that rates are reliable, accurate and transparent. To that end, in late 2014, ICE Benchmark Administration ( IBA ), the administrator responsible for LIBOR, finalised an error policy that provides for the intra-day re-fixing and re-publication of LIBOR rates where there has been an error in the calculation or submission process. The policy provides that LIBOR rates will be re-fixed or re-calculated if there is an error exceeding 3bps and that error is reported to IBA by 15:00 London time on the relevant day. Any re-fixed rates will be published by no later than 16:00 London time on the same day. It is understood that the European Money Markets Institute ( EMMI ), the administrator of Euribor, plans to consult on its own re-fixing policy shortly. It is possible that similar policies may be adopted in relation to other benchmarks. Whether to exclude the effects of a re-fixing and re-calculation of the chosen benchmark is a commercial point to be negotiated. The LMA definition of Screen Rate therefore provides the parties with a choice of whether to include or exclude the impact of any intra-day re fix of any benchmark rate. 2

5 Practice to date on this point has been variable. No clear preference for including or excluding the impact of rate re-fixing has yet emerged. Factors to be taken into account include convenience (the desire to calculate payments due based on the rate as originally published) and potentially, the extent to which any related interest rate hedging takes into account re-fixed rates. Under current ISDA terms (the 2006 ISDA definitions), interest rate hedging will take account of re-fixed/re-published rates only if they are re-published within an hour of the publication of the original rate. LIBOR re-fixes, based on the IBA s current policy, may therefore not apply. 3. Screen Rate Fallback Options LMA terms have always provided for the use of Reference Bank Rates if the chosen Screen Rate is unavailable. If the Reference Bank Rate is not available, each Lender becomes entitled to charge the Borrower its cost of funds for the relevant interest period. More recently, as described in the Booklet, the LMA added an option to use Interpolated Screen Rates as a fallback where possible, before invoking the Reference Bank Rates. The Benchmark Changes include a new fallback option, an alternative and more complex waterfall of fallback rates in place of the existing mechanic. According to the new waterfall, illustrated in the diagram below, should the Screen Rate be unavailable and interpolation impossible, rates for a shortened Fallback Interest Period and Historic Screen Rates will be used before moving to Reference Bank Rates and Lenders cost of funds. Screen Rate unavailable Failing which Interpolated Screen Rate Failing which Screen Rate for shortened Fallback Interest Period Failing which Interpolated Screen Rate for shortened Fallback Interest Period Failing which Historic Screen Rate for shortened Fallback Interest Period Failing which Interpolated Historic Screen Rate for shortened Fallback Interest Period Failing which Reference Bank Rate for original Interest Period Failing which Cost of funds for original Interest Period (individual Lender rates or weighted average) 3

6 A desire to increase the number of Screen Rate fallback options was apparent prior to the publication of the Benchmark Changes. In the Spanish market, for example, the use of rates for a Fallback Interest Period before moving to Reference Bank Rates became standard practice. In European loan transactions generally, variations on the LMA s new benchmark waterfall featured quite frequently during The longer waterfall seems to be emerging as the more popular choice in deals completed since the Benchmark Changes were published. We would suggest this preference is due to the longer waterfall making it less likely that Reference Bank Rates will be required. As discussed in section 6 below, some Lenders are reluctant to act as Reference Banks and it may be easier for arranging banks to find volunteers to take on the Reference Bank role, if the Reference Banks are to be called on only after other fallback rate possibilities have been exhausted. The LMA s intention is that the Fallback Interest Period in the longer waterfall should be as short as possible so that fallback rates are not relied on for too long. One week seems to be the period most often designated as the Fallback Interest Period, although longer periods of up to a month have been agreed in some deals. Similarly, the LMA s intention is that Historic Interest Rates in the longer waterfall should not be too historic. The maximum number of days old the rate is permitted to be seems currently to vary. A period of between one Business Day and one week is typical, with three Business Days a fairly common choice. 4. Market Disruption Under LMA terms, a Borrower can become obliged to pay each Lender its cost of funds in place of the agreed benchmark in two circumstances: if the Screen Rate is unavailable and the fallback provisions have been exhausted; or if the market disruption clause applies. Prior to the Benchmark Changes, the trigger for a move to cost of funds under the market disruption clause in the LMA s Investment Grade Agreements required a specified proportion of Lenders to notify the Agent that the cost to them of obtaining matching deposits in the [relevant inter-bank market] would be in excess of [LIBOR/Euribor]. This trigger has been adjusted. In the current Investment Grade Agreements, the trigger for a move to cost of funds requires a specified proportion of Lenders to notify the Agent that the cost to them of funding their participation in the Loan [from whatever source [the relevant Lender] may reasonably select]/[from the wholesale market for the relevant currency] would be in excess of [LIBOR/Euribor/other agreed benchmark]. The LMA s decision to alter the market disruption trigger is understood to be an updating measure, to reflect that loan participations may no longer be funded in the inter-bank market. This change has been quickly adopted and both options for calculating cost of funds are being used in current deals, with no particular preference either way yet apparent. 4

7 However, the changes to this provision have prompted renewed focus by some Borrowers on the market disruption provisions, specifically on the fact that they may be capable of being triggered at any point. Many loan market participants, in particular non-bank participants, may be unable to fund themselves at the agreed benchmark rate from Day 1, but participate nonetheless. Thus the clause may be capable of operation in the absence of disruption in relevant funding markets, notwithstanding the label market disruption. There are numerous ways in which such Borrowers concerns might be addressed should Lenders be minded to do so. The clause could be adjusted such that it applies only if the Lender s inability to fund at the agreed benchmark is due to a material and adverse change in conditions in the relevant funding market. In transactions involving a significant proportion of non-banks, the right to rely on the market disruption provisions might be limited to bank participants. Although not unheard of (and arguably justifiable), such concessions remain rare for the time being, perhaps indicating that these provisions are not yet being negotiated on a widespread basis. Where Borrowers are possibly gaining some traction is in relation to the proportion of Lenders who are required to notify the Agent to trigger a move to cost of funds. Most transactions over the past few years have provided for a notification threshold of Lenders whose participations represent 30-35% of the relevant Loan. There are indications in some European markets that this percentage has risen to 40% in more recent deals or even 50%, a level that historically (or at least since 2007) has generally been achieved only by the strongest Borrowers. A footnote has been added to the market disruption clause in the templates, suggesting that the parties should consider whether the Borrower should have the right to replace or prepay any Lender that seeks to invoke the clause. This point is being negotiated successfully by stronger Borrowers but it does not yet appear to have been generally accepted by Lenders. Lenders may be concerned that such a right presents an exit route which might be exploited by individual Lenders although Borrowers might equally use that argument as a reason to ensure the clause operates only in the event of adverse market conditions. Finally, it should be noted that the LMA published an alternative market disruption regime as part of its Finance Party Default and Market Disruption slot-in provisions. This alternative regime interposes an Alternative Reference Bank Rate between the market disruption event and cost of funds. It is likely to operate effectively only in larger syndicates because the intention is that the Alternative Reference Banks represent a different and wider pool than the Reference Banks. As a result, the alternative regime is presented as standard in the LMA s templates for leveraged lending. These provisions are mentioned simply for completeness here as they are rarely used outside the leveraged market. It might be anticipated that they will be used increasingly rarely across the market, in light of the current reluctance of a number of institutions to act as Reference Banks (see further section 6 below). 5

8 5. Cost of Funds Prior to the Benchmark Changes, if cost of funds applied (because either the Screen Rate is unavailable and the fallback provisions have been exhausted, or because the market disruption clause has been triggered), interest on the relevant loan was calculated based on rates notified by each Lender to the Agent as its cost of funds from a source reasonably selected by that Lender. In the current templates, the rate notified by each Lender for this purpose is defined as its Funding Rate. The parties are then presented with two options: either the parties can choose to pay the Funding Rate of each Lender as previously or, to pay a single weighted average rate which is applied to payments to all Lenders. If this new weighted average option is used, if any Lenders do not notify the Agent of their Funding Rate, the weighted average of the remainder will apply. It is understood that the option to use a weighted average rate was introduced for operational reasons, so might be preferred by Agent banks. In our experience, that seems to be the case. The weighted average is currently being adopted slightly more frequently, although the single Lender formulation is also being used. Some Borrowers are objecting to the provision that Lenders who fail to notify the Agent of their Funding Rate may take advantage of any new (higher) rate based on the weighted average of the Funding Rates of the remaining Lenders. It has been accepted by the Lenders in some transactions that to the extent available, such Lenders should continue to receive LIBOR, Euribor or other applicable benchmark rate in those circumstances. A footnote to this clause suggests that the parties consider whether the Borrower should be entitled to revoke a Utilisation Request relating to any Loan in respect of which cost of funds applies. If it is agreed that the Borrower should have this right, the timing and notification provisions need to be considered carefully. Under the LMA terms, Lenders are entitled to notify the Agent of their inability to fund at the agreed rate at any time up until close of business on the Quotation Date, which of course, depending on the currency, may be the same date as the day of funding. If the point is raised, the Lenders will need to consider whether they are willing to bring forward the cut-off date for notifying the Agent pursuant to the market disruption clause. 6. Reference Banks and Reference Bank Rates Practice in the European syndicated loan market generally has been for the Agent to appoint two or three Reference Banks in consultation with the Borrower, to provide Reference Bank Rates in the event the Screen Rate is unavailable. Reference Banks are generally syndicate members, except in Spain, where it is the norm to choose banks from outside the syndicate, with a view to avoiding any perceived conflict of interest. 6

9 The role of Reference Banks as the providers of fallback interest rate quotes has been in jeopardy since the LIBOR scandal first broke. A number of institutions are reluctant to act as Reference Banks, either at all or in relation to particular currencies. However, in the absence (for now) of a viable alternative, the Reference Bank Rates and related provisions have been retained as part of the Screen Rate Fallback options, but have been marked as optional provisions. Concerns about the availability of Reference Bank quotes are also thought to be the reason behind the replacement of Reference Bank Rates with Screen Rates in the LMA s euro denominated swingline provisions. Most euro swinglines have historically been priced based on Reference Bank Rates. The LMA has replaced the Reference Bank benchmark in its euro swingline facilities with the screen rates for either EONIA or the overnight euro LIBOR rate. If those Screen Rates are unavailable, a Reference Bank Rate is provided as a fallback, failing which, the Borrower must pay on a cost of funds basis. Notwithstanding their optional status, Reference Bank Rates remain a feature of the fallback machinery in most transactions currently. However, and, as we observe in the Booklet, if there are no or insufficient Lenders willing to act as Reference Banks on the date of the agreement, it is often agreed that the Reference Banks will be appointed by the Agent (in consultation with the Borrower) as and when required. Certain other changes have been made to the provisions relating to Reference Banks: In light of the ongoing process of benchmark reform, the definition of Reference Bank Rate has been updated to ensure it will operate as a proxy for the chosen benchmark, notwithstanding any future changes to the definition of the rate in question. New clauses acknowledge the increased sensitivity of the Reference Bank role following the LIBOR scandal and provide that no Reference Bank is obliged to provide a quote and exclude the Reference Banks liability, save in the case of gross negligence or wilful default. New confidentiality provisions oblige the Agent to keep Reference Bank quotes (used to calculate the Reference Bank Rate) confidential and place obligations on both the Agent and the Obligors to keep Funding Rates (individual lenders cost of funds, if cost of funds is applicable) confidential. The background to these provisions are the regulatory obligations of contributors to LIBOR and other benchmarks to keep their submissions confidential. It is thought that Reference Bank quotes and Funding Rates, given their likely similarity to benchmark submissions, should be treated as subject to the same confidentiality requirements. None of these changes has proved controversial as far as we are aware and, where relevant, are being included in most current transactions. 7

10 7. Zero floors and negative interest rates The option to place a zero floor on LIBOR and Euribor in the LMA templates was introduced in response to negative LIBOR rates for Swiss francs during 2011, as mentioned in the Booklet. Where the zero floor is included, if the relevant benchmark is negative, it will be deemed to be zero for the purposes of the agreement. The Benchmark Changes do not alter the zero floor language, but while on the topic of benchmarks, it is worth noting that in transactions in a number of European countries, the inclusion of the zero floor has become more contentious this year as the incidence of negative benchmark rates has increased. Negative interest rates have been a topic for discussion until quite recently, mainly in transactions in Swiss francs and the affected Nordic currencies. The emergence of negative Euribor and euro LIBOR rates broadens the potential impact of negative benchmark rates on the European loan market quite considerably. If the zero floor is not included and the relevant benchmark is negative, the risk to Lenders is that the borrower will benefit from a reduction in the Margin to that extent under LMA terms, Interest being the sum of the Screen Rate and the Margin. However, in most jurisdictions the impact of a negative benchmark on interest payments creates legal uncertainty and ideally, the point should be addressed specifically in the facility agreement. Under both German and Spanish law for example, the argument is not clear and the likely outcome may be that a negative benchmark would only reduce the Margin if this was seen as a possibility and intended by the parties when they entered into the agreement. Lenders will argue in favour of the zero floor that they cannot get funds without paying any interest even if the benchmark is negative (and looking at the interest rates paid by most banks on their bonds there is a fair basis for such argument). Borrowers may point out that a mismatch between lenders actual funding costs and the benchmark rate may apply whether rates are positive or negative; so if the loan has been agreed to be priced on a benchmark, that benchmark should apply whether positive or negative. As discussed in section 4 above, Lenders are also ultimately able to invoke the market disruption clause, but only if Lenders whose participations represent the requisite percentage of the relevant loan notify the Agent that they cannot obtain funds at the agreed benchmark rate. Lenders are currently insisting on the inclusion of the floor in most circumstances. However, we are aware that the zero floor language has been omitted from some recent facilities with the intention that negative rates should reduce the Margin on loans in the relevant currencies. In transactions where it is accepted that the borrower should have the benefit of the negative rate, the next question is what happens if the negative rate exceeds the applicable Margin? LMA terms do not make specific provision for this. If the borrower is intended to benefit from a negative benchmark rate to that extent, it is suggested that an express term would need to be built into the agreement, perhaps to the effect that the excess amount above the applicable Margin will be deducted from any principal due to the relevant lender. This is not a position we are aware has been agreed in practice. 8

11 OUR APPROACH The European Best Friends Group This note has been prepared by the firms comprising the European Best Friends group. We are the leading independent law firms in France, Germany, Italy, the Netherlands, Portugal, Spain and the UK. Each of us enjoys an unparalleled reputation for legal excellence and client service. We provide a cross-jurisdictional legal service that genuinely reflects what global means for our clients and our cross-border capability is second to none. In addition to our capacity in Europe, our extensive and meaningful relationships with market-leading firms from around the world underpin our approach to providing our clients with the best of the best global service. How does the Best Friends approach work in practice for our clients? Our effectiveness is demonstrated by our success in winning the largest and most complex international mandates. As a group, we ensure clarity, coherence and agility. Our clients work with a single united team, with one leader. Projects are partner led, but this is carefully measured to be cost-effective and fair. Each project is managed from the jurisdiction which best suits the client and each project can render a single account. Flexible working and billing practices can be tailored to the client and the job. There is a high level of communication and understanding between firms. We have made long-term investments to help foster connections at all levels: we have extensive experience of working and sharing knowledge together; our working practices and approaches are aligned and cultures are appreciated. 9

12 KEY CONTACTS If you would like to discuss any of the matters raised in this note, please contact one of the following lawyers or your usual contact at any of the Best Friends group firms: Bonelli Erede Pappalardo in Italy CATIA TOMASETTI Tel: EMANUELA DA RIN Tel:

13 Bredin Prat in France ALEXANDER BLACKBURN Tel: RAPHAËLE COURTIER Tel: raphaelecourtier@bredinprat.com SAMUEL PARIENTE Tel: samuelpariente@bredinprat.com KARINE SULTAN Tel: karinesultan@bredinprat.com 11

14 De Brauw Blackstone Westbroek in the Netherlands NIEK BIEGMAN Tel: JAN MARTEN VAN DIJK Tel: MENNO STOFFER Tel:

15 Hengeler Mueller in Germany JOHANNES TIEVES Tel: +49 (0) johannes.tieves@hengeler.com NIKOLAUS VIETEN Tel: +49 (0) nikolaus.vieten@hengeler.com DANIEL M. WEISS Tel: +49 (0) daniel.weiss@hengeler.com 13

16 Slaughter and May in the United Kingdom ANDREW MCCLEAN Tel: +44 (0) STEPHEN POWELL Tel: +44 (0) KATHRINE MELONI Tel: +44 (0)

17 Uría Menéndez in Spain and Portugal PEDRO FERREIRA MALAQUIAS Tel: ÁNGEL PÉREZ LÓPEZ Tel: SEBASTIÁN SÁENZ DE SANTA MARÍA Tel:

18 BONELLI EREDE PAPPALARDO BREDIN PRAT DE BRAUW BLACKSTONE WESTBROEK HENGELER MUELLER SLAUGHTER AND MAY URÍA MENÉNDEZ Milan, Genoa, Rome, Brussels, London Paris, Brussels Amsterdam, Brussels, London, New York, Shanghai, Singapore Berlin, Düsseldorf, Frankfurt, Munich, Brussels, London London, Brussels, Hong Kong, Beijing Barcelona, Bilbao, Lisbon, Madrid, Porto, Valencia, Brussels, London, New York, Buenos Aires, Lima, Mexico City, Santiago, São Paulo, Beijing, Bogotá This note contains a general overview of the issues described. It should not be relied on as a substitute for legal advice. Although each of Bonelli Erede Pappalardo, Bredin Prat, De Brauw Blackstone Westbroek, Hengeler Mueller, Slaughter and May and Uría Menéndez has taken all reasonable care in its preparation, no responsibility is accepted by any firm, nor any partner, employee or agent of any firm, for any cost, loss or liability, however caused, occasioned to any person by reliance on the material in this note. ksm57.indd515