On 5 April 2019, the European Commission published a long-awaited report on loan syndication and its impact on competition in credit markets in the EU (the "Report").
The Report was prepared for the Commission by external consultants and focuses on syndicated loans connected with leveraged buyouts, project finance and infrastructure finance, in a sample of six Member States which account for approximately three quarters of the EU's syndicated lending in these segments in Europe. It concludes that while market features and safeguards tend to limit the risk of competition law breaches, certain practices could give rise to concerns about collusive behaviour amongst syndicate members and the exertion of bargaining power contrary to the interests of borrowers and sponsors. It therefore makes a number of recommendations for safeguarding competition in syndicated lending and for promoting the development of the markets.
The financial services sector has seen significant enforcement action by competition authorities in recent years, and the Report's findings may prompt the Commission and/or national competition authorities to focus on syndicated lending by opening sector enquiries, initiating antitrust investigations into specific firms or conduct, proposing regulation or issuing guidance. Financial institutions active in this sector may wish to review their compliance policies and arrangements in respect of syndicated lending in light of the Report's findings and recommendations.
Background and scope
In DG Competition's Management Plan for 2017, the Commission noted that syndicated lending “exhibits close cooperation between market participants in opaque or in-transparent settings… which are particularly vulnerable to anticompetitive conduct”, and referred to the possibility of engaging in a study on potential competition law issues in this area. A call for tenders was issued in April 2017 and Europe Economics was commissioned to undertake the study (which it did in conjunction with Euclid Law).
The Report is based on a study of syndicated lending in the markets for leveraged buyout ("LBO") and project finance ("PF"), the latter including infrastructure finance ("INFRA"), in France, Germany, the Netherlands, Poland, Spain, and the United Kingdom. It notes that it does not aim to establish specific cases of competition law infringements, but to assess whether market features and processes in each segment are more or less conducive to potential competition law problems. The Report is wide-ranging and proposes not only safeguards to address key risks to competition but also non-competition-related measures to increase efficiency, e.g. the adoption of technologies such as smart contracting and blockchain.
In general, Poland was considered to have less choice in credible mandated lead arrangers ("MLAs") than the Western European countries studied. The authors observe that PF/INFRA markets tend to be more heterogeneous than LBO ones, requiring more specialist knowledge of certain types of risks and therefore potentially leading to more concentrated markets. They also observed more "home bias" (i.e. lenders with a parent in the relevant country being ranked higher) in the PF/INFRA segments than in LBO.
The Report identifies the following main risks to competition, observed throughout the lifecycle of syndicated loan transactions:
Market soundings: A risk of collusion may arise from MLAs crossing the boundary between generic and deal-specific market soundings, and also from communication to origination desks of information about specific lenders' appetite (even if obtained in the context of generic soundings). In addition, soundings between MLAs (whether specific or generic) may facilitate collusive action and increase the collective bargaining power of lenders. The authors consider that interactions in the PF/INFRA segment give rise to a higher degree of risk than the LBO segment.
NDAs: The Report highlights the lack of reliable ways to enforce restrictions in NDAs on information sharing in practice.
Single MLA (who may also act as advisor): The authors note that information sharing among lenders through a sole MLA may lead to coordination on price or terms to the detriment of the borrower. Where the sole MLA is difficult to replace, e.g. because it also has a role as an advisor to the borrower or sponsor, this risk is exacerbated.
Post-mandate collusion by lenders discussing the loan terms: The Report observes that the risk of this is low on the whole since the borrower/sponsor generally agrees the loan terms bilaterally with each lender following the mandate. However, two specific risks are noted: negotiations resulting in agreement on the highest common denominator (whether in respect of price or other terms) and the practice in some PF/INFRA deals, especially club loans, to bring lenders together at an earlier stage to discuss terms. The risk of collusion may be higher where the borrower is relatively unsophisticated, e.g. a municipal authority.
Tying of ancillary services to MLA services: The Report notes the general practice of agreeing the provision of directly loan-related ancillary services during the initial agreement of overall terms, over which the borrower/sponsor has control. However, it notes three issues:
- Respondents from Spain indicated that MLAs sometimes make the provision by themselves of ancillary services a condition of the loan. The Report calls this an "area of at least moderate concern" which raises the risk of sub-optimal economic outcomes.
- Lenders' knowledge of who is providing the loan-related ancillary services (following allocation to lenders at the initial stage of agreeing terms) provides scope for those lenders to discuss and collude on pricing.
- Ancillary services not directly related to the loan can be negotiated as part of the loan negotiation. In this respect, the Report notes that outside the UK (where such clauses are banned), both "right of first refusal" and "right to match" clauses are still used, which may result in a sub-optimal outcome for borrowers/sponsors.
Advisors belonging to the syndicate: The authors observe that the practice of using advisors who are part of the syndicate is widespread (particularly in the PF/INFRA segment), but that adherence to protocols around keeping this role functionally separate from lending should mitigate the resulting risks to borrowers. The authors also note that where an advisor is appointed without a competitive process and bundles its role with lending, there is a risk that the borrower may not receive the best loan outcome (even though the bundling may be done at its own request).
Advisors influencing borrowers in respect of transaction structure and terms: The Report highlights the separate risk of advisor MLAs' potential to influence borrowers to adopt a transaction structure or terms suitable to the advisor's lending arm. The Report notes this as an area of high concern where controls (such as internal protocols for managing such situations) are weak.
Coordination of lenders when restructuring upon default: The Report notes, first, that in the absence of an event of default, restructuring discussions between lenders should only be held with the borrower's consent. Following an event of default, however, discussions regarding potential restructuring are held collaboratively between syndicate members, which can enhance the risk of coordination – particularly where the borrower lacks choice of lenders outside the syndicate for a restructuring.
Tying ancillary services to refinancing: The authors point out that in conditions of default, lenders may have the opportunity to price ancillary services on non-competitive terms as a condition of the refinancing. As with refinancing generally, the risk is exacerbated where the negotiations are limited to existing members of the syndicate.
Other market failures: The Report also discusses non-competition-related inefficiencies in the markets, particularly around KYC rules and settlement processes.
Proposed safeguards and solutions
The Report identifies a number of safeguards to ensure competitive outcomes in the loan syndication process, including:
Training and policies: The Report emphasises the need for adequate training and policies for relevant staff at MLAs, in particular regarding the duty to provide neutral advice to clients and to identify and manage conflicts.
Ensuring that alternative options are introduced to the borrower: The Report calls for MLAs to ensure that alternative options are put to the borrower prior to aligning loan terms (including pricing) to a highest common denominator. Such alternatives may include inviting other lenders to participate or restructuring the loan.
Promoting competition between lenders: The Report calls for borrowers to ensure a competitive bidding process by approaching more potential lenders, maintaining bilateral negotiations with each of them prior to mandate and building latency into the bidding process.
Effective protocols on information sharing between a lender's syndication and origination functions: The Report recommends having enforceable protocols (which are enforced in practice) governing the manner and form in which any deal-specific information obtained from other potential syndicate members may flow from a lender's syndication function to its origination function, as a key safeguard against price collusion.
Promotion of unbundled price competition: To avoid impairing competition in neighbouring markets, the Report suggests that syndicates limit the cross-sale of ancillary services with lending. Where ancillary services are not directly related to the loan, the Report suggests that the offer of such services should be kept outside the syndication process.
The Report also discusses possible solutions to the general inefficiencies around KYC and settlement procedures, for example potential and existing uses of distributed ledger technology (particularly blockchain), including reference to the syndicated loan completed by MUFG, BBVA and BNP Paribas in 2018 using blockchain, on which HSF advised (see here).
The Report states that coordination of KYC processes among market participants could be an "area for future regulatory attention", and as regards settlement, the authors envisage a permission-based system where the sharing of transaction input data, as well as drawdowns and documentation for individual loans, could be automatised.
While the Report sets out the authors' own analysis and conclusions regarding the impact of syndicated lending on competition, it does not provide any insight into the Commission's position on how processes and practices in this field should be analysed under competition law. However, the Commission's statements in DG Competition's Management Plan for 2017 clearly evidence some suspicion regarding the scope for collusion in syndicated lending, and the conclusions in the Report may prompt it to scrutinise conduct in particular segments closely. Several national competition authorities (including those in the UK, Spain and the Netherlands) have considered aspects of syndicated lending in recent years and the report may encourage other authorities to follow suit.
The reaction, if any, by the Commission and other regulators to the Report's recommendations regarding data sharing, automation and the use of blockchain will also be of interest to ancillary service providers (e.g. hedging providers or payment agents), clearing systems and data protection authorities, as well as those involved in managing loan documentation.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2021