November 2, 2023 - In its 2016 Liquidity Risk Management Rule, the SEC classified loans as “less liquid investments” (which typically meant they could be sold in seven calendar days although the trades would take longer to settle). In the SEC’s November 2022 proposal, the agency suggested that that the less liquid investment category may be eliminated, and those assets would instead be classified as illiquid. This would be a major problem for open-end funds, which are not permitted to have more than 15% of total assets in illiquid investments.
While updating operational processes and replacing outdated technology should decrease settlement times, there also are product changes that could be implemented to reduce times further. An efficient, liquid secondary loan market benefits all loan market participants. It is recommended that arranging banks, private equity firms, sponsors and their law firms consider the following when drafting credit agreements:
Limit the Borrower Deemed Consent Period to No More Than Three Business Days
Limiting the consent period would shorten the settlement cycle. The borrower must consent to the assignment to a buyer (that is neither a current lender nor an affiliate to a current lender) before the agent bank can make the transfer effective in its books and records. It is important that all credit agreements contain a deemed consent provision, meaning that if the borrower does not respond within a specified number of business days, its consent is then deemed to have been given. Today the deemed consent period varies from five to 15 business days. The longer it is, the more prolonged the settlement time. The LSTA’s Model Credit Agreement Provisions recommend that the deemed consent period be three business days. By adhering to this recommendation, if a trade is suballocated at T+1 and the buyer notifies the agent bank promptly of the need for borrower consent, such consent would be obtained or deemed by T+4.
Borrower’s Pre-Consent for Broker-Dealers
It is necessary that dealers (including bank trading desks) provide liquidity for all loan market participants without delay. To do so, they will match their purchase of a loan with a subsequent sale. Because a dealer often does not hold a position in loan, borrower consent will be required. This means the settlement of the dealer’s purchase or sale of a loan cannot settle for at least as long as the deemed consent period. Because this process is repeated in successive trades in the same facilities it creates a significant logjam to efficient settlement. Similar to the pre-consent a borrower gives to lenders in the initial syndicate, it is recommended that dealers be pre-approved at the closing of the loan, so no borrower consent is required. Alternatively, dealers could be included on a whitelist at the time the credit agreement is made effective.
Use the LSTA Form of Assignment Agreement
All credit agreements should use the LSTA Form of Assignment Agreement, which can be automatically completed using the terms of the trade set forth in the trade ticket or confirmation. The LSTA form does not include additional questions that must receive responses from either or both the buyer and the seller before the form can be generated for execution. Tax forms (W-8s and W-9s) are provided by prospective buyers to administrative agents and their counterparties through the know-your-customer and onboarding processes. Tax questions should be answered by a careful reading of such tax forms and supplemental documentation obviating the need to include tax questions within the assignment agreement. Similarly, having a buyer acknowledge whether it appears on a disqualified lender (DQ) list should not be included on an assignment agreement. Delays in signing an assignment agreement can cause the buyer to lose delayed compensation.
Post Disqualified Lender Lists to the Public Side of Data Sites
If lenders of record are aware of the institutions listed on DQ lists at the time of trade, it will be possible to avoid certain sales. Therefore, the DQ list should be made accessible to all lenders (e.g., on the public side of the data sites) rather than requiring lenders to ask the agent to provide the list or confirm whether a party is or isn’t included on the list. When the DQ list is not readily accessible, a buyer can spend days trying to find out if it is on this list.
Enable Lenders to Grant Participations Without Consent or Notice Requirements
Traditionally, borrower consent has not been required for sales of participations, nor has there been a notice requirement for participations. However, it has been recently observed in certain credit agreements that there is a notice or consent requirement for participations. Participations serve as an important safety valve for settlement if a borrower does not consent to a loan transfer. Any restrictions on their use unnecessarily impinge on trading liquidity.
Apply for and Publish CUSIPs on All Deals and Facilities Early in the Process
For ease of origination, syndication, trading, and servicing, it is imperative that CUSIP numbers be applied for, issued, and published in time for inclusion within the bank book, on all allocations, subsequent trades, in the credit agreement/related documentation, and within all loan systems upon the initial deal set-up. Although data such as maturity date, credit agreement date and facility amount may be estimated at the time of CUSIP application, the CUSIP numbers issued will be final numbers and the respective data will be noted as estimated. Such data can be updated and noted as finalized at the time the deal closes.
Shorten Notice by Administrative Agent to Lenders
At quarter and month ends, to adhere to the credit agreement, administrative agents typically cease settling trades for a minimum of three business days to notify lenders of the interest rate, credit spread adjustment (if any), margin and maturity date and respective borrowing for each facility for the succeeding interest period. It is recommended that this requirement be revised to no less than ONE business day before the effective date of the interest election. This would provide workflow flexibility for the agents that can shorten settlement freezes and nevertheless provide timely notice to lenders and their service providers. The language setting forth this provision can be found in the LSTA’s 2/27/23 model credit agreements.