September 21, 2023 - On September 14, the Board of the International Organization of Securities Commissions (IOSCO), which includes the SEC but does not include any banking agency, published two consultations. Earlier this week, we reviewed its thematic analysis of “Emerging Risks in Private Finance”. Today we examine a consultation entitled “Leveraged Loans and CLOs – Good Practices for Consideration.” Given the lack of involvement of bank regulators, it may be surprising that IOSCO has chosen to launch this consultation which identifies 12 good practice measures in leveraged lending. The “proposed good practices are intended to guide market participants in their decision making when operating in the leveraged loan and CLO markets, as well as to encourage the development of these markets and the behavior of market participants in ways which support the fulfillment of IOSCO’s objectives.” Before turning to each of the 12 measures identified in the IOSCO consultation, it may be helpful to our readers to be more familiar with IOSCO.
What is IOSCO?
IOSCO is a non-regulatory organization comprised of leading securities regulators around the world. The Board of IOSCO which operates as the governing and standard-setting body of IOSCO is comprised of 35 securities regulators, including the SEC and CFTC as the U.S. representatives. The Board does not include any of the U.S. banking agencies, the Bank of England, or the European Central Bank. IOSCO has adopted 38 principles of securities regulation, which center on three objectives of securities regulation: protecting investors; ensuring that markets are fair, efficient and transparent; and reducing systemic risk. The consultation report on leveraged loan and CLO markets identifies certain vulnerabilities in these markets which, in IOSCO’s view, could impact these objectives.
What are the proposed good practices?
The 12 proposed good practices are organized into five broad themes: 1) origination and refinancing based on a sound business premise; 2) EBITDA and loan documentation transparency; 3) strengthening alignment of interest from loan origination to end investors; 4) addressing interests of different market participants throughout the intermediation chain, and; 5) disclosure of information on an ongoing basis.
At a high level the twelve good practices target:
- Demonstrable debt repayment capacity
- Appropriateness of dividend recaps
- Enterprise value calculations
- EBITDA complexity and opacity
- Transparency on covenants’ limitations
- Transparency and fairness during underwriting and syndication
- Alignment of interest between underwriting entities and investors
- Reducing restrictions on transferability of loans
- Managing conflicts of interest where private equity sponsors also act as lenders
- Managing conflicts of interest in the management of CLOs
- Disclosure in CLOs
- Disclosure on underlying loans
Two high-level observations are readily apparent: First, the consultation aims to target U.S. and European practices, but lumps together practices which may be observed in only one of the jurisdictions as the rationale for certain good practice recommendations. Second, the good practices on which IOSCO is consulting seem to misconstrue the basic legal relationship between the parties to a leveraged loan transaction and the sophisticated nature of leveraged loan investors. For instance, a number of good practices are suggested for underwriters which are at odds with market expectations and the legal reality of the arranger-lender relationship.
The LSTA will provide further analysis of the consultation in coming weeks and determine how best to respond to the consultation ahead of the comment deadline of December 15, 2023. Stay tuned!