January 3, 2024 - Recently, the LSTA submitted its response to the IOSCO consultation report on Good Practices for Leveraged Lending and CLOs. The response requests that IOSCO reconsider publishing a final report and highlights the many reasons why the proposed practices are ill-suited for the U.S. leveraged loan and CLO markets – and are anyway unnecessary. (The IOSCO consultation report has been covered here and here.)
The consultation report first observes the significant growth of the leveraged loan and CLO markets over the last 15 years. Recognizing this growth, the LSTA submission points to the important function leveraged lending and CLOs serve in financing U.S. companies. Leveraged loans provide an attractive, relatively affordable and flexible financing option to companies seeking to raise debt capital. Along with bonds and other means of financing, leveraged loans offer choice to borrowers who can decide which instrument’s characteristics best suit their needs.
Moreover, the LSTA submission asserts that despite the growth in the leveraged lending market, the fundamental characteristics of a leveraged loan have not changed. Leveraged loans are not securities under U.S. law and are not governed by either state or federal securities laws. This distinction is reinforced by the fact that they are overseen by the U.S. prudential regulators. In contrast to the securities markets, the lender base for the leveraged loan market is comprised entirely of sophisticated financial institutions that are contractually charged with conducting their own due diligence and making their own credit analysis and commercial decisions. In fact, natural persons are ineligible to act as lenders. Prospective lenders can – and do – perform their own diligence, request their own materials, including financial information, and disclaim any reliance on the loan arranger. Prospective lenders are well aware of the fact that loans are not governed by the securities laws or its disclosure regime.
The LSTA’s submission asserts that the proposed practices turn on its head the key feature of the leveraged loan market: the ability of borrowers and lenders to privately negotiate and agree to the terms that best serve their mutual interests. It is true that bargaining power shifts between those who have the money and those who need the money as interest rates, monetary policy and the macroeconomic environment impact market conditions. If the offered terms are unattractive, lenders need not lend and borrowers need not borrow. These are the dynamics of a healthy and functional market.
With respect to the U.S. leveraged loan market, the LSTA’s submission argues that the proposed practices are unnecessary, at times at odds with applicable regulation, fail to respect the contractual realities of the market and may lead to inappropriate – and potentially harmful – expectations of market participants. In addition, because the proposed practices would assign new responsibilities to arranger entities, liability to arrangers and potentially the costs for the companies seeking to raise capital from leveraged loans can increase substantially.
With respect to the U.S. CLO market, the LSTA’s submission argues the proposed practices are similarly unnecessary. Where feasible, they are redundant to current regulation and CLO structure. Moreover, the proposed practices would impose new transaction costs and undue burdens on the CLO manager. CLOs are highly negotiated by sophisticated investors who are fully capable of negotiating for their needs. It is not appropriate for IOSCO, through the proposed practices, to assume that it understands CLO investors’ needs better than the investors themselves, particularly when that assumption comes at a cost.
Finally, the LSTA’s submission addresses IOSCO’s stated concerns about U.S. leveraged lending and CLOs by viewing these markets through the prism of IOSCO’s three objectives: (i) protecting investors, (ii) ensuring that markets are fair, efficient and transparent, and (iii) reducing systemic risk. The first two objectives are addressed by legal and market realities described above. The third objective – reducing systemic risk – is addressed in detail in the “LSTA White Paper: Assessing Whether Leveraged Loans and CLOs Pose a Systemic Risk (December 2023)” which is attached as an exhibit to the LSTA submission. The LSTA White Paper is covered here.
Trade associations focused on other jurisdictions, e.g., LMA, ELFA and ACC, also submitted responses to the consultation report – responses, which varied depending on the constituent(cies) they represent. It is noteworthy that the ACC – a trade body representing asset managers and investors – made a similar request that IOSCO reconsider its intention to publish a final report on the proposed practices. As of now, IOSCO intends to publish its final report on the proposed practices in the first quarter of 2024.
For more information, contact Tess Virmani.