Syndicated lending is a well-established and critical way of banks sharing risk in financing larger or riskier projects which a single lender is unable or unwilling to assume. Such arrangements are therefore clearly in the interest of borrowers and increase market liquidity. However, syndicates also involve otherwise competing banks talking to each other about the terms of the financing in a manner which could reduce competition between them – which is where competition law concerns in this area have arisen. While borrowers and lenders alike want a simple and clear set of rules to follow, this has to date not been forthcoming from competition agencies, with widespread concern following a previous LMA Notice in 2014 suggesting that those involved in certain activity relating to syndicated loans could be engaged in criminal conduct.
In this context, the focus has switched to the findings of a recent report prepared for the European Commission on competition risks in syndicated loans. The Commission’s study seeks to understand whether the market is working well, having already identified that syndicated loans involve close cooperation between market participants in opaque settings that are particularly vulnerable to anti-competitive conduct. Key points to note are
- Lenders should be prepared for possible enforcement action against participants in the syndicated loans market given the Commission’s apparent concerns about this sector and the detailed information in the report that the Commission will now consider. There is also potentially heightened risk of further scrutiny given the Commission’s broader interest in wholesale financial markets.
- While specific evidence of competition infringements or inherently anti-competitive market features are not identified, certain features that may cumulatively increase competition risk are highlighted, as well as a number of specific risks – largely related to exchanges of sensitive information, lender dual roles and bundled pricing. However, the report also highlights critical safeguards which banks should implement to protect themselves (see below).
- A key aspect of the safeguards identified is that relevant protocols, processes and other protections to limit competition risk are actually followed in practice – this is an important message to achieve effective compliance, which we recommend is reinforced through regular compliance training.
At about €720bn in EU lending each year, syndicated loans are a significant source of finance and have benefits for lenders as well as borrowers – allowing several lenders to share credit risk and provide loans to a borrower in a single loan facility agreement. But care is needed given competition law generally prohibits competitors sharing competitively sensitive information (e.g. current and future price information, credit terms and lender cost data) or otherwise entering into arrangements to coordinate prices, share markets/customers, collude on bidding processes or fix/limit capacity.
The risk differs depending on the stage of the syndicated lending – e.g. (i) before the lending group is formed, each bank should compete individually and not exchange competitively sensitive information (ii) after the group is formed, banks may work together and exchange certain communications subject to the borrower’s consent and scope of instructions and (iii) after the mandate is signed, there may be competition issues around how to deal with a potential event of default.
The consequences of infringing competition law can be severe, including significant fines and large damages claims, meaning market participants (including those acting outside the EU) should familiarize themselves with the risks and take steps to mitigate them, not least the following critical safeguards the report identifies
- Duty of care and conflicts of interest – to protect borrowers sourcing debt advice from the same lender they may wish to appoint as the Mandated Lead Arranger (MLA), banks should train relevant employees and adopt clear policies to safeguard their duty to provide neutral advice to clients and be able to identify and manage conflicts. MLAs should also explore all options for borrowers before aligning loan pricing or terms upwards.
- Information exchange – enforceable protocols should be used and actively enforced to prevent inappropriate exchange of competitively sensitive information. This is important, in particular, to manage any transfer of pricing and deal-relevant information between loan syndication and origination functions.
- Bundling – syndicates should limit any cross-sale of ancillary services (e.g. future M&A advisory services) and keep this outside the loan syndication process if not directly linked to the loan. Absent market power, bundled offerings can be pro-competitive but the UK’s Financial Conduct Authority (FCA) has found no client benefit and banned agreements (e.g. in the form of right-of-first-refusal clauses) that give a right to provide future primary market services in the UK (with an exemption for bridging finance).
The report is the first in-depth competition review of the EU syndicated lending market, although certain national authorities have previously carried out work in this area. At 300+ pages and based on interviews with 37 lenders and 100 borrowers/sponsors, as well as debt advisers, credit rating agencies and other participants, the report focuses on three market segments – leveraged buyouts (LBOs), project finance and infrastructure finance in six countries (France, Germany, the Netherlands, Poland, Spain and the UK). While specific evidence of competition infringements or inherently anti-competitive market features are not identified, it highlights the following features that may cumulatively increase competition risk
- Pre-bid information sharing/collusion via market soundings
- Post-mandate convergence of terms and prices as a result of repeat transactions involving competing lenders over time
- Provision of ancillary services and bundling
- Tacit reciprocity where bookrunners are dealing with competing lenders
- Curtailed bargaining power of borrowers in financial difficulties and facing default (and possible coordination among lenders)
The report assesses in some detail the potential for these features to facilitate collusion among lenders or otherwise result in worse outcomes for borrowers by reference to six stages of the syndication process as follows
- Competitive bidding process for appointing individual banks to the lead banking group – information exchange related to market soundings by MLAs is the main area of concern at this stage. The more bespoke nature of loans in the project finance and infrastructure finance segments and less available information means the risk is higher in those segments relative to the LBO segment. Non-disclosure agreements are important to prevent inappropriate information exchange, but need to be followed in practice to be effective.
- Post-mandate to loan agreement – the scope for lenders discussing loan terms to the detriment of the borrower is generally considered low at this stage, although there are some circumstances where the risk of this is higher (e.g. loans involving less sophisticated borrowers/sponsors). Multiple interactions between lenders on transactions over time mean lenders may be able to observe each other’s strategies, but the associated risk is deemed relatively low given discussions at this stage do not involve detailed information.
- Allocation of ancillary services across banks, and the pricing of such services – a moderate concern (possibly mainly in Spain in practice) is that a small majority of MLAs make provision of ancillary services a condition of the loan, which may be sub-optimal for borrowers/sponsors, although a lack of precedent on whether this is unlawful is noted. The risks are greater in the project finance and infrastructure finance sectors where it is more common for borrowers/sponsors to allocate ancillary services directly related to the loan to lending banks at an initial stage, providing scope for banks to collude on pricing as they know who is providing which services. The risk is also greater if only a limited number of syndicate members can provide services, particularly in smaller national markets. As above, the FCA has banned requirements to provide ancillary services not directly related to the loan.
- Use of debt advisers that are also involved in the syndicated loan – this is widespread among borrowers and sponsors, although more common in the project finance and infrastructure finance segments. Functional separation (e.g. by Chinese walls) within the lending bank regarding this dual role helps mitigate concerns, although risks in the project finance and infrastructure finance sectors, in particular, are heightened if the adviser is appointed without a competitive process. Another potential concern is if advising banks attempt to persuade the borrower/sponsor – without them being fully aware – towards a strategy or debt structure that suits their lending arm. This would be a significant breach of internal protocols and an area of high concern where such controls are weak.
- Coordination by lenders on the sale of the loan on the secondary market – the report does not identify evidence of coordinated activity to manipulate prices in the secondary market. In contrast, there is widespread evidence of borrower/sponsor restrictions on secondary trading, limiting to some extent the development and efficiency of the secondary market and with minor knock-on effects on the primary market. However, there may be reasonable motivations for such restrictions (e.g. limiting distribution of deal-specific information).
- Refinancing in conditions of default – functional separation between origination teams and teams which take over loan discussions in the event of a default risk is highlighted. Discussions on restructuring in the event of default are performed collaboratively by syndicate members, potentially generating efficiencies but increasing the risk of coordination. There is evidence of restructuring teams receiving competition training, but it would be problematic if relevant processes are not followed in practice. The report also highlights a risk of syndicate members exerting market power if new finance is available only from the existing syndicate, and that another area deserving of monitoring is the risk that syndicate members may price ancillary services on non-competitive terms. But, in most cases, it appears such behaviour is constrained by the availability of non-syndicate members to provide financing or services.
The report helpfully identifies and assesses the competition risks related to syndicated lending. With the possibility of future enforcement action or other further scrutiny by the Commission or even national competition authorities to come, lenders should protect themselves by ensuring that their employees receive regular competition compliance training and that internal safeguards (e.g. information barriers, non-disclosure agreements and protocols) are effectively implemented to prevent inappropriate exchanges of information and to limit the cross-sale of unrelated services.