LONDON: The ECB has published its final guidelines to rein in risky lending practices among banks, mirroring rules already introduced in the US in 2013.
The publication of the leveraged lending guidelines comes at a time when the US is considering softening its rules, which grew out of the last financial crisis and effectively block banks from making loans to companies with a debt-to-earnings ratio greater than six times.
"Europe is introducing a set of guidelines thinking it is playing catch up with the US but arguably is aligning to a position the US was in yesterday rather than tomorrow," said Ropes & Gray finance partner Malcolm Hitching.
Banks regulated by the ECB are now trying to organise internally to make sure they can monitor and comply with the guidelines, which are set to come into force in six months, with the first audits in 18 months.
While it was assumed the introduction of the European guidelines would even the playing field between European institutions and their US counterparts, any reversal or diminishing of the rules in the US could reverse the competitive dynamic.
"What the US chooses to do will probably become the default position the majority of institutions globally will adhere to. Specifically European institutions will align with the ECB but everyone else will be in a different situation, so rather than a consolidation of the regulatory landscape, the ECB's LLG might end up confusing the matter," Hitching said.
The final ECB guidelines broadly mirror those in the US, especially after a controversial definition of Ebitda was toned down. It had become a flashpoint in the consultation when it was referenced as unadjusted, unlike in the US, but the final guidance allows for enhancements to Ebitda as long as they are justified.
"There are adjustments to Ebitda that are justified and made by sponsors in order to reflect the reality of businesses as they grow and evolve," said Kirkland & Ellis finance partner Neel Sachdev.
QUESTIONS REMAIN While bankers welcomed the changes to the Ebitda definition, they remain concerned about the scope of the new rules.
Leveraged transactions remain defined as all types of loans or credit exposure where the leverage exceeds four times total debt to Ebitda and where the borrower is owned by one or more financial sponsors. High leverage of six times total debt to Ebitda should remain exceptional and companies should be able to repay at least half of total debt over a five to seven-year term.
Although the ECB added exceptions to the definition for small and medium-sized enterprises and investment-grade borrowers, the guidelines still have a broad remit.
Corporate business and infrastructure loans as well as loans made to crossover Double B issuers could get caught by the new rules, as could acquisition and capital expenditure lines and so-called "freebie baskets" that allow for an extra turn of leverage to be added on to a business without the permission of lenders.
"Documentation has become very loose, especially the use of freebie baskets and you can use the guidelines to push back on these things," a head of leveraged capital markets said.
A lawyer added: "The guidelines are there to limit risk but should not be sweepingly used as a tool for banks to hide behind in a bid to pare back aggressive but justifiable sponsor terms."
WHAT CONSEQUENCES? There is a question mark over the consequences of not adhering to the new rules and while most banks will take a more cautious approach, the expectation is that some will seeks ways to work around the guidelines.
"Banks will find ways to make sure there are plenty of creative financials to finance leveraged buyouts, in order to make sure returns are not lessened. The extent to which the international banking community will stand behind the guidelines is up for question, as they are not a draconian set of rules with sanctions and punishment attached to them," a lawyer said.
It is likely, however, that a number of institutions such as direct lenders and banks not captured by the guidelines (including the likes of Jefferies, Macquarie and Nomura) will look to strengthen their position and increase market share.
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