Banking Talking Points Spring 2014

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1 Banking Talking Points Spring 2014 Welcome to the 'new look' Banking Talking Points and the first edition for This edition contains articles from a number of contributors across the firm including Richard Clayton and Parisa Clovis. Do please pass this on to any of your colleagues if you think they would find it of interest and of course, just drop us a line if you think anyone should be added to the mailing list. Feedback is always welcome so please also feel free to share your thoughts or ideas about this This edition in summary Articles Distressed about loan portfolio sales? Fixed rate loans to SMEs - the next mis-selling scandal? Foreign Account Tax Compliance Act (FATCA) update Editorial Non-bank lending - new players in the lending markets Other news Loan Market Association (LMA) updates and news 'Covenant lite' deals making come-back in Europe English law restructuring and insolvency measures have uses across the globe The Court of Appeal speaks on performance bonds Articles Distressed about loan portfolio sales? We all know that there have been quite a few sales of loan portfolios by banks in the past few years, predominantly due to regulatory capital pressures. Given the ongoing Asset Quality Review, word is that more European banks will be disposing of debt they deem to be 'non-core'. This means that large portfolios of assets (be they mortgage securities or loans) will be on the market and ripe for the picking. One point to note is that we shouldn't necessarily expect the deep discounts on these assets that we've seen in the past (assuming of course they are not in themselves distressed assets). Not only are there an ever increasing number of loan acquirers on the buy side but increasingly, bank balance sheets are in better shape and there's less urgency on the sell side than perhaps there was. We continue to act for, and speak to, buyers and sellers in this market and certainly see no sign of it abating. In contrast to this of course, there is increasing frenzy in the distressed loan sale market, driven in part from our friends across the Atlantic (many of whom do love a good 'loan-to-own'). Banks can increasingly afford to This publication is intended for general guidance and represents our understanding of the relevant law and practice as at 2 May Specific advice

2 crystallise losses on impaired assets, whereas previously regulatory capital pressures may have made this difficult (remember the good old 'amend and extend' days?). Fixed rate loans to SMEs the next mis-selling scandal? Fixed rate loans (FRLs) have been predominantly offered by lenders to small businesses and marketed as a way to borrow with higher levels of certainty on repayment amounts. As claimant solicitors and claims' farmers begin to exhaust the stock of swap mis-selling claims, and the Financial Conduct Authority's mandated review moves into what many hope will be its end phases, these solicitors and consultants appear to be looking around for the next area of bank vulnerability. Some seem to believe they may have found it in relation to FRLs (or loans with embedded derivatives as they prefer to see them). The argument that is being made is that there is, or should be, no difference in principle between a situation where: the loan and the hedging product are separate but the effect is to fix the interest rate payable by the customer (as is the case for the swaps currently under review); and a situation where the loan to the customer is fixed in relation to the customer, but where the bank has its own hedging arrangements sitting behind the loan. The effect is essentially the same in that the payments the customer has to make are fixed and the break costs payable are much the same. On the basis of this alleged 'embedded derivative', what a number appear to be trying to do is to encourage the banks and the regulator either to bring FRLs into the scope of the existing FCA review or to acknowledge that they are derivative and therefore regulated products. To date the FCA has maintained the line that FRLs fall outside its definition of a derivative and outside the scope of its rules and therefore, as a general rule, the review. However, according to press reports, Business Secretary Vince Cable has asked the FCA to look at the issue and a number of MPs have raised it in parliament. Martin Wheatley, the Chief Executive of the FCA, commented recently to the Treasury Select Committee that there is a gap in the applicable regulations comments that were seized on with some glee by claimant solicitors and consultants. The central issue in many of the cases we have seen appears to be the bank sales team's alleged failure to disclose the level of break costs payable before the FRL is entered into; many SME customers simply do not appear to have anticipated the level of those costs, which can be a very significant portion of the value of the loan. While our experience is that more cases of this nature are now being litigated or complaints raised with the Financial Ombudsman Service in relation to them, the stream has not yet turned into any kind of torrent. For the time being therefore this is an area that is worth simply keeping an eye on monitoring the terms and content of complaints and new claims to see the extent to which non disclosure in the context of FRLs, or simply the FRLs themselves, form the basis of these actions. Foreign Account Tax Compliance Act (FATCA) update With the implementation of FATCA now fully underway, financial institutions (FFIs) simply cannot escape its reach. FFIs should be aware of, and have the capacity to comply with, the regulatory obligations which they will be subject to going forward. From 1 July 2014, the following measures will apply: Grandfathering rights - obligations (including loans) entered into after this date will no longer benefit from grandfathering rights, which previously provided that payments (such as interest) will fall outside the scope of FATCA withholding, unless the obligation is materially amended after this date. Consequently, certain obligations entered into after 1 July 2014 could be subject to withholding, if a lender is deemed non-compliant under FATCA. Withholding on US FDAP - FATCA withholding will start to be applied to US-sourced interest, dividends, rents, royalties and compensation, payable on obligations committed or advanced after this date.

3 Given the number of extensions to the grandfathering dates we have seen up to now, some commentators think "this is it" and that no further extensions will be granted. To mitigate the risk of withholding on its transactions, FFIs should consider adopting the following approaches: IRS lists - FFIs intending to be included in the IRS's first list for 'deemed-compliant FFIs' are required to register using the IRS's portal by 5 May 2014, or alternatively, by 3 June 2014 for inclusion in IRS's second list. UK IGA - those FFIs which may benefit from the UK Intergovernmental Agreement, must obtain a Global Intermediary Identification Number by the end of 2014, to facilitate its inclusion on the IRS FFI list, to be published early Addressing FATCA in documentation - parties should consider incorporating appropriate wording into documentation to deal with the allocation of risk between the participating parties. The position adopted in a number of recent transactions has been an express carve-out of FATCA withholding from the tax gross-up clause and indemnity clause (and in some cases, increased costs), with a concurrent obligation on syndicate lenders to provide the requisite documentation to the agent or borrower to ensure compliance with FATCA's disclosure obligations. Additionally, the International Capital Market Association has recently published suggested wording for insertion into the standard GMRA, which effectively removes the obligation for the payer to grossup payments to the payee, in the event that FATCA withholding applies. This proposed wording is subject to ongoing review. Due diligence - FFIs must commence due diligence on client accounts to ensure they can fulfil the FATCA reporting obligations which arise from mid For further information on FATCA and its application on the loan market and the scope of the UK IGA, do please get in touch to request a copy of our FATCA guidance notes. Editorial Non-bank lending - new players in the lending markets We are all aware that new players are filling gaps supposedly left by banks in the lending markets. These gaps are being filled in all manner of ways. Hedge funds are becoming lenders of first resort for bridging finance and there is an increase in captive-financing offered by manufacturers. The 'payday lenders' in the consumer credit space are moving up the chain to SME finance, we're seeing new non-bank players in the mid-market corporate refinancing arena and even good old fashioned private equity houses are looking much more like the merchant banks of old. Concerns have been raised in some areas of the market. In the peer-to-peer space for example, it is not yet clear how the model will cope with serious levels of distress or default with respect to the underlying loans. The financial pages suggest that more than 60% of the peer-to-peer lending industry's loans are now purchased by institutions, which does tend to suggest a sense of legitimacy for the sector. But with talk of how best to bundle these loans into securitised bonds coupled with that lack of a track record on these loans going bad, there does appear to be a risk that the 'pre-crisis' mistakes of old may come back to the fore. Taking a step back and looking at the alternative lending movement as a whole, no-one can be under the illusion that the 'shadow banking' sector will remain out of sight of regulatory scrutiny. There is a sense of 'you're next' in terms of tight regulation from most of the national and supranational regulators. But notwithstanding that, alternative lenders do have a perceived key advantage over the traditional banking model which one would hope the regulators would recognise: they are generally financed through long term funding without a whiff of retail deposits. Not only does this enable a decent slice of financial arbitrage but it means that, in theory at least, the voice of the man in the street will not mean overburdening political interference with regulation in an effort to win votes. And what of traditional banks? It seems that all is not lost. Some well known clearers are teaming up with alternative providers, whether through financing SMEs in partnership or the provision of 'unitranch' finance. Here the traditional bank's senior loan is stapled to a mezzanine piece from the alternative provider, all under one document and with one interest rate the mezz just plays second fiddle in a distressed/enforcement

4 scenario, which enables the 'riskier' funding gap to be plugged. So there's potential for the future to be bright for everyone (if appropriately regulated, of course). Loan Market Association (LMA) updates and news LMA publish Islamic Finance Documents guide - There is a new guide to Islamic Finance Documents which provides guidance on how terms and concepts commonly seen in the LMA Primary Document suite are imported into a typical Islamic facility it focuses primarily on murabaha facilities. Revised LMA Standard Terms & Conditions for Par and Distressed Trade Transactions produced - Revised LMA Standard Terms & Conditions for Par and Distressed Trade Transactions have been produced, effective as of 3 March 2014 following conclusion of a "plainer English" project. Revised LIBOR definitions and impact of transition published - Revised LIBOR definitions and the impact of transition have been published (lest we forget that as of 1 February 2014, LIBOR is administered by ICE Benchmark Administration Limited). Schuldscheindarlehen LMA Product Guide produced - There is a new publication entitled 'Schuldscheindarlehen LMA Product Guide' which serves as an introduction to Schuldscheindarlehen and is aimed at those less familiar with the product. Other news 'Covenant lite' deals making come-back in Europe In the leveraged market, arguably 'covenant lite' or 'cov-lite' deals never completely disappeared in the US during the financial crisis. Even if new deals were not being written, many ended up in financial restructuring. Seemingly, they are now staging a come-back in Europe. The ever-increasing hunt for yield from investors has driven this and naturally, regulators are getting wise to this - their concern being a return to excessive risk taking that has caused us so much pain since the on-set of the credit crisis. English law restructuring and insolvency measures have uses across the globe A recent case used an English law scheme of arrangement as part of a financial restructuring where the company was registered in the Netherlands and the notes held by creditors were governed by the law of the State of New York. This is a further example of how English law restructuring and insolvency measures can have uses across the globe and not just on a domestic basis. The Court of Appeal speaks on performance bonds The English Court of Appeal has held that a valid demand made under a performance bond remains valid even if it subsequently becomes clear that the seller was not actually entitled to the money guaranteed by the performance bond. After payment had been made under the performance bond in this case, it became clear, as a result of a final arbitration award relating to the underlying transaction, that the seller was not actually entitled to the sum of money guaranteed by the performance bond. The bank argued that once the seller knew that it was not entitled to the money, it should hold the money on trust for the bank. However, the court held that once a valid demand is made under a performance bond, the seller acquires a complete and immediately enforceable cause of action against the issuing bank. TLT contacts Simon Coles, Partner T +44 (0) simon.coles@tltsolicitors.com

5 Richard Clayton, Partner T +44 (0) richard.clayton@tltsolicitors.com Parisa Clovis, Solicitor T +44 (0) parisa.clovis@tltsolicitors.com