HEDGING Y OUR BETS Hedge Funds as Borrowers: Documentation Issues Summary Outline

Transcription

1 HEDGING Y OUR BETS Hedge Funds as Borrowers: Documentation Issues Summary Outline Purpose/Use of Funds * Liquidity Key Documentation Issue: Availability & Priority Leverage Strategy (leveraged exposure or acquisition finance) Key Documentation Issue: Impact on investors not taking leverage exposure Priorities Cost of funds Risk mitigation (Adequate, available collateral when cash flows fail) Key Documentation Issue: Collateral and remedies Competition (Multiple sources of leverage) Key Documentation Issue: Intercreditor issues and Cross-Defaults Manage to Strategy Key Documentation Issues: Key Covenants & Defaults Compliance with Investment Policies Investment of New Subscriptions Reporting Minimum Net Asset Value Collateral Coverage (Curable versus Default) Other Indebtedness & Liens Volatility Structuring Fund strategy and limitations on leverage Key Documentation Issues: Authority (organizational documents and management agreement) Disclosure Collateral in open-end funds Master fund assets Key Documentation Issues: Liquidity versus Leverage Facilities Structural Subordination (subsidiary guaranties) Collateral Sharing Remedies * This outline covers leverage other than provided through prime brokerage accounts. LIBC/

2 Loans, securities, etc. Key Documentation Issues: Eligibility Criteria Percentage Limitations (Concentration or Buckets ) Trading (Managing Credit Improved, Credit Risk, Defaulted Assets) Valuation Closed end: Add commitment secured financing Key Documentation Issues: Authority to Convey (organizational) Executing the Remedy Quality of Failure Address operational risk with special purpose vehicle or segregated portfolios (entity structuring), shadow ratings driven portfolio structuring Warehouse facilities, CDOs and CLOs: holding the equity tranche provides leveraged exposure to the issuer s assets Address structural subordination, illiquidity issues through secured subsidiary guaranty Address cross-default (race to the bottom) through collateral sharing arrangements; mechanics for dividing indivisible interests Address illiquidity through side letter arrangements on redemption as well as mechanics for direct (effective) recourse to a subsidiary guarantor s assets Addressing illiquidity and structural subordination may mitigate dependence on manager Further address dependence on manager through assignment of management agreement, covenants relating to investment guidelines, volatility as well as threshold NAV covenants Manager Standard of care, conflicts Dependence on the manager: idiosyncratic, illiquid assets Fees, indemnities What strategy has the leverage provider underwritten? Offshore versus onshore LIBC/

3 HEDGING YOUR BETS DOCUMENTING LOANS TO AND FROM HEDGE FUNDS A. WHAT IS A HEDGE FUND? Background Typical Investors Typical Structures Brief Regulatory Overview Investment Advisers Act Investment Company Act State Licensing Requirements B. TYPES OF FINANCINGS Term A and B Senior Secured Revolvers Mezzanine Subordinated Debt Asset-Based, Cash Flow, Specialty C. DOCUMENTATION HOT BUTTONS Loan Mechanics (Borrowing) Funding Draws Cash Collateralization Onshore/Offshore Lending Requirements/Tax Concerns/ Seasoning Collateral/Administrative Agency Issues Defaults/Remedies Cure Periods Defaults/Reserves Amendments/Forbearance Financial Covenants Reporting Affiliate Restrictions Required Lenders Non-Consenting Loan Provisions Transfer Restrictions 144(a) D. INTERCREDITOR ISSUES Standstills Payment vs. Debt Subordination Enforcement Turnover Provisions E. EQUITY KICKERS YIELD LA v.2

4 Preferred Stock Loan to Own Warrants LA v.2 2

5 Hedging Your Bets Documenting Loans To and From Hedge Funds. Confidentiality Issues in the Loan Market Elliot Ganz, General Counsel The Loan Syndications and Trading Association March 15, 2007 Washington, D.C

6 Background Most information delivered by borrowers to lenders is delivered subject to a confidentiality undertaking Embedded in: Commitment Letters Electronic Workspace Splash Pages Provisions in Credit Agreements

7 Background Such information may also be subject to a duty of confidence Case law suggests that lenders have a duty of confidence to borrowers (Washington Steel Corp. v. TW Corp and ADT Operations v. The Chase Manhattan Bank) Market practice and company expectations are consistent with protecting non-public information provided by companies

8 Background Reg FD mandates that public companies not selectively share material info with investors Permissible selective disclosure includes disclosure to entities that are subject to confidentiality undertaking or duty

9 Loan Trading Issues Types of information in the loan market Syndicate Information Borrower Restricted Information Bank Loan Non-Restricting Information Public Information

10 Loan Trading Issues Loans trade on the basis of confidential, syndicate information Since all loan market participants have or are entitled to have access to syndicate information This is true even if a lender chooses not to receive the syndicate information Big Boy provisions Each Party mutually agrees that the other Party may have information that it is not disclosing in connection with the Trade and waives any claims against the other Party arising from the nondisclosure of the Excluded Information. As additional, mutual protection, each Party affirms its non-reliance on the other Party,

11 Loan Trading Issues Big Boy provisions The Buyer and the Seller represent and warrant to each other: it is a sophisticated party with respect to the Trade; it has or has access to such information as it deems appropriate to make an informed decision regarding the transfer of the Debt; it has independently and without reliance on the other Party, made its own analysis and decision to enter into the Trade The Buyer and the Seller further acknowledge to one another: the other Party may have or come into possession of information regarding the Debt or the Borrower/Obligor that is not known to it and may be material to a decision to enter into the Transaction ( Excluded Information ); it has decided to enter into the Transaction notwithstanding its lack of knowledge of the Excluded Information; the other Party will not have liability to it, and it waives and releases any claims it may have against the other Party with respect to the nondisclosure of the Excluded Information.

12 Securities Trading Issues Loan Market Participants ( LMPs ) routinely receive confidential information often including MNPI LMPS often also participate in the securities markets Securities trade solely on the basis of public information

13 Securities Trading Issues LMPs should implement and maintain information controls and related policies and procedures for handling syndicate information in order to avoid entering into securities transactions on the basis of MNPI. A firm s information controls should be tailored to the nature and scope of its business activities and operations

14 Securities Trading Issues LMPs should consider including certain key elements in their information controls: Information walls Physical separation Functional separation Wall-crossing procedures

15 Securities Trading Issues LMPs should consider including certain key elements in their information controls: Written and formalized policies and procedures Independent compliance and monitoring functions Procedures for communicating across information barriers Record keeping requirements Education and training Review and approval of policies and procedures by management

16 Securities Trading Issues LMPs should consider including certain key elements in their information controls: Trading restrictions, Restricted Lists and Watch Lists A Restricted List is a list of issuers or borrowers as to some or all of whose securities and other traded instruments a firm has decided to restrict securities transactions. A Watch List is a list of issuers or borrowers the trading in respect of whose securities is not prohibited but closely monitored. Trading restrictions may be used as a primary compliance tool to assure that securities about which a firm has MNPI are not traded.