United States: Proposed Revisions To LSTA Par/Near Par Delayed Compensation

On June 9, 2016, the LSTA published and circulated to its entire membership proposed revisions to the LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations (the "Par Standard Terms"). The changes proposed are the most significant economic changes that the LSTA has proposed to the Par Standard Terms.

The goal of these revisions is to quicken settlement times of par/near par secondary loan transactions. The proposed revisions will change the long standing practice of "no fault" delay compensation to a "requirements based' delay compensation model. To better understand the ramifications of this proposal, it is important to understand how delayed compensation works in bank debt transactions governed by the Par Standard Terms. Under the Par Standard Terms, between trade date and T+7 (e.g. trade date plus seven (7) business days), the seller retains the right to ordinary course interest and accruing fees on the debt for performing credits. From and after T+7, the benefit of ordinary course interest and accruing fees on the debt for performing credits are for the benefit of the buyer. This construct supports the premise that the trade should have closed by T+7.

The other component of par/near par delayed compensation is that a buyer is obligated to pay a seller interest on the purchase price that the seller would have received if the trade had closed on T+7. Had the trade closed on T+7, the seller would have received the purchase price on such date and thereafter would have earned some rate of return on the purchase price. Pursuant to the Par Standard Terms, the interest that a buyer is obligated to pay a seller on the purchase price is based upon an average of 1-month LIBOR between T+7 and the actual settlement date.

Although delayed compensation provides a two-way payment stream, the buyer generally receives a greater economic benefit in the delayed compensation calculation compared to the seller. In fact, with 1-month LIBOR at historic lows, a buyer effectively receives near zero interest financing to purchase bank debt from T+7 to the settlement date.¹  

The LSTA's proposed initiative is designed to discourage a buyer from keeping a par/near par trade open by terminating buyer's right to the benefit of ordinary course interest and accruing fees on the debt from and after T+7, if the reason the trade does not settle on a timely basis is buyer's unwillingness to execute the assignment agreement, close and pay the purchase price.² 

Under the new proposed terms, the buyer will generally be required to execute the applicable LSTA par/near par trade confirmation and related assignment and assumption agreement within one (1) business date prior to T+7. Additionally, on the date that the transfer is made effective by the administrative agent on the administrative agent's registry, the buyer will be required to pay the purchase price (to the extent it's a positive number) to the seller. To the extent the buyer complies with the foregoing requirement, the buyer will be entitled to receive the benefit of the interest and ordinary course fees accrued on the loan from and after T+7. In the event the buyer does not timely comply with the foregoing requirement, the buyer will lose the benefit of such delayed compensation under the proposed Section 6(g)(ii) of the Par Standard Terms.³

There are a few limited exceptions to the new proposed terms. Most notably, the obligation of buyer to timely comply with these requirements is predicated upon the seller delivering to the buyer the trade confirmation accurately setting forth the terms of the trade along with the related form of assignment and assumption agreement to facilitate the legal transfer within one (1) business day following the trade date. To the extent the seller does not timely comply with this obligation, the buyer will automatically be entitled to delay compensation under proposed Section 6(g)(ii) of the Par Standard Terms on a "no fault" basis. Additionally, the new changes will not apply to the extent the parties have agreed at time of trade to settle pursuant to a participation agreement.

Recognizing that the majority of par/near par trades on the secondary market now settle pursuant to an electronic settlement platform (such as ClearPar and Trade Settlement Inc.), the LSTA also built into the proposed revisions a new Section 27 to the Par Standard Terms specific to electronic settlement. The same timelines as set forth above for "paper" trades will also apply to trades settling on an "electronic platform." Although some of the mechanics built in for electronic settlement are different than paper settlement in terms of how to comply with the new formulations, the substance between the two constructs are substantially the same. The default option (if nothing is otherwise agreed upon by the parties) provides that the rules governing whether a buyer shall be entitled to interest on the loan accruing from and after T+7 shall be the terms relating to settlement pursuant to an electronic settlement platform.

One nuanced difference between the electronic settlement platform is that generally the party required to draft is the "dealer" (whereas the default option for "paper" trades is the seller).⁴ To the extent the dealer/buyer does not submit the trade details to the electronic platform within T+1, the seller must notify the dealer/buyer of such failure within three (3) business days following trade date ("T+3"). To the extent the seller does not timely notify the dealer/buyer then the dealer/buyer will be entitled to accrued interest and ordinary course fees on the loans from and after T+7.⁵

One of the biggest challenges for parties with respect to the implementation of these new terms and conditions will be for operational, closing and legal personnel to adjust their prior workflow habits to ensure that they are able to timely comply with these new requirements. The goal of the LSTA is to create more discipline to improve upon settlement of the transactions in a more expedited fashion.

Assuming these revisions take effect in the near future, one important consideration for buyers will be to confirm that they satisfy the requirements under the credit documents to become a lender prior to agreeing to enter into a par/near par trade. For example, many credit agreements have certain limitations on who can become a lender (e.g. no affiliates, no competitors, disqualified institution list, etc.). In order to be able to receive the benefit of interest and ordinary course fees from and after T+7, a buyer will generally need to execute the form assignment and acceptance agreement one (1) business day prior to T+7. Thus, a buyer will want to know prior to agreeing to enter into a trade that there will not be an issue with such buyer executing the form assignment and acceptance agreement (e.g. meets qualifications of an eligible assignee) prior to trade date. If a buyer enters into a trade without such diligence and then realizes it cannot become a lender, the buyer will be forced to decide whether to potentially violate the terms of the credit agreement (and take the legal risks that flow from that) in order to receive the benefit of interest accrued from and after T+7, or not to execute the assignment and acceptance agreement and thereby lose the benefit of any interest accruing from and after T+7. 

In addition to the changes proposed to the delayed compensation from a "no fault" basis to a "requirement based" approach, the LSTA has also proposed revisions to the timing in which a party will be able to exercise its buy-in/sell-out rights ("Par BISO") from fifteen (15) business days after trade date to T+7. Thus, the timing in which a party can serve a Par BISO notice has been moved to essentially mirror the timing requirements being imposed upon a buyer pursuant to the proposed "requirements based" delayed compensation. Therefore, if the buyer timely complies with its obligations under the "requirements based" delayed compensation, but the seller is not ready to close, the buyer will be able to seek to avail itself pursuant to a Par BISO remedy following T+7 (and not wait until after T+15). This remedy would generally be available to the buyer to the extent the seller sold the loans short (and did not cover promptly within five (5) business days after the trade date sale to the buyer).

This memorandum is intended to be a general summary of the proposed revisions and parties are strongly encouraged to review the changes proposed by the LSTA independently and consult with their own advisors. For parties' reference we have attached a link to a redline showing the changes proposed by the LSTA to the current Par Standard Terms.

To the extent market participants have comments on the proposed revisions, the LSTA has requested receipt of such comments by June 22, 2016. 

Footnotes

1. The 1-month LIBOR rates have been historically very low for an extended period of time ranging no higher than 0.5% since 2009. From 2005 through 2008 the 1-month LIBOR ranged generally from 2.5% to 5.5%.

2. One tool already available to a seller to force a "non-performing" buyer to close is the Par BISO. Pursuant to the Par BISO, a "performing" seller can sell-out the bank debt to a "substitute" buyer and, to the extent the purchase price to be paid by the substitute buyer is less than the purchase price that the non-performing buyer agreed to pay, the non-performing buyer will be required to "true-up" the performing seller so that it receives the difference between the amount it would have received from the non-performing buyer compared to what it received from its substitute buyer. Notwithstanding such right, for various reasons, there has been limited utilization within the secondary trading market of the buy-in, sell-out remedies. 

3. Additionally, the Seller will lose the benefit of delay compensation pursuant to the proposed Section 6(g)(i) of the Par Standard Terms.

4. A "dealer" is defined under the proposed terms as "(a) an entity that buys and sells loans as principal, for its own account, or for the account of its client and holds itself out to the market as standing ready in the ordinary course of its business to purchase from customers and sell to customers loans, in its capacity as a dealer or market maker in such loans and (b) is in fact regularly in the business of making a market in loans against borrowers."

5.An analogous concept exists for "paper" trades in situations where the "buyer" is the party responsible for drafting the confirmation and assignment and assumption agreement.  To the extent the buyer does not timely deliver such documentation within T+1, the seller must notify the buyer of such failure within T+3. If the seller does not notify the buyer then the buyer will be entitled to receive the benefit of interest accrued from and after T+7.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.