After a brief postponement, the Loan Syndication and Trading Association (LSTA) published revised Standard Terms and Conditions, effective September 1, 2016, for its Par/Near Par Trade Confirmation (Revised Standard Terms) to implement a new regime for par/near par delayed compensation. The changes represent the most significant revision of LSTA loan pricing in the almost 20 years since the LSTA was formed. Going forward, a buyer under an LSTA par/near par loan trade is not always entitled to "delayed compensation."
Delayed compensation refers to the buyer's entitlement, starting on the seventh business day after the trade date (i.e., T+7), to interest and accruing fees on the loan, minus an amount intended to compensate the seller for its cost of funds during the delay period.1 Until now, buyers have been entitled to delayed compensation as a matter of right on a no-fault basis. Under the new requirements model, the buyer is only entitled to delayed compensation if it fulfills a number of requirements or if the seller fails to satisfy certain of its requirements. These requirements pertain to the timing by which the LSTA Par/Near Par Trade Confirmation (Confirmation) and the assignment agreement in the form provided with the relevant credit agreement (Assignment Agreement) are executed and circulated. They also dictate when a buyer must be ready to close and when they are required to fund upon the settlement of the trade. The new rules are scheduled to be implemented in two stages, phase one and phase two. Some key provisions will be applicable for transactions entered into from September 1, 2016 to October 31, 2016 (Phase I). The rest of the provisions will go into effect for transactions entered into on or after November 1, 2016 (Phase II).
This note and the attached charts highlight some of the key changes to the LSTA delayed compensation pricing regime. Note that changes are not being implemented for LSTA distressed trades. Nor are they yet being proposed by the Loan Market Association (LMA), under which most European loans trade.
The Revised Standard Terms include two separate sets of requirements to determine entitlement to delayed compensation. The vast majority of LSTA par/near par transactions will follow the "Settlement Platform Requirements," which are applicable to transactions that settle on electronic settlement platforms, such as ClearPar or Virtus Trade Settlement Inc. The "Paper Requirements" are applicable to transactions that do not use an electronic settlement platform, but rather are settled on paper documents. The following diagrams outline key steps in the process of determining a buyer's entitlement to delayed compensation, using either paper documents or an electronic settlement platform. Note that unless stated otherwise, these flow charts reflect the Phase II in the implementation of these rules.
Settlement Platform Requirements for Secondary Trades
Paper Requirements for Secondary Trades
Specific Exceptions to the New Delayed Compensation Rules
The new delayed compensation rules, as stated in the Revised Standard Terms, are somewhat softened by a number of specific rules and scenarios in which the buyer will remain entitled to delayed compensation even if certain requirements were not met in a timely fashion, including:
- Participation Agreements. The selection of "Participation" as the form of purchase in the relevant Confirmation indicates that, after settlement, the seller will remain the lender of record on the books and records of the administrative agent. Under such circumstances, the buyer remains entitled to delayed compensation on a no-fault basis under the Revised Standard Terms.
- Failure to Obtain Consent. A delay in settlement caused by a failure to obtain any required consents to the assignment, such as those imposed by the administrative agent or borrower, will not cause the buyer to lose its entitlement to delayed compensation as long as the buyer otherwise satisfies its Paper Requirements or Settlement Platform Requirements (as applicable).
- New CLO Issuers. If the buyer is a special-purpose entity formed for the purpose of issuing collateralized loan obligations under an indenture, prior to T+7 the buyer may notify the seller of this and elect to have up to five consecutive business days preceding the effective date of the buyer's indenture treated as a "CLO Blackout Period." In the event that the buyer notifies the Seller of a CLO Blackout Period, a failure to close the transaction during the CLO Blackout Period will not result in the buyer losing its delayed compensation.
- Buyer Due Diligence/Know Your Customer. The buyer will not forfeit its delayed compensation if it delays in executing the Confirmation and/or the Assignment Agreement on account of having requested but not yet received required "know your customer" (KYC) or other "onboarding" materials from the seller. The buyer must have requested these materials prior to the date that it would otherwise be required to submit any documents under the Revised Standard Terms. Once the information or materials have been received, the buyer must facilitate the prompt settlement of the transaction.
- Purchase Price Calculation Error. If the buyer does not timely fund the purchase price due to the buyer's good-faith belief that the purchase price calculations are incorrect and provides the seller with notice detailing such belief, the buyer will still be entitled to delayed compensation for the transaction as long as the buyer has otherwise satisfied its Paper Requirements or Settlement Platform Requirements (as applicable).
- Material Error in the Assignment Agreement. If a buyer discovers a material error in an assignment agreement, the buyer may refrain from executing and delivering such assignment agreement without affecting the buyer's entitlement to delayed compensation as long as the buyer timely executes and delivers its signature to the confirmation and provides notice of the assignment agreement error within T+3. In the event the error is fixed within T+4, the buyer shall continue to be obligated to satisfy its Paper Requirements or Settlement Platform Requirements (as applicable).
- Force Majeure. In a provision applicable only to transactions settled on electronic settlement platforms, a buyer will not lose its entitlement to delayed compensation if it is unable to satisfy its Settlement Platform Requirements due to a failure in the functionality of the relevant electronic settlement platform that is outside of the buyer's control.
Early Day Trades
The Revised Standard Terms also revises the delayed compensation rules for "Early Day Trades." These are transactions often agreed to prior to the effective date of a credit facility and with a trade date no later than six business days after the Trigger Date of such credit facility. The Trigger Date is the date upon which the funds under the credit facility were advanced, or, in a case in which there is no initial funding, the effective date of the credit agreement. The delayed compensation rules for such trades are a bit different than those for regular trades. For early day trades, the important date under the Revised Standard Terms is the "Trigger Date" plus 14 business days. "Trigger Date plus 14" for early day trades can be compared to "T+7" for regular secondary trades, in that it is the targeted settlement date and the date the buyer becomes entitled to delayed compensation if it meets its requirements. Requirements are adjusted accordingly around Trigger Date plus 14. For example, an early day trade buyer must be prepared to settle and fund on Trigger Date plus 14 business days and buyer must have signed the Confirmation and Assignment Agreement on or prior to Trigger Date plus 10 business days.2
Timing of Purchase Price Funding
Another important aspect of the new delayed compensation rules deals with the obligation of buyers to promptly fund on the settlement date once all required consents have been obtained. If the buyer delays in funding, they will lose their entitlement to some or possibly all of the delayed compensation that they would have otherwise received.
Complicating the funding obligations is the fact that many off-shore entities need a day of lead time in order to fund. During Phase I, lead times can be any amount of time. In recognition of these limitations, under Phase II the electronic settlement platforms will contain a mechanism to allow buyers to select in advance that they will need an extra day to fund. In such circumstance, buyers may forfeit one day of delayed compensation that they would have been entitled to had they been able to fund on the settlement date.
The following charts highlight some of the key purchase price funding requirements under the new delayed compensation regime for transactions under the Paper Requirements and for those under the Settlement Platform Requirements.
Timing Requirements for Funding the Transaction (Settlement Platform)
Timing Requirements for Funding the Transaction (Paper)
These fairly revolutionary changes of the LSTA par/near par delayed compensation rules are likely to have far-reaching ramifications for the loan market. In contrast to other changes intended to affect settlement times, such as the BISO, these changes will likely succeed in reducing median par/near par settlement times to times much closer to the T+7 goal. The successful implementation of these changes is likely, however, to demand significant additional resources of already often understaffed middle office groups of both buyers and sellers. Under the new regime, parties will be under greater pressure to process trade documents quickly, while also being obligated to be prepared to close transactions on any business day. Additionally, a version of these changes is likely to be first replicated in the primary market and eventually even for secondary distressed trades for which settlement times are even longer. Any material success of the Revised Standard Terms in shortening settlement times is also likely to induce the LMA to move to a requirements-based model for delayed compensation.
1 This amount is calculated as the average one-month London Interbank Offered Rate (LIBOR) multiplied by the purchase price for the duration of the delay period.
2 For transactions entered into on or between September 1, 2016 and October 31, 2016, the applicable date is Trigger Date plus 12 business days.
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.