The much anticipated EU report on loan syndication was published on 5 April 2019. It was positioned as a fact-finding exercise, commissioned by the European Commission in 2017 and carried out by a third party consultancy, to study the functioning of the syndicated lending market and its possible implications for competition policy. The resulting report presents a mixed picture for competition in this sector; while few areas were flagged as potentially high risk, the report does list a number of areas of concern for competition and identifies several important safeguards to protect competition in the loan syndication process. The Commission has said in its Management Plan for 2019 that it will ‘assess the results' of the study to decide on appropriate next steps. In the meantime, this report provides a useful framework for a competitive analysis of possible issues and benchmark for compliance and risk management.
Loan syndication is no stranger to regulatory scrutiny. In addition to the Commission’s study, there have recently been a number of national competition investigations. In 2016, the UK’s Financial Conduct Authority (FCA) issued a number of warning letters to lenders regarding the alleged disclosure of sensitive information about terms and conditions of loans. In late 2017, the Turkish Competition Authority fined two banks for exchanging information relating to credit terms and other financial transactions. And in February 2018, the Spanish Competition Authority issued a controversial decision fining several banks €91 million for allegedly colluding to offer interest-rate derivatives under conditions other than agreed with customers.
The Commission has not given any rationale for commissioning this study, other than ‘the importance of the syndicated lending market in the EU’, noting that the ‘close cooperation between market participants in opaque and in-transparent settings’ make it ‘vulnerable to anti-competitive conduct’ and a commitment to monitor business practices of capital providers in wholesale financial markets.
The study focuses on specific segments of loan syndication, specifically those connected with leveraged buy-outs (LBOs), project finance and infrastructure finance (PF/IF). It also focuses on a sample of six Member States – the most significant in terms of the location of borrowers, lenders and investors, according to the study – France, Germany, the Netherlands, Poland, Spain and the UK.
There are a number of key takeaways from the study which we have sought to highlight below.
No evidence of highly concentrated markets – but Poland and Eastern EU Member states should be monitored closely
Generally, the report did not find any evidence of highly concentrated markets in any of the Member States considered, albeit it does flag that Poland may have a smaller pool of lenders, which could lead to concerns particularly in PF/IF. It considers Poland a good proxy for EU countries outside of Western Europe which could similarly face limited choice, and which it recommends ‘should be monitored most closely’.
Different antitrust risks for different stages of the syndication process
The assessment of the antitrust risks – and safeguards to manage those – varies depending on the stage of the syndication process.
The risk of market soundings at pre-bid stage. In the formation of the lead banking group, and the competitive bidding process for appointing banks to the group, the main risk highlighted in the report stems from market soundings, and in particular deal-specific soundings, containing competitively sensitive information which could be fed back to potentially competing origination desks.
The report flags a number of possible safeguards to manage this risk:
- ensuring the sounding only contains information as specific as is needed for its purpose. The study recognises that insufficient information might make a lender less likely to respond to an RFP (and ultimately negatively affect the borrower), but notes that the level of information required needs to be assessed on a case by case basis;
- explicit borrower / sponsor consent, which is a key factor in mitigating this risk, particularly where it specifies who may be contacted;
- functional separation between origination and syndication desks (which typically carry out such soundings), to limit the risk of collusion between originating banks competing for the mandate; and
- the use of NDAs to restrict the disclosure of information.
The study finds that generally the risk is relatively low in the LBO segment (where borrowers are well informed and can refer to previous transaction terms), but heightened in PF/IF given the need for more specific information in market soundings.
The risk of coordination against the borrower post mandate. To the extent that terms are agreed bilaterally with the borrower and joint discussions between lenders are limited to agreeing the documentation and syndication strategy, the report considers the risk of lenders colluding within the syndicate to the detriment of the borrower to be low. In some cases, the borrower brings lenders together earlier (e.g. a club deal) in which case that (higher) risk can be managed through borrower involvement and limiting discussions to the scope of the mandate.
The report does flag a ‘definite risk’ of lenders observing each other’s behaviours and strategies throughout repeated interactions on a mandate, which could enable coordination on future transactions. Overall, it considers this risk to be low.
The allocation and pricing of ancillary services. While most of the time the allocation and pricing of these services is either decided – and negotiated – at the outset or after closing, in some cases the provision of such services is made a condition of the loan. The study flags this as an area of ‘moderate concern’, raising the risk of a sub-optimal economic outcome for the borrower. This is at odds with the Spanish Competition Authority’s February 2018 decision, which specifically found that such a requirement was not a breach of competition law. The study makes a similar finding for ancillary services which are not directly related to the loan, and which the UK FCA has banned.
The risk of coordination and tying ancillary services in refinancing / default. The time pressured context of negotiations in the event of default, particularly where the syndicate might be the only option for the borrower, raises the risk of lenders acting in a coordinated manner and exerting market power, although this is tempered where new lenders from outside the syndicate are involved. The report also finds that the opportunity in such distressed circumstances to price ancillary services on non-competitive terms is ‘an area deserving future monitoring’.
The report identifies a number of key safeguards to protect competition in the syndication process:
- The duty of care to clients: the report requires a two-pronged approach to this duty. Banks should ensure:
- staff have adequate training and proper policies are in place to manage conflicts of interest and provide neutral advice to clients (especially where banks may be debt advisors as well as syndicate members, an area flagged as a ‘high concern’); and
- alternative options have been considered before aligning loan pricing or terms upwards to the highest common denominator. The report suggests that, where a particular lender in the proposed syndicate is asking for a higher price, the lead bank could consider involving a new lender or restructuring the loan, or the borrower could seek to mandate a bidding process for that position.
- Avoiding unnecessary information exchange, i.e. safeguards in the form of enforceable and enforced protocols to limit the circulation of information obtained in one function (syndication) to another (origination) to avoid alignment.
- Promoting unbundled price competition: limiting the cross-selling of ancillary services to avoid adversely affecting the conditions of competition in a neighbouring market, and keeping the sale of services which are not directly related to the loan separate.
While the report has flagged several areas of concern, it has generally not identified substantial competition issues with the loan syndication process in the Member States reviewed. The findings are largely factual, and to a degree nuanced. The report explores possible issues around certain practices while generally concluding these to be low risk or not widespread.
However, the safeguards that it identifies to protect competition and limit risks could have important implications - two key points stand out:
- The report appears to take issue with the (upward) alignment of prices between the proposed syndicate when the pricing is set, suggesting instead that where a bank is proposing to price higher, the lead bank or borrower should inject further competition into the process to manage the risk of a worse outcome for the borrower, for instance considering restructuring the loan or inviting a further bank to join the syndicate or bid for that place.
- A degree of separation between origination and syndication teams seems to be a given – the study expects protocols to manage the flow of information between these teams, and it expects these to be followed and enforceable.This makes it increasingly difficult for smaller organisations to use the same team to cover both functions and manage this risk at the same time.
The Commission has already stated that it is considering the results. It could launch a sector inquiry to have a closer look at the issues raised, or carry out further information gathering before enforcement action. It is also possible that national competition authorities consider taking action given some of the findings – a number of them have already been active in this sector. Banks and other industry participants would be well advised to address competition compliance and review practices in this area.