On 5 April 2019, the European Commission (EC) published its report on the EU syndicated lending sector, “EU loan syndication and its impact on competition in credit markets” (the Report). The Report has now been anticipated for some time, having been commissioned by DG Competition from Europe Economics in August 2017, reflecting and responding to increasing antitrust scrutiny of the syndicated lending sector. To date, enforcement action in this sector has been taken by competition regulators in jurisdictions including the UK, Spain, Australia and Turkey. 

Through the Report, the EC aims to assess whether the syndicated lending market is working efficiently and, in particular, how effective competition in the syndicated lending sector is at present, having regard to its significance as a source of debt finance (particularly on a large scale) for other economic activity within the EU. As such, the Report does not represent enforcement by the EC against any form of anticompetitive wrongdoing, although frequently antitrust scrutiny of general markets or sectors can identify areas for subsequent enforcement action by regulators. The Report's findings are based (among other sources) on interviews with 37 lenders and 100 borrowers/sponsors, as well as debt advisers and credit rating agencies.

Focusing on two areas of syndicated lending (leveraged buy-outs or LBOs and project/infrastructure finance) across a sample of six Member States, the Report identifies various competition law risk areas across the different stages of the syndicated lending process. These include:

• lenders’ use of “market soundings” to gauge the appetite of potentially competing banks to participate in a forthcoming syndication;

• transparency resulting from competing lenders’ repeated transactional interactions over time;

• restrictions requiring the borrower to procure ancillary services (such as hedging) from syndicate members;

• conflicts of interest where lenders simultaneously act as debt advisors; and

• possible coordination among lenders in the event of refinancing faced with borrower default. 

The majority of these areas are individually identified as “low risk” by the Report, but nonetheless their cumulative effect is to heighten the degree of antitrust risk associated with syndicated lending generally. Against these risks, the Report identifies three key safeguards on the lender side for allaying competition concerns, namely adequate attention to lenders’ duty of care to clients (e.g. through staff training and policies), internal protocols regulating information-sharing between loan syndication and origination functions, and limiting cross-selling of ancillary services. On this last point, the Report appears to favour the steps taken by the UK Financial Conduct Authority (FCA) in 2017 to ban certain restrictive clauses in banking agreements, flagging to players in this sector that they should re-consider their use of such restrictions across the EU.

The Report also points to two (not directly competition-related) areas for possible further work by industry and regulators, namely inefficiency in the secondary loan market, frequently as a result of transfer restrictions imposed by borrowers/sponsors, and whether lenders’ cumbersome “know your client” (KYC) requirements can be streamlined in future.

Analytical Framework

To get to grips with the vast syndicated lending sector – valued at approximately €720b across Europe in 2017 – the Report focuses on the six EU Member States in which the majority of borrowers, lenders and/or investors are located, namely the UK, Germany, France, the Netherlands, Spain and Poland. It also focuses on three areas of syndicated lending: (i) LBOs, i.e. M&A transactions in which debt is used to fund the buyer's acquisition of the target's equity; (ii) project finance (PF), i.e. financing for large-scale, long-term projects, frequently calling for large amounts of debt and equity financing; and (iii) infrastructure finance (Infra), i.e. a sub-set of project finance transactions whereby financing is provided for utilities, transport or telecommunications projects. Although these represent some of the most significant areas of syndicated lending activity, LBOs accounted for only around 7% and PF/Infra finance for only 4% of total syndicated debt in Europe in 2017, reflecting the very diverse range of uses to which such financing is put. The six Member States under investigation together accounted for around 75% of all syndicated lending in the 2017 LBO, PF and Infra segments in Europe, with Poland the smallest of the national markets by a considerable margin.

Findings

The Report identifies a number of “risk factors” relevant to assessing whether information-sharing and potential market power in the syndicated lending sector may restrict competition by facilitating collusion or abuse of dominance within the meaning of Article 101 or 102 of the Treaty on the Functioning of the European Union. These include:

• Market concentration. The Report notes that the market for syndicated lending in each of the Member States and segments under consideration generally does not appear to be concentrated, with a large number of lenders competing to win business across each relevant market. It does, however, note that a “home bias” favouring lenders based in-country tends to shrink the pool of potential mandated lead arrangers (MLAs) in Poland (and likely other central and eastern EU Member States), and that the specialist nature of certain mandates in the PF/Infra segment also tends to narrow the list of candidates.

• Lenders’ market shares.

• Availability of substitutes to borrowers/sponsors and their sophistication.

• Extent of market transparency and frequency of interactions and information-exchange between lenders.

In assessing whether and where competition law risk arises in practice, the Report breaks down the syndication process into various key stages.

a) Competitive bidding process for appointing MLA(s)

• According to the Report, even non-deal-specific market soundings between banks have the potential to facilitate collusive outcomes to the borrower’s disadvantage as a result of information regarding competing lenders’ risk appetite being communicated back to the “sounding” bank’s origination team, and this risk is heightened in the absence of functional separation between origination and syndication desks. While this risk is viewed as “relatively low” (at least in the LBO segment), borrower consent – potentially even specifying who may be contacted – was viewed by respondents as an important safeguard in ensuring that market soundings remain compliant with competition rules. In addition, NDAs implemented by the borrower/sponsor put banks on “clear notice” of their expectation that information should not be shared across lenders, even if such NDAs can be difficult to enforce in practice.

• The risk of problematic information-sharing during the competitive bidding process is heightened in the PF/Infra segment due to the comparative paucity of information enabling banks to take a view on the level of risk in this area. Moreover, the use of a single MLA occurs more commonly in this segment than in relation to LBOs (although the use of a single MLA remains rare in absolute terms), increasing the risk of coordination among syndicate members, especially where the MLA also acts as an adviser to the borrower/sponsor or where there are restrictions on replacing the MLA.

b) Post-mandate to loan agreement

• The Report finds that the risk of lenders coordinating vis-à-vis the borrower post-mandate is generally low, as it is common practice for the borrower/sponsor to agree loan terms bilaterally with each lender, with joint discussions between lenders limited to agreeing loan documentation and syndication strategy. The risk of coordination is slightly increased in the PF/Infra segment, where lenders may come together at an earlier stage to discuss loan terms (e.g. when negotiating a club deal), especially when the borrower is (comparatively) unsophisticated.

• Generally, multiple interactions between lenders over time create a risk of them observing one another’s behaviours and strategies, facilitating future coordination. This risk is classified as “relatively low”, as post-mandate discussions generally do not involve sharing detailed information about pricing and/or hold strategies.

c) Allocation of ancillary services across banks and pricing of ancillary services

• The Report states that, in most cases, allocation of ancillary services is decided as part of the initial agreement of loan terms or via a separate competitive process after the loan has closed. In a small minority of cases, however, MLAs make the provision of ancillary services by them a condition of the loan. Although not problematic per se, this form of restriction is found to increase the risk of the borrower/sponsor “achieving a sub-optimal economic outcome” and therefore to give rise to “at least moderate concern”. The Report refers to previous enforcement by the Spanish competition authority in this area and notes that all of the respondents who cited this form of conditionality were based in Spain, seemingly indicating that this practice occurs more commonly in Spain (and potentially adjacent markets) than elsewhere in the EU.

• Allocation of ancillary services to the lending banks at the initial stage (when overall loan terms are agreed) occurs more commonly in the PF/Infra segment, increasing the risk of collusion as a result of banks knowing who is to provide the services in question. This is particularly so where only a limited number of syndicate members are able to provide (for example) hedging services, meaning that antitrust risk associated with more bespoke transactions in smaller national markets (such as Poland) is greater.

• The Report notes that the FCA has previously banned the use of certain “right of first refusal” and “right to match” clauses in respect of services not directly related to the loan itself (e.g. further financing or investment services), and that their on-going use outside the UK represents a “continued risk to optimal outcome” for borrowers/sponsors.

d) Use of debt advisers also involved in syndicated loan

• Use of advisors who are also syndicate members is found to be widespread – especially in the PF/Infra segment – and in some cases there may be no other source of external advice. Where this occurs, the Report suggests that functional separation (e.g. through the use of Chinese walls) of the bank’s advisory and lending roles is important to mitigate the risk of the advisor influencing the borrower/sponsor towards a strategy or debt structure favouring its lending arm, which (absent appropriate controls) would be an area of “high concern”. Naturally, this risk is heightened in circumstances where a lender “bundles” its advisory and lending roles at the borrower’s request, as appears to occur in a limited number of PF/Infra transactions.

e) Lenders’ coordination on sale of loan in secondary market

• The Report finds no evidence of coordination to manipulate prices in the secondary market, where the sophisticated nature of buyers should limit any attempt at such manipulation. However, borrower/sponsor restrictions on secondary trading (e.g. preventing small transfers and/or requiring borrower approval for transfers) are commonplace and have the potential to impede the efficiency of trading in the secondary market. This may result in “(minor) knock-on effects” in the primary market as a result of secondary market pricing data being used in the primary market, at least in the PF/Infra segment. The Report therefore identifies restrictions on transfer in the secondary market as an area for possible future work, flagging that the secondary market has been demonstrated to have beneficial impacts on the primary market in the US, but that such positive impacts are less clearly apparent in Europe (at least on the basis of the limited data currently available).

f) Refinancing in conditions of default

• According to the Report, lenders’ restructuring teams are functionally separate from their origination teams and take over loan discussions in the event of a default risk. Collaborative discussions among syndicate members in the event of a default are undertaken at the borrower’s instigation, but the time-pressured nature of such discussions increases the risk of coordination, particularly where lenders who are not members of the existing syndicate are unwilling to provide finance, conferring a degree of market power on syndicate members. However, the Report emphasises that it found no evidence of abuse in these circumstances, and that frequently lenders’ restructuring teams undertake competition policy training.

• The Report further notes that the involvement of non-syndicate members in negotiating ancillary services generally counteracts the possibility of coordinated tying behaviour in relation to such services. However, in a “substantial minority” of cases, negotiations take place only with syndicate members, increasing the risk (already inherent in distressed circumstances) of ancillary services being priced on non-competitive terms.

The Report goes on to identify three critical safeguards against these competition risks in the loan syndication process:

a) Banks’ duty of care to clients. Adequate training and policies for (potential) MLA staff on topics including identification and management of conflicts of interest and the importance of providing “neutral” advice to clients is particularly important where the borrower sources debt advice from the same lender which acts (or may act) as MLA. In addition, before aligning pricing or other terms “upwards to a highest common denominator”, MLAs must ensure that the price is set at an “acceptable level” and that alternative options are not available, e.g. inviting other lenders to participate (with borrower/sponsor consent) or re-structuring the loan.

b) Avoidance of unwarranted information exchange. Banks should ensure that there are enforceable and enforced protocols concerning how deal-relevant information obtained by their syndication desk about potential syndicate members may be shared with the origination desk, while avoiding anticompetitive alignment of prices or other terms.

c) Promotion of unbundled price competition. Cross-sale of ancillary services should be limited to minimise the risk of impairing competitive conditions in neighbouring markets. Where such services are not directly linked to the loan, they should be negotiated outside the syndication process.

Conclusion

As in any situation where a competition regulator examines at a macro level the functioning of a market or sector, the risk areas and safeguards identified by the Report are likely to be interpreted as a guide to future enforcement activity – and how to avoid it – by the EC and national competition authorities in the syndicated lending sector. Those areas flagged by the Report as generating comparatively higher risk are likely to be of particular interest, namely: 

• information-sharing among lenders in more “bespoke” PF/Infra transactions (especially when combined with a more concentrated geographic market and/or the appointment of a single MLA, potentially also acting as a debt advisor); 

• post-mandate coordination among lenders in PF/Infra deals involving relatively unsophisticated borrowers; 

• restrictions on the borrower’s ability to procure ancillary services not directly related to the loan from non-syndicate members, particularly in distressed circumstances; and

• failure to implement appropriate internal controls on potential conflicts of interest by lenders which also act as debt advisors.

In addition to the risk areas and safeguards summarised above, the Report also raises two features of the syndicated lending market, characterised as “back office inefficiencies”, as possible areas for future work aimed at maximising the efficiency of the primary and secondary markets. First, onerous and time-consuming KYC requirements contribute to lengthy settlement windows, delaying the start of secondary market trading and even creating the potential for “gaming” if views on credit risk evolve over the settlement period. One means of addressing this problem may be industry/regulatory action to develop a common set of KYC documents, which would enable such documentation to be shared via a central repository. Secondly, borrower/sponsor restrictions on loan transfers can slow down secondary market settlement and introduce settlement risk, but there is little incentive for borrowers/sponsors to address this issue due to their lack of involvement in the secondary market. The Report does not propose a solution to this problem but notes that manual settlement systems and the KYC process also delay settlement, reinforcing the impression that streamlining KYC and settlement processes is viewed as an important step towards enhancing the efficiency of this sector.

The full text of the Report may be viewed here.