June 24, 2024 - Earlier this month, the International Organization of Securities Commissions (“IOSCO”) published its Final Report on “Leveraged Loans and CLOs Good Practices for Consideration,” concluding several years of work conducted by its member working group. In response to IOSCO’s September 2023 Consultation Report), the LSTA and other industry commenters urged IOSCO to reconsider publishing this Final Report given 1) the leveraged loan and CLO markets are functioning successfully, 2) many of the proposed practices are ill-suited to these markets, and 3) where not ill-suited, many of the proposed practices are redundant with existing regulatory and market frameworks.

The Final Report’s good practices remain largely in their original form, but several important changes requested in the LSTA’s feedback have been made. To assist members in their review, the LSTA has prepared a comparison of the Final version and the Consultation version and a high-level summary below. Members are also encouraged to review IOSCO’s Feedback Statement (Appendix to the Final Report at page 51) for a more detailed discussion of IOSCO’s response.

What do the good practices aim to do?

IOSCO has been following the evolution of the leveraged loan and CLO markets during the “prolonged borrower-friendly environment” post-Global Financial Crisis. The good practices are intended to address vulnerabilities in the leveraged loan and CLO markets that IOSCO has identified through its review and market soundings (which, notably, largely focused on EMEA markets). The good practices do not comprise either standards or recommendations, as per IOSCO’s taxonomy. Instead, they are designed to support market participants in their decision making when operating in the global leveraged loan and CLO markets. The Final Report clarifies it is drafted for a global audience where leveraged loan and CLO markets may be in different levels of development in jurisdiction with varying levels of existing regulatory frameworks. Some of the guidance will therefore not be universally applicable.

What do the good practices cover?

There are 12 measures included in the good practices covering five broad themes:

• Origination and refinancing based on a sound business premise
• EBITDA and loan documentation transparency
• Strengthening alignment of interest from loan origination to end investors
• Addressing interests of different market participants throughout the intermediation chain  
• Disclosure of information on an ongoing basis

The measures themselves are accompanied by supporting text and address:

• Debt repayment capacity assessment
• Divided recapitalizations
• Enterprise values
• EBITDA complexity and opacity
• Transparency on covenant limitations
• Transparency and fairness during underwriting and syndication
• Alignment of interest between underwriting entities and investors
• Reducing restrictions on transferability of loans
• Managing conflicts of interest where Private Equity sponsors also act as lenders
• Managing conflicts of interest in management of CLOs
• Disclosure in CLOs
• Disclosure on underlying loans

What are the most important changes made?

For the reasons stated in our comment letter, the LSTA does not see these good practices as necessary. However, the LSTA is gratified that IOSCO acknowledged many of the points raised. While those acknowledgments did not always translate into amended text, they are helpful in giving context to the good practices.

Several aspects of the good practices were clarified that IOSCO was not intending to describe prescriptive guidance or standardize market terms. For example, IOSCO recognized where market feedback indicated that commercial terms should be left to the transaction parties and are not meant to be mandated by regulators. To wit, IOSCO was explicit that its guidance around EBITDA adjustments is not meant to standardize definitions of EBITDA and market participants’ view that leveraged loan  proceeds, including incremental debt, may appropriately fund dividend recapitalizations. In another example, IOSCO recognized that its proposed timings for sharing and reviewing term sheet and full loan documentation may not be achievable in all circumstances and are not being proposed as binding timings. IOSCO also acknowledged the underlying reasons for the use of borrower consent and lists of approved and disqualified lenders and no longer discourage their use. For CLOs, IOSCO was clear that it was not trying to prescribe any limit on CCC assets and that is a decision best left to transaction parties.

IOSCO made helpful changes to more accurately reflect the roles of transaction parties. The responsibility for performing certain of the good practices was shifted to the borrowers / sponsors in response to feedback. For instance, borrowers / sponsors rather than arrangers / underwriters are encouraged to disclose assumptions underpinning the financial model or basis of enterprise value. Also borrowers / sponsors are the parties encouraged to disclose the quantity of incremental debt and associated baskets that is permitted as well as the ability to move assets beyond the reach of the lender group. Importantly, IOSCO recognized the legal risks underwriters may be exposed to by certain of the proposals, such as making risk factor disclosures or preparing and circulating a FAQ document of investor feedback during syndication and modified the good practices. IOSCO retained the concept of an investor feedback summary as helpful but caveated that arrangers must be mindful of potential liability and anti-competition claims in deciding to do so. Furthermore, IOSCO clarifies that arrangers should not be put in a position of advising and explaining risks to lenders. Helpfully, risk retention was removed as means of aligning arranger and lender interests.

The two measures and good practices for CLOs were largely left unchanged, but they are to be read in the context of the document being designed for a global audience and IOSCO recognized that they were addressed in the market practice and regulatory regimes of certain jurisdictions with mature CLO markets. The measures are designed for where that is not the case.

Conclusion

The Final Report concludes IOSCO’s review of the leveraged loan and CLO markets and offers “food for thought” for global market participants. The LSTA will monitor this space. While the LSTA does not expect further developments, it will keep members updated as necessary.