Expert Insights: Loan Agency Services in a Rapidly Evolving Market

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Christy: And welcome to today's webinar, "Expert Insights: Loan Agency Services in a Rapidly Evolving Market." My name is Christy DeMaio Ziegler, and I will be your host from the CSC webinar team.

We are very fortunate to have an amazing group of speakers today who will be sharing their insight and expertise with us, Annita Yeo, Kate Lagoe, Eric McDonald, and our moderator JP Nowacki. So without further ado, I'd like to pass on to our speakers and let them introduce themselves. Annita?

Annita: Hi. Goo morning, good evening, everyone. My name is Annita Yeo, and I look after the trust and agency business in APAC. I'm responsible for the strategic planning and delivery of our services in the region. My team and I specialize in servicing cross-border debt structures, loan agency, escrows, and real estate investment trusts. But where I am most passionate about is working with our clients to find practical solutions by applying real-life experiences garnered over 16 years in the industry.

Kate: Hi. I'm Kate Lagoe. I'm an associate director in the global capital markets business, based in the UK. I focus primarily on providing clients throughout the EMEA region with loan agency solutions for both new money and distressed transactions. I have over 10 years experience in the provision of corporate trust and agency services across the loan and debt capital markets.

Eric: Welcome, everyone. My name is Eric McDonald. I'm a director within the Global Capital Markets Division here at CSC in the United States. I've spent my career providing customized solutions to customers across the finance, energy, and technology industries, and today I specialize in providing highly customized, bespoke loan agency solutions for participants and credit facilities in the capital markets.

JP: Welcome, everybody. I'm JP Nowacki. I'm the commercial head for the global capital markets business in Europe. I was part of the team who established CSC's European capital markets business in 2017, and I've been involved in capital markets deals for over 25 years.

I'm really pleased to be moderating such a fantastic panel of speakers today. So without further ado, let's get started.

We've all witnessed a huge change in the loans market in recent times, and I'd be really interested to hear the panel's perspectives on these changes and in particular how agents have adapted to deal with such a rapidly developing market. I wonder, Eric, perhaps you could kick us off.

Eric: Sure. So let's take a little bit of a travel back in time, and I hate to go back to 2008 because I'm sure that doesn't bring back the best memories, but that's where a lot of change in our industry happened in recent times. Specifically in 2008 and the fall of the banking system, regulators responded by imposing new regulations, and that had the effect of restricting what the big banks were able to do. You know they were no longer able to participate in an unlimited number of credit facilities. They had to take a new look at how they perceived risk in anything that they were participating in. But what that actually ended up doing was opening the door to new types of lenders and credit structures.

So we saw an explosive growth in the private debt sector. Private debt funds have grown, and not only have they grown, but they've grown in the way that they participate in the market. So some of them may have started by participating in bilateral loans and just working with portfolio companies, but now they're often participants in those large, broadly syndicated transactions that the big banks used to participate in almost exclusively. And so agents have had to respond with the way that they've staffed their teams, with the systems that they use just to account for the different types of participants, the different information that they're looking for, and also to reflect the different types of transactions that they're on. So not only do the systems have to support those broadly syndicated transactions with thousands of lenders, but they also have to support thousands of credit facilities that have just one or a handful of lenders.

We've also seen the expansion in the type of collateral and the structure that collateral takes in credit facilities. So when you're acting as a collateral agent, you need to be aware of how that might play into the credit facility and exactly what your role is or the type of collateral that you're holding.

Fast-forward to today and what we're seeing, you know we're seeing an uptick in the restructuring space, and we're also seeing some stress hitting the banking market. So you want to make sure that your agents are working with smart banking partners to account for possible insolvency. You know agents are seeing that happen with Silicon Valley Bank. And they either may have been prepared, or they're reacting by partnering with more than one banking partner just to make sure. Hopefully, all of that has been isolated and we're not going to see any more bank collapses. But you want to make sure that your agent is prepared. In the event that the banking partner that they primarily use goes down, then they have another option.

And then with what we're seeing in restructuring, agents have to pivot from the healthy side to more of the restructuring side because we're going to see an uptick in the amount of DIP loans that are being entered into in the marketplace, exit financing opportunities.

And with the way that credit markets are today, they're highly sophisticated. So we're seeing many other special situations enter the market, and a flexible agent and a fast agent is going to be able to adapt to all of those changes.

So those are some of the things that I'm seeing here in the United States.

Kate: Continuing on from Eric, from a European perspective and particularly looking at the growth of the private credit side, which we've certainly really seen booming over the last few years, just the current state of play, in the second half of 2022 and the start of 2023, we have seen there's some slowdown in deal activity in the direct lending market, with almost a 15% reduction on the second half of 2022 compared to half one, according to Deloitte's Private Debt Deal Tracker. This is primarily attributed to market volatility, and also we've seen a drop in asset valuations.

We are seeing that some of these deals are typically taking slightly longer to put together, which coupled with an increase in the divergence between seller and buyer valuations is leading to a greater number of mid-market deals collapsing pre-close or just taking a lot longer to get to the finish line. When there is this increase in uncertainty and more potential pitfalls in getting a deal over the line, using an experienced independent agent can really add value for deal counterparties by really smoothing out the pre-closing and closing process, whether that's being more flexible in terms of documentation negotiation, making KYC as straightforward and pain-free as possible, or just really being ready to move quickly and accommodate any last-minute changes without impacting closing deadlines.

On a macro level, the broader economy has perhaps performed a little bit better than we've expected in the medium term. However, the general consensus really is that a coming recession is probably merely delayed, rather than canceled. So in terms of future proofing, the other thing too it's really important to look out for is a proactive agent who's able to engage effectively with stakeholders should a borrower become distressed or an event of defaults occur.

JP: I think it's fair to say that there's no conversation to be had about change in the loans market without talking about our favorite topic of reliable transition. Kate, perhaps you can add your perspective on where we stand here.

Kate: Sure. Thanks, JP. Happy to. Well, firstly I think you'll all agree that for the lay market, the LIBOR transition has been probably the biggest operational challenge the market has seen for the last 20 to 30 years. Luckily we're nearly at the end of the road, and certainly from a European perspective we're lucky in that we've actually completed the majority of the work in terms of LIBOR transition now, with most LIBOR settings ending from the 1st of January '22.

Due to COVID-19, the UK market did see some adjustment to some of the interim timelines, but it was agreed between the RFR Working Group, the FCA, and the Bank of England. But the overall deadline in the end was still met. And from late 2020 onwards, we've seen pretty much all new deals originated using alternative reference rates. And the rates we're primarily seeing in our market are, of course, SOFR or SONIA.

The pace of transition in the lay market was somewhat behind that of the bond market initially. So in terms of the legacy LIBOR linked deals, it was really key that as an agent we were able to proactively engage with stakeholders to assist in facilitating amendments for any benchmark conversions. But that was all tidied up pretty nicely. So we're pretty much there in Europe.

Eric, I know you're approaching the finish line. Have you seen anything?

Eric: Yeah. So, Kate, you know, I just hope most of the participants out there are wondering why this is even a topic and that they've already addressed everything. So the good news is, you know, from the American perspective, the end is almost here, but not all credits are prepared for the transition even to this day.

So now is the time to go back and review all of your credit documents, and your agent can help you with this. And we are working through it with some customers. You want to check to make sure that the proper fallback language is in there. You want to make sure that there's something like a default rate, a default fallback rate, or one where the lender directs what the rate is going to be at the time of LIBOR's expiration. There is also the option to have the agent choose, but our recommendation is always to have the default rate or the fallback rate preset in the documentation or to have the lenders make that direction.

So just to remind everybody, now is the time to go back and review all of your credit documentation, amend and finalize the successor rate and do it now. And then going forward, you know, you want to make sure that that proper language is in your credits, and you also want to make sure that the language isn't too restrictive. So, for example, we've seen a couple scenarios where the default fallback rate is going to turn the loan into a non-performing loan, and that is certainly not the intention of the deal participants. So you want to make sure that there's flexibility in the rate that can be chosen at the time that a benchmark may go away.

And I'm sure you're thinking, well, now we're set with SOFR. We don't have to worry about SOFR going away. Well, I'm sure at the time that a lot of these credits were made, you never thought that LIBOR was going to go away. So you want to make sure that your language could account for anything that may happen out in the marketplace. And you also want to make sure that you work with an agent to make sure that they're agnostic in terms of the rate that is chosen. You know, we have to be flexible. We had to make sure that our systems were updated in order to handle any potential successor rate that might come with the expiration of LIBOR. So whoever you're working with, make sure that their systems are also ready to go when LIBOR goes away.

So that's what we're seeing here in the States.

JP

That's great. Thanks, Eric. Annita, what are you seeing?

Annita: Well, JP, every company is unique. We see borrowers actively engaging with lenders and advisors to assess the impact of this transition on their existing loans, derivatives contracts, as well as identify agreements that may need to be amended or renegotiated. Equally important is the evaluation of the potential impacts of the transition on the company's overall financial strategy. That's why we've been working very closely with borrowers in various aspects of this transition.

Sometimes we help them review the output of tests conducted to ensure the data integrity remains after adjustments are made. Other times, you know, we've been working on rollout of new systems at our own end, looking at loan servicing systems and processes which actually support the use of these alternative reference rates. In fact, we sometimes discuss mechanics with our clients who are on similar platforms as us. So it has largely been collaborative as we journey this transition.

In short, companies should take proactive steps to engage with their agents to ensure a smooth transition away from LIBOR and to minimize disruptions to their operations. To conclude, JP, companies should really consider assessing the impact of the transition, understand the alternative reference rates, review the loan documentation, and implement updated systems and processes.

JP: That's very clear, Annita. Thank you. And it sounds as though we may not necessarily be quite there yet, but pretty close. Hopefully, we won't be asking this question again this time next year.

I guess, looking forward, this is just one part of a much broader landscape of regulatory changes, with a huge amount going on and I suspect a lot more change to come down the pipeline. Annita, perhaps you could pick up the thread on that. What more changes do you see?

Annita: Well, I'm sure all can relate when I say that the financial structure has seen significant and rapid changes in the regulatory landscape. This has led to enhanced risk management requirements on agents all over. For example, here in Singapore, the Monetary Authority has introduced various regulations aimed at strengthening the resilience of the financial system, including regulations on cybersecurity and money laundering. These regulations have actually led to increased compliance requirements for agents, increasing their potential exposure to legal and reputational risks.

Our team is fortunate to have a strong legal and compliance support within the business itself. This is where an agent with a global presence has an advantage because we know it is crucial to have a robust risk management framework in place, including policies and procedures to help us identify, monitor, and manage these risks. Therefore, we have actually invested very heavily in technology and training to ensure compliance with these regulatory requirements.

Regulations in APAC have also been working together, okay, to harmonize the regulations across the region. This is aimed at promoting consistency in regulations and facilitating cross-border transactions. CSC has been operating in many major cities in the region, including Australia, working closely with regulators and market participants through our local and regional teams who are well versed in multiple sets of regulations across these jurisdictions.

JP: That's great. Thanks very much, Annita. Eric, do you have thoughts?

Eric: Yeah, sure. So, you know, much like Annita mentioned at the beginning, we're watching the regulations here in the United States with regard to anything that may impact the banking system. With the fall of Silicon Valley Bank, there may be changes on the way, and we're going to have to monitor to see how that will impact agents and our business. But as I mentioned before, you want to make sure that you speak with your agent to understand that they have smart banking partners and perhaps multiple banking partners to ensure that in case one of their partners is affected, they have a fallback and won't have any impact on your credit facility.

Some of the other global impacts that we've seen to regulations and how it's impacted our business here in the States, specifically looking at the war in Ukraine, when that started, we immediately saw massive changes to KYC and AML, and specifically the types of individuals that could or couldn't participate in the flow of money, such as individuals who were Russian or resided in Russia. And I'm not sure if you remember, but when that all started, it seemed as though the regulations were changing by the minute, if not by the hour. So our team was constantly staying on top of those changes. And you want to make sure that whatever agent you're working with is also constantly monitoring any sort of regulatory impact on KYC and AML and being smart with how they work with you and your clients in evaluating any risk to a deal participant.

And one other thing that we are monitoring here in the States that could impact agents here, especially with transactions that are in the cannabis space. So, for example, cannabis is legal in Canada, and there are many public companies that are publicly traded in the Canadian Exchange. But here in the United States, it's still a Schedule I narcotic, which disqualifies any participant immediately in KYC. So how do you balance the difference between something legal in one country and illegal in another? So that's something that we're keeping our eye on, and we're monitoring things in Washington to see if they're going to make any exceptions to cannabis or take it off the Schedule I list.

But at the end of the day, there are things that are happening on a global scale. We're constantly paying attention, and all agents need to be aware of what's going on in the world and how that might change the flow of money and how it might impact their clients who are participating in the credit facilities that they're acting as agent on.

Kate: I completely agree with you, Eric. Much like both you and Annita have alluded to, I think it's more and more important to keep up with the regulatory environment, particularly in what seems to be a continually changing regulatory landscape.

I think one of the key additional factors we have here in Europe is the ongoing impact of Brexit, which is obviously yet another topic that we seem to have been talking about for an incredibly long time now. Whilst we've been talking about it for a long time, it is still relatively early days in the overall scheme of things. But post-Brexit, I think there is certainly the potential we are going to start to see greater and greater divergence between the EU and UK regulatory framework in the financial and capital markets in the medium to long term, most likely as new legislation is introduced. So I think it's really important for agents and for all market participants to keep an eye on these developments.

Here at CSC, we are really well positioned to manage any changes which come down the line as we have operational teams both in the UK and in multiple offices in the EU. So we can continue to service our clients without interruption and effectively service deals in the best regulatory jurisdiction for them.

JP: So no slowdown in new regulations by the sounds of things. No surprises there. Thank you very much, Kate. Last topic for the session today, I think we've all seen what's happened in the emergence of ESG, and I suspect this is probably the tip of the iceberg. Perhaps Kate you could just kick us off with some impressions of how you think that ESG demands are going to continue to shape the market.

Kate: Absolutely. Thanks, JP. Yes, as we all know, over the last few years we've certainly seen sustainable and socially responsible lending become much more mainstream. Obviously what the huge positive of that is, you know, the general benefits beyond the financial markets, but also this positive with the mainstream is there's less time needed to be spent making the case for sustainable financing and more time we can spend looking at the finer details as sustainability does become embedded in the market.

At present, certainly in the loan market, demand really remains investor driven rather than driven by regulation. But this is a rapidly changing space, and both the EU and the UK are eyeing substantive packages of new green and sustainable finance legislative and regulatory updates.

The EU is somewhat ahead here. For example, they introduced the Corporate Sustainability Reporting Directive for large and listed companies at the beginning of the year. But the UK has recently published their updated Green Finance Strategy. And we expect the sustainability disclosure requirements regime to come in later in the year.

What does this really mean for us as a market? Again, it's still slightly early to say. I think we can see more regulation coming down the track. I think there's likely going to be more reporting requirements. But ultimately, sustainable finance is here to stay. There is a bit of a balancing act I think going forward between encouraging the expansion of these sustainable structures and increasing demand, but also ensuring we do have a robust framework to monitor these transactions, to monitor borrowers, and to mitigate any accusations of greenwashing.

JP: I agree. A lot to come there, Kate. How does that compare with your perspective, Annita?

Annita: Well, we definitely see an increase in ESG linked loans, and as agents we are increasingly involved in servicing such loans for our borrowers. And these loans, they actually offer borrowers incentives, financial incentives actually for achieving specific ESG targets. So with greater focus on ESG considerations, we see ourselves playing a more active role in monitoring this delivery of reports on ESG performance of the underlying assets. It's definitely very rewarding to work with our borrowers on such reports as they provide all stakeholders with greater transparency into the ESG performance of the loans.

So as investors seek to align their investments with their values, agents are also expected to be a more active role in monitoring ESG performance, adopt these ESG standards and best practices themselves. These support agents, like us, with increased opportunities to collaborate with our stakeholders as we maneuver the rise in sustainable and socially responsible lending.

JP: Got it. It makes sense. Any final thoughts, Eric?

Eric: Yeah, JP. So in the United States, ESG lending and ESG transactions are primarily investor driven. There's very little regulation or regulatory incentive to participate in those types of transactions. But investor requests and investor-driven deals certainly are leading to a changing landscape here in the United States. So we're seeing the types of transactions related to ESG change. So, for example, we're seeing a big uptick in project finance deals especially related to sustainable energy product projects. And, you know, as an agent, we've been able to react to that and create a highly specialized team specifically to work on those types of transactions.

You know, at the end of the day, as an agent, we are agnostic. But if we see an opportunity to help the market evolve, we're going to take that, and that's what we're doing when it comes to ESG here in the United States.

JP: Great. Thank you, Eric. Thank you indeed, Kate and Annita. That was a super insightful session, from my perspective, a huge amount going on in the loans market and we covered a lot of ground there. We are, however, at time. So thank you again. Very appreciative all your thoughts.