On 14 September 2023, the International Organisation of Securities Commissions (IOSCO), the internal policy forum for securities regulators, and which is widely regarded as the global standard setter in the space, published two reports for industry consumption:
- the first, its consultation report on proposed good practices on leveraged loans; and
- the second, its final report on emerging risks in private finance.
Recent evolution of participants in the leveraged loan and collaterised loan obligation (CLO) markets away from traditional players, both in the investor and borrower spaces, and the relatively rapid growth of the private finance markets and shift away from the dominance of the public finance markets has led IOSCO to call to leveraged loan and CLO market participants1 and private finance firms for greater transparency in these markets.
The work of IOSCO recognises the changing vista of global finance and demonstrates its continued efforts to support market integrity and shore up the markets against turbulence on the road ahead. However, it remains to be seen whether and how the eventual standards recommended by IOSCO will be adopted by the UK Financial Conduct Authority (FCA) (and, indeed, comparable regulators in other jurisdictions) which, by virtue of being members of IOSCO, have agreed “to cooperate in developing, implementing and promoting adherence to internationally recognised and consistent standards of regulation, oversight and enforcement”2. In particular, will this apparent encroachment into private leveraged loan markets be taken forward by the FCA?
There is quite a stark juxtaposition in IOSCO (with its securities markets mandate) publishing this report on leveraged loans only days after a US appeal court in the important Kirschner case affirmed that these are not securities (with attendant lessening of regulatory obligations).
Consultation report: Leveraged Loans and CLOs: Good Practices for Consideration
In its consultation report on good practice in leveraged loans and CLOs, IOSCO calls for improved practices in these markets.
With their aim to “support sound leveraged loan and CLO market practice and further IOSCO’s market integrity and systemic risk objective”3, the proposed good practices follow assessment by IOSCO of the leveraged loan and CLO markets and in particular:
- the impact that an increasingly borrower friendly environment – including the adoption of more sparing and less stringent covenants – has had on the protection offered to investors;
- the adequacy of transparency in the space; and
- whether the recent developments in these markets have given rise to potential conduct related issues.
IOSCO has identified certain weaknesses in the leveraged loan and CLO markets which it considers could impact its objectives to:
- protect investors;
- ensure that the markets are fair, efficient and transparent; and
- reduce systemic risk.
In response, and with the aim of shaping the decision making of those operating in the leveraged loan and CLO markets and in doing so promoting the objectives of IOSCO, IOSCO propose 12 good practices on the themes of:
- 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; and
- disclosure of information on an ongoing basis.
IOSCO seek feedback from industry participants on their proposed good practices by 15 December 2023 with a view to crystallising a final report on its recommendations.
Final report: Thematic Analysis: Emerging Risks in Private Finance
Part of the work of IOSCO aims to “better understand the potential vulnerabilities that might arise from private financing activities”4. In its final report on emerging risks in private finance, IOSCO identifies that the opacity of the private markets, specifically identifying both private equity and private credit in this regard, presents a real threat to the ability of regulators and market participants to appropriately quantify risk.
Whilst traditional publicly listed markets are subject to the rigours of substantial listing and disclosure regulation it is recognised that the private markets, which have grown substantially in the economic climate of recent years, are currently not. Whilst this presents advantages to the private markets – notably a lower cost base – IOSCO identifies that the opacity of the private markets, in particular around valuations, may put investors at risk.
IOSCO propose that if the cost of debt remains high, with interest rates in the proximity of, or exceeding, their current levels for longer than anticipated there is likely to be both a reduction in the availability of funding to support private finance activities and a further increase of associated interest rates. IOSCO warn that these pressures, coupled with the opacity of the markets limiting ability to assess the financial health of any borrower and the perceived limitations on adequate risk analysis, could pose a significant threat to the wider financial system and suggest that the sector might “respond in such a way to uncover hidden risks”4. Just how the private markets might embrace any move towards increased transparency remains to be seen.
1 The leveraged loan and CLO markets are often considered together as leveraged loans are sold to special purchase vehicles and are in turn packaged, via securitisation, into asset backed securities, CLOs.
2 The objectives of IOSCO are to:
- cooperate in developing, implementing and promoting adherence to internationally recognised and consistent standards of regulation, oversight and enforcement to protect investors, maintain fair, efficient and transparent markets and seek to address systemic risks;
- enhance investor protection and promote investor confidence in the integrity of securities markets, through strengthened information exchange and cooperation in enforcement against misconduct and in supervision of markets and market intermediaries; and
- exchange information at both global and regional levels on their respective experiences to assist the development of markets, strengthen market infrastructure and implement appropriate regulation, c.f. IOSCO Fact Sheet, November 2022.
3 Mhairi Jackson, Chair of Committee 3 on Regulation of Market Intermediaries.
4 IOSCO, Final Report on Thematic Analysis: Emerging Risks in Private Finance, 14 September 2023