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Finance brief - 1 July 2013
- Announcement of LIBOR changes
- Farewell to the Mandatory Costs Schedule?
- BCOBS: Use of the right set-off
- Can a lender ever rely on a material adverse change event of default?
- A guide to lending against life assurance policies
- Trophy properties - some considerations for lenders
The Loan Market Association informed the market in March that it would cease to publish its Mandatory Costs Schedule on 1 April. Although this followed a consultation note in January, it nevertheless came as a surprise to many, and has caused some debate about how, if at all, mandatory costs should be dealt with in future.
The LMA mentioned that the withdrawal of its formula coincided with the transfer of the FSA's functions to the Financial Conduct Authority ("FCA") and the Prudential Regulation Auithority ("PRA"), and that lenders might now be paying periodic fees to both those authorities. But it added that it was the difficulties experienced by agent banks in calculating mandatory costs that had led to its decision. The formula (or rather formulae) set out in the schedule were insufficiently flexible to deal with syndicates comprised of lenders with different levels of mandatory cost, and had become costly to administer. Syndicates are often now larger and more diverse than when the formula was introduced. The LMA forms of loan agreement now treat the provisions for charging mandatory costs and the mandatory cost formula as optional.
This has left those preparing facility agreements in somewhat uncertain territory. The LMA formula for mandatory liquid asset costs was published as a recommendation in December 1998 and has been widely used, not only for syndicated transactions but also, in amended form, for bilateral facilities. It allows lenders with a facility office in the UK to charge for the "opportunity cost" in relation to sterling loans of having to maintain non-interest bearing cash deposits with the Bank of England in respect of a bank's sterling "Eligible Liabilites" in order to fund the Bank's monetary policy and financial stability functions. It also covers the payment of regulatory fees to the FSA on both sterling and non-sterling loans. Lenders with a facility office in an EU member state that has adopted the euro may charge for minimum reserve requirements imposed by the European Central Bank, although these are not routinely charged. The formula does not contemplate mandatory costs for lending from a facility office outside the UK or another EU member state.
In passing, the Bank of England has retained the right to charge special deposits, but has not done so.
Despite comment for some years that the mandatory costs formula was little understood, and should be simplified, there was a marked reluctance in the market to address the issue. As the LMA pointed out, the mandatory costs schedule was widely seen as "boilerplate" not requiring discussion or amendment.
Now that the formula has been withdrawn, there appear to be a number of options for mandatory costs.
First, in bilateral transactions, it remains possible to follow the longstanding practice of not using a formula, and simply to allow the lender to calculate and certify its mandatory costs: i.e. its costs of meeting mandatory capital reserve requirements and regulatory fees.
Second, lenders may continue to use the last published LMA formula, amended as seems appropriate, or a formula designed to achieve a similar result. Indeed it was not unusual to include an MDC (or MLA) formula before the LMA published its form. At present the drafting changes required are relatively minor, but this may not remain the case over time. Moreover, this does not deal with the difficulties faced by agents that have caused the LMA to withdraw its formula.
Third, the burden of calculating mandatory costs could be shifted from the agent (based on information supplied by the lenders) to the lenders themselves, who would then supply this to the agent. This would, however, arguably involve more work for the finance parties as a whole, and if the FCA/PRA element were to remain based on reference bank figures, this would appear to require continuing involvement by the agent.
Fourth, the LMA suggested in its consultation paper that the agent's rate or a reference bank rate could be used for all relevant lenders. Presumably there was insufficient support for this for the LMA to recommend it.
Fifth, some lenders have taken the decision, particularly for bilateral facilities, not to charge mandatory costs, either including an element for them in the margin (as was sometimes done for Basel II costs), or simply absorbing them. Although the amount of eligible liabilites required to be kept has been slightly increased by a recent Treasury statutory instrument, the increase is unlikely to be seen by lenders as material. In fact in many cases lenders may regard mandatory costs under the LMA formula as simply being not at all material to them. One concern with this approach is whether it will allow lenders to pass on such costs if they are substantially increased in the future, which will depend on the terms of the loan agreement and the nature of the increased costs. The LMA increased costs wording covers increased costs as a result of the introduction of or change in any law or regulation or in compliance with any new law or regulation, and to the extent attributable to a lender having entered into its commitment or funding or performing its obligations under the loan agreement. It seems doubtful that mandatory costs are directly "attributable" to participation in the facility, and so they may not be covered by this provision.
The LMA announcement says nothing about mandatory costs under facilities documented before April, but probably does not need to. Although the formula has been removed from the LMA website, it has been customary to incorporate it in full into a schedule to the loan agreement. Moreover, the formula contains provisions allowing the agent to modify it, after consultation with the borrower and the lenders, to reflect any changes in law, regulation or the requirements from time to time of the Bank of England, the FSA or the European Central Bank (or their successors). Given this wording, and the amounts involved, it seems unlikely that borrowers will consider it worthwhile challenging the continuing use of a mandatory cost provision in the LMA form, or that lenders will think it worth amending existing facilitites in the absence of such challenge.