The market will come to appreciate ECB’s leveraged lending rules
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The market will come to appreciate ECB’s leveraged lending rules

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The ECB’s announcement it was planning leveraged lending rules for the banks it supervises has been polarising, confusing, and often emotional. But the market will come to appreciate it in time.

Confusion about the ECB’s announcement of guidance for leveraged lending was inevitable. The consultation on the guidance released last week was long on the stultifying and verbose language common in legislative documents, yet short on actual detail of what exactly is in the ECB’s cross-hairs, and how it will deal with supposed offenders.

That will come with time, and the development of the guidance, and the ECB is keen for feedback and questions.

But it has been more forthcoming on why it’s choosing to introduce the guidance. When deputy general for banking supervision Patrick Amis silenced a conference room with his announcement of the guidance in September, “pipeline” and “distribution” risk were the big themes.

One lawyer said last week that the issues around underwriting were as important as the headline leverage ratio cap. The Fed, which introduced leveraged lending guidelines in 2013, has even put certain banks under probation, he said, with corresponding degrees of scrutiny, depending on how suspect their underwriting practices actually were.

Amis’ anxiety that a eurozone bank would risk such aggressive underwriting exposures was obvious during the announcement, and considering the broader condition of some banks’ asset books, he’s right to act.

One provision in the draft that particularly sticks out is the ECB’s insistence on using unadjusted Ebitda in calculating the leverage ratio of a loan.

Even the ratings agencies use adjusted calculations, so using unadjusted figures will make for sober reading to many issuers.

With the increasing prominence of the technology sector in leveraged finance, a rule based on unadjusted figures could curtail a large amount of loan issuance, as the role of ‘pro-forma’ is punctured and potential synergies largely ignored.

No adjustments can be made for non-recurring expenses, exceptional items and other one offs, the draft reads.

Though professional investors should be adept at picking apart the business forecasts of borrowers, they should welcome this clear insistence. It clamps down on debt predicated on the often illusionary forecasts of self-interested players.

Veritas’ failed syndication of some $6bn of high yield bonds and leveraged loans is a classic of the genre, and the buyout debt was only finally cleared off the balance sheets of the banks involved in August, 10 months after the proposed syndication.

One of those banks was Jefferies who, thanks to its status as a securities firm, rather than a bank, is exempt from the US guidelines. The Fed’s introduction of the US rules in 2013 proved a boon for the firm, allowing it a far more aggressive underwriting appetite than its regulated bank competitors, and catapulting it up the leveraged finance league tables in 2014.

But Jefferies was on several other hung deals aside from Veritas in the last year, and its appearance among the bookrunners in leveraged finance has been a rare sight in 2016, in Europe at least. Arrangers have plenty of incentives to avoid hung deals, but when they are regulated banks, why risk it from a systemic perspective?

That is Amis’s message, and one the market will come to appreciate.

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