EBF response to the ECB consultation: Draft guidance on leveraged transactions
EBF advisor: Sarah Schmidtke
Publication date: 26 January 2017
EBF acknowledges that market conditions warrant a specific monitoring of credit quality in general and leveraged finance exposures in particular by the ECB. We welcome initiatives to bring discipline and best practices to this specific market segment.
However, the very wide definition of leveraged transactions as well as the preeminent role implicitly assigned to the level of leverage as a risk indicator are of concern. The level of leverage is indeed a key figure to assess risk, but we deem important to stress that other factors (e.g. the purpose of the financing) as well as other key figures (e.g. internal and external ratings) significantly contribute to a comprehensive risk evaluation.
Because of the very low commitment threshold (€5m) the guidance includes a significant number of SMEs, which are not financed by leveraged finance markets but are clients of retail and commercial banking networks. We therefore propose that the commitment threshold should be materially increased for example to €25m. In order to exclude SMEs being captured by the ECB guidance we also recommend to introduce an additional net sales threshold of €50m. Moreover, we propose that banks should conduct a purpose test to assess whether a transaction meets the relevant criteria to be considered leveraged lending. In its currently drafted form the guidance captures a large number of SMEs and many of these companies may be unable to provide the requested information and data and will therefore find it more difficult to raise bank financing. We are concerned that this may prove an obstacle to growth and jobs in the EU as SMEs are a crucial pillar in the European economy.
The guidance captures companies with different risk profiles and does not take into account that some industries structurally carry higher leverage than others.
It also raises level playing field concerns because it only applies to significant European institutions within the SSM. This does not only put significant European institutions of the SSM at a competitive disadvantage; it will also help unregulated players, including shadow banking entities such as private debt funds, to grow in this market segment, potentially leading to higher leveraged companies We are concerned that this will contribute to systemic risk.
The ECB guidance is, in a number of areas, more restrictive than the US Fed guidance, which does not seek to exclude adjustments/reasonable enhancements to EBITDA and does not require such transactions to be approved at the highest level of credit committee. As a matter of principle, we call for a harmonisation of the definitions between supervisors to ease the reporting burden for banks, improve the comparability / monitoring for supervisors and ensure a level playing field.
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