On 23 November 2016, the European Central Bank (ECB) published its draft guidance to banks on leveraged lending, launching a public consultation period that runs until 27 January 2017. The draft guidance is very similar to leveraged lending guidance issued by the US federal banking agencies in 2013, which has had a significant impact on the leveraged lending market in the US. There are some significant differences between that ECB’s guidance and the US guidance that could raise issues of competitive equality between US, European and other banks. Below we highlight some of the important differences between the US guidance and the ECB’s draft guidance.
As predicted a year ago, the adoption of US-style covenant-lite terms in European leveraged deals continues apace. This is hardly surprising given that the existence of ultra-low interest rates are sparking intense competition for yield amongst financial investors. Sponsors and advisers are increasingly applying approaches from the US leveraged loan and global high yield bond markets to European leveraged loans. Sponsor friendly terms are very much in fashion.
Covenant-lite loan financings are far from uniform in Europe at this stage, yet they continue to evolve gradually. In 2013, we saw some fully US-style covenant financings for the acquisition of European assets documented under New York law and either partly or wholly syndicated in Europe. Next came Loan Market Association (LMA) based English law credit agreements that were stripped of most of the financial covenants.
Earn-outs, where additional consideration is paid post-completion based on the performance of a target business, are becoming increasingly common in private M&A transactions. Our recent survey of European deals between July 2013 and June 2015 shows earn-outs were used twice as often as during previous periods surveyed, although overall, this still represents a small minority of transactions.
So why the increase in earn-outs? According to conventional wisdom, earnouts bridge the valuation gap between buyers and sellers, so they share the risk of the future target business’ performance. Earn-outs have been used for this purpose on a number of recent transactions.