Secondary Debt Trading – Part 1

Following the execution of the loan documentation by the borrower and the lender(s), some loans do not remain static. Often, debt is bought and sold on what is known as the secondary trading market and, throughout the life of the loan and on the final redemption date, the borrower may well have to make capital and interest repayments to someone entirely different from the lender(s) who originally entered into the relevant loan agreement.

The vast majority of trades use the standard terms and conditions prepared by the Loan Market Association (“LMA”), the basis of which is the concept that “a trade is a trade”. This means that once a trade is agreed, it must be carried out one way or another and, save in the context of very few exceptions, it cannot be cancelled. One of the consequences is that whilst a transfer by novation or assignment is usually the preferred method of trade, if this is not possible the parties may be forced to resort to an alternative transfer process (such as sub-participation) instead.

In this series of articles, we will briefly discuss the differences between each method of transfer and the key considerations when deciding which one to choose in the context of a trade involving UK entities (further factors may apply if the seller, the buyer or the borrower are incorporated in a foreign jurisdiction).

In this series, we will be discussing each of the following transfer methods:

• Novation;
• Assignment; and
• Sub-participation.

Our final article will look at the differences between each method and the key considerations relating to choosing the method which works best for you. Join us in two weeks for the second article of the series, covering the main aspects of novation.

Q: What is secondary debt trading?

A: Secondary debt trading is the process whereby existing loans are traded and new lenders buy the debt owing to existing lenders. The secondary loan market is a lender-only platform and borrowers may not trade their debts.

Q: What kind of debts are traded?

A: Both performing loans, also known as par loans (where the borrower’s ability to repay the loan is not in doubt) and distressed loans (where the borrower is facing financial difficulties and is unlikely to be able to repay its debt in full) can be traded.

Q: How are debts traded?

A: Whilst the LMA’s standard terms and conditions are often used, the parties to a trade are free to depart from them and negotiate bespoke provisions. Once all terms are agreed, the trade often takes effect via a phone call between the parties, and a letter confirming the transaction follows. One of the key negotiation points is the method of transfer to be used, and this will be explored in this series of articles.

Q: Why buy or sell debts?

A: Lenders may wish to spread their risk exposure by diversifying their debt portfolio. A lender may be prepared to buy distressed debt if they plan to make a profit by selling it on afterwards, or if they wish to influence a borrower’s restructuring or insolvency by becoming creditors of that borrower. Finally, in respect of syndicated loans (where a number of different lenders provide debt to a borrower under a single loan agreement), the lack of restriction on the amount of debt being traded means that lenders that were not able to join the syndicate when it was originally formed can still join it at a later date.

Q: I am a borrower – if my lender wants to trade my debt, do I have to agree?

A: Borrowers cannot block a trade, however, depending on the transfer method being used and on the specific terms of the facility agreement, they may have to be notified and to provide consent. If a borrower does not wish to consent to a trade, this does not mean that the trade cannot take place, but it does mean that another (sometimes less advantageous) transfer method must be used.

In our next article, we will be focusing on novation, one of the key transfer methods available when parties wish to effect a transfer in the secondary debt markets.