Secondary Debt Trading – Part 5

How to choose the right transfer method

Whilst it is easy to see why novation can often be seen as the best outcome for all parties, sometimes specific considerations come into play and mean that another method of trade may be more appropriate.

For example, if the seller/existing lender wishes to maintain its commercial relationship with the borrower or if the trade is to remain confidential, sub-participation may be a better option as the borrower will rarely be aware of any change in the identity of the ultimate funder.

If the seller does not mind the borrower being made aware of the trade but there is a concern in relation to a possible challenge of new security, then an assignment may be preferable as the so-called “hardening periods” (discussed previously here) of the new security will not have to restart and the security already in place will continue to be effective.

Whether or not any commitments are undrawn at the time of the trade will also be relevant, as if this is the case, assignment and funded participation may not be the best methods of transfer. This is because, since only rights can be assigned, any remaining payment obligations cannot be assigned to a third party and funded participation, by definition, can only apply to funds which have already been drawn down.

If it is important for the buyer to have direct contractual rights under the loan documentation, either novation or assignment may be appropriate and, if the seller needs to offload its liabilities for regulatory purposes, then novation be the best solution since it allows the seller to completely remove a loan from its balance sheet.

The importance accorded to specific rights (such as voting rights in a syndicated loan) under the loan documentation means that a buyer may be reluctant to agree to a sub-participation.

Timing may also be a potential issue as it is likely that, where a novation or an assignment is involved, the agent under a syndicated loan agreement may have to conduct lengthy KYC checks on the buyer, which may delay the trade significantly. It is also useful to note that if the identity of the new lender raises passporting issues in relation to withholding tax, then further delays can be expected whilst the buyer and the borrower obtain the relevant clearances and approvals from HMRC.

Finally, it is also important to bear in mind that the parties may not have a choice in the matter: if novation cannot take place because the borrower will not grant its consent, due to the position that “a trade is a trade”, the transaction will be forced to take place in another form.

Do not hesitate to contact a member of our banking & finance team if you would like to discuss any of the above or any of the other issues discussed during this series of articles or if you are thinking of entering into a transaction (either as a borrower or a lender) where secondary debt trading may be a consideration at some point in the future and you would like to better understand its implications on your rights and obligations.