Trends for Distressed Debt Hedge Fund Managers
Distressed debt hedge funds often face a number of legal issues with regard to their investments. Post-Lehman, understanding the rights and liabilities attached to the actual contracts has become paramount for managers. The following article, contributed by Karl Cole-Frieman of Cole-Frieman & Mallon LLP, provides some background on a recent conference which discussed the secondary loan market.
The LSTA Annual Conference and the Secondary Loan Market
On October 29, 2009, we attended the annual conference for the Loan Syndications and Trading Association (the “LSTA”). Conference attendance was significantly up in 2009 from 2008, reflecting an increase in trading volume in the secondary loan market, and robust market conditions for service providers as a result of the spike in settlement on distressed documentation following Lehman’s collapse in 2008.
Secondary Loan Market Panel
Of particular interest was the panel regarding “Recent Developments in the Secondary Loan Market” moderated by Elliot Gans, Executive Vice President and General Counsel of the LSTA. Other panelists included:
- Linda Giannattasio, Director and Counsel in Citigroup’s Office of the General Counsel.
- Robbin Schulsohn, Karl Cole-Frieman’s former colleague at JPMorgan Chase, where she is Executive Director and Assistant General Counsel.
- Claire Pierce, Managing Director if Chapdelaine Credit Partners. Claire was in-house at Bank of America for many years before joining Chapdelaine.
- Bridget Marsh, Senior Vice President & Assistant General Counsel of the LSTA.
- Jennifer Tallmadge, Assistant General Counsel at Bank of America.
Notably, the panel lacked a Buy Side perspective, which impacted the topics of discussion.
Buy-In/Sell-Out Provisions (“BISO”)
A relatively recent change in standard documentation for Par Trades is the inclusion in the LSTA Par/Near Par Trade Confirmation of a BISO provision for confirmations beginning February 2009. The BISO provisions addressed the problem of counterparty risk for failure to settle a trade. Previously, if a counterparty refused to settle a trade, there was little that the performing party could do short of litigation. The BISO provisions, which have recently been modified, establish the circumstances under which a performing party in a Par Trade may terminate its obligations under a trade confirmation and effect a cover transaction in respect of the loans. There is a lot of discussion about adding a BISO provision to the LSTA Distressed Trading Documents.
The panel expressed some mixed views about the success of the Par BISO provisions. In general, the BISO provisions have been considered successful in reducing settlement times in 2009. However, the provisions have only been in effect in a rising market, and it remains to be seen what will happen next time there is a systemic downturn in the market. It is possible that market participants could become overwhelmed sending and responding to BISO notices.
Distressed Documents for Performing Loans
The panel also discussed the phenomenon post-Lehman of trades that settled on distressed documents for performing loans. After the Lehman bankruptcy the loan prices fell significantly even for performing loans. Buyers reacted by insisting that trades settle on distressed documents instead of Par documents, causing significant delays in settlements. Generally the panel, which was dominated by Sell Side representatives, felt the market behaved irrationally in requiring distressed documents for performing loans based solely on price. One the other hand, the distinction between par and distressed has historically been determined solely by price. It is not clear what other objective measures loan purchasers can rely on. From a Buy Side perspective, it might be worth spending an additional $20,000 in delayed compensation to make sure their $200,000,000 is fully protected.
Settlement Times for Loan Trades
Despite the BISO provisions in the Par confirmations, there are systemic problems causing settlement delays in 2009. Although Linda Giannattasio indicated that 90 percent of Citibank’s par trades are settling in T+7, Elliot Gans provided raw data for 3Q 2009 that shows that problems persist. For par trades, the average trade settled in 18 days, while the median settlement time was 11 days. For distressed trades, the average trade settled in 45 days, while the median trades settled in 36 days. Performing loans that trades on distressed documents post-Lehman are shifting back to Par documents, contributing to the delays.
Shift Date Rule
The LSTA plans to publish new rules for determining the “shift date,” or the date in which loans shift from Par to Distressed, and therefore must settle on distressed documents. The existing process, which has never worked well, is that the LSTA polls dealers on the shift date. Under the forthcoming rules, the LSTA will select the shift date and it will be binding on all parties. Upon request, the LSTA will review trade data and other supporting material to determine the date. Where unable to make a determination, the LSTA will assemble a Determinations Committee made up of LSTA Board members. Elliot Gans indicated that some market participants would prefer the LSTA select a random date to the current polling system. Nevertheless, we expect these new rules to be somewhat controversial when rolled out by the LSTA.
To find out more about the secondary loan market and other topics impacting hedge fund managers, please contact Karl Cole-Frieman of Cole-Frieman & Mallon LLP (www.colefrieman.com) at 415-352-2300 or [email protected]
Other related hedge fund law articles include:
- Distressed Debt Fund of Funds
- Issues Involved in Closing a Distressed Debt Fund
- Hedge Fund Investment Strategies
- Deciding on a Hedge Fund Strategy
- What is a Hedge Fund “Gate” Provision