In an effort to reduce settlement times and improve market liquidity, the Loan Syndications and Trading Association’s (the “LSTA”) Liquidity Committee has designed new delayed compensation rules for par/near par trades, Phase I of which is effective today, September 1, 2016, with the second phase expected to become effective on November 1, 2016. The new regime shifts from a “no-fault” model to a requirements based model to address the role of the Buyer in settlement delays. The rules focus on Buyer performance over the life of the trade in determining whether the Buyer will be entitled to delayed compensation, and thereby incentivizing the Buyer to perform and persist to move toward settlement within the LSTA recommended timeframe of T+7.
The target settlement time for par/near par trades is T+7, however, as many loan market participants know, such trades often take significantly longer than T+7 to settle. Settlement delays can be the result of many factors, among them, delays in obtaining required consents, assignment processing times, unsettled upstream inventory and seller and buyer performance. The new rules seek to address settlement delays that result from Seller and Buyer performance, taking into account exceptions outside the trade parties’ control, as well as alternative settlement methods. The rules apply to both trades that settle manually, on paper, (“Paper Trades”) and those that settle via an electronic settlement platform (“Electronic Settlement Platform”). Although substantially the same, the requirements for Paper Trades (the “Paper Requirements”), if elected by the trade parties, differ slightly from the requirements for trades that settle on an Electronic Settlement Platform (the “Settlement Platform Requirements”), which is the default method under the delayed compensation protocol, primarily due to technical differences in each form of settlement. This Client Alert briefly discusses the prior delayed compensation regime before exploring the new regime and its requirements as they generally apply for each of Phase I and Phase II of the rollout.
The “Old” Delayed Compensation Regime: No-Fault
Prior to the new rules, delayed compensation was calculated based on a “no-fault” model, which aimed to put both the Buyer and the Seller in the same economic position they would have been in had the trade settled within T+7 (trade date plus 7 business days) and not in the delay period (the period between T+7 and the settlement date). For trades settling after T+7, the purchase price for the loan, therefore, factored in delayed compensation, which was calculated such that (i) the Buyer received the benefit of interest and fees accrued on the loan during the delay period, and (ii) the Seller received an amount intended to cover the cost of carry accrued at LIBOR on the purchase price during the delay period. The “no-fault” model did not require the Buyer or the Seller to perform or satisfy any settlement requirements in order to receive delayed compensation, therefore, providing no incentive to meet a T+7 settlement date goal.
The “New” Delayed Compensation Regime: Requirements Based
Phase I – September 1, 2016 through October 31, 2016
Settlement Platform Requirements
The Buyer must, subject to certain exceptions, satisfy certain basic requirements by T+6 (Trigger Date +12 for Early Day Trades)1 to be eligible to receive delayed compensation. Those basic requirements are the Buyer must (i) execute the confirmation and assignment agreement, (ii) select a settlement date of T+7 (Trigger Date +14 for Early Day Trades) or earlier and select “Persisted” (meaning the Buyer must be ready and willing to settle the trade until the settlement date) and (iii) also timely pay the purchase price to the Seller on the delayed settlement date (the “Buyer Settlement Platform Requirements”).
When settling via an Electronic Settlement Platform, in order for the transfer documents to be generated, the dealer (whether the Buyer or the Seller) must submit the trade details no later than T+1. If both the Seller and the Buyer are dealers or neither is a dealer, then this obligation falls on the Seller. If the Buyer is the dealer and if the trade details are not submitted by T+1, the Seller may provide a notice to the Buyer setting forth the trade details no later than T+3 (the “Dealer Failure Notice”), at which point the Buyer must submit the trade details to the Electronic Settlement Platform within T+5 (Trigger Date +10 for Early Day Trades) and satisfy the Buyer Settlement Platform Requirements in order for delayed compensation to apply.
If the Buyer fails to satisfy the Buyer Settlement Platform Requirements, delayed compensation will still apply if (i) the Seller, when required, fails to submit the trade details to the Electronic Settlement Platform by T+1, or (ii) the Seller fails to timely provide a Dealer Failure Notice.
Paper Requirements
The Buyer must, subject to certain exceptions, by T+6 (Trigger Date +12) for Early Day Trades) satisfy certain basic requirements, to be eligible to receive delayed compensation. These requirements differ depending on whether or not the Buyer is the drafting party.
If the Buyer is the drafting party, (i) the Buyer must deliver to the Seller on or before T+1 the confirmation and the assignment agreement, and (ii) upon receipt from the Seller of its executed signature pages, within 1 business day of such receipt, deliver to the Seller the Buyer’s executed signature page to the confirmation and deliver to the agent the assignment agreement executed by both the Buyer and the Seller. If the Buyer fails on or before T+1 to deliver the confirmation and the assignment agreement, the Seller may notify the Buyer (the “Buyer Failure Notice”) no later than T+3 of such failure, at which point the Buyer must deliver to the Seller by T+5 (Trigger Date +10 for Early Day Trades) the confirmation and the assignment agreement, each executed by the Buyer, and within 1 business day of its receipt from the Seller of its executed signature page to the confirmation and the assignment agreement, submit the assignment agreement executed by both the Buyer and the Seller to the agent in order for delayed compensation to apply. If the Seller fails to provide a Buyer Failure Notice by T+3, then delayed compensation will apply unless the Buyer fails to timely pay the purchase price to the Seller.
If the Seller is the drafting party, the Seller must deliver the trade confirmation and the assignment agreement to the Buyer on or before T+1. If the Seller complies with the foregoing, then the Buyer must deliver to the Seller on or before T+6 (Trigger Date +12 for Early Day Trades) its executed signature pages to the confirmation and the assignment agreement in order to receive delayed compensation. If the Seller fails to satisfy its trade documentation delivery requirements, then delayed compensation applies unless the Buyer fails to timely pay the purchase price to the Seller
Where the Seller is responsible for obtaining any required consents and the trade does not settle by T+7 (Trigger Date +14 for Early Day Trades), the Seller must deliver to Buyer a copy of its executed signature page to the assignment agreement any time from T+7 (Trigger Date +14 for Early Day Trades) until the settlement date and also notify the Buyer of a proposed delayed settlement date by no later than 6:00 p.m. (NYT) on the business day immediately preceding such proposed delayed settlement date, provided that Seller reasonably determines in good faith that all consents and conditions to settlement will be satisfied by such proposed delayed settlement date. If the Seller timely provides such notice of a proposed delayed settlement date and notifies the Buyer of the effectiveness of the assignment (i) on or prior to 11:00 a.m. (NYT), then the Buyer must pay the purchase price to the Seller on the effective date of the assignment, or (ii) after 11:00 a.m. (NYT), then the Buyer must pay the purchase price to the Seller no later than the business day immediately following the effective date of the assignment. If the Seller does not timely notify the Buyer of a proposed delayed settlement date, then the Buyer must pay the purchase price to the Seller no later than the business day immediately following the date the Seller notifies the Buyer of the effective date of the assignment.
Where the Buyer is responsible for obtaining any required consents and the trade does not settle on T+7 (Trigger Date +14 for Early Day Trades), then if the Buyer is notified of the effective date of the assignment (i) on or prior to 11:00 a.m. (NYT) ), then the Buyer must pay the purchase price to the Seller on the effective date of the assignment, or (ii) after 11:00 a.m. (NYT), then the Buyer must pay the purchase price to the Seller no later than the business day immediately following the effective date of the assignment.
The Exceptions: Other Circumstances When Delayed Compensation Still Applies
Delayed compensation will still apply if (i) a purchase price calculation error exists such that the Buyer has not timely paid the purchase price because of its reasonable belief in good faith that the purchase price calculation is incorrect and the Buyer has so notified the Seller on or prior to one business day prior to when such purchase price was due and has otherwise complied with its other Buyer requirements, (ii) if a material error in the assignment agreement exists, provided that the Buyer notifies the Seller and uses commercially reasonable efforts to fix the error by no later than T+3 (T+6 for Early Day Trades) and if such error is fixed by T+4 (T+8 for Early Day Trades), then the Buyer needs to satisfy its requirements, or (iii) due to force majeure relating to the functionality of the Electronic Settlement Platform outside of the Buyer’s control and which the Buyer cannot overcome.
Delayed compensation will also apply if (i) third party consents are not obtained, provided that the Buyer has satisfied its requirements, (ii) participation is selected as the form of purchase in the confirmation, and (iii) if the Buyer has not satisfied its requirements because it has timely requested “know your customer” (“KYC”) information for onboarding purposes but has not received such information from the Seller, provided that upon receipt of such KYC information, the Buyer uses good faith efforts to complete its KYC review and onboarding requirements in a commercially reasonable manner in order to promptly settle the trade.
New CLO Issuers and CLO Blackout Periods
The new rules recognize that a Buyer may be a special purpose entity newly formed to issue collateralized loan obligations under an indenture (a “New CLO Issuer”), and accounts for the challenges faced by New CLO Issuers in the warehousing stage in meeting the T+7 target settlement date by allowing a CLO Issuer to designate a period of not more than 5 consecutive business days preceding the effective date of the indenture under which a New CLO Issuer issues notes (the “CLO Blackout Period’) during which the New CLO Issuer will not have to settle trades, but will still receive the benefit of delayed compensation. A New CLO Issuer may designate only one such period as a CLO Blackout Period before the effective date of the Indenture. Before and after the CLO Blackout Period, the New CLO Issuer will be expected to settle trades. In the case of settlement via Electronic Settlement Platform, if the Buyer on or prior to T+7 (Trigger Date +14 for Early Day Trades) indicates on such Electronic Settlement Platform that it is a New CLO Issuer, such Buyer may, at any time from T+7 (Trigger Date +14 for early Day Trades) until settlement, select a CLO Blackout Period during which the agent will not be able to make an assignment effective and delayed compensation will still apply. For Paper Trades, if the Buyer on or prior to T+7 (Trigger Date +14 for Early Day Trades) notifies the Seller that it is a New CLO Issuer, such Buyer may, at any time from T+7 (Trigger Date +14 for Early Day Trades) until settlement, select a CLO Blackout Period during which the Seller or the Buyer (depending on which party is responsible for obtaining required consents) shall notify the agent not to effectuate an assignment during such period and delayed compensation will still apply.
Phase II – Delayed Compensation After November 1, 2016
The LSTA recognized the need of some market participants for “lead time” prior to effective date of the assignment in order to prepare to fund the purchase price. That “lead time” is the period of time between when the agent is ready to make as assignment effective and when the Buyer (or the Seller in some cases) is ready to actually fund the purchase price. While during Phase I the Buyer will not be penalized if it has designated lead times on an Electronic Settlement Platform, in Phase II, lead times of greater than one day will no longer be accepted and the basic requirement to execute the confirmation and assignment agreement (and deliver them to Seller in the case of Paper Trades) will be shortened from T+6 to T+5 (from Trigger Date +12 to Trigger Date +10 for Early Day Trades). The LSTA concluded that this one day pull back was necessary in order to stay within the T+7 (Trigger Date +14 for Early Day Trades) settlement target while at the same time allowing a one day lead time. Market participants having lead times of one day may, in certain circumstances described below, forfeit delayed compensation for that one day of lead time. Delayed compensation will not apply in circumstances where the Buyer has designated a lead time of greater than one day on an Electronic Settlement Platform.
Payment Timing
On and after November 1, 2016, for trades settled on an Electronic Settlement Platform, if the parties receive notice from the agent that the assignment agreement is ready to be made effective (i) on or before 11:00 a.m. (NYT ), the Buyer must pay the purchase price on the same day of such notice unless the Buyer has elected to receive one business day’s advance notice, in which case the Buyer must pay the purchase price no later than the business day immediately following such notice, (ii) after 11:00 a.m. (NYT) but before 6:00 p.m. (NYT), the Buyer must pay the purchase price no later than the business day following such notice, and (iii) after 6:00 p.m. (NYT), the Buyer must pay the purchase price on no later than one business day immediately following such notice unless the Buyer has elected to receive one business day’s advance notice, in which case the Buyer must pay the purchase price no later than two business days following such notice. To the extent the Buyer has elected to receive one business day’s advance notice, and the notice is received from the agent on or before 11:00 a.m. (NYT) or after 6:00 p.m. (NYT), then, provided the Buyer timely funds the purchase price based on that lead time and complies with the other Buyer Settlement Platform Requirement, the Buyer will forfeit one day of delayed compensation, which will automatically be deducted on the Electronic Settlement Platform. The Buyer and the Seller, however, may mutually agree to override the effective date on which the assignment agreement is to be made effective as prescribed by the foregoing rules, and if the agent makes the assignment agreement effective on such other date agreed to by the parties, then the Buyer must pay the purchase price to the Seller no later than such date.
Ready, Set, Go!
The revised LSTA Standard Terms and Conditions for Par/Near Par Trades is effective September 1, 2016, implementing Phase I for any trades with trade dates of September 1, 2016 through October 31, 2016, while Phase II will go into effect thereafter for trades with trade dates of November 1, 2016 or later. Electronic Settlement Platforms have been updated to reflect the changes. Market participants should be mindful of the time frames for performing their respective requirements when trading. Buyers, in particular, should be sure to meet performance deadlines if they wish to be eligible for delayed compensation in the event settlement is delayed. CLO managers should also be familiar with settlement requirements and the limited exceptions available to them when settling trades during the warehouse period. While this Client Alert has explored the new rules and many of the factors which apply in calculating delayed compensation, a number of additional factors may impact the calculation and whether and to what extent delayed compensation applies in any given trade (including, but not limited to, negative purchase prices and net credited amounts). For trade specific questions or general questions about this memorandum and calculating delayed compensation, please contact Daphne Coelho-Adam at (212) 574-1233 or coelho-adam@sewkis.com.
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1An “Early Day Trade” means a trade for which the trade date is a date on or before the sixth business day following the Trigger Date for such trade. The “Trigger Date” is (i) the date of initial funding under the credit agreement or (ii) if there is no funding of any facilities under the credit agreement at or about the time it becomes effective, the date the credit agreement is executed and delivered.
