The FCA's final ban on right of first refusal/right to act provisions: will it affect corporate lending and acquisition finance markets?
05 July 2017
On 27 June, the UK Financial Conduct Authority (FCA) published a policy statement1 setting out the final form of its proposed ban on right of first refusal and right to act provisions relating to the supply of certain future primary market services from a UK establishment.
As a result of feedback received in response to the consultation on the proposed ban, the FCA has clarified its scope. Most importantly from a corporate lending and acquisition finance perspective, the final ban is limited to provisions relating to the supply of future primary equity or debt capital market or M&A services.
This means the ban will not affect provisions relating to the supply of future lending services. Nor, in our view, is it intended to affect provisions relating to the supply of future loan hedging services.
The ban continues to include an exemption for bridging loans, but the FCA has revisited definition of "bridging loan". In a welcome development, it now focuses on the commercial intent of a loan, rather than its term.
The changes to the scope of the final ban mean that it should have little or no impact on current practice in the corporate lending and acquisition finance markets. However, the FCA has indicated that it remains open to extending the ban to other wholesale market services if it sees evidence of restrictive provisions being used to the detriment of clients for those services.
The ban will apply to provisions in agreements in writing entered into on or after 3 January 2018. The policy statement makes clear that the ban will not apply to provisions in agreements entered into before then.
Prompted by concerns about potentially anti-competitive behaviour, the FCA launched a market study into investment and corporate banking in May 2015.
In its final report on the study, the FCA concluded that some restrictive provisions used by institutions in engagement letters and other documents could affect competition for investment and corporate banking services with no clear benefit to clients. The FCA identified right of first refusal and right to act provisions as the most restrictive and concluded, on balance, that institutions should no longer be allowed to use them.
In October 2016, the FCA published a consultation paper on a proposed ban.2 The consultation closed on 16 December 2016.
For more information on the background to the ban, see our previous publication: How the FCA's proposed ban on right of first refusal/right to act provisions affects corporate lending markets.
The final ban
The consultation feedback on the proposed ban primarily focused on its scope, both in terms of the services affected and the location of the clients and firms subject to the ban. In response, the FCA has clarified the scope of the ban, aligning it more clearly to the scope of the market study in respect of the services affected but retaining the original geographic scope.
The final ban prohibits a firm from entering into a written agreement with a client that includes a right of first refusal or right to act provision relating to the supply of future primary equity or debt capital market or M&A services to the client.
Key points to note for corporate lending and acquisition finance
Future lending services. The FCA has clarified that provisions relating to the supply of future lending services are not caught by the ban.
Following the consultation, there was some confusion around the application of the proposed ban to provisions relating to the supply of lending services and, in particular, accordion and incremental facilities. Although the proposed ban was effectively limited to certain regulated activities and did not appear to apply to the supply of future lending services, the consultation paper included comments suggesting that accordion and incremental facility provisions might be caught.
However, the policy statement confirms that the ban does not apply to lending services and makes specific reference to accordion provisions.
Future hedging services in connection with acquisition finance loans. There was also some uncertainty around the application of the proposed ban to provisions relating to the supply of future hedging services in connection with acquisition finance loans.
In its policy statement, the FCA notes that respondents to the consultation commented that the proposed ban would go beyond the scope of the primary market services investigated in the market study and that, in particular, it would extend to secondary market activities such as hedging. In light of this feedback, the FCA has aligned the scope of the ban more clearly with the scope of the market study so limiting its application to future primary equity or debt capital market or M&A services.
In our view, provisions relating to the supply of hedging services in connection with acquisition finance loans are not intended to be caught by the ban. However, some uncertainty remains because such services may still come within the new definition of "primary market and M&A services" (on the basis that they may be services relating to M&A).
This uncertainty is unlikely to be an issue in practice because the ban only applies to the supply of "future" services. These are described as services which may be required in the future but are not specified or certain at the date of the relevant agreement, and in most cases loan hedging services are clearly in the contemplation of the parties when the loan is agreed.
The FCA further clarifies in its policy statement that the ban is not intended to prevent clients from agreeing terms for a specific piece of future business they know they will undertake. Typically, right of first refusal and right to act provisions relating to the supply of loan hedging services only restrict a client in relation to the hedging required in connection with a specific loan. Such provisions fall outside the ban because the hedging is a specific piece of business the borrower knows it will undertake and is not therefore a "future" service for the purposes of the ban.
Clarification of the scope of the bridging loan exemption
The proposed ban does not apply to right of first refusal or right to act provisions included in agreements relating to bridging loans where the restrictive provisions relate to the longer-term financing that is intended to replace the bridging loan (eg a bond issue, equity issue or a business disposal).
The definition of "bridging loan" was originally very narrow and limited the exemption to loans with a term of 12 months or less. However, the FCA has expanded the definition in response to consultation feedback. Acknowledging that there is no "one size fits all" definition for bridging loans, the exemption now applies to any "loan provided to a client for the purpose of providing short term financing, and with the commercial intention that it be replaced with another form of financing".
The FCA has provided guidance on what types of loan may qualify as bridging loans for the purposes of the exemption in the form of a non-exhaustive list of three characteristics which, if satisfied, are indicative of a bridging loan. The first of these is a statement in the documents relating to the loan that it is a temporary solution until the borrower is able to obtain longer-term financing. The second is that the loan is short term, typically less than 4 years from signing, or has other features to discourage the client from retaining it as longer term financing (eg interest rate step ups). The final characteristic is that the loan includes a mandatory prepayment event requiring the proceeds from the future longer term financing to be used to prepay it.
In our experience, most bridging loans will satisfy the second and third characteristics, but may not satisfy the first. It is possible that market practice may develop to include an express statement in documents to satisfy the first characteristic. However, the guidance is not intended to be exhaustive and a loan not satisfying the characteristics will still be considered a bridging loan if it can be shown that the purpose of the loan is to provide a client with short-term financing and the commercial intent is to replace the loan with another form of financing.
The FCA has also reconfirmed its view that the bridging loan exemption is intended to capture warehouse facilities as these have a similar function to bridging loans.
When the ban comes into effect
It appears that the ban will apply to written agreements entered into on or after 3 January 2018, although this is not entirely clear. The instrument enacting the ban comes into force on 3 January 2018. However, in its policy statement, the FCA refers to the ban applying "with effect from 3 January 2018" and, separately, to it coming "into effect for agreements entered into after 3 January 2018".
Banks and other FCA regulated institutions with an interest in the corporate lending and acquisition finance markets will welcome both the clarification of the scope of the ban and the expansion of the bridging loan exemption.
The changes to the scope of the ban mean it should now have little or no impact on current practice in those markets. However, the FCA's comments in the policy statement that it remains open to extending the ban to other wholesale market services sound a note of caution. The FCA could not be clearer that it will respond if it sees evidence of firms using restrictive provisions that adversely affect competition without any clear benefit to clients.
1 PS17/13, "Investment and corporate banking: prohibition of restrictive contractual clauses" (June 2017)
2 CP16/31, "Investment and corporate banking: prohibition of restrictive contractual clauses" (October 2016)