Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two)

For the majority of 2011, European secondary loan markets had buy-side traders frustrated by low liquidity, volume and deal flow, and sell-side traders were left to wonder if and when they do source, will enough friends come out and play.  Is this the calm before the storm?  Many in the distressed community believe it is, and that loans will play a significant role in the corporate distressed wave expected to hit shore in 2012 as part of €221 billion worth of European leveraged loans set to mature between now and through 2015.  The high yield market was a savior in 2011 for many borrowers whose loans were set to mature in 2013 and 2014.  However, with some of these deals already having gone sour and the pool of remaining loans deteriorating, the high yield market is not likely to save the day again.  Regardless of the capital market options, when the refinancing peak reaches its heights in Europe and the U.S. in 2014, bad loans will likely be left behind in droves.  To assist investment funds in filling their proverbial sandbags and preparing to pick up potentially lucrative pieces in the aftermath, David J. Karp, Special Counsel at Schulte Roth & Zabel LLP (SRZ), Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, are publishing in the Hedge Fund Law Report a two-part series on trade risks specific to loans in the European market.  This first article will focus on certain macro issues arising in the context of European secondary loan trading, through analyzing regulatory, tax and credit documentation factors which can impact the success of a trade.  In particular, this article analyzes, among many other relevant issues: what jurisdictions and applicable lender restrictions play into a trade; whether a debt purchase subjects an investor to a withholding tax, and, if so, whether the investor can obtain the benefit of an exemption or a reduced rate of withholding tax; the requirements to accede as a lender of record under a loan agreement, including eligibility requirements, minimum thresholds and borrower consent rights; and any additional steps an investor must take to perfect its debt transfer and consequences for failing to take the requisite action.  The second article, to be published in an upcoming issue of the Hedge Fund Law Report, will look at trade issues affecting an investor at time of trade and on a more micro level, covering transfer perfections, LMA transparency guidelines, trade documentation, form of transfer and additional terms of trade.

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