LONDON (Reuters) – Global securities regulators have proposed tightening how the leveraged loan market operates to tackle “vulnerabilities” after a prolonged period of low interest rates led to deteriorating standards.
Leveraged loans are loans extended to companies that already have high debt, and therefore are at a higher risk of default.
Global securities watchdog IOSCO said it had identified “some vulnerabilities in the leveraged loan and collateralized loan obligation markets which may be exacerbated by the behavior of certain participants and market practices.”
Its proposed “good practice” seeks to address issues such as “covenant-lite” – or loans that do not contain safeguards such at restrictions on the borrower’s ability to transfer collateral beyond the reach of lenders, IOSCO said in a statement.
Covenant-lite loans now make up 90% of the leveraged loan market, up from just 1% in 2000, IOSCO said in a public consultation paper on its proposed new guidance.
Another issue is overly-aggressive adjustments to earnings before interest, taxes, depreciation and amortisation (EBITDA) of a company borrowing money, IOSCO said.
“Alongside looser covenants, there is evidence that headline debt-to-EBITDA may be understated,” it said.
Investors have long worried that the EBITDA used, boosted by “add backs”, may not be achievable, and that it masks the true amount of leverage.
“EBITDA adjustments based on future synergies, earnings and asset disposals should be made on a reasonable basis and borrowers are encouraged to provide clear justifications of these adjustments to investors,” the proposed guidance says.
There is also a lack of transparency in the private finance market, which has experienced rapid growth, with private market assets under management reaching $12.8 trillion in June 2022, IOSCO said in a separate report.
U.S. companies have raised more money in private markets than in public markets in each year since 2009, it added.
“While the inherent opacity in private finance provides investors with some insulation from the transparency costs faced in public markets, it could also jeopardize availability of information that regulators and investors require to effectively assess risks,” IOSCO said.
But any attempts to increase transparency would need to carefully balance the increased costs to market participants, with the benefits to the financial system more broadly, it added.
Source: Economy - investing.com
