Kramer Levin’s Comments to the Current LSTA Shift Date Rules

The LSTA has requested comments on its Shift Date rules, which have been in effect since Sept. 8, 2011. Below is our commentary on the current LSTA Shift Date rules along with our proposals to amend the current rules.

Under the current rules, the LSTA uses a two-step process to determine a Shift Date.

Step 1: Review Trade Data. The LSTA reviews information it receives on a monthly basis from dealers, which details the loan trades entered into by such dealers during the previous month and whether such trades settled on par or distressed documentation. If the LSTA can make a determination based on this data, it publishes a Shift Date.

Step 2: Supporting Information. If the LSTA can’t determine a Shift Date pursuant to Step 1, the LSTA reviews “Supporting Information,” which includes information relating to the borrower/obligors (including the existence of any defaults) and the industry in which the borrower/obligors do business, information published by rating agencies, loan/bond/CDS pricing, and other information obtained from the public side trading desk of the administrative agent under the credit agreement. If this data is inconclusive, the LSTA convenes a meeting of a Determinations Committee.

An original aim of the LSTA Shift Date rules was to establish, on behalf of all market participants, a fair and balanced approach in determining when loans should trade on distressed documentation. In the LSTA’s Handbook of Loan Syndications & Trading, the LSTA states that it is “dedicated to advancing the interests of the marketplace as a whole and promoting the highest degree of confidence for investors.” However, the implementation of these rules applicable to investments in distressed companies has produced some unfair results. This is primarily due to our understanding that, in practice, the LSTA’s primary method to determine a Shift Date is to rely exclusively on data provided by dealers and, in most cases, on the use of par documentation preferred by dealers. We note that in the vast majority of secondary trading, the dealer does not make an investment as a principal but, instead, facilitates transactions between sellers and investors. As such, a dealer has little incentive to seek the benefits provided by distressed documentation that may be desired by investors in distressed and troubled companies.

Buyers, on the other hand, are the parties that bear the risks inherent to this asset class. The LSTA’s Handbook states that “If a Borrower does commence a bankruptcy case, then full repayment of the loans will be subject to a number of bankruptcy law provisions (e.g. preference actions, fraudulent transfers, equitable subordination).” As is understood by all market participants, many of these bankruptcy-specific risks predate any bankruptcy filing, sometimes by many months, and once a company files, these risks may significantly impact potential recoveries.

In order for the Shift Date rules to more fairly reflect the LSTA’s long-standing risk allocation incorporated in its published forms, we have proposed that Step 1 be eliminated from the analysis. Instead, consistent with the goals of market efficiency and fairness to all market participants, the LSTA should rely on purely objective market data as the primary driver of whether a credit should be trading on distressed documentation. Thus, we have proposed that the LSTA and market participants adopt a protocol whereby loans automatically shift from par to distressed if any of the following occur:

• If a loan trades at a price of below 75 cents for 30 consecutive calendar days based on an average of independent sources. (The LSTA Handbook states that “any material discount from par reflects a level of concern in the market that the distressed loan will not be performing according to its terms.” And yet, under the current Shift Date methodology, it is not uncommon for credits priced in the 50s, 60s and 70s to be traded on par documentation.)
  
  
• If a payment default occurs which is not timely cured.
  
  
• On the petition date of a bankruptcy filing (which is already standard market practice).

In instances where none of the above has occurred but a Shift Date request has been submitted, we have proposed that the LSTA should follow the current Step 2 procedures which rely on objective market data from disinterested third parties.

There are multiple benefits to this approach. First, and most importantly, it provides bright-line rules for all market participants, removing uncertainty and increasing liquidity by providing a clear set of guidelines on which all parties can rely. Second, it provides confidence to distressed investors that they will receive fair protections against certain risks inherent in this asset class. Third, it reduces the challenges and burdens on the LSTA, as it can rely on readily available and objective market data.

As long-standing and active advisors to market participants, we are prepared to consider these and other practical and commercial recommendations to the LSTA’s current Shift Date rules.