Europe

UK: Breathing Space Scheme Regulations

 

A draft of the Debt Respite Scheme (Breathing Space Moratorium and Mental Health Crisis Moratorium) (England and Wales) Regulations 2020 (the “Regulations”) was published on July 15, with a view to implementing the scheme in England and Wales. It is anticipated that the Regulations will come into force on May 4, 2021.

Overview

The Regulations propose to provide a debtor (specified as an individual in one of the eligibility criteria) with the opportunity to obtain a moratorium that provides “breathing space,” during which creditor action is prohibited, to allow debtors to engage with a debt adviser in order to seek a sustainable solution to their debt problems with their creditors.

How Can Someone Obtain a Breathing Space Moratorium?

In order to enter a breathing space moratorium, a debtor will first have to access advice from a “debt advice provider,” meaning an FCA-regulated debt adviser or an adviser from another organization that qualifies for an exemption from FCA authorization (such as a local authority).

It is worth noting that for the purposes of the Regulations, the “insolvency exclusion” ordinarily available under FSMA 2000 will not apply to a debt advice provider, thus preventing the application of the exception that removes debt counseling as a regulated activity when undertaken by an insolvency practitioner as an officeholder or in reasonable contemplation of an appointment.

Furthermore, a debtor is excluded from accessing a breathing space moratorium if that individual has entered a breathing space moratorium in the previous 12 months.

When considering whether a breathing space moratorium ought to apply, the debt advice provider must assess whether:

  1. the debtor has sufficient funds or income to discharge or liquidate his debts as they fall due;
  2. it would benefit the debtor to enter into a debt solution (such as bankruptcy, an individual voluntary arrangement or a voluntary debt management plan);
  3. the debtor may be eligible to enter into a debt solution during a moratorium or as soon as reasonably practicable after the moratorium ends; and
  4. the moratorium period is necessary in order for the debt advice provider (i) to assess which debt solution would be appropriate for the debtor, (ii) to advise the debtor on which debt solution would be appropriate or (iii) for a debt solution to be put in place.

What Are the Protections of a Breathing Space Moratorium?

During the breathing space moratorium, the accrual of contractual and default interest is stopped, as well as the incurrence of fees and charges. Creditors are also prevented from taking enforcement action against the debtor. The creditor recovery and enforcement moratorium extends to any contact between the debtor, the creditor or his agent relating to the repayment of debts covered by a breathing space moratorium. A breathing space moratorium will include almost all personal debts with broadly the same set of exclusions as apply in bankruptcy and will cover the business debts of sole traders who have a turnover under £85,000.

Additionally, creditors are barred from the retrospective application of interest and charges should a debtor leave the breathing space moratorium without entering a debt solution.

However, if a debtor falls into arrears on an ongoing liability (such as mortgage payments, rent, insurance premiums, taxes and utility bills) as it falls due to be paid during the breathing space moratorium, he will not be protected from enforcement action or the charging of additional interest, fees and charges on these missed bill payments.

Creditor Notifications

It is proposed that entries and exits of debtors to and from a breathing space moratorium would be recorded through an Insolvency Service-run central portal that will be populated with information supplied by the debt advice provider. Creditors would be informed through this service of any entries and exits.

Additionally, it is proposed that there will be a private register of debtors in the scheme, and individual creditors will have access to a register of those individuals who owe them debts who are in a breathing space moratorium and have been included in the portal. However, creditors will not be able to access details of other debtors on this register.

Mental Health Moratorium

Additionally, an alternative mechanism to a breathing space moratorium will be available to debtors receiving treatment for a mental health crisis. In such cases, a debt advice provider would not carry out a financial assessment, but instead would provide access to a breathing space moratorium on the basis of evidence demonstrating that the debtor is receiving mental health crisis care.

Evidence of such a mental health crisis will be available from social workers, nurses, occupational therapists or clinical psychologists who have specific training in mental health and mental capacity law, are experienced in supporting people in crisis and are usually based in community, crisis or home treatment teams and approved by local authorities.

The mental health moratorium benefits from the same protections as the breathing space moratorium, although it is not fixed at 60 days and instead will continue for however long the individual’s crisis care lasts.

Timescales

The protections afforded by a breathing space moratorium last for a period of 60 days, and as noted above, debtors may not access a breathing space moratorium if they have entered a breathing space moratorium in the previous 12 months.

No earlier than 25 days and no later than 35 days after the commencement of the moratorium, the debt advice provider will have to complete a “midway review” to ensure that the debtor is continuing to comply with the ongoing eligibility requirements.

Our Thoughts

The Regulations will offer welcome relief for debtors. Although it is uncertain what the “state of play” will be when the Regulations come into force in May 2021, the ongoing Covid-19 pandemic has led and is likely to continue to lead to a greater number of defaults on debts. While many creditors have been accustomed to providing informal breathing space moratoria to debtors in order to support them in seeking appropriate debt advice, the Regulations introduce greater formality to the process. It is likely that without the introduction of the Regulations, during a period with an uncertain economic outlook, many creditors would have been more reluctant to provide informal breathing space moratoria.

Notwithstanding the above, the Regulations will be particularly relevant when it comes to payday loans and credit cards, where the high rates of interest charged can be very burdensome. With the pausing of interest and default interest under the Regulations, individuals will be offered some respite from such debts.

Finally, in a world where mental health is becoming an increasingly discussed topic, it is a positive step that the Regulations will introduce mechanisms to protect vulnerable individuals in society.

UK Government’s COVID-19 Support for Businesses: A First Stocktake Three Months On

 

Since March, governments around the world have implemented unprecedented measures in an attempt to avoid a severe economic downturn as a result of the COVID-19 pandemic. In the United Kingdom, HM Treasury (“Treasury”) has spearheaded these efforts for the government. The UK government’s measures include the Coronavirus Business Interruption Loan Scheme (“CBILS”), the Coronavirus Large Business Interruption Loan Scheme (“CLBILS”), the Bounce Back Loan Scheme (“BBLS”) and the Future Fund Scheme (“Future Fund”, and together the “Schemes”). To date, the UK government has provided £38.36bn worth of support through the Schemes (directly or via guarantees), enabling finance to be provided to 913,265 companies under the Schemes.[1]

Since their inception, the UK government has published data and statistics on the implementation of the Schemes. This enables a first stocktake three months since the launch of the first of the Schemes.

UK Government Schemes

Each Scheme targets businesses of different sizes and, as such, provides differing levels of UK government-backed support. The Treasury launched:

  • CBILS on March 23. CBILS is available to small and medium enterprises (“SMEs”) with an annual turnover of no more than £45 million. Under CBILS, the UK government provides the relevant accredited lender with a partial guarantee (80%) in respect of the outstanding balance of the relevant facility (subject to an overall cap per lender). Any facility provided under CBILS is up to a maximum amount of £5m.
  • CLBILS on April 20. CBILS is available to businesses with annual turnover of more than £45 million. Facilities of up to £25m are available, via accredited lenders, for businesses with an annual turnover between £45m and £250m. Facilities of up to £200m (in respect of term loans and revolving credit facilities) and £50m (in invoice finance and asset finance facilities) are available to businesses with an annual turnover of more than £250m.[2]
  • BBLS on May 4. BBLS provides loans, through accredited lenders, of between £2,000 and up to 25% of the borrower’s turnover, up to a maximum of £50,000. There are no turnover requirements, but BBLS is targeted at SMEs.
  • The Future Fund on May 20. The Future Fund adopts a different approach to the rest of the Schemes. It is targeted at innovative UK companies with good potential that typically rely on equity investment—i.e., it is more in line with start-up and venture capital financing mechanisms. The Future Fund is an investor-lead Scheme, and the UK government will match the third-party investment (with a minimum of £125,000, up to a maximum of £5m). Such UK government matching investment is by way of subscribing for convertible loan notes issued by the relevant company.

Taking Stock

Nearly three months on, the Schemes have received over one million applications and supported hundreds of thousands of business across the UK.

As of June 14, CBILS had supported a total of 49,247 facilities out of a total of 96,492 applications, equaling an application success rate of 51%. The value of the accepted applications amounts to £10.11bn, averaging just over £205,290 per debt facility.

In contrast, the CLBILS aimed at large corporations has backed facilities in the value of £1.77bn for a total of 279 successful applicants. This totals just over £6.3m per applicant on average. The success rate for CLBILS has so far been lower than that for CBILS: only around 42% of applicants have been approved.

BBLS boasts by far the greatest number of successful applicants: 863,584 small businesses have been able to secure funding through the Scheme. This high number also translates into a high success rate: Just short of 82% of applicants have had their applications approved. Dispensing a total of £26.34bn, businesses have on average obtained £30,500 in finance.

Funding obtained under the Future Fund Scheme has so far totaled £146m. The money has gone to 155 successful companies out of a total of 577 applicants, who have received an average of approximately 940,000. This amounts to a success rate of just under 27%.[3]

Comparing two metrics reveals notable differences between the Schemes:

1. Success rate: Successful applications under BBLS are by far the highest proportion with 82%, eclipsing the other Schemes. In comparison, the Future Fund has provided finance to just 27% of applicants. CBILS and CLBILS have application success rates of 51% and 42%, respectively, sitting in between the two other Schemes.

While the UK government has not published further analysis of these discrepancies, the varying success rates no doubt indicate the more stringent application criteria and more thorough scrutiny, cultivating a more selective application processes for the larger debt facilities (as opposed to the lower facility size and shorter maturity of BBLS loans). 

2. Approved amounts: The average amount of £30,500 granted under BBLS is considerably closer to the UK government’s cap of £50,000 than that of other Schemes. In contrast, the other three Schemes’ average facilities come in significantly below the maximum amount available under those Schemes. CBILS applicants’ average funding of £205,290 sits against a cap of £5m, whereas the average CLBILS facility of £6.3m pales against an available maximum of £25m or up to £200m, depending on the size of the business (although noting the £200m cap was only increased to that amount, from £50m, on May 19). The Future Fund’s average disbursement of £940,000 is somewhat closer to the £5m cap.

As the UK government has not released detailed application statistics, it remains speculative whether lower levels of support to a larger number of businesses has been prioritized, or whether companies are applying for lower amounts of finance than anticipated. Equally, the UK government-imposed caps may have also been designed to meet all eventualities, acting as a ceiling with substantial buffer, rather than suggesting an expectation that most companies would apply for funding close to the respective caps. That said, the low average size of a CLBILS facility of £6.3m is very surprising given that the maximum facility size was increased to £200m cap (from £50m) on May 19 following discussions between the UK government, lenders and business groups.

Another reason why the CLBILS facility size and/or acceptance rates may be low is that, notwithstanding the Chancellor clarifying that CLBILS could be accessed by private equity-owned companies, it has been reported[4] that private equity-owned companies are still prevented from accessing CLBILS (for example, Hawksmoor, of which the majority is owned by Graphite). The rationale for these refusals is that such private equity-owned companies do not meet the CLBILS criteria, and particularly that they were an “undertaking in difficulty” as of December 31, 2019 (this requirement effectively comes from EU state-aid rules). Private Equity firms often fail this test, even if they are operating successfully and are in no financial difficulty, because they tend to be highly leveraged.[5]

Alternative Lenders

In line with the unprecedented scale of economic support, the UK government has also adopted innovative approaches to lending by approving alternative lenders as part of its COVID-19 Schemes. Alternative lending used in this context (i.e., not including true direct lending/alternative credit funds) tends to mean peer-to-peer lending, but it can also include finance from challenger banks, using technology to connect loan investors and borrowers on online platforms. Borrowers turning to these types of alternative lending providers often struggle to secure funding from traditional lending institutions, such as banks. Such loans typically have higher interest rates, a lower duration and are often unsecured.[6] Emerging in the UK in 2005, the practice gained traction in the aftermath of the financial crisis as a lifeline for SMEs and has since increased its market share consistently.

Amid the COVID-19 pandemic in May, the British Business Bank approved four fintechs as part of CBILS to lend money: Assetz Capital, Atom Bank, Ebury and Fleximise.[7] Other approved alternative lenders include Funding Circle, a dedicated SME peer-to-peer lending platform, and Starling Bank, a leading challenger bank.[8] BBLS has accredited a more limited number of alternative lenders, including Starling Bank and Tide, a challenger bank focused on offering banking services to SMEs.[9] The lenders accredited to provide finance to large corporations under the CLBILS remain, to date, traditional lenders, such as Barclays, NatWest or Santander.[10]

The UK government’s move to approve such alternative lenders and fintech companies may illustrate a broader readiness to engage with a budding group of innovative businesses within the lending sector. Such alternative lenders have long constituted a lifeline to SMEs, which may be unable to access funding through traditional avenues.[11] In the current COVID-19 environment, such lenders may become increasingly important to keep SMEs afloat, inside and outside of the UK government-guaranteed Schemes.

We noted in “COVID-19 UK: Finance – Large Business Loan Scheme launched and available to PE owned and large companies – Insight” that it will be interesting to see whether direct lending/alternative credit funds will look to become accredited lenders under CLBILS to take advantage of the UK government guarantee, given that these types of lenders are used to, and are well positioned to, structure and provide bespoke financing solutions. However, as outlined above, to date direct lending/alternative credit funds have not seemed to want to be become accredited lenders.

Concluding Thoughts

Unprecedented challenges often call for unprecedented responses. The UK government’s readiness to pour significant amounts of money into Schemes supporting various segments of the economy has been critical to the survival of many businesses. As updated figures are published over the next months, it will become increasingly evident whether the UK economy’s need for UK government-supported debt facilities will grow, subside or remain steady; how much finance businesses continue to require; and how successful their applications are. The ultimate stocktake of these Schemes, however, is likely still some time away, once the medium- to long-term economic effects of the pandemic crystalize.


[1] UK government, ‘HM Treasury coronavirus (COVID-19) business loan scheme statistics’, June 16, 2002, <https://www.gov.uk/government/collections/hm-treasury-coronavirus-covid-19-business-loan-scheme-statistics#history>.
[2] Companies that borrow more than £50 million through CLBILS are subject to certain restrictions. These restrictions include: (i) no dividend payments to be made other than those that have already been declared; (ii) no share buybacks; and (iii) no cash bonuses, or pay raises, to senior management and/or directors except in certain limited and specific cases.
[3] All figures from UK government, ‘HM Treasury coronavirus (COVID-19) business loan scheme statistics’, June 16, 2002, <https://www.gov.uk/government/collections/hm-treasury-coronavirus-covid-19-business-loan-scheme-statistics#history>.
[4] “Private equity-owned companies miss out on bailout loans”, Financial Times, May 19, 2020.
[5] Please see a future “Insight” to be published on https://covid19.orrick.com/UK/ for further discussion on this topic.
[6] Kenneth Michlitsch, ‘An introduction to alternative lending’, Morgan Stanley Insights, May 20, 2020, <https://www.morganstanley.com/im/en-us/financial-advisor/insights/investment-insights/an-introduction-to-alternative-lending.html>; Funding Circle, ‘What is alternative lending’, February 26, 2019, <https://www.fundingcircle.com/us/resources/alternative-lending/>.
[7] Victor Chatenay, ‘Four new alt lenders have been accredited under the Coronavirus Business Interruption Loan Scheme’, Business Insider, May 11, 2020, <https://www.businessinsider.com/four-alt-lenders-approved-for-cbils-2020-5?r=DE&IR=T>.
[8] British Business Bank, ‘CBILS – current accredited lenders and partners’, <https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-scheme-cbils-2/current-accredited-lenders-and-partners/>, accessed June 20, 2020.
[9] British Business Bank, ‘CLBILS – current accredited lenders and partners’, <https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-schemes/bounce-back-loans/current-accredited-lenders-and-partners/>, accessed June 20, 2020.
[10] British Business Bank, ‘CLBILS – current accredited lenders and partners’, <https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-schemes/clbils/current-accredited-lenders-and-partners-2/>, accessed June 20, 2020.
[11] SME Finance Forum, ‘MSME finance gap’, <https://www.smefinanceforum.org/data-sites/msme-finance-gap>, accessed June 20, 2020. 

Tecnicas Reunidas Saudia v The Korea Development Bank: UK HC Considers Demand Guarantees

 

In the recent case of Tecnicas Reunidas Saudia (TRS) v The Korea Development Bank (the Bank), for which the judgment was published last week, the High Court, Queen’s Bench Division (Technology and Construction Court (the TCC)) considered a demand guarantee executed by the Bank in favor of TRS, which formed part of an agreement around certain advance payments made by TRS to a subcontractor.

It is generally recognized that calling on a demand guarantee is a serious step and is therefore not one to be taken lightly. However, as the negative economic impact of COVID-19 continues, parties who would have hesitated to make a call previously may find themselves with no option but to do so in the circumstances. The only real defense is known as the fraud exception (i.e. where there is a fraudulent claim and the issuer knows that the demand is fraudulent), which is extremely difficult to establish. Despite some other jurisdictions taking steps to gradually widen this narrow exception to include aspects of unconscionability, the English courts have yet to do so. This case reiterates the position that if a claim is made under a demand guarantee, payment will be enforced by the English courts save in very limited circumstances.

Background

TRS was engaged by Saudi Aramco to execute two EPC contracts for the Fadhili Gas Plant in Saudi Arabia, a multibillion-U.S.-dollar project designed to process 2.5 billion cubic feet a day of gas from the Hasbah and Khursaniyah fields. TRS engaged as a subcontractor Sungchang & Abdullah Al-Shaikh Contracting Co. Ltd. (Sungchang). In October 2017 TRS paid Sungchang an advance payment, after Sungchang provided TRS with a demand guarantee executed by the Bank, by way of security. In October 2019 TRS terminated its engagement of Sungchang, and in December TRS demanded payment from the Bank under the demand guarantee.

TCC Hearing & Judgment

Before the TCC, the Bank argued that it rejected TRS’ right to be paid on the basis that it was a condition of the demand guarantee that TRS’ advance payment to Sungchang had been paid into a numbered account held with HSBC Bank (the HSBC Condition). The HSBC Condition provided that “It is a condition for any claim and payment under this guarantee … that the funds paid in advance payments subject to the terms of the subcontract must have been received by the sub-contractor on its account number … held with HSBC.”

The advance payment funds had been paid to that bank account, but it was not a HSBC bank account as such. It was a Saudi British Bank account, associated with HSBC and 40% owned by HSBC Holdings, as there was no HSBC presence as such in Saudi Arabia, using the account number provided.  

The defendant contended that even if the advance payment had been made by the claimant, it had not been made to a HSBC account with the relevant account number but rather at the Saudi British Bank, therefore the HSBC condition had not been fulfilled.

Nevertheless, the TCC found in favour of TRS and held that as a matter of interpretation, the HSBC Condition referred to an account held with a branch of HSBC or a bank associated with HSBC.  Mr. Justice Waksman held that the court would strive for an interpretation that was open to it on the words of the guarantee and that would avoid pointlessness or absurdity. Rather than limit the expanded version of the condition to a branch of a bank trading as HSBC, it should be a bank or a branch of a bank ‘trading as HSBC or associated with HSBC.’ The bank where the advance payment had been paid – the Saudi British Bank – was a bank associated with HSBC, and alternatively, that “HSBC Bank” was a misnomer for Saudi British Bank.

Additionally, Mr. Justice Waksman noted, if the position had been as contended for by the Bank, then a very odd result would occur. It would mean that the guarantee had been worthless from the moment that it had been executed. That was because, on the Bank’s case, the HSBC condition could never have been complied with, even though payment had been made to a bank account with that number and to the only domestic bank associated with HSBC in Saudi Arabia. The interpretative approach had to be one that recognized that one interpretation would not merely be commercially risky or commercially disastrous for a party, but it would also mean that there was no point in the document at all.

The TCC also proceeded to consider two alternative arguments raised by TRS based on the Uniform Rules for Demand Guarantees (URDG) (which the guarantee incorporated) – (i) non-documentary conditions and Article 7 URDG and (ii) rejection formalities and Article 24 URDG. While obiter, as the decision had already been made on interpretation grounds, the considerations are nonetheless of general relevance.

Article 7 of the URDG provides that:

  • “A guarantee should not contain a condition other than a date or the lapse of a period without specifying a document to indicate compliance with that condition. If the guarantee does not specify any such document and the fulfilment of the condition cannot be determined from the guarantor’s own records or from an index specified in the guarantee, then the guarantor will deem such condition as not stated and will disregard it except for the purpose of determining whether data may appear in a document specified in and presented under the guarantee do not conflict with data in the guarantee.”

Justice Waksman held that, as the Guarantee did not specify a document that TRS was required to submit to demonstrate that the advance payment had been paid into the correct account, the HSBC condition was a non-documentary condition that should be disapplied pursuant to Article 7 of the URDG. This is the first English judgment that considers the operation of Art. 7, which is incorporated into many of the demand guarantees.  Some doubt had previously been cast on how a provision incorporated by reference (like Art. 7) could operate so that a specifically agreed non-documentary condition should be disregarded.

Article 24 of the URDG provides that:

  • “d. When the guarantor rejects a demand it shall give a single notice to that effect to the presenter of the demand. The notice to that effect shall state:
  • i. that the guarantor is rejecting the demand, and
  • ii. each discrepancy for which the guarantor rejects the demand.
  • e. The notice required by paragraph (d) of this article shall be sent without delay but not later than the close of the fifth business day following the day of presentation.
  • f. A guarantor failing to act in accordance with paragraphs (d) or (e) of this article shall be precluded from claiming that the demand and any related documents do not constitute a complying demand.”

TRS presented its demand in person but, when the Bank rejected TRS’ demand, it did so initially by way of a SWIFT message sent to BNP (the advising bank, acting for TRS). The rejection was notified to TRS the following day, outside the five business day period allowed by Article 24. Therefore, the Bank’s notice of rejection was not sent within 5 business days of TRS’ demand to TRS as the presenter of the demand, pursuant to the time bar provision in Art. 24(d) of the URDG, and the Bank was precluded from claiming that the demand was non-compliant.

The Bank was ordered to pay the full value of an on-demand guarantee of £8.2 million, plus interest and costs.

Comment

It is likely that the COVID-19 pandemic will result in more calls being made pursuant to demand guarantees, both domestically and internationally and, as such, cases like the above may well be seen more frequently in the coming months. Parties who have provided demand guarantees, or been given them, will need to be more sensitive than ever to the circumstances in which they can be called, and the clear limitations placed on resisting their calls under English law.

The judgment also poses some interesting questions regarding whether conditions regarding payment are capable of applying where they are not stipulated within the documentary requirements of the guarantee. Previous English cases where the URGD does not apply suggest that conditions that do not expressly carry documentary requirements may give rise to an implication that the fulfilment of the condition needs to be confirmed. However, where the URDG does apply, a tension may arise between these cases and the requirement in Article 7 for operative conditions to “specify” documentary requirements. Additionally, with respect to the obiter consideration of Article 24, and in particular its strict interpretation, parties should ensure that the correct “presenter” of a demand is identified and not merely assume that a rejection sent to the notifying bank will be sufficient. 

Future Fund Goes Live

 

The UK Government’s Future Fund, a co-investment initiative to help UK start-ups, is now live and accepting applications.

Under the scheme, which was announced on April 20, the government will provide convertible loans ranging from £125,000 to £5 million to certain UK-based high-growth innovative companies, subject to at least equal match funding from private investors, and will be managed by the British Business Bank (BBB). This means that the minimum loan to a company is £250k with no maximum, since there is no upper limit on the amount that additional investors may co-invest.

There is no requirement for a company to make regular repayments, and the intention is that the loans will be converted into equity at a discount at the next funding round or after three years.

BBB states on its website that “the Future Fund uses an online platform based on a recognized financial instrument, and a set of standard terms with published criteria. This allows investors to provide rapid support to the companies where they see good potential. Importantly, it provides a clear, efficient way to make funding available as widely and as swiftly as possible without the need for lengthy negotiations.”

Although the Future Fund is capped at £250m of state money, Rishi Sunak, the chancellor, indicated this week that he would be “more than happy” to extend the scheme should demand outstrip the initial funds allocated.

The government’s Future Fund page includes the template convertible loan agreement for applicants. Applications for the scheme can be made on the British Business Bank’s Future Fund webpage, which also has detailed information about the scheme.

The Future Fund program is investor-led. An application on the platform is initiated by a lead investor who will provide information about itself, other investors in the round and the company. If an application is successful, the platform will generate documentation for the company and all investors to sign.

Unlike equity investment, there is no requirement under these convertible loans to value the company, which helps speed the process at a time when company valuations have been significantly hit by COVID-19. Applications are submitted through the BBB portal, the process for which takes approximately 21 days.

These convertible loans may be a suitable option for businesses that typically rely on equity investment and are unable to access other government business support programmes because they are either pre-revenue or pre-profit. The financing supports companies are facing a significantly extended length of time between funding rounds, due to the impact of the current economic situation.

Start-ups are eligible for the Future Fund if:

  • it is UK-incorporated. If the business is part of a corporate group, only the parent company is eligible[1];
  • it has raised at least £250,000 in equity investment from third-party investors in the last five years;
  • none of its shares are traded on a regulated market, multilateral trading facility or other listing venue;
  • it was incorporated on or before December 31, 2019; and
  • (i) half or more employees are UK-based or (ii) half or more revenues are from UK sales.

Participation in the Future Fund scheme will not negatively impact enterprise investment scheme (EIS) investments in a company. Whilst EIS investors are not precluded from participating in the Future Fund scheme and triggering matched investment from the Future Fund, they will not be able to obtain EIS relief on such investment through the Future Fund scheme and may lose their entitlement to make future EIS investments in that company going forward.

Further information concerning eligibility, matched funding requirements, headline economic terms, governance terms and the application process is available here.

The Future Fund is part of a wider package of support for UK businesses suffering liquidity or other financial problems caused by the COVID-19 pandemic. Other measures include:

  • £750 million of targeted support for SMEs will be available through the national innovation agency, Innovate UK’s grants and loan scheme. The first payments will be made by mid-May.
  • The HM Treasury and Bank of England COVID Corporate Financing Facility (CCFF), which will provide funding to sound businesses by purchasing commercial paper of up to one-year maturity, issued by firms making a material contribution to the UK economy.
  • The Coronavirus Business Interruption Loan Scheme (CBILS). This a temporary scheme, which is being delivered by the British Business Bank via its accredited lenders (including high-street banks, challenger banks, asset-based lenders and smaller specialist local lenders). It aims to support businesses with an annual turnover of no more than £45 million access bank lending and overdrafts. A lender can provide up to £5 million in the form of term loans, overdrafts, invoice finance and asset finance.
  • The Coronavirus Bounce Bank Loans (BBL) for small businesses launched on May 4. Under this scheme, businesses will be able to borrow between £2,000 and £50,000 from accredited lenders. The government will provide lenders with a 100% guarantee for approved BBLs and pay any fees and interest for the first 12 months. No repayments will be due from the borrowers during that period. After the initial 12-month interest-free period, a flat rate of 2.5% interest will be charged. A business that has already taken out a loan under the CBILS of £50,000 or less can switch that loan to the BBLS until November 4.
  • The Coronavirus Large Business Interruption Loan Scheme (CLBILS). Under this scheme, the government will guarantee 80% of loans of up to: (i) £25 million to firms with an annual turnover of more than £45 million; and (ii) £50 million for firms with an annual turnover of more than £250 million. From May 26, the maximum loan will be increased to £200 million. Those borrowing more than £50 million will be subject to certain restrictions on dividend payments, share buybacks and executive pay for the duration of the loan.

[1] There have been indications that an exemption will be applied to the criterion that the applicant must be UK incorporated for companies that have ‘flipped’ to another jurisdiction (possibly U.S. or EU only) in order to be able to participate in an accelerator program, such as Y-Combinator. Confirmation of this and details are awaited.

Financial Measures Recently Introduced as a Result of COVID-19

 

Background and Context

On March 9 and 10, The Financial Policy Committee (“FPC“) met to discuss developments since its meeting on October 2, 2019 and the consequences of Covid-19.

Questions have arisen as to how the government, individuals and businesses can respond to the potentially devastating economic effects resulting from the expanding spread of the Covid-19 and the social lockdowns that are being implemented. In the summary and record of these meetings (available here), it is stated that:

“the FPC has taken action to respond to the financial stability risks associated with the economic disruption resulting from Covid‑19. These actions, taken in concert with actions taken by the Bank, the Monetary Policy Committee (MPC) and the Prudential Regulation Committee (PRC), have sought to reduce pressure on banks to restrict the provision of financial services, including the supply of credit and support for market functioning, and ensure that the financial system can be a source of strength for the real economy during this challenging period.”

The actions referred to above include the Bank of England’s (“BoE“) new Term Funding Scheme and the Covid Corporate Financing Facility.

Term Funding Scheme (“TFSME”)

Objective

This scheme was announced by HMRC on March 11 and seeks to ensure that the benefit of the cut in the bank rate is passed on to the economy. It aims to increase the availability of funding for banks which, in turn, will increase the amount available for lending, especially to small and medium sized enterprises.

By offering four-year funding at (or close to) the BoE’s bank rate, the TFSME seeks to “incentivize banks to provide credit to businesses and households to bridge through a period of economic disruption and provide additional incentives for banks to support lending to SMEs that typically bear the brunt of contractions in the supply of credit during periods of heightened risk aversion and economic downturn.”

Interest charged by the BoE will be equal to the bank rate plus a Scheme Fee, which is determined at the end of December 2020 based on the total net lending.

Eligibility

To qualify, the banks and building societies in question must be participants in the BoE Sterling Monetary Framework and signed up to access the Discount Window Facility. Further information on these tools is available here.

Participants will be able to make drawdowns during the Drawdown Period which will run from April 27, 2020 to April 30, 2021 and are to provide Net Lending Data in a form specified by the BoE on a quarterly basis.

Further information from the BoE is available here.

Covid Corporate Financing Facility (“CCFF”)

The CCFF aims to provide additional help to firms “to bridge through Covid‑19 related disruption to their cash flows.” It is to operate for 12 months and may continue as long as is required in order to help alleviate cash flow pressures.

Form of Assistance

Information made available by the BoE (here) explains that this is to take place by way of the purchase of short term debt in the form of commercial paper – an unsecured debt instrument issued by the company in question.

The commercial paper will be purchased under this facility (by the BoE through Covid Corporate Financing Facility Ltd) with the following characteristics:

  1. maturity of one week to twelve months;
  2. a credit rating of A-3 / P-3 / F-3 / R3 from at least one of Standard & Poor’s, Moody’s, Fitch and DBRS Morningstar as at March 1 2020 (where available); and
  3. issued directly into Euroclear and/or Clearstream,

Eligible Companies

It is explained by the BoE that to qualify under this facility, companies should be UK incorporated (including those with foreign-incorporated parents and with a genuine business in the UK), have significant employment in the UK or have their headquarters in the UK, although the BoE will also have regard to the amount of revenue generated in the UK and the number of customers based in the UK.

Importantly, and in addition to the above, companies wishing to benefit from the CCFF must demonstrate that it was in sound financial health immediately prior to the shock arrival of Covid-19. The BoE explains that the easiest way to demonstrate this is to have or acquire a rating which is either a short-term rating of A3/P3/F3/R3 or above, or a long-term rating of BBB-/Baa3/BBB- or above by at least one of the major credit ratings agencies.

Where the company does not have a credit rating, its bank should contact one of the major agencies to seek an assessment of credit quality. This should then be shared with the BoE and HM Treasury.

The names of issuers and securities purchased or eligible will not be made public.

Legislative Changes and Regulated Activities

With regards to the implementation of this facility, the Financial Services and Markets Act 2000 (Exemption) (Amendment) Order 2020 was published on 20 March 2020. This amends the list contained in Part 1 of the Schedule to the Financial Services and Markets Act 2000 (Exemption) Order 2001 such that Covid Corporate Financing Facility Ltd is exempt from the general prohibition contained in section 19 of the Financial Services and Markets Act 2000 (which prohibits the performance of regulated activities in the UK unless carried out by an authorized or exempt person).

Preparing for Brexit’s Impact on Capital Market Operations in the United Kingdom

 

Overview

The United Kingdom made headlines when it voted to leave the European Union in June 2016. Popularly named “Brexit”, the move began a tumultuous four-year voyage that seemingly came to completion on January 31, 2020 when the UK’s withdrawal became official. However, as many are coming to realise, the nation is just now beginning to face some of its biggest challenges yet.

While the UK may be officially out of the EU, the European Union Withdrawal Agreement Act of 2020 (EUWA) called for a transitory implementation period that will end on December 31st of this year. Until that deadline, the UK will largely be treated as a Member-state of the EU while trade negotiations are underway. However, the agreement period largely prevents an extension beyond the fast-approaching 11-month deadline, making this the country’s last chance at striking a satisfactory trade deal with the EU.

The EUWA currently provides that directly applicable and operative EU laws such as the Market Abuse Regulation, the Transparency Directive, and the Prospectus Regulation will be converted into UK law at the end of the year. However, this does not amount to a workable level of certainty, in that such regulation, once converted, would be exposed to domestic revision or amendment.

Impact on Capital Market Regulation

The potential failure to achieve a trade deal presents particularly significant issues concerning, firstly, the “passporting” system (i.e. the system that enables banks and financial services firms that are authorised in any EU or EEA state to trade freely with minimal regulatory oversight – thereby serving as the foundation of the EU single market for financial services) and, secondly, the creation of a new EU Capital Markets Union, of which the UK has traditionally been a strong supporter.

More specifically, the UK will no longer be a part of the EU’s single-market system and will be treated as a third-party country lacking passporting or equivalence rights in the EU. This could be detrimental to both the EU, who relies on UK’s economic activity to bring revenue into the EU, and for the UK, a hub for international transactions instigated by firms that capitalise on the minimal red-tape requirements made possible by the Capital Markets Union. Abdication of the passporting and equivalence practices in the UK could particularly affect instances where there are lower numbers of retail investors in more than one Member State, as individual approvals would be required in each such Member State due to the absence of said practices.

What Practitioners Need to Know

As it stands, the presumption is that the UK will be considered a third-party country at the end of the implementation period. Consequently, some UK firms with operations in the EU are relocating to EU member-states (or are considering doing so) in order to preserve their passporting rights. EU regulators and supervisors are monitoring this activity, and it is important for professionals at every level to stay updated on the various guidelines and resources released by authorities to assist practitioners during the transition period.

With the potential failure to achieve a free trade deal still on the table, businesses and their advisors need to be prepared to reckon with its consequences. For example, the European Central Bank has been pressuring banks to accelerate their Brexit strategy plans and implement a substantial portion of its policies by the time the withdrawal deadline occurs. If firms cannot rely on regulatory equivalence, firms may have to incur significant costs that could affect their financial stability, hence why they should be considering potential mitigating mechanisms to counteract such effects.

Furthermore, on February 4, 2020, the Statutory Auditors and Third Country Auditors published their regulatory amendments to address deficiencies of retained EU law arising from the withdrawal of the UK from the EU in relation to the regulatory oversight and professional recognition of statutory auditors and third country auditors in the UK. In addition to updating the adequacy standards of nations such as China and South Africa, the amendments also provided an assessment framework for the equivalence of third countries’ audit regulatory frameworks and enabled the audit exemption currently available to subsidiaries of UK and EEA parent undertakings to continue to be available to those subsidiaries where their financial years have already begun.

While players across the board are giving their best efforts to deliver a smooth and fair transition of the UK out of the EU, only time will tell how complicated and contentious the terms of such transition will be. With or without a free trade arrangement, it is especially important for financial professionals, attorneys, and other advisory professionals to be vigilant in their assessment of regulatory developments as they are released.

The Continued Rise of Sustainable Finance in the UK and EU

 

The present and future impacts of climate change, human rights violations, environmental, labor and regulatory violations and poor corporate governance on the quality of investments and credit risks have spurred widespread recognition for the importance of environmental, social and governance (ESG) considerations in lending and investment activities.

The rapid development of the sustainable finance sector seen in 2019 has continued into 2020. “Sustainable finance” is a very broad term, but in short, it is any form of financial service and/or product which integrates ESG criteria into business, financing or investment decisions. The financial markets are now starting to possess a range of tools in the “sustainable finance” space.

The value ascribed to robust ESG credentials also continues to grow. Companies and financial institutions are increasingly seeking ways in which they can conduct business in an environmentally-conscious manner and minimize ESG risks. Attention is coming from all sides – from activists such as Greta Thunberg; from regulators, with Mark Carney recently pronouncing on the integration of climate-related financial risks into day-to-to-day supervisory work of the regulators of the financial sector; and from investors such as BlackRock. Also, in the “BNP Paribas ESG Global Survey 2019” 78% of respondents stated that ESG is either playing a growing role or becoming integral to what they do as an organization (including in respect of what they investor in and/or who they lend to).

With the focus on sustainability and ESG only increasing, the appetite for sustainable finance products is set to continue to increase in 2020 and beyond.

Rise in Popularity of Sustainability-Linked Debt Products

There have always been compelling environmental reasons for sustainability-linked financial products and yet it is only recently that the economic rationale for such investments has come to the forefront. 2019 was a record year for sustainable finance, with more sustainable debt issued globally than ever before. The total raised was US$465bn globally, up 78% from US$261.4bn in 2018, according to Bloomberg data.

The key instruments from a pure financing perspective currently appear to be “Green Loans/Bonds” and “Sustainability-Link Loans/Bonds”.

It is important to know that “Green Loans/Bonds” and “Sustainability-Link Loans/Bonds” are different.

  • “Green Loans/Bonds” use the proceeds of such instruments to finance green projects or related capital expenditure (e.g. renewable power generation, carbon reduction and waste reduction).
  • “Sustainability-Link Loans/Bonds” do not have a dedicated use of proceeds and are not linked to green projects or green business (more flexible than “Green Loans/Bonds” but nevertheless, a good way for a company to demonstrate its ESG credentials). Rather, they include performance criteria linked to sustainability or ESG criteria/targets. Such criteria/targets can be measured by way of a general ESG rating or specific agreed criteria/targets. If the borrower hits the relevant sustainability or ESG criteria/targets, the loan will be cheaper. Recent deals have also adapted a two-way pricing structure, with the price of the loan increasing if the borrower fails to meet its ESG targets, further incentivizing the borrower to meet its ESG targets.

However, “Sustainability-Link Loans” are a relatively recent development in Europe. For example, it was reported that:

  • in May 2019, Masmovil Group, the Spanish telecom operator, was the first European borrower to include an ESG-linked margin ratchet in leveraged loan facilities, being a 15 basis point pricing adjustment linked to its third party ESG score (but noting that the pricing adjustment only applied to the capex and revolving credit facilities and not the much larger term loan debt); and
  • in December 2019, Jeanologia, a Spanish developer of eco-efficient technologies for the apparel & textile industry, completed the first sponsor-backed (Carlyle) ESG-linked term loan. The margin is directly linked to a sustainability performance indicator produced by the borrower, related to its water-saving processes. If the borrower meets its targets, the margin tightens, while if the target is missed by 15% or more, the margin ratchets upwards.

In addition, the Loan Market Association (LMA) published the Sustainability Linked Loan Principles (SLLP) in March of 2019, which provide suggested criteria for setting and monitoring sustainability targets of “Sustainability-Link Loans”. The criteria are meant to be ambitious and meaningful to the borrower’s business. The metrics vary and there is no market standard, from ESG scores (provided by third party ESG rating agencies) to borrower led / specific targets (as seen in the examples above). As such, the SLLP recommend they should be negotiated on a deal-by-deal basis. However, on a related point, the European Leveraged Finance Association (ELFA) has started, together with the LMA, to engage with borrowers, private equity sponsors, arrangers, rating agencies and others in order to develop a standard set of the most relevant disclosures for the purpose of making informed ESG-related investment decisions.

Legislative Change on the Horizon

There are many legislative changes on the horizon in relation to the development of robust sustainable lending products and sustainable finance more generally. These include: (i) the Taxonomy Regulation, which is expected to be formally adopted, introducing an EU-wide classification of environmentally sustainable activities; (ii) the Disclosure Regulation (main provisions coming in to force from March 2021), which will impose new transparency and disclosure obligations on certain firms; (iii) the Low Carbon Benchmark Regulation, effective as of December 10, 2019, which will continue to set out minimum requirements for EU climate transition benchmarks and ensure that these benchmarks can work alongside other pre-existing ESG objectives; and (iv) the development of technical standards by the ESMA on disclosure provisions for sustainable investments during 2020. From an investor/lender perspective, the Disclosure Regulation (noted at (ii) above) will be key, as it will require certain firms, including asset and fund managers, to comply with new rules on disclosure, as it regards to sustainable investments and sustainability risks.

Furthermore, it was reported this week that the current European Commission is prioritizing climate change in all sectors, including in financial services. An update to the law known as the “Green Taxonomy” would require banks, insurers, and listed companies with more than 500 staff members to report how much of their expenses are put towards environmental initiatives such as reduction of greenhouse-gas emissions. In a quest to widen its net, the European Commission is hoping to broaden the scope of the non-financial reporting even further in the legal proposal that is due by the end of 2020. The proposal likely seeks to cover asset managers, as well as large unlisted companies. Although some unlisted companies, such as Ikea, already do produce voluntary reports on sustainability, these new requirements may come less favorably to those companies seeking to avoid higher reporting burdens by staying off the public markets or to companies headquartered in more climate-skeptic countries.

Although changes to the regulatory capital treatment of sustainability linked debt are in contemplation at both a European and UK level, they are in their infancy. Currently, the focus of regulators appears to be on driving a conscious governance and disclosure framework and on integrating ESG risks into the management policies of regulated firms.

Recent Reports and Strategy Statements

Several reports and strategy statements have been published in recent weeks by a variety of prominent industry regulators and trade bodies in respect of ESG. Some highlights include:

The European Securities and Markets Authority (ESMA) published its Strategy on Sustainable Finance on February 6, 2020, setting out how ESMA will prioritize sustainability by embedding ESG factors in its work. The key priorities for ESMA include transparency obligations, risk analysis on green bonds, ESG investing, convergence of national supervisory practices on ESG factors, taxonomy and supervision. Steven Maijoor, Chair, said: “The financial markets are at a point of change with investor preferences shifting towards green and socially responsible products, and with sustainability factors increasingly affecting the risks, returns and value of investments. ESMA, with its overview of the entire investment chain, is in a unique position to support the growth of sustainable finance while contributing to investor protection, orderly and stable financial markets.”

The Investment Association (IA), the trade body that represents UK investment managers, published its Shareholder Priorities for 2020 report in January of this year. In the report, the IA noted its support for the recommendations made in the Green Finance Strategy released in early July 2019 by the UK government. Such recommendations set out two objectives: 1) to align private sector financial flows with environmentally sustainable growth that is supported by government action; and 2) to increase the competitiveness of the financial sector in the UK.

The UK Sustainable Finance and Investment Association (UKSIF) published a report on February 6. The report found that pension scheme trustees are failing to comply with their investment duties. Following a change to the law in 2019, trustees must publish their approach to protecting people’s pension savings from the financial risks of climate change and other ESG issues. UKSIF report: 1) found that only one third of a representative sample of trustees have complied with the legal transparency requirements and are calling for the Pensions Regulator to carry out a review to investigate levels of compliance across the UK’s pensions sector; and 2) looked at the different policies trustees have adopted to comply with the new regulations. It found that although most trustees say they believe ESG issues will affect the financial performance of their scheme’s assets, most trustees have adopted “thin and non-committal” policies to manage ESG financial risk.

Summary

In short, ESG is no longer a peripheral exercise thanks to investor demand, regulation and greater certainty about the link between ESG risks and long-term financial performance. And as noted above, the focus on sustainability and ESG is only increasing.

The EU’s Whistleblowing Directive

 

On November 26, Directive (EU) 2019/1937 of the European Parliament (EP) and of the Council of October 23 (the “Directive“) on the protection of persons who report breaches of Union law was published in the Official Journal.

Background

In light of recent information scandals including Cambridge Analytica, the Panama Papers and Luxleaks, the European Commission (EC) sought to introduce a unified measure granting protection to persons who report breaches of Union Law. These scandals have highlighted how crucial whislteblowers can be in uncovering unlawful activities, and the European Union (EU) has introduced the Directive to strengthen the enforcement of Union law and protect the freedom of expression of the whistleblower when interviewed on this topic, as explained by Maria Mollica, the EU Commission’s Policy Officer. While various Member States have addressed whistleblower protection in their own national legislation, the protection is often restricted to specific areas and thus the Directive attempts to unify and harmonize the approach taken by all Member States.

The Directive

Protection is afforded to whistleblowers to the extent they fall within the definition of “reporting person,” a natural person who reports or publicly discloses information on breaches acquired in the context of his or her work-related activities (Article 5(7)). In turn, this disclosure extents to information “including reasonable suspicions, about actual or potential breaches, which occurred or are very likely to occur in the organization in which the reporting person works or has worked or in another organization with which the reporting person is or was in contact through his or her work, and about attempts to conceal such breaches.” “Breaches” refers to any act or omission that is unlawful and relate to the Union or defeat the object or purpose of the rules in the Union (Article 5(1) and (2)).

It applies to businesses which employ at least 50 employees and they are required to implement internal channels to facilitate the reporting.

In terms of its scope, the Council of the European Union (EUCO) explains in a press release that “the new rules will cover areas such as public procurement, financial services, prevention of money laundering, public health, etc. For legal certainty, a list of all EU legislative instruments covered is included in an annex to the directive.” Further, regarding the protection awarded to reporting persons, it is stated that “the rules introduces safeguards to protect whistle-blowers from retaliation, such as being suspended, demoted and intimidated. Those assisting whistle-blowers, such as colleagues and relatives, are also protected. The directive also includes a list of support measures which will be put in place for whistleblowers.”

Next Steps

On November 26, the directive was published in the Official Journal and it will enter into force on December 16. Member States then have two years from that date to implement its terms and transpose its requirements into national legislation. Press Release. Legislative Text.

Securitization Regulation – Updates to the Questions and Answers by the European Securities and Markets Authority

 

On November 15th, The European Securities and Markets Authority (ESMA) published a new and updated version of its Questions and Answers in respect to the Securitization Regulation. 

The refreshed Questions and Answers provide direction on disclosure requirement in relation to ESMA’s draft technical standards, amongst other things. Questions and Answers.

 

Commission Delegated Regulation on Changing the Base Euro Amounts for Professional Indemnity Insurance

 

The Regulation varies the base amounts in Euros (see Article 10(4) as well as (6)) of the Insurance Distribution Directive) by 4.03%, i.e. the percentile changes in the index of consumer prices (Europe).

It should be noted that the Commission Delegated Regulation is coming into force on December 12. However, the Regulation will be operational and applied from June 12, 2028. As such, MS have half a year after its entry into force to adapt national legislation. Furthermore, the six months gives MS time to enable and allow insurance (and reinsurance) intermediaries and their insurance providers time to implement the steps necessary to ensure compliance. Commission Delegated Regulation.