Kramer Levin Naftalis & Frankel LLP

The Financial Stability Board (FSB), an international body established in 2009 to implement and promote effective regulatory, supervisory and other financial sector policies, issued its most recent annual Global Monitoring Report on Non-Bank Financial Intermediation 2018 (FSB 2018 Report) on Feb. 4, 2019.

The FSB has been conducting an annual monitoring exercise since 2011. The most recent report, the FSB 2018 Report, covers data through year-end 2017 and encompasses 29 jurisdictions, which together represent over 80 percent of global GDP.

In October 2018, the FSB estimated approximately $1.4 trillion in institutional leveraged loans (i.e., loans held by non-banks) to be outstanding globally. If amounts held by banks on balance sheets are included, this estimate increases to $2.2 – 2.4 trillion, with such amounts further increased if undrawn amounts are accounted for. FSB noted that the leveraged loan market has grown significantly in an environment of low interest rates and lenders’ willingness to extend loans with fewer credit protections (i.e., “covenant-lite” loans). The FSB noted that lower-yield interest rate spread, lower credit protection and increased leverage ratios suggest that risk levels relative to returns may have increased for investors.

Within this environment, the FSB also noted that non-bank financial intermediaries (CLOs, private equity funds, retail and other investment funds, etc.) are becoming influential market players. Not only have these entities provided an increasingly large share of financing in the leveraged loan market globally but they have also expanded the mechanisms employed to provide such funding to the extent that they are taking on traditional bank roles. For instance, some non-bank entities have provided what are considered typical bank services, including syndicating term loans. Similarly, affiliates of private equity funds are also acting as institutional lenders.

The FSB suggests that these structural changes, increased leverage ratios and weakened underwriting standards may indicate that non-banks are more vulnerable to economic downturns and liquidity stress. Given that non-banks purchase the majority of leveraged loans in the primary market, they have greater exposure to potentially adverse market developments. As such, the FSB concludes that developments in the leveraged loan market warrant close monitoring as they raise concern for spillovers to other markets. The FSB further concludes that these developments, together with the complexity and lack of transparency of the leveraged loan market, warrant consideration of enhancing information collection in order to have a clearer view of the market and its risks.

This suggestion to enhance information collection may indicate a desire on the part of regulators to require information and disclosures by heretofore unregulated lenders/non-banks to better assess global risk.

The full report can be found here.

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