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Rosali Pretorius, a partner at Dentons, advises that loan agreements were not intended to fall within the definition of ‘specified investments’ in the Financial Services and Markets Act 2000 (FSMA 2000) (Regulated Activities) Order 2001 (RAO), and doubts that Fons HF (in liquidation) will be the last word on the subject.
A letter to the Treasury from the City of London Law Society (CLLS) asks for clarification on the meaning of a loan agreement, and whether it falls within the meaning of debenture, following a recent Court of Appeal case which has caused uncertainty in the law and is causing confusion in the loan market. The CLLS is seeking clarification that HM Treasury is not treating loan agreements as debentures, and that these activities are not intended to be regulated activities.
The Court of Appeal in Fons HF (in liquidation) v Corporal Limited and Pillar Securitisation S.a.r.l. and another  EWCA Civ 304,  All ER (D) 215 (Mar) held that the loan agreements were debentures because they ‘created or acknowledged debt’ and even went as far as to state that a loan agreement which is undrawn at the time it is signed can create or acknowledge debt. Prior to this decision it had been generally acknowledged by practitioners and academics that a loan agreement did not create or acknowledge a debt. It had been thought that a loan agreement sets up the contractual mechanics for the debt to arise, but until the loan has been drawn down in accordance with those mechanics there is no debt in existence. However, according to Gloster LJ, this approach is ‘unnecessarily technical’ and the debt ‘clearly arises on execution of the loan instrument itself, albeit that such obligation may be contingent on drawdown actually taking place’.
I do not agree with the judgment. I don’t think a debt necessarily arises on the execution of a loan agreement, for the reasons described above. You mention that loan agreements could be caught under RAO, art 77 as a result of the decision. I would agree that if loan agreements are debentures, they could be caught under the RAO. But it is important to remember that the decision does not address the RAO at all, and therefore, this decision cannot create a binding precedent for interpreting the RAO. Other factors support the view that loan agreements were not intended to fall within the definition of ‘specified investments’ in the RAO, I therefore doubt that this judgment will be the last word on the subject. However, it does create some uncertainty, which I understand has been raised with HM Treasury.
Given that the FSA’s historical viewpoint was that the loan or loan facility agreement did not constitute a financial instrument under RAO, art 77, have either the FCA or Prudential Regulation Authority (PRA) said anything about the judgment?
Not that I am aware of. However, there is precedent for disagreement between the court and the FCA on the perimeter. When in Watersheds Ltd v (1) David Da Costa (2) Paul Gentleman  All ER (D) 140 (Feb), it was suggested that activities that the regulator considered to fall within the RAO in fact fell outside it (so the opposite to the Fons problem in that respect), the FCA commented that:
‘It appears to the FCA that the judgement should be considered in the light of the case to which it relates. Also, the court does not seem to have had the benefit of a relevant argument.’
The same logic could apply here, as the court did not even mention FSMA 2000, nor does it appear that counsel referred to the generally accepted view in the loan market.
I would be surprised if the PRA and FCA would start to prosecute for breaches of the perimeter purely as a result of the Fons decision. In any event, even if loan agreements were ‘specified investments’, many aspects of lending and borrowing under loan agreements are likely to benefit from exclusions which would make authorisation unnecessary for that type of activity.
I think that this is most likely to affect unregulated lenders in the shadow banking sector dealing in the secondary market for loans and intermediaries arranging and advising on loans. Bank lenders are already authorised. Most borrowers should be able to rely on one or more of the exclusions from the dealing as principal activity. There is also an exclusion for those acknowledging debt when they are the lender, which may help an unregulated lender in the primary loan market.
Many commercial loan market intermediaries are unregulated. They would be likely to carry on the regulated activities of arranging deals in investments and investment advice (and, potentially, dealing as agent in investments). There are potentially exclusions for certain of the arranging activities (but these are not certain to be effective), and there are no apparent exclusions for any advisory activity.
Yes, there are queries being raised by the main bank lenders in the market. HM Treasury has the power under FSMA 2000, s 22 to make orders to define activities within the perimeter of regulation. It could therefore clarify RAO, art 77 by explicitly taking loan agreements out of the definition. HM Treasury is not constrained by the relevant European legislation, the Markets in Financial Instruments Directive 2004/39/EC (MiFID) in either its current form or just agreed new version. Loan agreements are not included within the list of financial instruments in MiFID.
I think that clarity would be useful, especially for intermediaries and for those participating in the secondary market. In the meantime, loan market participants should each consider the risk to their own activities in the light of the decision.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
First published on LexisPSL Banking & Finance. Click here for a free trial.
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