Seeking rating agency confirmation

Seeking rating agency confirmation

What were the key issues raised in BNY Mellon Corporate Trustee Services Limited v Taberna CDO I plc, in which the parties sought summary judgment on whether an event of default had occurred leading to the noteholder being able to have their payments accelerated? The case contains a particularly interesting discussion about rating agency confirmations.

Original news

BNY Mellon Corporate Trustee Services Ltd v Taberna Europe CDO I plc and other companies; Citicorp Trustee Company Ltd v Taberna Europe CDO II plc and other companies [2016] EWHC 781 (Ch)

What were the facts of the case?

Notes (the notes) were issued by two collateralized debt obligation (CDO)  special purpose vehicles. The proceeds of those notes were used by their issuers to acquire pools of assets to service their noteholders. The assets were managed by a collateral manager. Barclays held the most senior notes, A1 notes, in each structure and had bought credit default swap protection on those notes. Barclays claimed that obligations owed by the issuer to the noteholders had been breached, meaning that an event of default had occurred and that payment of the notes should therefore be accelerated. Barclays claimed that certain swaps were impermissible and applied for summary judgment.

The collateral management agreement (CMA) set out requirements in relation to interest rate hedging. In the CMA, it was set out that the collateral manager was obliged to hedge transactions if certain thresholds were met, and the hedging had to be a 'form approved interest rate hedge' (FAIRH). If it was not a FAIRH, rating agency confirmation (RAC) had to be obtained as well as Class A1 noteholder consent received. The relevant rating agencies were all three of Standard & Poor's Rating Services Inc (S&P), Fitch Ratings Inc (Fitch) and Moody's Investors Service Inc (Moody's). Written confirmation had to be obtained from them in the form of a RAC that the hedging would not result in the rating of the notes being reduced, qualified or withdrawn.

The swaps that Barclays were disputing (the disputed swaps) were in relation to hedging connected to a loan granted to a Spanish property company. The disputed swaps were entered into to hedge the interest rate risk of entering into that loan and exceeded certain of the thresholds set out in the CMA. Barclays said that the disputed swaps were not FAIRH and that RAC and noteholder consent had not been sought.

What is summary judgment?

A summary judgment is a judgment made by the court without the court having to decide a claim or an issue and so no trial is required. A judgment may be ordered following a successful application by a party (either a claimant or defendant but more commonly a claimant) or on the court's own initiative. It is important to be aware when a summary judgment application can be made and also when the courts will not make such an order.

Paragraphs [21] and [22] of the judgment discuss summary judgments and how the prospect of success must be 'realistic' rather than 'fanciful' and summary judgment should not be granted where there is additional information that would be available if a full trial was held.

What is the importance of rating agency confirmation?

RAC is often set out as a requirement when entering into a connected transaction that might adversely affect the underlying transaction's rating. RAC is generally required where the rating of a structure or party instrumental to that structure may be downgraded. For example, the Titan case (US Bank Trustees Ltd v Titan Europe 2007-1 (NHP) Ltd [2014] EWHC 1189 (Ch), [2014] All ER (D) 90 (Jun)) discussed in detail the right to require the replacement of the servicer of a loan in a commercial mortgage-backed security structure, which included a condition that RAC had to be obtained stating that the underlying notes would not be adversely affected by the replacement. In that case, there was discussion about what would constitute a RAC where one of the rating agencies would not provide a RAC as a matter of policy.

The condition requiring a RAC is typical for most rated structured products transactions. The language set out in the CMA in the Taberna case is set out below:

'with respect to any specified action or determination, receipt by the Issuer and the Trustee of written confirmation by each Rating Agency [ie Fitch, S&P and Moody’s]…that such specified action or determination will not result in the reduction, qualification or withdrawal of any of the ratings currently assigned to the Rated Notes by such Rating Agency'.

This is typical language used in the market and references the fact that the action will not result in the reduction, qualification or withdrawal of a rating assigned to the relevant notes.

In the Taberna case, there were two disputed swaps, T1 and T2. In relation to T1, a written RAC was provided by Fitch which clearly set out that the hedge would not result in a suspension, qualification, withdrawal or downgrade of the relevant notes. Email correspondence was entered into with Moody's and S&P by Merrill Lynch (the arranger of the notes and the original noteholder) whereby the rating agencies acknowledged that they 'did not have a problem' with the structures, but it was acknowledged that formal RACs should be requested. There is no form of wording expressly prescribed for a RAC and so Taberna argued the email correspondence was sufficient. Merrill Lynch had even sent an email to the former collateral manager saying that '3 rating signoffs' had been obtained. However, the emails were not addressed to the issuer and trustee as the RAC obtained from Fitch was. It could be argued that the issuer and trustee had delegated responsibility to Merrill Lynch.

In relation to T2, there was no correspondence similar to that received for T1. It was argued that the confirmations received for T1 applied equally to T2 and that written confirmation of the rating of T2 was received which amounted to a RAC. However, it is difficult to argue that the RAC received for T1 could apply to T2 and that the rating given to the swap could be construed as applying to the notes, without analysing whether such swap would lead to an adverse impact on the notes.

Summary judgment was granted for T2 as there was no documentation in place to suggest a RAC had been obtained but not for T1, where the facts were in doubt.

What should lawyers take away from the case?

RACs came to the forefront of practitioners' minds at the height of the financial crisis when certain financial institutions holding positions such as trustee in large structured products transactions were downgraded and in cases such as Napier Park European Credit Opportunities Fund Ltd v Harbourmaster Pro-Rata Clo 2 BV [2014] EWCA Civ 984, [2014] All ER (D) 197 (Jul) where AAA notes were downgraded (see News Analysis: How have the courts interpreted a downgrade of AAA Notes and a subsequent upgrade as a trigger in a CLO deal? for more information). This decision highlights how important it is to obtain RACs where the documents require it and how each transaction must be looked at individually (unless otherwise set out in the underlying document). There is no form for a RAC but if the rating agencies are amenable (and they should be as they will have sight of the underlying document before it is rated), the language in the RAC should match the language set out in the underlying document so as to avoid any ambiguity. In the event of a downgrade it is clear that a RAC should be obtained if stated in the document (which it is very likely to). This case highlights that practitioners should also be careful to ensure that their clients clearly understand what they have to do in various other 'non urgent' circumstances. In this case, it was clear that where a hedge was not an FAIRH, a RAC had to be obtained.

Emma Millington, solicitor in the Lexis®PSL Banking & Finance team.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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About the author:

Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.

Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.