The European Central Bank is handing its charges a new way to lose business. Recent years have seen America’s big banks looking stronger than those in Europe. By implementing tougher rules on leveraged loans used in private equity deals than U.S. regulators, Frankfurt may exacerbate the trend – and give UK banks a hand too.
The new draft guidance on leveraged transactions had been expected for some time. European regulators were lagging behind U.S. peers. Back in 2013, they imposed curbs that made it hard for banks to lend more than six times EBITDA.
The European version is similar, but differs in one big way: it stipulates that EBITDA should be a reported, or “unadjusted”, number that strips out one-off factors. EBITDA adjustments are common in leveraged deals, which often coincide with changes, like firing employees, or buying other assets.
There is some justification for the hairshirt approach. In hot markets, company owners squeeze looser terms – like allowances for unspecified cost savings, or future acquisitions. That can make companies look less indebted than they are. One rule of thumb is that any adjustment in excess of 10 percent of the reported EBITDA is a red flag. Yet practitioners argue that the market can distinguish between sensible and cheeky adjustments.
The rules, if fully implemented and enforced, could make a big difference. It will push new business to asset managers and hedge funds that are already doing an increasing amount of lending. They will snare investment banking fees too.
The rules could also change the competitive dynamics for banks. American regulated firms will be subject to the looser U.S. rules, giving them an advantage over European ones in both Europe and the U.S. markets. UK-based banks, meanwhile, may be able to circumvent both sets of rules, assuming that Britain’s exit from the European Union doesn’t make it harder for banks to lend to European borrowers from London.
The rules highlight the increasing fragmented regulatory backdrop. European politicians are threatening to not apply new global capital standards that penalise the use proprietary models to measure riskiness. They fear those would give even more advantage to U.S. banks at a time when continental players are losing ground in investment banking business. They now have one more reason to fret.
Request a free trial of Breakingviews here.