The recent turmoil in the
financial markets has led to banks and leasing companies
concentrating on the costs associated with their liquidity and
regulatory capital requirements.
Market disruption clauses have
frequently been invoked by financiers over the past few weeks in an
attempt to pass their additional funding costs on to borrowers.
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The question arises as to whether they
can also pass onto their customers the cost of any changes to the
regulatory capital they are required to ascribe to any
financing.
The Basel 2 Accord, which came into
force across the European Union at the beginning of 2008, sets out
international rules for capital adequacy regimes. It provides for a
linkage between the size of a bank’s loan/lease portfolio and its
regulatory capital.
The methodology for calculating that
linkage is complicated. It will depend on whether the bank has had
an Internal Ratings-Based Approach (IRBA) approved by its
regulator, in which case the bank would calculate the capital
charge for any particular financing largely on a self-regulated
basis, or whether it works under a Standardised Approach, in which
event the capital charge will be determined under formulae set out
in the Accord. Basel 2 sets out conditions under which a lessor
with an IRBA may be able to claim relief on its capital charges by
virtue of its ownership of the relevant asset.
The capital charge for a financing is
liable to change during its term. This may happen because there is
a change in the credit rating of the borrower (for institutions
with an IRBA), or in the loan to value ratio implicit in a
financing.
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By GlobalDataThere is also the risk that a
regulator may require a bank to change the basis on which it
calculates its capital charges, such as by denying that relief
should be available for the leasing of a particular class of
asset.
Could a bank pass on these costs to
its customer? Many loans and finance leases include margin ratchets
(where the margin is linked to the customer’s credit rating) or
specific provisions dealing with loan to value ratios.
However, it is important also to
consider the effect of the “Increased Costs” clause. This clause
requires lessees to indemnify lessors for any increased costs they
incur as a consequence of any change in any law or regulation, or
in its interpretation, administration or application.
Whether a lessor’s IRBA constitutes a
regulation for these purposes, and what would be meant by the
“application” of an IRBA by reason of a change in circumstances,
are difficult questions.
It is to be recommended that the
precise scope of this clause be fully clarified at the time of
negotiation.
The author is a consultant at the
law firm Norton Rose y
