Increased costs,new regulatory charges for banks

Increased costs

The increased costs clause in a facilities agreement protects the lender from any change in the economics of the lending transaction by providing that a cost arising after the making of the loan and which would reduce the amount otherwise paid to the lender, should be payable by the borrower.  To be included in the clause, the costs must arise from changes in law or regulation occurring after the date of the agreement.  Once the change which brings in the increased cost is implemented, it is expected that lenders will include the increased costs when pricing the transaction.  Difficulties arise where future increased costs are certain to be introduced but the actual change in law or regulation is not yet in place and the cost implications of the change cannot yet be quantified.

Basel III

The raft of new regulations banks face worldwide include various provisions which will definitely increase costs when implemented, but by how much is not yet clear.  Prominent among these new regulations is Basel III which will require banks to set aside more capital and inevitably result in higher lending costs, particularly for liquidity facilities.  Basel III will be introduced in Europe by a European Union directive.  Proposals for this legislation will be published in April 2011 but implementation on a national basis will not begin until 2013 and full implementation will only be completed in 2018. 

In relation to Basel II, once the full details and implications of the likely increased costs were understood, borrowers required a clear ‘carve-out’ of the Basel II costs from the increased costs clause.  The same can reasonably be expected in relation to Basel III.

The Loan Market Association (LMA) has warned that the Basel II carve out in the increased costs clause in its standard form facility agreements might inadvertently include Basel III costs (if Basel III is implemented by an amendment to the Basel II regime).  The LMA has not provided any recommended drafting on the point and we understand that it does not intend to do so.  As a result, some lenders are trying to include a specific reference to include Basel III in the increased costs clause.  The success or failure of this move is likely to depend on the relative bargaining position of the parties. 

Other regulatory costs

Another future cost for banks in several European jurisdictions will be government imposed bank levies (the UK, France and Germany have confirmed plans at present).  In the UK, the bank levy will probably be implemented by July 2011 and will have retrospective effect from 1 January 2011.  Again, the market has not yet reached a settled treatment of bank levy costs in increased costs clauses.

In the US, uncertainty as to the cost implications of the Dodd-Frank Act are resulting in increased costs clauses which apply regardless of the date when the cost-triggering change occurs.  This is a move from the more standard US position, which limits the period during which the increased costs clause can be invoked.  The UK Association of Corporate Treasurers has warned its members to expect US banks operating in European markets to attempt to include similar provisions in European loan facilities.