Seminar highlights recent growth in sub-participation trade finance sell-downs

The increased level of activity in the distribution of secondary market debt in the form of sub-participation agreements, a back-to-back non-recourse funding arrangement between grantor and a participant that can be utilised in isolation or in conjunction with the endorsement and delivery of negotiable instruments, was a key topic of discussion at the most recent lecture of Denton Wilde Sapte's trade and export finance series.

The well-attended seminar on May 15 addressed the selling of risk in trade finance transactions and was delivered by Simon Cook, a partner in the firm's banking and finance department. "Since last summer, there has been a noticeable increase in the level of activity in the sub-participation market which at least partly is a consequence of the recent difficulties in the loan markets forcing banks to try to manage their balance sheets more effectively and reduce their exposure. At the same time other banks are entering the market and are willing to participate behind the scenes to build up assets in this area,” Cook told GTR.  

Cook also addressed the underpinning market practice of such sub-participation agreements, observing that banks were often producing their own agreements in a time-consuming process that was regularly weighted towards the grantor. The precise suitability of official guidelines in respect to the liquid qualities of trade finance instruments like promissory notes and the security and structure demanded by a participant in a trade finance transaction were also explored against the backdrop of increased sub-participation activity. "There has been a drive to streamline sub-participation documentary processes which has resulted in the emergence of the Bankers' Association of Finance and Trade (BAFT) standard form master sub-participation. As a document, it is more tailored to trade assets than, say, the LMA (Loan Market Association) standard form sub-participation which is obviously good news but only time will tell whether this form will have the other benefits envisaged by BAFT of reducing negotiation time and standardising the product,” Cook told GTR.

The need for a framework is illustrated by the different types and agreements of sub-participation, including risk and funded participation and master and syndicated agreements. Cook also highlighted the issues of protection and risk for both grantor and participant, emphasising that although borrower consent is not strictly required, and it is rare for a borrower to restrict participation, a loan agreement must contain the appropriate provisions and both parties confront challenging risks. These can include the double insolvency risk with the lack of direct access to collateral confronted by the participant, while grantors face maladministration and participant insolvency risk. Cook concludes that despite a move towards standardisation “it is likely that certain more complex underlying transactions will still have their own tailored sub-participation arrangements."