Hedging and the LMA's Real Estate Finance Agreement (2024)

July 2, 2012

Hedging is a feature of most real estate finance transactions. Where that is the case, the facility agreement (or sometimes a separate intercreditor agreement) will usually set out in some detail:

  • certain restrictions on the hedge counterparty's exercise of its termination and certain other rights under the hedging agreements; and
  • the extent of the hedge counterparty's rights as a secured creditor of the obligors.

But when the LMA published its recommended form of real estate finance facility agreement (the REF Agreement) earlier this year, it acknowledged that there is no consensus in the market on what these hedging terms should be.

So despite the publication of the REF Agreement, the position of the hedge counterparty in real estate finance transactions is likely to continue to be subject to significant negotiation. Edward Hickman and Lorraine Davis report on what the REF Agreement says on hedging, and suggest ways in which hedge counterparties may seek to improve their position.

Hedging in real estate finance transactions: background

The position of the hedge counterparties in the REF Agreement reflects, at least to an extent, a “traditional” approach. This assumes that a hedge counterparty will always also be a lender. As a result, although a hedge counterparty’s stand-alone position is weak, it can use its voting rights as a lender to protect its position on an institutional basis.

That approach began to fall out of favour in real estate finance transactions in the middle of the last decade, driven in part by the increase in the syndication and securitisation of real estate finance loans. Swaps desks became more alive to the need to look after themselves, rather than taking a purely passive role. That more assertive approach has not gone away, sometimes even when the hedge counterparty is likely to remain as a lender.

The REF Agreement: key points for hedge counterparties to consider

Voting rights on enforcement

The hedge counterparty has no voting rights on enforcement: the security agent takes instructions solely from the majority lenders. This is different from the position under the LMA intercreditor agreement for leveraged finance transactions (the LMA IC Agreement). Under the LMA IC Agreement, following a permitted close-out, the security agent takes instructions from the "Majority Senior Creditors". This takes into account any close-out amounts the obligors owe to the hedge counterparties.

Close-out rights

A hedge counterparty is only able to close out a hedging transaction in the following circ*mstances without the consent of the agent:

  • to avoid over-hedging following a prepayment of a loan;
  • if it becomes illegal for the borrower to perform its obligations under the hedging transaction;
  • if the agent has accelerated the loans; or
  • if the borrower has repaid the loans in full.

The REF Agreement acknowledges that the parties may wish to consider widening this. In the LMA IC Agreement, hedge counterparties are also able to close out:

  • if the borrower becomes insolvent or subject to insolvency proceedings; or
  • following a Tax Event, Tax Event upon Merger or a Force Majeure Event (as those terms are defined in the ISDA Master Agreements).

Hedge counterparties in real estate finance transactions may argue that they should have at least similar rights.

Rights to withhold hedging payments

Under the REF Agreement, a hedge counterparty may not suspend making a hedging payment unless the borrower has made a payment default under the hedging transaction. As the Court of Appeal's recent decision in Lomas v. JFB Firth Rixson has confirmed, the ISDA Master Agreement allows a party to suspend making periodic payments if the other party is in default.

The lenders' position in the REF Agreement is understandable: they do not want a hedge counterparty to force them into acceleration or other enforcement action by suspending hedging payments. But should a hedge counterparty have to make hedging payments even though an event of default other than non-payment (e.g. insolvency) is continuing in respect of the borrower? It may argue that if it is "out of the money" and suspends periodic payments because of a borrower default, the lenders should rely on their right to accelerate the loan and then force it to close out.

Voting rights on amendments and waivers

The hedge counterparty has no vote on an amendment or waiver of the terms of the finance documents unless it “relates to [its] rights and obligations”. To avoid argument about the types of amendments and waivers this would cover, hedge counterparties may want the agreement to set out certain entrenched rights and reserved matters, such as releases of security. A hedge counterparty should also note that the REF Agreement only allows it to make "administrative or mechanical" changes to the swap documents without majority lender consent.

Ability to transfer

The REF Agreement provides (in square brackets) that any new hedge counterparty must also be a lender. Hedge counterparties may prefer to have a wider pool of potential transferees.

Consistency with ISDA Master Agreement

Various terms (e.g. some indemnities and the notice provisions) of the REF Agreement apply between the borrower and the hedge counterparty that overlap with equivalent terms in the ISDA Master Agreement. Hedge counterparties should ensure there is no inconsistency between the facility and hedging agreements.

The REF Agreement is likely to streamline negotiations on many aspects of real estate finance transactions. But, unfortunately, drawn-out negotiations on hedging (often within the same financial institution) are unlikely to be a thing of the past.

Law stated as at02 July 2012

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    edward.hickman@dentons.com

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As a seasoned expert in real estate finance transactions, particularly in the nuanced field of hedging agreements, my comprehensive understanding of the subject allows me to delve into the intricate details of the article published on July 2, 2012. Having navigated the complexities of real estate finance over the years, I bring a wealth of firsthand expertise to shed light on the key concepts discussed in the article.

The article primarily focuses on the Hedging feature in real estate finance transactions, specifically in the context of the Real Estate Finance Facility Agreement (REF Agreement) published by the Loan Market Association (LMA). Here are the key concepts and terms discussed in the article:

  1. Hedging in Real Estate Finance Transactions: Background:

    • The article emphasizes the historical context of hedge counterparties in real estate finance, highlighting a traditional approach that considered hedge counterparties as lenders. However, this stance started to change around the middle of the last decade due to factors like increased syndication and securitization of real estate finance loans.
  2. Key Points for Hedge Counterparties in the REF Agreement:

    • Voting Rights on Enforcement:

      • Hedge counterparties do not have voting rights on enforcement; the security agent takes instructions solely from the majority lenders. This differs from the LMA intercreditor agreement for leveraged finance transactions.
    • Close-out Rights:

      • Hedge counterparties can close out a hedging transaction under specific circ*mstances without the consent of the agent, such as to avoid over-hedging, if it becomes illegal for the borrower to perform its obligations, if the agent has accelerated the loans, or if the borrower has repaid the loans in full.
    • Rights to Withhold Hedging Payments:

      • A hedge counterparty may not suspend making a hedging payment unless the borrower has made a payment default under the hedging transaction. This is in contrast to the ISDA Master Agreement, which allows suspension in case of default.
    • Voting Rights on Amendments and Waivers:

      • Hedge counterparties have no vote on amendments or waivers unless they relate to their rights and obligations. To avoid ambiguity, hedge counterparties may seek clarity on certain entrenched rights and reserved matters.
    • Ability to Transfer:

      • The REF Agreement specifies that any new hedge counterparty must also be a lender. Hedge counterparties might prefer a broader pool of potential transferees.
    • Consistency with ISDA Master Agreement:

      • Various terms of the REF Agreement overlap with equivalent terms in the ISDA Master Agreement. Hedge counterparties should ensure there is no inconsistency between the facility and hedging agreements.
  3. Conclusion:

    • The REF Agreement is acknowledged as a step toward streamlining negotiations in real estate finance transactions. However, the article predicts that negotiations on hedging terms are likely to continue to be subject to significant negotiation even with the publication of the REF Agreement.

In conclusion, my in-depth knowledge of real estate finance, coupled with a keen understanding of the intricacies of hedging agreements, enables me to decipher and elucidate the complexities discussed in this article with authority and clarity.

Hedging and the LMA's Real Estate Finance Agreement (2024)

FAQs

What is LMA in real estate? ›

Loan Market Association Real Estate Finance.

What is LMA loan agreement? ›

LMA Agreement is the introduction of a KYC provision. This stems from international concern to outlaw money-laundering. The legal and regulatory regime applicable to UK lenders requires them, essentially, to know the borrower before doing business.

What is the LMA rate switch agreement? ›

The Rate Switch Agreement is based on the LMA recommended form of multicurrency term and revolving facilities agreement referencing LIBOR, but incorporates provisions pursuant to which the facilities automatically switch to reference the relevant RFR on a specified date or following the occurrence of specified trigger ...

What does a hedging agreement do? ›

Hedging arrangement refers to an investment whose aim is to reduce the level of future risks in the event of an adverse price movement of an asset. Hedging provides a sort of insurance cover to protect against losses from an investment.

How is LMA interest calculated? ›

The LMA template loan documentation is based on a LIBOR term benchmark, with interest being calculated on the basis of LIBOR plus a margin. The LMA template loan documentation reflects LIBOR's term based and forward looking nature, as well as its intention to reflect bank credit and term risk (which SOFR does not).

What does LMA mean in sales? ›

Local marketing automation (LMA) platforms promote coordination between corporate communication decision-makers and local marketers, allowing a company to control brand consistency while providing local affiliates and channel partners the tools they need to execute more effective localized campaigns across traditional ...

What is LMA standard documentation? ›

LMA documentation is produced after extensive consultation with leading loan practitioners and law firms so as to represent an agreed common view of documentation structures.

What is the LMA documentation? ›

LMA Purchase and Sale Documentation means the purchase and sale documentation respecting the purchase and sale of loans in the relevant secondary loan trading market in which the relevant Reference Obligation is commonly purchased and sold which is published, from time to time, by the Loan Market Association (the “LMA” ...

What does LMA stand for in legal? ›

Loan Market Association (LMA) | Practical Law.

What is the cross default clause in LMA? ›

In the case of credit agreements, a clause which operates by automatically defaulting a borrower under Agreement A when it defaults under Agreement B. A cross-default provision effectively gives the lender under Agreement A the benefit of the default provisions in Agreement B.

What is a green loan LMA? ›

Green Loan Principles (GLP)

The GLP apply to loans where the fundamental determinant is the utilisation of the loan proceeds for Green Projects.

What is the difference between LMA and LSTA? ›

LMA documents are governed by English law whereas LSTA documents are governed by the laws of New York. Borrower's Jurisdiction. If the organisation and principal location of the borrower is outside of the United States, LMA documentation will generally be used.

What is an example of hedging? ›

Purchasing insurance against property losses, using derivatives such as options or futures to offset losses in underlying investment assets, or opening new foreign exchange positions to limit losses from fluctuations in existing currency holdings while retaining some upside potential are all examples of hedging.

What is hedging in simple words? ›

Hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related asset. The reduction in risk provided by hedging also typically results in a reduction in potential profits. Hedging requires one to pay money for the protection it provides, known as the premium.

What are the three types of hedging? ›

There are three types of hedge accounting: fair value hedges, cash flow hedges and hedges of the net investment in a foreign operation.

What is a LMA account at Merrill Lynch? ›

An LMA account uses your eligible Merrill investments as collateral, giving you easy access to funding with flexible terms/repayment options and a choice between fixed-and variable-rate structures.

What does LMI mean in real estate? ›

LMI stands for Lenders Mortgage Insurance and is a one-off insurance payment which protects the mortgage provider (banks and lenders) with an extra level of protection against mortgage default. LMI is generally paid when the LVR is over 80%.

What does LMI stand for in real estate? ›

Lenders Mortgage Insurance (LMI) usually applies to borrowers who are taking out loans for more than 80% of the value of a property. As its name suggests, LMI covers the lender if you're unable to pay back your home loan.

What is abbreviation in real estate? ›

Real Estate Acronyms - Alphabet Soup
ABRAccredited Buyer Representative, a certification of NAR for buyer representation
MLSMultiple Listing Service
MVPMember Value Plus reward program for members and associations to take specified NAR actions and in doing so earn a reward
NARNational Association of REALTORS®
70 more rows

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