The Insider/Outsider Conundrum
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When a debtor has entered into a period of financial distress, the level of information available to creditors, and the consequences of receiving that information, may vary significantly depending on the nature of the relevant creditor’s debt claim against the debtor.
Most debt arrangements, such as bank loans and private placement notes, are private in their nature. The underlying legal terms and conditions will generally only be known by the parties to the relevant contract, and third parties will only be permitted to access the underlying documents if they sign a confidentiality agreement.
Bank loans and similar private instruments will also customarily entitle the lenders under those contracts to receive non-public information regarding the debtor, such as management accounts and budget projections, which will provide more precise detail about the current and expected financial performance of the underlying borrower. This information may include management commentary with reference to key performance indicators. As a result, the private creditor financial reporting is usually commercially sensitive and constitutes information that would not generally be available in the public domain.
As restructuring negotiations progress, bank lenders may also request additional information beyond that to which they are contractually entitled under their loan agreements. The bank lenders may also insist on this as a condition of their support of the restructuring discussions or in consideration of their agreement to stand still in relation to any breach of covenant. By electing to receive this information, which is available to all syndicate members, banks will generally remain free to buy or sell positions in the underlying loan.
In contrast, the terms and conditions of publicly traded debt instruments, such as listed bonds, will generally entitle the holders to certain historic public financial information, usually on a quarterly basis. As a general rule, no forward-looking information will be made available by issuers of public securities. Bondholders need to consider actively how and in what form they are prepared to receive financial information about the debtor during the course of restructuring negotiations, as receipt of material non-public information may restrict the relevant creditor’s ability to trade its holdings in public instruments.
This is a particularly pertinent issue when creditors choose to participate in an ad hoc committee, which, by its nature, may allow the participating creditors to gain access to information about the debtor and other stakeholders that is not publicly available. This is a key issue to consider at the outset of any bondholder restructuring process.
The Market Abuse Regulation
To determine whether the receipt of non-public information has the effect of restricting a bondholder from trading, it will be necessary to take into account all relevant local laws applicable to the relevant market in which the public instrument is traded, together with the location of the entity purchasing the security and, potentially, any manager that advises that purchasing entity.
It is beyond the scope of this chapter to provide a comprehensive overview of all applicable laws in different jurisdictions. Instead, we focus on the UK and EU market abuse regimes, which govern (among other things) securities issued and listed on regulated markets within the United Kingdom and the European Union. The key legislation is contained in the Market Abuse Regulation (MAR), which was brought into force across Europe with effect from 3 July 2016 and was onshored as part of UK legislation following the United Kingdom’s departure from the European Union. MAR had repealed and replaced the previous Market Abuse Directive.
MAR was intended to establish a common regulatory framework across all Member States by providing a more uniform interpretation of the EU market abuse framework, which more clearly defines rules applicable to all Member States. As MAR was brought into effect as a regulation rather than a directive, it was immediately enforceable as a matter of law in all EU Member States (including, at that time, the United Kingdom). There are some divergences between the UK MAR and the EU MAR. Broadly, the EU MAR covers financial instruments listed or traded on EU trading venues and other connected instruments (e.g., derivatives relating to those financial instruments). The UK MAR covers financial instruments listed or traded on UK, EU or Gibraltar trading venues as well as connected instruments. Consequently, an EU traded instrument will be in scope of both the UK and the EU MAR. Other divergences are beyond the scope of this chapter. The MAR rules referred to in this chapter are common to both the UK and the EU MAR.
For members of ad hoc committees relating to distressed debtors, the most likely instruments that will be covered by the market abuse regime will be listed financial instruments, such as shares and bonds. However, MAR also covers financial instruments of which the price or value ‘depends on or has an effect on the price or value of a financial instrument . . . including, but not limited to, credit default swaps and contracts for difference’.
Financial instruments that are either admitted to trading on a regulated market, or for which a request for admission to trading on a regulated market has been made, are caught by the market abuse regime. Financial instruments traded on other types of trading venues (multilateral trading facilities and organised trading facilities) are also in scope of MAR.
MAR defines market abuse as consisting of one of three offences: insider dealing, unlawful disclosure of inside information and market manipulation. In this chapter, we focus on the insider dealing offence.
Insider dealing (including attempted insider dealing) is prohibited under Article 14 of MAR.
Article 8 of MAR provides that insider dealing arises where ‘a person possesses inside information and uses that information by acquiring or disposing of, for its own account or for a third party, directly or indirectly, financial instruments to which the information relates’. Cancelling or amending an existing order on the basis of inside information will also constitute insider dealing for these purposes.
Where a person is in possession of inside information and acquires or disposes of, or attempts to acquire or dispose of, the relevant financial instrument, Recital 24 of MAR states that it should be implied that the person has used that inside information. Therefore, it will be incumbent on the market participant accused of insider dealing to rebut this presumption.
One means of rebutting the presumption would be to demonstrate that an effective information barrier was in place between the person responsible for making the trading decision within the market participant’s organisation and anyone holding or having access to inside information. However, for many bondholders, this raises a number of practical difficulties. As is the case with many distressed investment funds, in smaller organisations it may not be possible to obtain the necessary degree of physical segregation between staff and related information technology systems.
MAR also provides some limited exemptions for share buy-back programmes and stabilisation, but these would not be available to bondholders.
National regulators have powers pursuant to MAR to impose a variety of sanctions on any person found to have committed insider dealing, including disgorgement of any profits, in the United Kingdom unlimited fines, and in the European Union, a maximum fine of at least €5 million for individuals and at least €15 million for organisations, suspension of authorisations and bans from holding managerial positions within the financial services industry. Although this chapter deals only with the civil market abuse regime under MAR, insider dealing may be serious enough in terms of impact on the market, amounts involved or intent of the participants for criminal sanctions to apply, including imprisonment.
Given the broad nature of insider dealing under MAR, bondholders wishing to retain the ability to trade in their underlying instruments refrain where possible from receiving any non-public information. If a bondholder is in receipt of non-public information, an assessment will need to be carried out as to whether that information constitutes inside information for the purposes of MAR to determine whether there is a risk of insider dealing when entering into a trade.
Article 7 of MAR sets out the following requirements that must be met for information to be considered to be inside information for the purposes of MAR:
- it must be precise in nature – namely, information that indicates:
- a set of circumstances that exist or that may reasonably be expected to come into existence; or
- an event that has occurred or that may reasonably be expected to occur, and is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of the financial instruments;
- it must not have been made public;
- it must relate, directly or indirectly, to one or more issuers or to one or more financial instruments; and
- if it were to be made public, it would be likely to have a significant effect on the prices of the relevant financial instruments, or on the price of any related derivative financial instruments. For these purposes, information will be likely to have a significant effect if a reasonable investor would be likely to use it as part of his or her investment decisions.
When any information is determined to meet the above requirements for inside information, even if the relevant bondholder refrains from trading, an offence under MAR can still be committed if that inside information is unlawfully disclosed to a third party. It is very important, therefore, that inside information is identified and legal advice is taken before any information is disseminated. This often becomes a material issue for the debtor and its board to manage during a financial restructuring process, as under MAR it is necessary to create and maintain an insider list.
The insider/outsider conundrum
As finance structures have become more complex, it is increasingly common for distressed debtors to have raised finance through a mixture of public and private debt.
Creditors holding public instruments issued by a distressed debtor therefore face a conundrum as to whether they wish to receive non-public information in respect of the debtor if doing so will restrict them from trading.
The primary advantage for creditors who choose to remain ‘public’ will be the freedom either to stake build by purchasing more of the relevant financial instrument or to manage their risk at any point by selling their bonds on the open market, assuming there is sufficient market liquidity for them to do so.
However, public creditors will not have parity of information with other private creditors and will not be able to engage directly in negotiations with the debtor without restricting themselves.
Forming a public committee
In most instances, to preserve access to market liquidity and to encourage the involvement of as wide a group of stakeholders as possible, ad hoc committees will normally initially be formed on a public basis.
To facilitate the formation of a public committee, one or more large holders will often appoint a law firm or a financial adviser to assist. These advisers will assist with identifying additional holders who may wish to join the committee.
Holders wishing to join the ad hoc committee will be required to share with the advisers details of their current holdings in all instruments relating to the debtor and to undertake to keep the advisers updated regularly on any changes to their holdings. Fees are usually indemnified by the issuer.
The disclosure of each individual creditor’s holdings will typically be made on a confidential basis and the advisers will be permitted to disclose to the committee only the total aggregate holdings of all members of the ad hoc committee.
Can formation of ad hoc committee constitute inside information?
Once sufficient holders willing to participate in the ad hoc committee have been identified to allow a meaningful conversation between the debtor and its advisers and the advisers to the ad hoc committee to take place, it is normal practice to issue a public statement, typically through a regulatory news agent announcement, confirming and making public the formation of the ad hoc committee.
The next step will ideally be for the ad hoc committee to meet and seek to formulate a restructuring proposal, which, if agreed and implemented, would be acceptable to the members of the committee as a whole. This proposal will be intended to provide the ad hoc committee’s advisers with a broad mandate to commence negotiations on behalf of the ad hoc committee with the debtor.
However, before discussing any proposal, careful consideration will need to be given as to whether such a proposal could of itself potentially constitute inside information, which would have the effect of restricting the ad hoc committee from trading. Recital 54 of MAR notes that information regarding a market participant’s own plans and strategies for trading should not be considered to be inside information, but that ‘information regarding a third party’s plans and strategies for trading may amount to inside information’.
Although it is theoretically possible, therefore, for any proposal or strategy agreed among the ad hoc committee members to be inside information, much will depend on whether the information is precise and specific enough to affect the pricing of the relevant financial instrument.
This analysis will need to be carried out and determined case by case. For example, a different view may be taken where an ad hoc committee controls 75 per cent of a particular bond and may be able to force through a proposal as a fait accompli, than in a case where a committee can only effect negative control of a situation by blocking a proposed set of amendments.
Similarly, a contrarian position taken in discussions by one ad hoc committee member may have little impact on the likely ultimate negotiation and implementation of a restructuring proposal. However, this analysis may be somewhat different if that creditor is known to hold a veto right or a cross-holding elsewhere in the corporate structure that will provide material leverage in negotiations.
Ultimately, it is in the interests of all creditors that an ad hoc committee is able to discuss matters freely within their group, so it will fall to the advisers to best manage the membership of a public committee at the formation stage to ensure that the committee is correctly constituted as a public committee and will be able to operate on that basis for the foreseeable future.
Once the ad hoc committee has agreed an outline restructuring proposal or strategy for commencing negotiations with the debtor, the next step is for the legal and financial advisers to the committee to begin discussions with the debtor and its advisers. Members of the ad hoc committee will not participate in these discussions to preserve their ‘public’ status.
At this point, the debtor will usually require the ad hoc committee’s advisers to sign up directly to a confidentiality arrangement with the debtor. Once signed, the ad hoc committee advisers will be able to receive non-public confidential information, including up-to-date financial information and any restructuring proposals prepared by the debtor and its advisers. Any confidential information will be retained by the advisers and not shared with the wider ad hoc committee at this stage. This information will then be used to underpin initial negotiations between the respective parties, with the bondholders being solely represented by legal and financial advisers.
As discussions between the ad hoc committee advisers and the debtor progress, it will become necessary for some or all of the members of the ad hoc committee to ‘go inside’ and take receipt of private information.
The timing for making this decision is a question of judgement and will be determined by a number of factors, including:
- the progress of discussions between the ad hoc committee’s advisers and the debtor;
- the underlying financial performance of the debtor and, in particular, whether there is any requirement for creditors or a third party to provide new money to allow the debtor to continue to operate while restructuring negotiations continue; or
- whether there is sufficient liquidity in the market, in terms of willing sellers or buyers of the relevant financial instruments, to justify the ad hoc committee members remaining public.
Confidentiality arrangements and cleansing
Where it is determined that members of the ad hoc committee will become private and elect to restrict themselves from trading, the relevant members will be required to enter into confidentiality agreements with the debtor. However, wherever possible, the ad hoc committee members will wish to limit the period for which they are restricted from trading.
As such, it is normal practice for the confidentiality agreement that will be entered into with the debtor to include a ‘sunset’ date, after which, if a restructuring has not been agreed, the creditors will be cleansed and made ‘public’ again by the debtor agreeing to place any inside information provided to ad hoc committee members in the public domain. Debtors will need to be comfortable, therefore, that any information they share with creditors may be made public in due course and tailor their disclosures accordingly. Forward-looking financial information will rarely be published and, therefore, such information will need to be withheld from bondholders unless they are willing to be restricted until such information is stale. Although a question of fact in each case, the market convention for information becoming stale is 180 days.
The length of the period for which creditors will be restricted will obviously be a matter for negotiation, but will need to provide sufficient time for negotiations to take place between the various stakeholders, while not restricting the creditors for any unduly onerous period. One common solution is to link the sunset date to the next key reporting date in the debtor’s financial calendar.
Another key point of negotiation will be whether it is possible for the sunset date to be extended and, if so, what consent will be required from creditors to permit this. As most creditors will wish to be in control of their own trading decisions, the optimal position for creditors will be to require unanimous consent for any extension, but it may be that a compromise is reached by allowing an extension to be agreed by a majority decision.
Creditors will also wish to have some input into agreeing what information will be put into the public domain to ensure that all inside information has been cleansed and they are free to trade. As a minimum, creditors will normally insist on receiving a right to be consulted on the content of any disclosure. Where possible, creditors will also insist on having the right to ‘self-cleanse’ or ‘blow out’ information if they are not satisfied with the content of the disclosure by publishing such additional information as they consider necessary that has not been included in the debtor’s cleansing announcement. Again, depending on the outcome of negotiation, this right could be linked to a majority decision or provide each individual creditor with his or her own right to disclose information.
In a well-managed process, the precise ambit of all material non-public information is agreed in advance between advisers prior to any bondholders going private.
Public creditors – managing cross-holdings
As restructuring negotiations progress, it may become strategically important for creditors to acquire cross-holding positions in competing classes of debt to increase negotiating leverage and hedge risk.
Where the cross-holdings are held in private debt instruments, public creditors risk receiving non-public information that could constitute inside information under MAR. As such, creditors acquiring stakes in private debt instruments, such as bank loans, but wishing to remain public, will need to ensure that appropriate measures are put in place to prevent the creditor from receiving any private information in its capacity as a lender under the relevant loan agreement.
In respect of large syndicated facilities, bank agents will often provide for information to be disseminated to lenders through an online data room. Often, the agent may provide the option for a lender to designate itself as a ‘public’ lender and only receive information from the debtor that has been designated as public information.
However, there is no guarantee that material information will be made public. Many bank facilities also include a ‘snooze-you-lose’ provision, which allows debtors to disregard lenders for voting purposes if no response is received by a voting deadline. In these circumstances, a ‘public’ lender could find that it has forfeited its vote on a material matter, without ever knowing that the vote had taken place.
A further alternative is to arrange for the private information to be sent to a person within the creditors’ organisation who is separated from the person managing the position for trading purposes by an information barrier, or to a third-party custodian or law firm.
In some circumstances, it may not be possible to shield the public creditor from all non-public information. One example of this would be changes in drawings under a revolving credit facility, in circumstances where the amount of available commitment under that facility is considered price-sensitive. Unless an appropriate custodian arrangement can be put in place, the creditor would need to be informed of the drawings under the facility so as to manage the movement of funds and the reconciliation of interest and fees payable in respect of the facility.
 Ross Miller and Alex Ainley are partners at Simmons & Simmons LLP.
 Regulation (EU) No. 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (MAR).
 Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003 on insider dealing and market manipulation (market abuse).
 MAR, Recital 5.
 MAR also covers a wider range of instruments and trading venues, including multilateral trading facilities, organised trading facilities, commodity derivatives and spot commodity contracts and emissions allowances, as well as behaviour affecting benchmarks. These additional instruments and venues are beyond the scope of this chapter and are not discussed further here.
 MAR, Article 2(1)(d).
 ibid., Article 2(1)(a).
 ibid., Recital 7.
 The reasonable investor test is the actual test that must be applied in each case. Additionally, and on a practical note, case law over the years suggests that a small price movement does not prevent information from being inside information.