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Basel 3 and the LMA note on the Increased Costs Clause
Practical Law UK Legal Update 2-504-8543 (Approx. 3 pages)
Basel 3 and the LMA note on the Increased Costs Clause
by Kenneth Gray, Norton Rose
| Published on 28 Feb 2011 |
This article is part of the PLC Global Finance February 2011 e-mail update for the United Kingdom.
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The LMA has issued advice on negotiating the Increased Costs Clause in its recommended forms of facility agreement in light of the Basel III Accord. These pro-formas contain a footnote suggesting language for use where it is considered appropriate to exclude Basel II from the scope of the Increased Costs Clause.
The LMA has issued advice on negotiating the Increased Costs Clause in its recommended forms of facility agreement in light of the Basel III Accord. These pro-formas contain a footnote suggesting language for use where it is considered appropriate to exclude Basel II from the scope of the Increased Costs Clause. As Basel II has now been implemented (at least within the EU) and as the indemnification under the Increased Costs Clause relates to changes in law, it may be thought that this exclusion is now superfluous. However, there is still plenty of scope for changes in the way that Basel II legislation is interpreted or applied.
The LMA's advice arises from a concern that, by agreeing to the suggested Basel II exclusion, banks might inadvertently exclude from the scope of that clause any increased cost arising from the implementation of Basel III. This could happen when; Basel III is legislated for and it is consolidated with the existing Basel II legislation so that the definition of Basel II also captures the subsequent Accord.
Perhaps more fundamental is the question of the circumstances in which any bank will be able to recover its increased regulatory costs under current facility documentation. In due course banks will be able to factor the increased costs into their interest calculations, but can they recover these under existing documentation?
Banks and borrowers need to consider what circumstances might give rise to an increased lending cost as a consequence of the implementation of the Basel Accords and who should take the risk of that cost in each case. For example, the cost of maintaining a facility might be affected (amongst other things) by:
- The enactment of legislation giving effect to the Basel III Accord.
- Its progressive implementation between now and 2018.
- The introduction of the capital conservation and countercyclical buffers.
- Any variation of either of the Basel accords, including anything carried out under the "to be agreed" provisions (for example in respect of strategically important financial institutions).
- A change (whether in law or otherwise) which affects the risk-weighting of a particular loan.
- Any change in the risk-weighting approach adopted by a particular bank.
Whether any such cost could be claimed by a lender under a particular facility would depend on the exact drafting of the clause: it is not just a change in law but also a change in its interpretation or application which is covered. The lenders will also need to establish the amount of the increased cost and refer it back to the particular loan.
Further information on Basel III can be found on Norton Rose'sblog.