Private credit remains a key business line for all interested parties: established sponsors are seeking new financing solutions as deal-making slows and investment cycles extend; borrowers seeking a broadened set of investment opportunities that require bespoke financing structures; and lenders continuing to innovate with a wide array of finance solutions.
As financing structures become even more bespoke, and as new providers of private credit continue to enter the market, this note serves as a reminder to any non-bank creditor that, whilst the private credit market is unregulated in general terms, they should be mindful of some of the UK regulatory pitfalls to be avoided.
In some jurisdictions like the UK, commercial lending is not generally an activity requiring a banking or investment licence. However, non-bank lenders must be mindful of a range of UK regulatory issues that can arise depending on how the arrangements are structured. We have highlighted some of the most common issues below.
While many of these considerations will be similar in a European context (given that they stem from the requirements of EU law, many of which have been retained in the UK), additional requirements are likely to be relevant, including from an ESG perspective. A number of European jurisdictions have local law regimes relating to the provision of credit by non-bank lenders that also need to be considered on a case-by-case basis.
Does the provision of funding fall within the scope of regulation?
This depends on the form that the funding takes. Unsecured commercial loan agreements are not specified investments in the UK. Entering into such agreements as a lender or arranging such transactions will not constitute a regulated activity. As mentioned above, the position is not the same in a number of EU states where local law requirements and restrictions may apply to the provision of credit by non-bank lenders.
By contrast, shares and other equity securities (which may form part of private credit transactions, particularly in the context of hybrid debt/equity transactions) are specified investments in the UK. Therefore, buying or selling such securities as principal or agent is a regulated activity, although exclusions may be available to escape the need for authorisation. Arranging deals in such instruments is also a regulated activity and for that activity few viable exclusions may be available.
In addition, such instruments are covered by the UK financial promotion regime such that an unauthorised firm will need to ensure that it does not communicate an invitation or inducement to acquire or dispose of such securities unless it can rely on an exemption under the Financial Promotion Order or the communication is approved by an authorised person.
An unauthorised firm may also need to ensure it can rely on an exemption from the requirement to produce a prospectus.
Similar issues can arise in relation to bonds, debentures and other “instruments creating or acknowledging indebtedness”.
In the UK, carrying on a regulated activity in breach of the general prohibition is a criminal offence. In addition, agreements made by an unauthorised person in the course of carrying on a regulated activity in breach of the general prohibition are unenforceable against the other party. Similar issues arise where the agreement is made through a person acting in breach of the general prohibition or in consequence of a communication made in contravention of the financial promotion restriction.
As a result, it is crucial to determine whether the proposed activities could give rise to any regulatory issues at the outset before any arrangements are entered into or marketing activities are undertaken.
Anti-money laundering (AML) registration as an Annex 1 financial institution
The UK Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the MLRs) impose requirements relating to customer due diligence and money laundering systems and controls on “relevant persons” acting in the course of a business carried on by them in the UK which involves one of more “listed activities”.
If a person carries on a listed activity in the course of a business carried on by them in the UK, it becomes subject to the requirements of the MLRs and needs to apply to be included in the Financial Conduct Authority’s register of Annex 1 financial institutions. Such listed activities include (among others):
“2. Lending including, inter alia: consumer credit, credit agreements relating to immovable property, factoring, with or without recourse, financing of commercial transactions (including forfeiting [sic]).
3. Financial leasing.
…
6. Guarantees and commitments.
7. Trading for own account or for account of customers in any of the following:
(a) money market instruments (cheques, bills, certificates of deposit, etc.);
(b) foreign exchange;
…”
There are exclusions available from the requirement for registration. One such exclusion that may apply in this context, depending on the particular circumstances, provides that where a person carries on a listed activity on an occasional or very limited basis, as defined in the MLRs, it does not need to be registered. In addition, persons whose sole listed activity is trading for own account are also excluded where they do not have a “customer”.
Note that it is a criminal offence for a person to carry on the business of an Annex 1 financial institution unless that person is included in the register or has applied for registration in the register but its application has not yet been determined. The FCA can also impose civil fines.
However, a failure to be registered for AML purposes does not give rise in the UK to the risk of unenforceability of contracts, unlike activity which involves a breach of the general prohibition or the financial promotion restriction (as discussed above).
Insurance mediation
In some financings, lenders may require the borrower to put in place insurance. Where this is the case, lenders should be wary of becoming involved in putting the insurance arrangements in place. If a lender is involved in putting in place insurance between an insurer and a borrower, it could be at risk of carrying on the regulated activity of arranging deals in insurance contracts. Financial promotion issues can also arise. Care must therefore be taken to ensure that the arrangements are structured such that they do not result in a breach of these requirements to avoid any risk of unenforceability or other adverse consequences.
Client Alert 2023-166
