The lending market to investment trusts is relatively mature and over the past decade a reasonably settled transaction structure has developed with loans from banks often provided on an unsecured basis.

This reflected the investment grade nature of many of the borrowers in the sector and the comfort taken by lenders from the regulated nature of the investment trusts market.

This is now changing with many lenders in the sector looking to offer loans on a secured basis in order to maintain a competitive pricing model for loans to investment trusts. That may be explained away by a general tightening in credit markets, a reaction to the future implementation of the latest tranche of Basel III rules, or other changes in lending policies.

For investment trust boards, this may not be a welcome development, however keen to maintain the gearing needed for investment and to do so at an acceptable cost, they may have little option but to accept that their loans will be secured at the next renewal.

In practice, it is unlikely that the grant of security will impact the investment trust in the ordinary course of business. The security being sought by lenders is a floating charge which by its nature “floats”, allowing the company to deal in its assets as part of its usual investment business, until such time as an enforcement event or other crystallisation of the floating charge occurs. However, there are a few practical and process points to consider.

If the investment trust has other debt in place, or will have in the future, it’s likely that those other creditors will also now wish to take security to maintain parity with the secured bank loan. For example, if the investment trust were to raise longer term debt through a private placement to sit alongside its shorter term, secured bank debt. And investment trusts will have to consider their depositary and custodian arrangements too. Some of these agreements may require the consent of the depositary to be obtained before any security can be granted by the investment trust at all.

The depositary is a regulated function for investment trusts, being an independent third party responsible for the safekeeping of assets and performing cash flow monitoring and oversight duties. Some thought will therefore be required as to how the floating charge granted in favour of lenders will live alongside the depositary arrangements. The depositary is likely to want some clarity about the manner in which it will receive instructions following a crystallisation event – what will the process be and how will due authority to provide instructions be evidenced? Some depositaries may require a formal control agreement to be entered into with the lender to evidence how this will work in practice, even though it is only ever likely to be used in a doomsday scenario.

This all adds an extra layer of time and cost to the loan facility renewal process for investment trusts. Against this background we would recommend that some extra leeway is built into the usual loan facility renewal timetable and that discussions are started early with depositaries and custodians on the grant of security and any precise expectations they will have on documentation.