What do Highland Capital Management, Fortress Investment Group LLC and Cerberus Capital Management have in common? The firms, which manage some $110 billion among them, are on a list that says they can never invest in a $155 million loan that’s trading in U.S. markets.
RBS Holding Co., the owner of direct marketer Quadriga Art, banned the three firms and seven others last year from buying parts of the loan, according to two people with knowledge of the matter who asked not to be named because the decision was private. They were deemed, the people said, to be too demanding in debt restructurings, a fate that executives at RBS -- which has no relationship to the Scottish bank -- considered as Quadriga’s business faltered.
Unlike any other market in the U.S., the blacklist rules in leveraged loans. No regulator polices trading in the $800 billion market. Here, borrowers -- and the investors who control them -- choose who gets into the club. It would be as if Apple Inc. got to decide who could buy its stock.
“I really can’t think of a good example of another market where you really are selling to a lot of people but you still retain the right to keep some people out,” said Elisabeth de Fontenay, a professor at Duke University School of Law in Durham, North Carolina, and a former corporate lawyer.
While banks managing stock and bond deals can pick which investors are allotted securities in public offerings, anyone with enough money can buy the assets once they start trading in the market. Not so with loans. The lists prohibiting investors can last until the debt matures.
Booming Market
The practice poses risks to a market whose size has quadrupled from about $200 billion over the last decade as plunging interest rates fueled investor demand for securities that offer extra yield. Blacklisting reduces the number of potential buyers, which in turn makes the loans difficult to trade, and can exclude the savvier investors who are better able to fight for creditor rights in a default.
“These types of limitations are tremendously detrimental” to the market’s quantity and quality of buyers and sellers, said Greg Margolies, a senior partner at Los Angeles-based Ares Management LP, which manages about $80 billion in assets including speculative-grade debt and real estate. “Ares will not invest in a name where secondary liquidity can dry up immediately because an issuer has decided to blacklist a number of market participants.”
Blacklist Defined
The Merriam-Webster Dictionary defines blacklist as “a list of persons who are disapproved of or are to be punished or boycotted.” In the loan market, there are three things that can warrant punishment: having a reputation for being a tough negotiator in debt restructurings, like Highland and the other firms in the RBS deal; having an affiliation with a borrower’s competitor; or simply being disliked.