Despite nearly 20 years working as a banking and finance lawyer, one thing I have never understood is why banks in New Zealand all have their own terms and conditions for security and loan documents. If ever there were documents that were well suited to industry standardisation, they would be it. Consistency of documentation and processes in areas where the banks do not compete – like this - would reduce transaction costs, and free them up to focus on areas where they could innovate and compete.
This is not a new idea
I know that Simon Jensen was keen to progress it while General Counsel of Westpac in the 1990s, and Richard Susskind has also written of it in Tomorrow’s Lawyers in terms of a “collaboration strategy”, where he believes clients should come together and share the costs of certain forms of legal service. While he believes an “efficiency strategy” will be favoured to address the “more for less” challenge in the short term, he believes the collaboration strategy will come to dominate in the longer term. He specifically highlights the banking sector, and says:
“The most dramatic example of the collaboration strategy is one I have advocated for some time for major banks. It applies to their work in regulatory compliance. Major banks spend many hundreds of millions of pounds each year on compliance. Many of these financial institutions operate in well over 100 countries, each with different legislation and regulations, and each requiring not only compliance with their respective rules but also regular submissions of documentation and forms to their regulatory bodies. Keeping up to date with new regulation and changes in old regulation, educating tens of thousands of people on their obligations, understanding the local practices and preferences of regulators, introducing standard processes for supporting the preparation and submission of documentation – these are the tasks facing compliance specialists.
My simple contention is that some banks could come together and share the costs of undertaking many of the compliance jobs that they have in common.”
I completely agree with Susskind in relation to compliance, but in my view most loan and security documentation is also unnecessarily duplicative and costly. Loan and security documentation is materially the same across the sector as each time they update their documents, banks review other bank terms, borrow any concepts they like, but then reword it to achieve the same substantive effect but without copying.
The case for collaboration
All this adds a lot of cost, but little value, as banks do not compete on the terms of this documentation anyway. By the time the customer sees these documents, they have already committed to the loan and it is simply a question of implementing it as swiftly, effectively and cheaply as possible. However, because each bank has their own bespoke documents that need to be reviewed and advised on by lawyers acting for the borrowers, the cost of telling the client that “it’s pretty much a standard loan and security package” are much higher than they need to be. There would be an even stronger case for releases of guarantees and securities, and transaction closing opinions or certificates.
There are already examples of banks or industry participants adopting common documentation for substantial benefit. In derivatives, there is the standard ISDA documentation, and the New Zealand Bankers’ Association has developed standard priority documentation which can be used to regulate competing priorities between security documents. The Auckland District Law Society does have some standard security documentation, but it is not used by the banks. There is essentially a standard form of director’s certificate that has evolved through market practice, and the Banking & Financial Services Law Association has created an Australian standard closing opinion, created “…to have some consistency in the basic closing opinions given by law firms in this market in an effort to avoid the extensive and costly negotiations and delays that so often bedevil what could be a relatively straightforward process”.
There are external influences suggesting a greater move towards standardisation would be desired. The new unfair contracts regime provides one impetus, as there is less scope for unnecessarily unfair terms that used to regularly appear in bank documents. It is also consistent with the approach to the Credit Contracts and Consumer Finance Act that was recently confirmed by the Supreme Court in the Motor Trade Finance case, where lenders should adopt a consistent approach to the recovery of costs so that they can compete more transparently on the interest rate.
Customisation and the pride of authorship
Of course, there will always need to be elements of customisation. Some banks systems will calculate interest and manage payments differently for example, and there should always be scope to innovate, and negotiate the wording of particular clauses to ensure that they fit the specific situation, but how much easier would it be if the banks started with a standard set of terms, and then noted additions or amendments to them by exception in a specific schedule so that lawyers time and focus could be limited to what is substantively different.
One of the impediments to adopting a standardised approach is overcoming pride of authorship. Some lawyers (in-house and in firms) are convinced that “their way” of drafting a particular right or obligation is better than any other. While there are definitely nuances, mostly outside of the core obligations around interest calculation and payment it’s fiddling at the edges. Banks are unlikely to move to take enforcement action without a clear and compelling breach, not a technical one on the margins.
That is not to say that customisation is not possible, or easily accommodated. It is now also easier than ever to customise “standard” documents using document automation. A wide variety of specific situations that might arise can be covered off via agreed optional clauses. There is effectively no limit to how many of these options could be available, because built-in logic could ensure that only the ones which are actually relevant are included in each case. When they are included, however, that can be done in a best practice and familiar format, and in a single location for easy identification and review, reducing costs of review and negotiation. As well as substantially reducing the time and cost of legal review of transaction documents, there are other potential benefits from greater standardisation.
• It would make it much easier to buy and sell loan and security documents, as buyer and vendor due diligence time and costs could be greatly reduced by allowing a focus on the financial terms of the loans, and not detailed assessment of the legal boilerplate.
• This type of standardisation would be a great first step along the way towards “smart contracts” based on blockchain technology. This short video showing a smart contract initiative by Barclays Bank when using standard ISDA variables demonstrates the possible benefits of reducing the variability of loan and security document terms as part of a similar approach.
It would be a significant effort to adopt a more standardised approach to loan and security documents. Egos would have to be parked at the door, and protections would need to be included to ensure that the terms were reasonable and fair to lenders and borrowers (and in relation to legal opinions and certificates, lawyers), while still enabling customisation, innovation and competition. However, the NZBA priority documents are evidence that it can be done, and Barclays’ smart contracts example is a tantalising glimpse of the possible benefits that could lie in wait if it was done properly.
What do you think?
For more information on how document automation can assist in the safe and efficient customisation of standard banking documents, visit LawHawk’s Banking Page.