86 4 Debt
From a legal perspective, loan instruments can be “negotiable instruments” and
regarded as “Wertpapiere”, or receivables that are neither “negotiable” nor “Wert-
papiere” (see Volume II).
Loan instruments can differ in terms of seniority. The Economist described the
wide range of loans instruments as follows: “With the new investors has come a
bewildering variety of loans. Instead of a short chain – secured creditors, unse-
cured creditors and shareholders – now there are senior or first-lien creditors (who
have first dibs on a company’s assets), second-lien creditors (who also have
claims over the assets of a company, but who get paid only after first-lien credi-
tors), mezzanine creditors, senior subordinated debt holders and subordinated debt
holders. At the bottom of this caste system, as before, are the shareholders, who
get any leftovers.”^7
Some loan instruments are asset-backed. For example, the “conduits” (special
purpose vehicles) that invested in US subprime mortgages before the financial
market crisis that began in mid-2007 issued various kinds of asset-backed loan in-
struments: Asset Backed Commercial Paper (ABCP); Credit Linked Notes (CLN);
and Asset Backed Securities (ABS). Typical loan instruments that were issued by
those conduits but were not asset-backed contained Commercial Paper (CP) and
Medium Term Notes (MTN).
There are convertible loans and loans that are not convertible. There are also
other distinctions. For a taxonomy of payment obligations, see Volume II.
Nature of loan agreements. An intertemporal value transfer is characteristic of
all loan transactions, and loan transactions are characterised by performances that
are separated by a relatively long period of time.^8
Loan transactions can thus be contrasted with many predominately non-financial transac-
tions between two contract parties in which there is no intertemporal value transfer. The
two parties structure their agreement so that each party has to perform all or part of its obli-
gations at about the same time that the other party has to perform its obligations. For exam-
ple, in a purchase and sale contract, the buyer will have to pay the seller or make arrange-
ments for it to be paid at more or less the same time that the seller ships the goods to the
buyer.
The separation in time of the performances of the two parties influences both the
underlying logic of a loan transaction and the dynamics of the negotiations be-
tween the borrower and the lender.^9 First, the borrower might refuse to repay the
loan when it falls due. The lender must therefore manage credit risk. Second, the
lender counts on the borrower performing its obligations in a timely manner so
that the lender will be able to repay its own obligations when they fall due. The
lender will therefore have to manage refinancing risk.
(^7) The walking dead, The Economist, December 2007.
(^8) Bradlow DD, Some lessons about the negotiating dynamics in international debt transac-
tions. In: UNITAR, Problems and Perspectives of Debt Negotiations, DFM Document
Series, Document No 9, Geneva (April 2000).
(^9) Ibid.