The international regulator has investigated the practice for several months, with support from national bodies like the Financial Conduct Authority (FCA), and will soon launch a consultation report.

“It will be an opportunity for market participants to engage with regulators on potential sources of conduct risk and conflicts of interest,” said the spokesperson. “Sponsor designated counsel has been one among many topics raised and discussed during our extensive engagement with market stakeholders.”

For direct lenders, this feels less revelatory than it does overdue, as designation has been losing its grip over the private credit market for some time, according to sources.

“Designation has definitely declined,” said one lawyer that advises direct lending clients.

The practice first emerged in the US syndicated loans market after the global financial crisis, growing to become a recognised feature of European private credit during recent cheap money years. It is known to cause contention between parties with opposing interests in a deal.

Disagreements over designation can be a particularly sore point in private credit because, as a second legal source put it, “direct lenders invariably hold the risk of any loan until maturity, without a liquid secondary market to offload their risk”.

“This makes the terms on loans very, very important,” the legal source added.

Access: designation first backfires

Despite its proliferation during the Covid-19 pandemic, designation first exploded into marketeers’ conscience amid the debacle over Access Group’s refinancing last summer.

Law firm Kirkland & Ellis advised the software company on the financing, which was Europe’s largest-ever unitranche deal at the time. Under K&E’s recommendation, fellow law firm Shearman & Sterling was appointed as designated legal counsel for the consortium of lenders involved on the deal, according to press reports.

Unhappy with what they saw as Shearman’s conflicted interests, several of the lenders vented their frustrations to the press, drawing attention to much of the conflict around designation at the time.

The lenders hired their own lawyers to provide extra legal advice due to concerns that Shearman was not representing their best interests, according to Bloomberg.

Since then, engaging third-party firms as ‘over-the-shoulder’ or ‘shadow’ lawyers has grown to become a common — although critiqued — method through which lenders can counter some of their designation worries.

“I hate using shadow counsel because it means twice as much work,” an in-house legal source said. “You have to coordinate the shadow lawyers and sit as this conduit between them and the designated counsel, passing messages back and forth from one to the other.”

“That said, it is a necessary evil,” they added.

A year on from Access, designation still takes place, especially at the larger end of the market. For example, in EQT’s recent £1.25bn financing to buy Dechra, law firm Milbank advised a group of 10 private credit funds involved in the deal — including Blackstone.

But, as has become almost a standard for such arrangements, law firm White & Case provided additional legal counsel to Blackstone to support its involvement in the deal, people close to the matter said.

Lender resistance grows

If shadow counsel was only a makeshift fix to private credit’s designation concerns, the emerging practice of a ‘choice of three’ looks a more viable long-term counterbalance.

Many lenders have taken to proposing short lists of 2-4 law firms they would be happy to work with, for the sponsor to choose from, according to the second source.

This tends to be the case, agreed the first source, saying that the “choice of three” has become “commonplace” for lenders, especially in the mid-market space.

“I think proposing three firms is a lot more palatable to lenders as it gives them more control,” they said.

LPs catch wind

Such workarounds to designation leave open the question: what can IOSCO’s report bring to the table? The sense is lenders have taken the matter into their own hands and reached a practical solution through the choice of three method.

The answer may extend further up the structural ladder. It isn’t rare to hear of LPs asking questions on how funds ensure they receive independent advice in spite of designation, said multiple sources.

Such curiosity would be in line with what a number of sources identified as growing LP sophistication and a tendency towards increasing scruples. Questions no longer focus on just the performance of underlying borrowers but also on the term sheets in place to protect lender interests.

It may reassure LPs less involved in day-to-day dealings with designation to know that regulators have dissected the practice and drawn their conclusions (whatever they may be).

While LPs come to terms with the practice, plenty of lenders will hope IOSCO can confine designation to the history books.

Blackstone and White & Case declined to comment. EQT and Kirkland & Ellis declined to comment. Milbank and Shearman & Sterling did not respond to a request for comment.