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Tuesday, 24 October 2017

Better together?

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  • US subsidiaries of European insurers such as Alliance and AXA have also raised money in this market, with much of the paper snapped up by banks, insurers and corporates

Private placement remains tiny in Europe compared with public markets, but is growing fast. Smaller and unrated borrowers have been looking for alternatives to ever-scarcer bank loans, while cash-rich non-bank financial institutions, such as insurers, have been looking for new investment opportunities. On paper, it is a match made in heaven but the market remains highly disparate and to flourish it needs greater consistency.

In the US, the private placements market has matured into a major component of the financial landscape. No such behemoth exists in Europe. A series of regional offerings are, however, emerging in response to the retreating bank loan market, which has left a void for financing small and mid-cap companies, or those that are unrated or not well-known.

Private placement also proved itself to be reliable and steadfast throughout the crisis in 2011–12 while many other markets were only open intermittently. Europe wanted its own version to secure steady financing for its smaller companies.

Talk of a European private placement market remains potentially misleading because what exists is very fragmented. But then, talk of a US market is equally misleading, given that well over 50% of issuance in that market comes from outside the US. Nearly 20% of it is even in foreign currencies – mainly sterling, euros and Canadian and Aussie dollars.

In Europe, France, Germany and the UK have emerged as the main hotbeds of activity. Each has its own legal and cultural nuances, but they do share some characteristics.

Size

European deals tend to be much smaller than US ones, ranging down to as small as €25m, though the typical range would be €50m–€250m. The European market has also been more receptive to crossover credits than its US equivalent, and is more flexible in terms of tenor and how deals can be structured.

The French private placement product is essentially listed, a structure that was selected for the convenience of its principal investor base, French insurance companies. About 2-1/2 years old, it is still in its infancy. But from a standing start it has now done more than 60 deals. The majority of them offer debt with tenors of five to seven years, shorter than the typical duration in the US market, about 80% of which is for seven years or longer.

Even within France each deal uses different documentation and execution procedures, but efforts are being made to increase standardisation. Most deals have been executed for entities that have been listed, but with private marketing.

Germany

The German Schuldschein market is arguably the most comparable to the US market, being the most established. It offers a greater choice of tenors, with the majority less than five years but around a third coming in a five to seven-year duration – and some longer than that.

It is popular among issuers in the German-speaking jurisdictions of Europe in particular and has repeat issuers that are well-known to investors. But foreign issuers are showing an increasing interest, with France and the UK successfully issuing.

US subsidiaries of European insurers such as Alliance and AXA have also raised money in this market, with much of the paper snapped up by banks, insurers and corporates.

In the UK, the product takes the form of direct loans by non-bank financial institutions, with no middleman institution being involved.

Bulldog market

Even before private placement started taking off in Europe the UK was doing its own deals, with institutions such as M&G having been active for years. Social housing and infrastructure have also emerged as active sectors, with financial institutions happy to conduct their own due diligence.

“The Bulldog market has been around for years and has grown, but remains modest in both amounts invested and numbers of active investors,” said Michael Thilmany, managing director for private placements at HSBC.

“Today, there are about a dozen US insurance companies that lend sterling or euros which they usually swap back into dollars but occasionally hold,” he said.

Other markets have also grown up around specific sectors that can be viewed as precursors to a broader European private placement market. The institutional term loan market, for example, has emerged as an alternative in the infrastructure space, with deals that look like loans but with a longer tenor, in some cases offering seven, 10 and even longer maturities.

“There are still fewer investors in Europe, and even fewer who can do these private placements unrated and unlisted. So for now the market is not as deep as in the US”

 

“These have been finding favour among some UK and European infrastructure companies, which have been using the product as a complement to the bank market as well as the US private placement and public capital markets,” said Angus Whelchel, co-head of private capital markets at Barclays.

The early growth phase

Demand for credit has been feverish, especially among insurance companies and debt funds, with public and secondary markets at times struggling to keep pace.

Governments, trade bodies and banks had all hoped a European private placement market might offer more interesting investment opportunities.

“European institutional investors are starting to set up dedicated teams for private placements, to compete with the bank product,” said Priya Nair, managing director for corporate and infrastructure DCM at RBC.

“The supply of new deals is not keeping pace with existing demand. These investors want to provide longer-term lending and so can be engaged sooner by borrowers/sponsors.”

Growing up

Yet the investor base still has a lot of maturing to do before the market can rival that of the US.

“There are still fewer investors in Europe, and even fewer who can do these private placements unrated and unlisted,” said Nair. “So for now the market is not as deep as in the US.”

The market will continue to grow but to fulfil its potential, some believe it must transform itself from a series of informal and decentralised markets into a single homogeneous market with a consistent legal framework.

“The challenge of developing a single pan-European private placement market is not legal, it’s behavioural. The market will only evolve if the relevant market participants want it to”

“We will need the various smaller European markets to merge for them to survive but it won’t be easy. It will probably involve some trial and error,” said Whelchel.

Framework

An important step would be the development of its own self-regulating body to oversee the market, as the National Association of Insurance Companies does in the US. This would give the market the framework within which further, standardised development could occur.

Currently, it is not only the documentation that varies between deals and jurisdictions, but the whole process. Whereas the US has a very clear process, in Europe some deals follow the US route while others are structured and placed in a variety of ways – recently RBC even closed a private placement using a Dutch auction/closed bids process.

“The LMA and ICMA have both been pushing for the creation of a pan-European private market,” said Whelchel. “The LMA has developed some early stage standardised documentation which is just the first step but you can see momentum building.”

The two groups are working together on a note format variant of the loan PP documentation, the reasoning being that many target corporates will be comfortable with starting with the loan format under documentation. The idea is to ensure new lenders under the PP in note format are on an equal footing with loan format lenders and existing bank lenders.

Regulatory support

S&P has developed a model explaining how it might award credit scores for unrated corporates wishing to do a private placement deal and this kind of infrastructure should be a catalyst for further growth, making it easier for lenders to participate in the market. Further cost transparency and some explicit regulatory support will also help the market grow.

Another positive development would be the formal use of UK law to govern the market.

“Currently, the Schuldschein market operates under German law and the French PP market operates under French law,” said Whelchel. “For a pan-European market to emerge it needs to operate with some flexibility in this regard to accommodate as broad a market as possible.”

“The use of English law to govern international financings is one of the UK’s greatest exports, so of course a market that used English law would be an advantage,” said Phil Smith, a partner at Allen & Overy.

“It has been used in Europe for centuries. A European corporate doing a deal in the US may not have used law documentation before, whereas I suspect that English law is likely to be more familiar. Similarly, an Italian or Belgian corporate would probably find it more difficult to navigate French or German law than English law.”

Overcoming regional differences

However, while such measures would help create a favourable environment for growth, they will not deliver it alone. “The challenge of developing a single pan-European private placement market is not legal, it’s behavioural,” said Smith. “The market will only evolve if the relevant market participants want it to.”

Putting the right regulation in place will drive the process. Insurers, for example, have to be mindful of applicable capital restrictions.

“In this regard, regulatory change, such as Solvency II, will play a part in determining how private placements evolve,” said Smith. “But it’s primarily a commercial consideration.”

So far, French investors seem to prefer the bond format while Germans prefer the Schuldschein loan format. In the middle are the Dutch and UK investors, which seem to be relatively agnostic.

But these deep-rooted cultural differences present a considerable challenge to the evolution of a single, pan-European private placement market. The cultural differences do not end there.

“German and French investors are most comfortable lending to businesses they know or at least know about, whereas US and UK investors have more experience of credit and are therefore happier looking further afield,” said Thilmany. “But European investors are getting more experienced with credit now and the gap is closing.”

This bodes well for the emergence of more pan-European private placement markets in Germany and France.

The market may fail to develop not because it remains fragmented but because economic conditions undermine the business case for using it. Rising interest rates or other circumstances could put a dampener on demand for credit. But the hope is that private placement will remain competitive by offering additional spread on what is available in the public markets.

Beyond survival, exactly how private placement will develop in Europe remains a mystery.

“I don’t see the UK, French and German investors [through Schuldschein] coming together to have one voice on structure immediately,” said Nair.

“There is a place for all of them and the diversity is a positive because it gives issuers more options. But arrangers are still at the stage where we are trying to figure out what everyone wants.”

If it can move past that stage, standardising the product across jurisdictions will bring new advantages for issuers and investors.

“A single pan-European market would be an advantage because the greater liquidity would mean deals getting done at a better price,” said Smith.

“Eventually, that may allow it to not only complement but to perhaps compete with the US market. European issuers don’t always want dollars, so when they do a US deal they have to arrange a swap back into their functional currency of euros or sterling. It would make sense for them to do the deal in those currencies in Europe if they could do it a competitive price.”

“The European PP market will grow though it will take time, and as it does this will certainly take market share from the US,” said Thilmany.

“But the two can be complementary. For example, the US offers capacity but Europe offers the chance to do smaller deals. We think we can play a leading role in the further development of the international private placement markets.”

To see the digital version of this report, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

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