Brexit: Bigger slice of smaller pie for debt funds(1)

The UK’s vote to leave the EU last week has sent shockwaves across the world. And while it is still too early to tell what the implications will be, some in the private debt space are seeing opportunities.

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It must have been among the most turbulent seven days in UK political history. Since Friday, we’ve seen the pound plunge, the UK stripped of its AAA rating and the beginning of leadership elections in both the Conservative and Labour parties. And while the referendum showed a clear victory for the ‘leave’ vote, there are already questions over whether the UK will actually exit the European Union.

As the impact of the vote sinks in, many in the private debt industry are now turning to the question of recession and its potential impact on the asset class. In the wake of the vote, foreign banks are reportedly drawing up plans to leave should the UK’s access to the single market no longer be guaranteed. One debt fund manager I spoke to said that a recession may result in banks further retreating and a bigger space opening up for direct lenders to deploy capital in the UK mid-market.

But while banks may retreat, David Parker, managing partner at Marlborough Partners, is sceptical about a very substantial increase in the number of opportunities available for non-bank lenders. He said: “The uncertainty in the market will mean less M&A activity, however even if banks pull back a little, overall deal flow will fall and debt funds can only follow the transactions out there. Debt funds may increase the share of loans they originate, but it will simply result in them having a bigger slice of a smaller pie.”

On the distressed side, some are optimistic about potential deal flow. Only yesterday, Mark DeNatale, partner at CVC Credit Partners, said that the structural changes to the European banking landscape as a result of the referendum present “attractive investment opportunities” as the fund reported it has €2.5 billion in commitments to deploy in the European market. Earlier this week, our colleagues in the US reported increased interest in the distressed market since the vote.

Voices in the industry suggest the larger and more experienced lenders will weather the storm. Those with long-term relationships with investors in the UK market and an archive of completed deals should be able to seize on the space as banks retreat. Funds operating with smaller teams and less experienced managers, however, may find themselves swallowed up in a wave of consolidation in the alternative asset management space, a prediction that one placement agent makes.

On the legal side, some are disappointed to see the UK’s more liberal approach to regulations disappear as the Capital Markets Union (CMU) continues to take shape. Jonathan Hill, UK commissioner responsible for the CMU, announced his resignation. For a number of lawyers I spoke to, there are worries that certain member states may guide a pan-European framework for alternative investment funds originating loans that will involve more burdensome restrictions.

On the first day of the PDI Germany event in Munich last week, many were confident that the UK electorate would vote to stay in the EU. The following day there was a stunned atmosphere. Overwhelming numbers in the industry (although few would go on the record) supported ‘remain’, opting for the status quo instead of an unknown future.

Long-term predictions are impossible at the moment as the UK still continues to digest a decision of this magnitude. There is no historical precedent for the country to point to and many in the industry are cautious about their operations as the UK continues to breathe the toxic atmosphere created by the conflicting ‘leave’ and ‘remain’ campaigns.