The growth of private debt in Europe is often spoken about with reference to its development in the UK. With its Anglo-Saxon business culture, strong links with the US and lender-friendly legal regime, this is not surprising. Indeed, the same reasons could be cited to show why the UK led the way in the development of the European private equity industry many years earlier.
But you can’t tell the whole story without also looking at the continent’s second market just across the Channel. France is sometimes characterised as being unfriendly to business, dominated by powerful trade unions, unhelpful to lenders and a closed market that prioritises domestic business.
Despite this, it has seen enormous growth in private debt investment. So why has this market, rather than Europe’s biggest economy in Germany, become the hotbed for private debt on the continent? Moreover, with the UK in a period of unprecedented political turmoil, could France claim its crown?
Deloitte’s Alternative Lender Deal Tracker shows France has consistently been the second most popular destination for mid-market private credit lending in Europe. This trend goes back several years, which is when private debt really began to take off on the continent.
It has consistently stayed ahead of Germany and, in some recent quarters, has come close to matching transaction volumes in the UK. In Q3 2018, there were 38 deals in France compared with 45 in the UK; in Q2 2019, France had 25 deals to the UK’s 35. There is still a significant gap, but it is certainly narrowing. Since Deloitte began recording deal volumes in Q4 2012, the UK has totalled 732 transactions, followed by France on 485 and with Germany well behind on 206.
The importance of France is summed up by London-based investor Chris Fowler, managing director at CVC Credit Partners: “Our initial view on France was ‘wait and see’. There are challenges being a senior lender in the country, which has a legal system that is generally more borrower-friendly than other jurisdictions. But it is such a large market that it’s hard to ignore.”
A tale of two banking systems
To understand why private debt was able to establish such a strong foothold in France rather than in Germany, it is useful to examine the differences between the two countries’ banks.
“The retrenchment of [domestic and international] banks away from anything [in France] that is not a plain vanilla transaction has really helped private debt to grow,” says Damien Scaillierez, founding partner at pan-European lender Kartesia. “Smaller companies or those with more complex financing needs are where this asset class has a major role to play. In Germany, it is quite different, as smaller companies are still supported by the local banks.”
The banking situation in France arguably bears more similarity to the UK than markets such as Germany, Italy or Spain. France has a relatively small number of large banks and a smattering of smaller regional players, a set-up that would appear to provide significant opportunities for small and mid-market lenders to become competitive.
Thierry Vallière, head of private debt at France’s largest asset manager, Amundi, believes the structure of the country’s banking sector has made it stand out. “France has strong, healthy banks that want to do larger deals that need a lot of leverage but aren’t so interested in smaller mid-market deals,” says Vallière. “Other countries have local bank networks that are more willing to support small clients regardless of the cost.”
The banking set-up also gives some inherent advantages to private debt funds. Although France’s banks may favour large deals, they can rarely underwrite whole loans, even in the mid-market. They instead need to rely on syndication, which places limits on how deals can be structured.
Geoffroi de Saint Chamas, head of the Paris office at European fund manager Pemberton, explains: “Where banks struggle is they generally need to be able to sell down part of – or all in certain cases – their exposure and so they cannot afford to be as flexible in documentation, as that would create a risk that they would not be able to sell on the position.”
Nose to the ground
The stereotype that France can feel like an opaque and closed market has at least some foundation in reality. French businesses like to work with other French businesses. They want to borrow from lenders who speak French and who are ideally accessible to them via a Paris office. That’s not to say there is no benefit to having boots on the ground in, for example, the UK or Germany; but France can be a particularly difficult market to crack if you aren’t local.
“You absolutely need to be there,” says CVC’s Fowler. “Having a local presence in France is more important than it is in most other countries.” The wider CVC group has been present in the country for many years, but in 2019 its credit arm set up its own practice to aid in origination there and has completed two deals in the past 12 months.
The need to be local means that non-native firms without the resources to set up a physical presence in Paris can find it difficult to get going. This is reflected, according to de Saint Chamas, in the make-up of the country’s private debt community.
“Despite a large number of private debt funds targeting the French market, there is only a small number of strong players with serious teams on the ground, with good and longstanding relationships with financial sponsors,” he says. “This is a country where you need to have a local office. If you want to do business with the manager of a company based in a regional city, then you need to put someone credible in front of them who speaks French, who has a truly local culture and experience. And you need an address in France.”
Localism is not only useful for building relationships with businesses, corporate financiers and financial sponsors to originate deals. It can be even more critical when facing challenging situations in this debtor-friendly jurisdiction.
Kartesia’s Scaillierez says: “France is less standardised than other markets and when things don’t go the way you expect it can get very complex. If you are in a situation where you need to recover assets it’s absolutely vital to be local to understand how to manage such a process.”
The legal system is perhaps the biggest difference between the French and UK markets. This may be a core reason why France has played second fiddle for so long. Credit investors cannot bank on making a few good deals to secure a healthy return for investors, and being able to recover assets or restructure companies is a vital piece
However, de Saint Chamas believes credit selection can mitigate the effects of France’s debtor-friendly rules. “France is, to a certain extent, a more borrower-friendly environment than some other jurisdictions in Europe,” he says. “But I don’t think that’s as critical as it used to be. It’s more important to focus on backing the right credits and picking firms you can work with, as there’s much less of a culture of taking the keys to the company at the first sign of trouble.”