It’s time we talked about Italy.
The image of a slow-moving and unreliable place to invest in debt appears increasingly unfair in the wake of recent legal developments in the country. In February, prime minister Matteo Renzi announced a decree enabling international debt funds to originate loans in Italy. It’s a welcome development, but it still might not be enough to change the image of the country in the eyes of private debt participants.
Providing debt in the Italian mid-market has been restricted historically to the traditional bond format, a complex and costly process for borrowers and lenders. The latest legislative changes fundamentally alter the type of product that international alternative lenders can offer to investors. It enables them to offer loans to companies and opens the door to seizing on the advantages of non-bank lending. These include speed and flexibility for borrowers, as well as higher returns for institutional investors in a low interest rate environment.
The legislation, however, is not perfect. Single transactions cannot exceed 10 percent of total commitments to the fund, reducing the amount a fund can lend. The freedom to originate loans is restricted to closed-end vehicles and the leverage ratio between total assets and net asset value in funds marketed to institutional investors cannot exceed 150 percent. Similar to banks, fund managers will have to regularly report to the Bank of Italy on its transactions.
But the killer: interested generated by firms not based in Italy are required to pay a 26 percent withholding tax, unlike their Italian counterparts for which no such restrictions apply. This difference will result in a number of lenders outside of the country pricing in the tax payment when structuring loans for borrowers and ultimately undermining the aim of introducing more sources of finance for Italian companies.
Speaking to those working in Italy, there is confidence that adjustments to the legislation will be made as the government has demonstrated a determination to open up the space for alternative funds. A dialogue between the industry and the government is already underway.
The Bank of Italy is currently undertaking the second stage of the legislation, holding a consultation on how the risk diversification cap is measured and the authorisation process for banks seeking approval to originate loans. Stakeholders have until 12 September to register their concerns on these draft provisions.
One fund manager operating in the Italian mid-market has observed that competition to lend has already intensified. The leading Italian banks are stuck with what some estimate is around €360 billion in non-performing loans, an alarming figure that has held the constant attention of both European and Italian authorities (as well as the financial press) throughout 2016. But as these pressures continue to build up in the banking sector, ultimately restricting lending, it’s important the government establishes a space that makes both borrowing from alternative lenders and deploying capital in the country attractive.
As both LPs and GPs continue to assess the true impact of Brexit and begin to review their country allocations, Italy has to seize the opportunity arising out of the uncertainty around the largest and most sophisticated private debt market in Europe. As the fund manager told us, increasing competition is positive for his fund: it boosts the awareness of the country as a viable debt market. In this rising tide, the authorities need to do more to ensure that all boats are lifted, rather than left to sink under burdensome restrictions and punitive tax rates.