Pushing back

It’s been an interesting few years for the world of business development companies (BDCs).

Long considered fringe players in mid-market finance, publicly-listed BDCs have stepped up in recent years to provide much-needed capital to mid-market companies, particularly as larger banks scale back lending to smaller, riskier businesses.

This has led to a rash of new entrants in the market; the number of active BDCs in the US has grown from four as of nine years ago to nearly 30 as of May, according to a recent Reuters report. And as their proliferation and contribution to the market has grown, so too has their desire to address their grievances with Washington, DC regulators.

“The BDC model has worked very, very well. And some modernisation after 33 years probably has more momentum now given the increasing role BDCs are playing in middle market finance,” says Jim Hunt of THL Credit.

In October, the Small Business Investor Alliance (SBIA) – an industry organisation that counts THL Credit, Monroe Capital, Fifth Street Finance and New Mountain Finance as members (among others) – sent a letter to the US Securities and Exchange Commission requesting the regulator adjust its treatment of BDCs to reflect their growing position in the world of mid-market finance. 

“Current regulation has made it extremely difficult for BDCs to deliver on their mission to fund small and medium sized businesses starved of growth capital,” wrote SBIA president Brent Palmer in a letter to SEC chairwoman Mary Jo White. “The current restrictions on BDCs make the capital raising process for BDCs less flexible, less efficient and more expensive than necessary – which ultimately each BDC’s ability to invest in growing US businesses.”

In particular, the organisation has targeted regulations that exclude BDCs from being defined as ‘Well-Known Seasoned Issuers’ – which would enable them to register more easily with the SEC – as well as certain investor communications restrictions and the requirement that BDCs not exceed a 1:1 debt-to-equity ratio as prohibitive to the industry’s growth..

“BDCs are fundamentally operating companies. They are thriving, operating businesses. However, they’re actually regulated under the ’40 Act, like mutual funds, rather than an operating business,” says Stephanie Paré Sullivan, general counsel for THL Credit. Most operating companies have an easier time filing and registering issuance with the SEC, she adds. Easing filing requirements would make it much easier – “less bulky, less cumbersome”.

“The goal, as outlined in the letter and highlighted in the legislation, is to modernise portions of the BDC regulations to treat BDCs like other operating companies for SEC filing purposes, and to facilitate BDCs’ ability to raise capital that they can in turn invest into growing small businesses,” she says.

Palmer is careful to point out that the regulations the SBIA has taken issue with are not prohibitive to the formation of BDCs on their own. Indeed, the market opportunity for BDCs has only grown over the last two years – at least 15 have held initial public offerings since January 2011, according to Raymond James research.

Taken together, however, they do present a formidable challenge for new entrants. Those challenges are amplified at the lower end of the market, where the potential for smaller BDCs to grow may have been stifled by the costs associated with formation, he tells Private Debt Investor.

“We’re not pushing for massive deregulation. That’s not what we’re suggesting. We think the market should decide how many BDCs there should be and how much funds are flowing into the space,” Palmer says. “The growth shouldn’t be impeded or hindered by specific regulatory actions. The structure should sort of stand on its own.”

Inertia

In addition to petitioning the SEC for changes to its regulatory regime, the SBIA also has engaged with leaders on Capitol Hill to help combat what Palmer describes as institutional inertia. The SEC hasn’t taken umbrage with any of the revisions his organisation has proposed, he says. They simply need to be spurred to action.

“We’re not expecting pushback there … we’re trying to shock that institutional inertia to do what, in many cases they want to do already,” he says. “Pretty much all of these issues have been previously raised with the regulators, and feedback has not been negative or hostile. It’s ‘Sorry, we’ll get to that’. Well, time’s been wasting for a good long while, so it’s time to get it done.”

The organisation has already established a presence as a lobbying entity, Palmer says. Its political action committee has provided political donations to several key members of Congress, including Republican Scott Garrett, the chairman of the Subcommittee on Capital Markets and Government-Sponsored Enterprises for the House Financial Services Committee, according to watchdog organisation OpenSecrets.org. Garrett also spoke at the SBIA’s BDC Roundtable in September, Palmer says.

In January, Representative Nydia Velaquez introduced legislation that tackles many of the issues highlighted in the SBIA’s letter, including allowing BDCs to own investment advisers and introducing parity in how their offerings are treated. 

Even so, despite the SBIA’s efforts to ameliorate the regulatory environment in which BDCs operate, there are still those who argue these vehicles remain a risky bet, particularly given the volatility of the credit markets over the last few years. “Fueled by the availability of low-cost financing, BDCs run the risk of over-leveraging their relatively illiquid portfolios,” wrote the Financial Industry Regulatory Authority in a January letter. That suggests an element of hostility to lightening the regulatory burden, but there’s all to play from the SBIA’s perspective.