As the British economy returns to growth, UK mid-market companies – firms with revenues between €100 million and €1.5 billion (£85 million; £1.3 billion) – are facing a contracting bank lending environment, which threatens their continued growth and development. Indeed, mid-market companies are more affected than larger companies, and the funding shortfall for these firms is expected to amount to £450 billion between now and 2017.
Meanwhile, the UK private placement (PP) market is growing – with an estimated £6 billion raised in the past three years – and the presence of willing investors suggests that it may help plug the funding gap. However, it lacks transparency in terms of deal flow, and other barriers – such as regulation – stand in the way of further development.
Investor appetite is increasing
Net lending by banks to the UK nonfinancial corporate sector has been contracting since December 2008, forcing mid-market companies to look elsewhere for growth-enabling funds. To an extent, this has been addressed by a 48 percent increase in outstanding bond issuance and private placements in the same time frame. Indeed, investors are showing particular interest in mid-market companies in general in the low yield environment.
And this increasing investor appetite is borne out by growth in the UK private placement market. In the UK, most investment is sourced locally through fund managers or insurance companies, which invest directly in companies domiciled in their own countries. Private placement deal flow spiked in 2013, totalling between 30 and 50 loans (up from only a handful in 2011 and 2012). With the average size of these transactions about £85 million, the total amount raised in the UK since 2011 is estimated to be between £3 billion and £6 billion.
Public and private initiatives could spur further growth
In order to encourage more funding for midsize businesses from sources other than banks, the UK government set up the Business Finance Partnership (BFP). Under the scheme, funding from the government is matched by fund managers. As of last November, 18 midsize companies have received a total of £827 million of lending. So far, at least six new funds have been created for the scheme from Alcentra UK, Ares Mangement, Hayfin Capital Management, Intermediate Capital Group (ICG), M&G Group, and Pricoa Capital Group. ICG, one of the scheme members, reports making nine investments in the past twelve months in UK mid-market companies in support of their long-term growth aspirations.
In addition to the BFP scheme, a number of commercial initiatives have emerged – from intermediaries such as Tresauris and Eurocredit Exchange – that aim to bring together mid-market borrowers and new non-bank investors. What’s more, the Confederation of British Industry has published a handbook for mid-market firms looking for alternative sources of finance, with information on PPs as well as other vehicles such as asset-based lending and self-issued retail bonds.
Yet the alternative funding market for UK mid-market companies remains in its infancy, and there are a number of obstacles to address if the market is to develop. Regulation is one such obstacle, given the EU’s Solvency II Directive does little to encourage insurers – some of the biggest potential investors in this asset class – to provide funding. As a report by the Association of Corporate Treasurers (ACT) points out, “the Solvency II complications act as a fundamental barrier for insurance company investors such that without some loosening of the regulatory burden, a UK PP market is unlikely to develop in much volume in the near term.”
And other problems persist. These include a lack of liquidity and transparency, the need for indices to monitor market performance, lack of investment track record (including default history), the high cost of investment in credit analysis for investors, and the need for standard documentation.
Capitalising on growth
In order for UK mid-market companies to benefit from the recent rebound in the economy – and in order for the PP market to really take off – more information about their credit-worthiness is required to create a transparent marketplace.
For this reason, Standard & Poor’s launched its Mid-Market Evaluation (MME) service in June 2013, Europe’s first credit benchmark aimed specifically at increasing the transparency and comparability of midsize companies. An MME offers an independent and private opinion of midsize companies’ relative creditworthiness and the drivers behind this assessment.
Given that investors are becoming increasingly amenable to investing in this new asset cla ss – as the current low-rate interest environment persists – the UK private placement market may have the potential to bridge the funding gap for mid-market companies. Yet this market will struggle to fulfil its potential without a concerted push from policymakers, intermediaries and market analysts to help link willing investors with businesses in need of funding.
Taron Wade and Alexandra Krief are both analysts at Standard & Poor’s Rating Services and are based in London and Paris respectively.