Making the case for Europe

Flexible, popular and well-established: a description of the private placement (PP) market that other forms of alternative credit would give an arm for.

The market’s origins are firmly in the US but, since the Global Financial Crisis (GFC) exposed holes in Europe’s financing model, a variety of trade bodies and governments have pushed the development of a distinct European private placement market.

As it stands, however, the nascent European market has problems. It is fragmented, with regulatory barriers in many jurisdictions, and is lacking definition.

Supposedly private transactions have been listed in France – defeating the purpose of the traditionally non-public market. For Germany and its neighbours, the Schuldschein market meets much of the need that the initiative aims to address. Indeed, its popularity has prompted non-German lenders to launch Schuldschein products.

But the legal issues are being ironed out. A year ago, French legislators dropped listing requirements for securities investments by insurers. And last December, the UK’s Treasury scrapped withholding tax on private placements.

Furthermore, several trade bodies are working on other problems within this developing market.

GLOBAL PP

From the borrower perspective though, pushing to develop a separate regional market is regressive, argues Brian Bates, a partner at US-based law firm Morrison Foerster.

He says the US private placement market has outgrown its roots and is in practice a global marketplace.

“Regional markets are great if there’s a specific need for local lending and you have a local relationship. I’m not denigrating that. But, generally speaking, the bigger the market you’re borrowing from, the more aggressive and company-friendly the terms will be simply because there’s more competition. For instance, I believe that the ‘UKPP market’ is already within the global PP market,” says Bates.

Bates points out that US and other investors lend in euros and other European currencies with investors typically taking the currency risk and swap costs. Borrowers only have to cover those costs if they repay early. Documentation often uses English law – the market standard for financing transactions in Europe.

The US market is hugely liquid and Bates claims the issue of liquidity is key. Even when investors commit intending to hold to maturity, having a liquid underlying secondary market cuts risk.

Jason Rothenberg, head of US insurer MetLife’s private placement team in London, agrees that calling it the US private placement market is a misnomer. Less than half of the issuers are US-based companies, with about 35 percent of borrowers in the market coming from Europe.

He also seconds the point that the scale of the US market is a massive advantage for both investors and borrowers.

“To my mind, the existing private placement market offers a lot of flexibility for European issuers and European companies will continue to be very well served by the existing market,” says Rothenberg.

WORKING GROUPS

In early January, the Loan Market Association (LMA), a trade body with a catalogue of standardised documentation for the syndicated loan market, published its private placement templates.

European borrowers accustomed to the LMA standard will find the documents familiar, explains Amelia Slocombe, senior associate director at the LMA (pictured). Given documentation they are comfortable with, it will be easier for those borrowers to venture into private placement, rather than having to use the “completely different looking” standard US documents.

But the markets shouldn’t been seen in terms of which is best, she says. “I don’t think they need to be competing markets,” says Slocombe. “There’s a lot of liquidity out there at the moment and people will opt to use the document that’s most appropriate.”

It’s not just the LMA that is working on developing the European market. A few days after the LMA published their loan and bond PP documents, the Euro PP Steering Committee, a French group, released their two model agreements.

In addition, another larger working group is set to produce guidelines in the coming weeks. The Pan-European Private Placement Working Group (PEPP WG) includes both the French Euro PP committee and the LMA as well as the Association for Financial Markets in Europe, the Association of British Insurers and the European Private Placement Association, with the International Capital Market Association (ICMA) co-ordinating.

WHY EURO PP?

You would be forgiven for finding the flurry of working groups confusing. But for those at the coalface of establishing a European PP market, there are clear imperatives driving the work.

The well-worn arguments about diversifying from bank financing in the wake of the credit crunch have won over several governments which have legislated to encourage the market. 

For ICMA’s Nicholas Pfaff, a senior director in the market practice and regulatory policy unit, who co-ordinates the work of PEPP WG, the regional market will supplement the existing market. It will open up private placements to sub-investment grade European borrowers keen to move beyond the bank market, but unable to transition straight to the bond market. Borrowers which are currently underserved by the US PP market. 

“This European market is going to address the untapped demand of medium-sized cross-over European corporates in a much more significant way. It’s additional; it’s a question of making a bigger pie,” says Pfaff. 

His target is to have a decent-sized European PP market established within the next three to four years.

The appetite is there. The French market has taken roughly three years to reach average annual volumes of €3 billion and, as well as the trade bodies, a number of large institutional investors have thrown their weight behind PEPP WG, including Delta Lloyd, Federis Gestion d’Actifs, KBC Group, LGIM, M&G Investments and Natixis Asset Management.

M&G Investments is an established PP investor and Calum Macphail, head of private placements at the firm, explains why European investors are backing the PEPP WG. “Clearly what we’re trying to do here is increase the opportunity for funds that we manage,” he says.

NOT CONVINCED

While acknowledging that progress has been made and agreeing that local financing is important, Bates claims that more US investors are seeking yield by moving down the credit curve. He says that the US market is developing to accommodate lower-rated medium-sized European borrowers.

While MetLife itself is interested in moving down the credit curve, Rothenberg doesn’t agree with Bates’ outlook. “Given the lower liquidity in the private placement market compared to public bonds, the existing private placement market is likely to remain primarily an investment grade space,” he says.

BORROWERS CHOICE

With a significant number of investors on board, a European PP market is firmly on the horizon. 

The shape remains lumpy with disparate national markets emerging, and potential volumes remain unclear. But the various lobby bodies have made substantial progress. 

The choice between a US and European private placement market for either side of the transaction is pretty academic. MetLife’s Rothenberg agreed that if the documentation and other conditions met their requirements, then there is no reason why, in time, the firm wouldn’t invest in a European private placement market.

For borrowers, even without the benefits of the established market’s liquidity and competitive terms, having another source of financing can only be positive.

And European corporates want a private placement market on their doorstep – a survey by law firm Allen & Overy showed overwhelming support for it.

“One of the drivers behind all [these initiatives] – it’s not simply down to investors and others thinking, ‘this is a good thing’ – it’s pretty consistently been something that European corporates are asking for as well,” says M&G’s Macphail.

The ultimate shape of a European PP market will be decided by borrowers making decisions based on the terms available in competing markets – including the bank and bond markets. 

As ever, the bottom line is the only factor that will sway a chief financial officer. 

THE DOCUMENTS

The LMA documents set out to create a flexible template. They cover loan and note options, as well as addressing non-bank investor-specific concerns about transferability and include a ‘make whole’ provision, explains Slocombe.

Euro PP has produced two model agreements – one for loans, one for bonds. They were drafted under French law but are designed to work under different legal jurisdictions with adjustment. The group was established in late 2012 by CCI Paris Ile-de-France and the Banque de France. The committee includes more than ten French investors.

The Pan-European Private Placement Working Group is set to issue its guidelines on the market including descriptions of the role of each market participant, a definition of PP as well as an outline on best practice in the coming weeks, says Pfaff.