UK private placements — avoiding splendid isolation
Efforts to boost the UK’s private placement market are making it easier than ever for borrowers to access non-bank finance. But for some, the UK private placement market should be reaching for greater union with its European counterparts, even as Brexit wrenches Britain and the EU further apart. David Bell reports.
There’s a clear direction of travel in the UK’s private placement market, says Tim Conduit, partner at Allen & Overy in London.
While sceptics may have belittled the nascent asset class just a few short years ago, there’s no doubt that UK private placements, and UK private debt in general, are becoming serious financing options for corporate borrowers that are too big to simply arrange a banking overdraft, but too small to consider the public debt markets or warrant the attention of bank lenders that face constrained balance sheets and onerous capital charges.
“This market is a robust part of the corporate funding mix in a way that it wasn’t even just two years ago. It’s no longer niche,” says Conduit. “Five years ago banks would say that raising £700m in the private market would be impossible. You would not find any advisers saying the same thing now. Now we regularly see private placements raising over £1bn in a single transaction. The market is significantly more liquid, with more participants and bigger ticket sizes.”
The maturing UK private debt market is now “firmly entrenched” in the capital markets, says Max Mitchell, head of direct lending at Intermediate Capital Group in London.
UK infrastructure and property are two big industry segments where private placements are playing a key role.
LondonMetric Property, a FTSE 250 real estate investment trust, closed a £130m private placement deal in September last year, selling a three tranche deal to UK and US investors to pay down some of its unsecured credit facility. The UK Reit invests in retail property.
Dover Harbour Board, meanwhile, agreed £55m of funding from Allianz Global Investors this January through a 30 year private placement bond to support the redevelopment of Dover Western Dock.
“At a time when the needs of pension and life assurance investors are not being met by traditional capital products, we are delighted to have the opportunity to show how both needs can be satisfied through the type of private debt products available in our rapidly expanding alternative assets platform,” Allianz’s UK infrastructure debt portfolio manager Adrian Jones said in January.
The private placement bond was complemented by two £35m revolving credit facilities, provided by RBS and Lloyds, and a £75m loan from the European Investment Bank.
Rule change eases execution
The private placement chunk of Dover’s project was a deferred draw “qualifying private placement”, which under new rules, introduced in the UK in January last year, qualifies for an exemption from withholding tax for the interest paid on the instrument. The measures were brought in to stimulate the UK’s private placement market — a clear signal of the political intent to encourage the provision of credit to the economy through the PP market.
The rule was aimed at transactions that fall outside the “quoted Eurobond exemption” whereby UK issuers that list transactions publicly can gain relief from witholding tax for investors. The rule offers an alternative to double taxation treaty relief for non-UK investors.
“It has made it easier for existing issuers to tap the market, although it hasn’t in itself been a catalyst for new issuers,” says Conduit. He says the ability of issuers to place private deals without listing them was welcomed by the borrower base, for whom total privacy is often a key concern. “The new rule has been helpful in ironing out this wrinkle and clients have been pleased to be able to use it,” he says.
The Dover Western Dock transaction, supplemented by the £70m of revolving facilities provided by RBS and Lloyds, also challenges a common misconception among some observers of the private debt market — that non-bank lenders are filling a lending vacuum left by banks’ total withdrawal from the sector. That thesis is a “fallacy”, according to ICG’s Mitchell.
Banks have had less risk appetite for lending to certain segments of the economy, he says, and have preferred to transmit the liquidity provided by central bank stimulus into investment grade classes.
But though traditional bank lenders have faced squeezed profit margins, with increased capital charges and shareholder pressure to cut costs, they have not retreated entirely.
“From our experience, bank lenders never went away — they merely reduced the size of single issuer concentrations,” says Thomas Duetoft, head of origination at Pemberton Asset Management.
Both investors say, however, that private lenders are better placed than bank lenders to manage long term investment to corporate borrowers that are too small to access public debt markets.
Mitchell says: “Bank lending can sometimes involve excessive levels of leverage and maturity transformation — all of which creates systemic risk, but none of these are features of private debt markets.”
Duetoft adds: “Funds such as ours act as a solid transmission mechanism for long term, stable capital in areas that banks are still active in, but just not lending to the same capacity.”
Piece of a bigger puzzle
Though UK private placements, and private debt more broadly, are weaving themselves more deeply into the fabric of corporate finance, some feel the endgame should not be to build a functioning UK PP market in isolation. The bigger picture, Conduit says, is how the growing UK PP market fits into the wider development of a genuinely pan-European private placement market, one that could rival the wall of capital in the deep and liquid US market.
“UK PP will never be enormous — even sterling-based investors do not solely want exposure to the UK,” he says. “UK PP will develop and the transaction execution will become more streamlined, but only if there is a consensus about how to do this across Europe.”
Conduit adds: “You have to see the UK as part of the European picture. The European private placement market is quite fragmented, although it is functioning.
“In France the market is working well because of central bank initiatives encouraging French investors to fund medium sized and often larger corporates. Germany has its Schuldschein market which is deep and liquid, and increasingly serving corporate borrowers outside Germany. Italy has also taken legislative steps to make it easier for corporates to access non-bank funding. The question is how the UK fits into this.”
Creating a genuinely cross-border private placement in Europe, with the UK a key player, would help alleviate a concerning trend in bank lending — the retreat of capital behind national borders in the Eurosystem, as banks show more wariness of lending to each other.
Data from the European Central Bank showed at the end of February that while lending between banks and the rest of the economy has been growing steadily on aggregate, it is increasingly fragmented.
Cross-border lending between eurozone banks fell year on year by 6% to €1.26tr in January this year, the data showed. In December last year, the figure had fallen to its lowest level since 2004. In 2008 cross-border flows surpassed €2tr.
“Bank lending has become localised,” says Duetoft. “Lending hasn’t evaporated but banks are focusing on their domestic markets.”
The trend could be a golden opportunity to demonstrate the cross-border potential of private placement markets in Europe.
But the big question is whether European jurisdictions push forward with plans to develop a standardised regulatory approach to private placements, or whether markets like the UK develop in isolation.
The International Capital Market Association and Loan Market Association have already drafted standardised templates for transactions, an important building block for closer integration of the markets.
But efforts to bring the UK and European markets closer together will undoubtedly be put under strain by the UK’s vote to leave the European Union, as well as stalling efforts on the European Commission’s flagship Capital Markets Union project (see separate chapter on page 5).
Conduit, nonetheless, is confident that efforts to align private placement markets will not fall by the wayside. He says the UK is likely to continue to regulate in parallel with Europe and the CMU.
“I’m quite optimistic about how feasible this is, despite events such as Brexit. The UK is a significant economy in Europe — from a supply and demand perspective, there will be continued market pressure to remain integrated with Europe,” he says.
Despite political pressures leaning towards fragmentation in the Eurosystem, investor and borrower appetite for cross-border transactions is healthy, says Conduit, and that should encourage a more streamlined cross-border market to emerge, helping the UK develop in conjunction with its European peers.
“The number of PP investors across Europe has increased significantly in the last couple of years. A lot of those investors in Europe want exposure to the UK, and a lot of UK investors still want exposure to Europe,” Conduit says.
“The homogenisation of European private placements is inevitable, regardless of Brexit. Investors aren’t really respectful of national borders and they just want to be able to invest.”