For many participants in Europe’s leveraged market, 2014 on first impressions heralded something approaching a new normal.
According to data from 3i, Debt Management, leverage debt issuance in 2014 reached a total of €150bn; leveraged loan issuance was €78.4bn, the highest volume since 2007; and European high yield had another record-breaking year with total issues of €72bn. The European CLO market performed similarly strongly, raising €14.5bn, the third-strongest year of issuance on record.
But behind the semblance of a market re-asserting its momentum, a number of fundamental features are coming together to divert the market’s direction of travel. And these changes have potentially far-reaching implications for law firms engaged in the European leveraged landscape.
The strong performance of high-yield in the first half of 2014 gave way to a far more volatile second half, triggered by geopolitical events in Russia, the Ukraine and Syria as well as macro-economic instability in the eurozone, and political uncertainty in Greece. The European high-yield bond markets will certainly remain liquid in 2015, but new issues will be vulnerable to volatility. Periods when the markets are effectively closed will be shorter than historically has been the case, but the very fact that the uncertainty is trending upwards will dampen high-yield excess.
The availability of deep pools of liquidity, and in particular the competitive interaction between Europe and the US as sources of leveraged debt capital, and the product interplay between loans and bonds are driving, at the documentation level, convergence of debt terms.
European lenders have hitherto been slow to loosen covenants for leveraged loans, but are now permitting borrower-friendly features more traditionally found in US loans and bonds. Cov-lite loans in Europe are gaining momentum, albeit that their share of the European debt market has some way to go before it equates to that in the US. Convergence has been accelerated by European sponsors more frequently accessing the US market for loans on better terms and on higher leverage multiples, and the readiness of US institutional debt investors to participate in European deals in search of more attractive yields.
CLO resurgence and the emergence of banks willing to undertake the expected uptick in M&A-driven activity (as opposed to re-financings of existing debt or dividend recaps that have been among the key drivers of the bond markets) will slightly shift the market balance towards loans rather than bonds.
More dramatic effects on the mid-market of European leveraged deals will be caused by the strong acceleration of alternative direct lending across Europe. The number of debt funds set up has more than doubled from 2009 to 2014, as private debt seeks to generate attractive risk-adjusted returns in the space opened up by the European banks deleveraging their balance sheets. Data from Deloitte implies that direct lending funds currently have €45bn of committed capital to deploy, and a further €15bn will be raised over the next 12 months. Not only will deal flow increase for direct lenders, but hold sizes will grow, and terms will be looser and more flexible. There is likely to be closer collaboration between banks and direct lending funds as these competitors learn to live side by side. If, as rumoured, the Bank of England imposes lending curbs on leverage loans held by banks similar to the restrictions enforced by US regulators, then the market is likely to suffer further dislocation, and non-bank lending will benefit.
The private placement markets (both US and European) for European issuers are contributing to market liquidity, particularly in France. Issuers in the UK, Italy, Belgium and Spain all accessed the newly-developing private placement market last year. In addition, the German Schuldschein market is opening up to non-German issuers. In all, the private placement market for sponsor-led transactions in Europe has firepower of more than £25bn.
The Pan-European Private Placement Working Group, an initiative co-ordinated by the International Capital Markets Association, building on the initiative behind the French Euro PP Charter, has promoted the standardisation of private placement terms; the Loan Market Association has launched new loan and bond documentation for European private placements under English law.
The transatlantic internationalisation of the European leveraged debt markets and the momentous increase in private debt liquidity are contributing to a pace of change in relation to participants, products, epicentres of capital, terms and documentation, which is unprecedented in the market’s history.
Law firms are inextricably bound up in such shifts. There are exciting opportunities for those that can adapt quickly and authoritatively to such changes.
Mark Vickers is a banking partner and member of Ashurst’s board. Helen Burton (pictured) is a banking partner and head of financial institutions and funds.