Treasury Today Country Profiles in association with Citi

Future perfect: the institutional investor’s view of corporate debt

Coins spilled out of jar with dollar origami birds

Phoenix Group is the UK’s largest consolidator of closed pension and life funds. Treasury Today spoke to Scott Robertson, Head of Financial Management, to find out about his investment strategies, the pressure of getting it right on a £12bn fixed income portfolio and what he can offer corporate treasurers.

Acquiring the pension annuities, endowments and life policies from companies that no longer wish to operate them is the stock in trade for UK-based Phoenix Group. In acquiring these assets from corporates, it gives it run-off periods to maturity that are often counted in decades. This arguably assures its future.

With assets under management of £74bn (and if plans for the acquisition of competitor Standard Life come to fruition, this will increase to over £200bn) the firm’s long-term asset base can also play to corporate funding needs rather well.

AUM seeking borrowers

Scott Robertson, Phoenix’s Head of Financial Management, sets the investment strategy for its £12bn fixed income annuity portfolio. In taking on the investment risk of the combined annuities it has acquired, he invests firstly to make enough to pay policy holders their guaranteed fixed sum, then to pay shareholders invested in the funds, and finally to make it profitable for Phoenix.

With direct lending to good quality corporates – through bilateral transactions and private placements – gaining in popularity (notably as corporates continue to seek diversification of funding), Robertson is also responsible for the direct sourcing of private debt assets. It is this aspect of his role, he reports, that is currently generating most excitement.

Indeed, his team – drawn from different but complementary professions – is increasingly charged with developing contacts in the banking, asset management and broker communities, and directly in the corporate world.

As Phoenix builds out its direct sourcing capability over the next 18 months or so, it aims to meet the growing finance needs of treasurers and, in doing so, exploit this investment opportunity for Phoenix stakeholders.

The market it patrols is mainly UK and is thus primarily geared to sterling deals, but it also looks at non-sterling assets, typically US dollar and euro but also yen, usually putting cross-currency swaps in place for these.

Whilst there are no targets for deal size per se, £20m to £40m is par for the course, says Robertson. The Standard Life acquisition is expected to complete by end of Q3 and Phoenix’s annuity funds will then almost double. Naturally, more and larger deals are being sought. “It is our ambition on the private debt side to increase our illiquid assets to somewhere in the region of 33% to 40% of our AUM,” he says. The numbers here will be large but growth will be about “evolution not revolution”. And for good reason.

Credit quality

“We are a natural holder of long-term illiquid assets because we have liabilities [like pensions] that match that,” says Robertson. However, the more illiquid assets are taken on by Phoenix, the more illiquid its portfolio becomes, and the greater its risk exposure is in the longer term. This affects pricing to a degree, but it also means the lender’s level of due diligence is naturally high. Credit quality is thus a key consideration for Robertson. The longer the tenor, the more credit quality matters.

For Phoenix, borrowers must be investment grade (BBB or equivalent and above) or at least offer a guarantee or wrapper to enhance its creditworthiness. However, each deal is looked at on its own merits, explains Robertson, adding that internal ratings assessments will be applied, where there is no external rating, to each borrower (of which more below).

Of course, being regulated by the Prudential Regulation Authority (PRA), Phoenix will look at the capital implications for itself, as part of any deal. In much the same way a bank is tied to Basel III internal capital requirements, so Solvency II imposes a charge on each asset.

Making a deal

When considering a new deal, especially of the kind that the firm has not tackled before, there are numerous internal challenges to overcome. Phoenix has formed a ‘private asset on-boarding’ group which will be called upon to assess each new opportunity, looking at matters such as capital treatment and accounting, and the likely operational and regulatory impact of these.

For corporates, with credit quality forming the backbone of any direct lending or private placement deal, he emphasises the long-term nature of any arrangement. To protect its own interest, he will therefore be looking for either a ‘non-call’ structure (so it can’t be redeemed early by the issuer) or a ‘make-whole’ provision (where an early redemption is possible, but the issuer must pay future interest payments).

The key is in finding a balance. With current liabilities going out to 2050 and beyond, any bilateral deal must be mutually beneficial. Indeed, comments Robertson, “it’s important that we work on the relationship aspect at the same time so that the way the deal is constructed suits both parties, rather than trying to use a broad-based offering that might work in the wider market”.

Although increasing regulatory pressure makes scrutiny on the firm’s private assets necessarily robust, it remains “selective” about deals. But, says Robertson, it has the flexibility to offer a wide range of values and tenors, and even arrange forward transactions, where the deal is done but the funds are drawn down by the corporate only when needed (in some cases, a matter of a few years down the line). With Phoenix holding all investments to maturity, it can afford to be creative but, he notes, this inevitably creates “some very strange cashflow profiles” on the books.

Treasury approach

As its corporate lending plans ramp up, treasurers looking to diversify their corporate finance activity might be considering the private placement market. If so, some research in advance is advisable, says Robertson, this at the very least will help companies to set realistic expectations, not least around the lender’s stringent regulatory obligations.

“Treasurers will need to understand that on the insurance side there is a lot of scrutiny of private assets,” he explains. This is particularly the case in the UK’s defined benefit pension space. Indeed, illiquid assets present a concern for the authorities who are keen to know how investment firms will cover their liabilities in the event of a problem.

Generally, each national regulator has a degree of discretion on the implementation of the insurers’ main regulatory burden, Solvency II. For corporates seeking funding thorough a provider such as Phoenix, with credit quality very much to the fore, it is vital that treasurers ensure the required information and documentation is present and clear, says Robertson.

With a strict regulatory requirement for insurers to invest only in quality, this would require the corporate to share a range of public and private qualitative and quantitative data with the lender’s own ratings assessment team. Given the size of the debt, this would typically be of the kind that an external credit ratings agency (CRA) would require for a public issuance.

In fact, obtaining a private rating from a regulated CRA (such as Fitch, S&P or Moody’s), though not essential for a private placement, will boost the funding opportunities for corporates in this space, says Robertson. Having done so will certainly familiarise the corporate’s internal team with the rating process it is likely to encounter when seeking direct lending. However, he is keen that corporates should not be lulled into thinking that the private placement rating process will be “a lighter touch” than for public debt issuance; it is not.

Holistic view

With Phoenix signalling its intention last year to enter the bulk annuity market (in the UK alone there are predictions of strong growth, with more than £15bn worth of deals over the course of 2018), clearly many corporates are keen to de-risk by divesting their schemes

“When a company does something transformational like selling its pension scheme, there is likely to be another major project in progress on the corporate finance side which the treasury department will also be fully involved in,” notes Robertson.

In his role as Head of Financial Management, presiding over a very long-dated investor base, he clearly sees potential synergies with corporates looking at debt restructuring and offloading their pension schemes. With this in mind, treasurers looking to assure the financial future of their businesses, he believes, should now be thinking holistically about how they execute their plans. Pensions, it seems, are now a very interesting source of corporate capital.