In a year where bank lending once again contracted and the ultra-low rate environment pushed investors still further out on the yield curve, it seemed inevitable that private placements would be one of the hot topics of 2014. And so it proved.
Corporates, wherever they are in the world, now need new options when it comes to financing the business. Accordingly, those companies for whom the public debt capital markets are not a feasible option, the private placement markets are becoming an increasingly popular alternative source of capital. The trend can be seen worldwide although, as we will see, there are some important differences between, and even within, regions such as Asia and Western Europe.
A turbulent decade
Asian capital market issuance is growing rapidly. Regulation has been one of the drivers. In recent years, there have been efforts in the region to improve access to public capital markets through the simplification of legal documentation and the investor base has widened substantially.
“Traditionally Asia has been a bit of a bank loan market,” says Vijay Chandler, Executive Director of the Asia Securities Industry & Financial Markets Association (ASIFMA). The bond market is typically smaller relative to the loan market, at least in terms of the total outstanding. Although this continues to be the case, there are signs that change is afoot. “What has happened in recent years is that the banks have been pulling back from the syndicated loans market, largely as a result of the Basel III guidelines and other regulatory pressures. Bond issuance has really grown, as a result.”
There has been a change, also, in the type of debt being issued on Asia’s capital markets. About a decade ago, private placements in Asia were – with the benefit of hindsight – moving into bubble territory. Western hedge and private-equity funds came to take advantage of the region’s burgeoning growth, but soon found that there was little to purchase on Asia’s underdeveloped capital markets. Some corporates in Asia, meanwhile, faced obstacles to issuing on the public capital markets. Thus each party ended up solving the other’s problem, and the issuance of dollar-denominated debt boomed.
“This was before the financial crisis, remember, so everyone was gung-ho. You had the likes of Indonesian mining companies coming to the market looking for bridge finance prior to an initial public offering (IPO) or a public bond issue, and we had all these investors looking to invest in corporate bonds at a time when the public markets were pretty much full,” notes Chandler.
“What has happened in recent years is that the banks have been pulling back from the syndicated loans market, largely as a result of the Basel III guidelines and other regulatory pressures. Bond issuance has really grown, as a result.”
Vijay Chandler, Executive Director, Asia Securities Industry & Financial Markets Association (ASIFMA)
For a while, this proved a happy arrangement for all concerned. Investors bought up all the debt they could, providing companies with much needed financing, and secured very attractive yields in return. Then, in the autumn of 2008, the music finally stopped.
According to Chandler, around 80-90% of the deals struck during those heady pre-crisis days had to be refinanced. “A lot of them were very short-tenor private transactions,” says Chandler. “That meant that if your company’s deal was priced in 2005-06 – or even as late as 2007 – by 2010, you needed to refinance either through an IPO or some sort of bond offering, both markets which were, of course, closed by that time.”
The subsequent freeze in capital market lending didn’t last long, however. Debts were successfully restructured, and sovereign wealth funds took up some of the remaining slack and now, remarkably, the capital markets are once again growing at a rapid pace, although the bulk of what is being issued, this time, is denominated in local currencies, not USD.
Asia is not a homogenous region, by any means. The split between public and private issuance still varies considerably across jurisdictions, therefore. Public placements now account for the lion’s share of corporate bond issuance in a number of Asian countries such as China, Malaysia, the Philippines and South Korea. However, in other markets, like India, private placements have remained the primary form of bond issuance representing more than 80% of the corporate bonds issued domestically in 2012 and 2013.
The regional disparities are, of course, all a matter of pricing. “In many Asian markets, the costs of public issuance still exceed those associated with private placement by a multiple,” says Hannah Levinger, Analyst, Global Risk Analysis, at Deutsche Bank. “As a result, private placements are still a common issuance regime. Companies can tap longer-term financing with a few selected investors while saving on regulatory costs and requirements and avoiding lengthy and burdensome procedures.”
Such features make private placements a very attractive proposition for some businesses, particularly smaller, fast-growing companies who need capital to finance their growth plans. Recognising this, there have been initiatives in some countries, most notably China where obtaining capital is one of the biggest problems faced by SMEs, to help smaller companies execute private placements. A pilot initiative for SME bonds was launched by the Chinese regulator in 2012, which was followed up in 2013 by an announcement to extend private issuance to a wider region and companies registered at the “new third board” a nationwide share transfer platform for non-listed companies.
“The move was seen as both a measure to stimulate the development of the corporate bond market and reduce SME’s reliance on bank loans,” says Deutsche Bank’s Levinger. “As a result, private placements have seen steady growth in Asia.”
Luxury or necessity?
We have also seen a growing level of interest in private placements from companies in Europe – and similar initiatives encouraging firms to reduce their reliance on bank loans.
In autumn 2014, private placements – and specifically the question of whether a European PP market to rival the US will develop – was one of the most keenly discussed topics at the Loan Market Association’s (LMA) annual Syndicated Loans Conference in London. On that question, the general sentiment was optimistic. A straw poll of the 850 delegates in attendance found that a sizeable majority (78%) believe that such a market will become established within the next decade. In addition, just under half (49%) indicated their conviction that we will see one emerge within as little as five years.
Earlier in the session, a panel of fixed-income investors were asked if a Europe-wide market for private placements is even needed. After all, companies today can choose to issue a private placement in the US market denominated in dollars, before converting back into euros. In fact, a lot of companies these days are even finding investors in the US willing to lend to them in euros, thereby saving them the bother of executing the conversion themselves. Companies might also find the credit they need in one of Europe’s local markets – the German Schuldschein sector, and the nascent French and UK markets – each of which has seen growing international interest from both investors and issuers in recent years.
However, the ability to issue private placements in a pan-European market would be a big advantage for borrowers, the panel insisted. “It would be much easier for companies to borrow locally in local currency,” Calum Macphail, Head of Corporate Private Placements at M&G Investments, told delegates. Investors, he explained, tend to extend their willingness to lend right across the yield curve when dealing with familiar, local companies.
A European market would also simplify the process enormously, especially on the legal side of things, he added. “If borrowers have the ability to use documentation that is familiar and consistent and cheapens the process – that has got to be beneficial as well.”
Investors would stand to benefit too, Emmanuelle Nasse Bridier, Chief Credit Officer at the AXA Group, pointed out. It’s no secret that institutional investors have felt the need to be a bit more adventurous with their portfolios of late. In the current ultra-low yield market, insurance and pension funds have found it all but necessary to diversify into new asset classes to secure some return on the amount of liquidity they are now holding. Developing a pan-European PP market would certainly help them in that respect.
“For us insurance companies a European private placements market would offer new opportunities that are not available on the public market, most of which are well organised and strongly performing corporates,” she noted. “We are looking for new investment opportunities with that type of company.”
“If borrowers have the ability to use documentation that is familiar and consistent and cheapens the process – that has got to be beneficial as well.”
Calum Macphail, Head of Corporate Private Placements, M&G Investments
The need for consistency
Having agreed unanimously that building a private placement market in Europe would be a positive step, the panel then moved on to address the barriers that need to be overcome before that can become a reality. When the question was put to delegates earlier the answer was clear. Just under half (47%) said that the main thing that Europe needed to begin competing on equal terms with the USPP market was greater standardisation, particularly with respect to the legal documentation used across various jurisdictions.
Eliminating such inconsistencies is something that the LMA has itself taken a leading role in. In January 2014, the group announced that it is working with banks and law firms on developing a standardised template for use in private placement transactions. Further encouragement for this objective came when, in February 2015, the European Commission (EC) published a Green Paper “Building a Capital Markets Union,’ promising steps to facilitate the work of industry bodies in developing common market practises and documentation for private placements. This is just the beginning, however; the investors on the panel were keen to emphasise that much more progress is needed in this space if Europe is ever to rival the USPP market. “Regulation is very different around Europe when it comes to credit markets,” AXA Group’s Bridier said. “I think if we had a European framework around investment regulation that would solve a lot of the problem.”
If the industry now joins forces to iron out the differences at local level then the liquidity should soon follow, the panel concurred. “We are seeing investors become increasingly interested in European private placements markets,” asserted Richard Waddington, Head of Loan Sales at Commerzbank. “Clearly there are challenges, but we’ve got to work together to overcome these challenges and help develop and grow the market,” he added. “There is most certainly demand from issuers, but it is about trying to match that demand with investors’ requirements.”
Achieving that match may take some time, but it is not beyond the industry’s reach. In the end the panel arrived at the consensus that a pan-European market will emerge in time, albeit a segmented one. That is not as contradictory as it might first seem, M&G Investments’ Macphail explained. If a company wants to raise a relatively small amount of funding – say €10m – then it may still be best served by its local market. But there are, of course, no shortage of companies who have larger requirements and, for them, tapping into larger pools of liquidity on a pan-European basis would be the more ideal option.
“There is most certainly demand from issuers, but it is about trying to match that demand with investors’ requirements.”
Richard Waddington, Head of Loan Sales, Commerzbank
“If we are talking about a market for everyone, not just the happy few, then you need to have a different response depending on the requirement,” he said. “For a small bilateral loan then local is great. However, we also need to cater for the needs of those larger companies who want to borrow Europe-wide. I think the market is flexible enough to accommodate both.”