Investor interest in the European loan markets and increased need for portfolio diversification has necessitated hedge funds to focus on a wider range of European loan markets whilst at the same time managing risk. Recently, hedge funds have begun to explore new investment opportunities in Italy. Italy’s 2014 regulatory changes and its proposed changes in 2015 are intended to facilitate direct investment in Italy by non-Italian lenders to enable such lenders to have greater efficiency and transparency than ever before.
On 24 June 2014 the Italian Government adopted Law Decree no. 91 (the “Decree”) that, inter alia, introduced regulatory changes to permit Italian companies’ to gain greater access to non-bank debt financing. The Decree lifts certain regulatory restrictions which have traditionally prevented non- Italian banks and hedge funds from lending directly to Italian companies.
Previously, under Italian law, the purchase and sale of loans from and to Italian counterparties could only be carried out by authorised banks and financial intermediaries. As a result, the Italian market developed “fronting structures” whereby non-authorised investors could gain exposure to Italian borrowers. These structures were generally implemented through agreements governed by non-Italian law (often in the form of funding agreements/arrangements with a similar structure to sub-participation agreements) between an Italian lender of record, who would act as the fronting bank, and investors who were not authorised to lend directly into Italy.
From a tax perspective, withholding tax was generally levied on interest paid on loans advanced by a non–Italian lender. The rate was subject to any applicable reductions under a double taxation treaty between Italy and the investor’s jurisdiction.
The Decree permits Italian securitisation SPVs (ISVs) to lend to Italian businesses other than micro-enterprises (enterprises which employ fewer than ten people and whose annual balance sheet does not exceed EUR 2 million).
The lending activity provided by the ISVs must: (i) utilise the assistance of banks and financial intermediaries during the origination process to select potential borrowers; (ii) retain a “significant interest” in the financing transaction, but unlike the requirements for insurance companies (see below), the threshold for ISVs is not stated. In addition, the notes issued by an ISV to fund the financing granted by the ISVs must be subscribed to by “qualified investors”(as defined in the Italian Finance Act) only. Qualified investors include (but are not limited to) Italian and foreign entities authorised and regulated to operate in financial markets (e.g., banks, investment firms, other authorised or regulated financial institutions, insurance companies, pension funds, and broker dealers) and other institutional investors whose principal activity is investment in financial instruments, including securitisation entities as well as large corporations.
The Decree also permits insurance companies to directly extend loans to Italian businesses.
The rules and conditions of such lending activity will be implemented by IVASS, the Italian insurance supervising authority, and must take into consideration, inter alia, the following principles: (i) potential borrowers must be selected by a bank or financial intermediary; and (ii) such bank or financial intermediary must retain a “significant interest” in the financing transaction, which means an interest equal to at least 5% of the loan granted by the relevant insurance Company. In addition, the insurance company must be adequately capitalised and have an internal control and risk management system which allows the insurance company to manage risks typically associated with lending activity.
WITHHOLDING TAX EXEMPTION
The Decree introduced an exemption from withholding tax for interest paid by Italian borrowers on medium to long term loans (i.e., loans with a term of at least 18 months plus a day) to (i) financial institutions established in an EU Member State; (ii) insurance companies established and authorised under the law of an EU Member State; (iii) collective investment undertakings which do not make use of financial leverage (including tax transparent entities set up in EEA countries included in a list territories permitting adequate exchange of information with Italian tax authorities).
It is now expected that the Italian Government will enact in the first half of 2015 specific regulations to further permit Italian borrowers access to alternative sources of financing and clarify the scope of the application of the Decree. Furthermore, it is expected that the “qualified investor” criteria will be expanded to include entities not expressly included under the current set of regulations which would further facilitate direct lending in Italy for other types of investment vehicles.
The regulatory changes, which permit direct lending to Italian borrowers, are intended to improve the terms and availability of credit for Italian businesses in the medium term and to open the loan market to non-bank lenders, encouraging the development of alternative financing structures for Italian borrowers. Additionally, the exemption from Italian withholding tax will also facilitate cross-border syndication and secondary market transactions by, reducing costs for non-bank lenders interested in lending in Italy.