In this year’s global overview, we touch on several macro trends relating to legal regimes and markets and try to read the tea leaves as to what 2020 might bring for the global restructuring community.
Monetary policy, default rates and cheap liquidity
The combination of disappointing European GDP growth rates (and to a certain extent slower Chinese and US growth) plus the continuing popularity of protectionist trade policies is contributing to expectations of a global economic slowdown. That said, the much-predicted global boom in restructurings thus far remains more a prediction than an actuality. This in part is because of (and evidenced by) global default rates remaining persistently below long-term averages – in Europe, the US and globally. At the same time, central banks are looking increasingly dovish, with the Federal Reserve cutting its lending rate for the first since 2008 and the European Central Bank thought to be also considering a rate cut. So, contrary to what some expected a year or so ago, the current era of low interest rates and quantitative easing doesn’t look like ending anytime soon.
There is no doubt that many capital structures (and not only ‘zombie companies’) are, at least when compared against traditional long-term views, overleveraged and appear unsustainable. However, a combination of the persistently low interest rates, tolerable economic growth and the large amount of refinancing liquidity allow these structures to be propped up, refinanced and stumble on.
The availability of cheap debt has also led to well-documented increased levels of deal leverage (with ever higher valuations) and the proliferation of weak ‘cov-lite’ standards in loan and bond documentation. Towards the end of 2018, the leveraged loan market hit a bump with fears of a possible US recession, but it has since rebounded in light of the increasingly dovish Federal Reserve. Borrowers continue to demand more and more favourable terms as leveraged finance lenders hunt for any sort of yield. Looking into the future, this continued loosening in standards may well amplify the effects of any economic downturn if valuations prove overly optimistic, debt becomes too expensive to maintain and lenders or bondholders are only able to step in at such a late stage that rescue and recovery becomes too challenging or expensive.
Trade tensions and the wider world
Despite the relatively stable (albeit muted) global economic outlook, macro geopolitical tensions loom large. The current US–China trade war means that some companies are having to transform their supply chains as investors shift their production capacity out of China. Where the protectionism under President Trump will lead remains to be seen, especially were he to be re-elected for a second term, which seems a possibility. Add to this the increasing tensions in the Middle East, Hong Kong and the impact of Brexit – and the warning bells of the risk of a global downturn are getting ready to ring (but exactly when remains unclear).
Sectors under stress
The automotive sector is facing disruption from multiple directions. To name just a few, there’s a disappointing global growth, electric vehicle sales are rising and diesel engines in cars are declining in popularity. In 2011/12, roughly 55 per cent of new cars in the EU were diesel-powered but this has since dropped to 36 per cent. Overall, global car sales are predicted to fall by four million in 2019, partly because of US trade policy and its effect on sales into China. Manufacturing in China has also declined, with some of the Chinese factories of Ford and PSA running well below full capacity at historic lows, far below the level required to be profitable.
Retail continues to struggle a lot, particularly in the UK (but also around Europe and the US). A strong dollar will only add to UK retailers’ domestic troubles, as they are hit with the dual threat of increased import costs and the lowered purchasing power of the British consumer – the Bank of England estimates that a 5 per cent depreciation of the value of the pound increases consumer prices by nearly 1 per cent. In last year’s guide, we dubbed 2018 the ‘year of the CVA’ for English retailers. This year the trend continues, with the company voluntary arrangements (CVA) of high street giants Arcadia and Debenhams dominating the headlines. However, retailers such as Superdry and Halfords are intentionally not taking the CVA route, instead focusing on renegotiating leases due for renewal on more favourable terms, perhaps benefiting from a more lessee-friendly market because of the threat of CVAs hanging over uncooperative landlords.
Despite US sanctions on Iran and plummeting Venezuelan production, Brent crude oil (at the time of writing) is hovering around the US$60 per barrel mark and well below where some had hoped it would settle. It is widely expected that OPEC will continue to cut production to support crude prices and the economies of the cartel’s members, but US shale production and slowing economic growth seem likely to prevent a large rise in oil price, absent a macro shock. As a result, the United States continues to see numerous energy sector restructurings and Chapter 11 filings.
Brexit means . . . ?
This overview would not be complete without mentioning the European elephant in the room, Brexit. At the time of writing, the UK under Boris Johnson is due to leave the EU on 31 October 2019. He has certainly taken a much stronger (some would say belligerent) approach and, while wanting a revised Brexit deal, has said that, come what may, the UK will leave on 31 October – even if that means a ‘no-deal’ Brexit. This has galvanised those opposed to a no-deal Brexit and it is very unclear as to how this will evolve – no-deal, Government of National Unity, second referendum, extension of the exit date, national election, these all get talked about with no one knowing. On the basis that whatever we suggest here will be distant speculation by the time of publication, we will say no more. However, it seems clear that, whatever lies ahead, there will be some losers and Brexit is only likely to increase restructurings in the UK and parts of Europe once the current stasis is past.
Despite the American Bankruptcy Institute engaging in a large-scale reform project on Chapter 11 a few years ago, there has not been any significant reform in the US in the last year. While still the most powerful restructuring regime, parties remain concerned about the overall cost of Chapter 11s and their attendant litigation. This has led to an increase in pre-arranged and pre-packaged Chapter 11s where the court process only lasts weeks or even only a day (eg, Fullbeauty, Sungard Availability Services). Such quick Chapter 11s are the exception but indicate a possible US market evolution in response to the cost concerns.
India continues to evolve its restructuring regime and, given the size of its non-performing loans (NPL) market, is a country much watched by restructuring professionals. China is increasing the number of NPL sales but is, overall, still nascent in dealing with its restructuring needs. In Europe, there are two noteworthy changes: the Dutch scheme and the EU restructuring directive.
It remains to be seen whether Singapore becomes the popular bankruptcy venue that it was designed to be.
The Dutch scheme
After many years, the much-trumpeted ‘Dutch Scheme’ seems to be in its last stages, having been laid before the Dutch Parliament in early July 2019. The Dutch legislation provides that a debtor may propose a restructuring plan to all or some of its creditors or shareholders which, if certain voting thresholds are met, can be confirmed by the court, making it binding on all affected parties. The restructuring plan may include a cross-class cram-down and group company obligations.
The Dutch legislator has also adopted a novel approach of creating two versions of the restructuring plan: a public version that would fall within the remit of the EU Insolvency Regulation (EIR) and a private version that will fall outside the ambit of the EIR. If a debtor chooses the EIR version, it will need to have its centre of main interests (COMI) in the Netherlands, but, on the plus side, the Dutch restructuring scheme will then benefit from automatic recognition through the EU (within the terms of the EIR). If a debtor chooses the private non-EIR version, like for an English scheme, it will not need to have its COMI in the Netherlands, thereby lowering the entry hurdle. On the downside, no EIR automatic recognition will be available (although recognition through the Judgments Regulation or the UNCITRAL Cross-Border Insolvency Model law may be available if there is a Dutch establishment).
All in all, the Dutch scheme remains the new European process to watch and, if it is interpreted pragmatically by the Dutch courts, we expect it to become a popular restructuring tool in Europe.
EU Restructuring Directive
In Europe – also after many years in the making – Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt (what a title!) has now been published. It will come into force two years after publication, meaning that EU member states have until July 2021 (or, if they are particularly struggling, until July 2022) to implement its measures.
Although diluted a little in the final stages, this Directive remains a powerful and well-thought-through piece of legislation. The proposal does not prescribe a single European restructuring regime, but sets ‘minimum standards’ that all member states’ insolvency laws must meet; a lot will therefore depend on how member states choose to implement it. If implemented by member states to its fullest degree (there is a certain amount of optionality), it will transform the EU’s restructuring regimes making them far more restructuring-friendly.
It is a truism to say that we are one year closer to a downturn than we were last year. The question that economists are now asking themselves is whether or when the big bang will come – or whether the economy will limp on as it currently is. As far as the macro political environment is concerned, all factors for a recession are certainly in reach, but we are in unchartered waters. Previous cycles have not had anything like such prolonged ultra-low interest rates, loose monetary policies and easily accessible alternative sources of capital; there is, therefore, a real uncertainty as to how much economists can look to the past when trying to predict what will come next.
As far as restructuring tools go, we do not believe that Brexit and the Dutch scheme will mean the end of the English scheme of arrangement. Whether there will be a material erosion of the English scheme remains to be seen. Two factors will be most relevant in this: first, will (at least within the EU) more restructuring plan tools develop because of the EU Restructuring Directive? Even if the latter does come to pass (and looking at the Dutch scheme in particular), restructuring tools must not only look good on paper – a tried and tested track record is indispensable for their widespread adoption. Second, can Chapter 11 be made more efficient and less costly? With the English scheme being somewhat less attractive post Brexit, parties will test harder if a US Chapter 11 is the answer. Perceived costs are a disincentive, which is why we have seen some sizeable companies such as Syncreon (and Nyrstar, but that was also because of recognition issues) prefer to use the English scheme of arrangement.
This guide, as a way of keeping track of global legal developments, will continue to be an important reference tool. As ever, we hope that you enjoy reading and using it.