The global dislocation in the financial markets which began in 2007 prompted a decrease in lending and an increase in regulation in the European and the US economies, amongst others. This paper looks at recent initiatives designed to encourage a pan-European private placement market in the face of such financial adversity. We consider whether the signs are promising, but also contemplate whether the existence of the seasoned US private placement market is an more of an impediment to, rather than a model for, the idiosyncratic European market.
The financial crisis and a move towards alternative funding sources
Market participants on each of the arranger, issuer and subscriber sides of bond transactions will be well aware of the extent to which recent (and now not-so-recent) regulatory developments have restricted the speed and ease with which transactions in both the US and Europe may be executed since the global financial crisis. With particular regard to CLOs and other types of securitisation, the constantly evolving parameters of "risk retention" in its various forms, together with increased disclosure and rating requirements are playing an increasingly prevalent role in the transaction structuring experience. Although we are seeing an upturn in activity of late, those markets have been subdued, and a lag in the provision of regulatory clarity both in Europe and across the Atlantic means that a return to increased and sustained levels of activity cannot yet be said to be just around the corner.
In view of this, talk is of the search for alternative funding sources. There is now the burgeoning appearance of challenger banks, and the fintech area is booming, with the smart money on that area becoming stronger. Increased funding options are also rearing their heads in the form of the retail bond market, peer-to-peer lending and private placements.
US versus European private placement market
The US private placement market is well established and globally active, with deals involving both US and non-US issuers. In contrast, the private placement market in Europe has been slow to get off the ground. The factors prevalent in the US market which permit a holistic and relatively uniform approach towards private placements are simply absent in Europe. The presence of conflicting and disparate legal systems in Europe is an obvious obstacle to the creation of a recognisable private placement market. As we will see below, initiatives in Europe at a national level are gaining momentum, however progress remains fragmented and relatively slow. To date, the European countries which nominally have private placement markets (of a significant size) are the UK, Germany and France. There are however, strong trends which highlight an increase in private debt deals in the rest of Europe.
As evidenced by the guide published in 2015, the European Commission supports the development of a pan-European private placement ("PEPP") market for corporate debt. The goals of the PEPP include the provision of financing for medium-sized companies, risk diversification and market standard transactions. The practicalities of achieving such standardisation in Europe, however, are daunting and the drive to encourage a PEPP consists of a number of initiatives which of necessity have had their genesis at a local level.
France has enjoyed a strong growth in the private placement market and has been active in promoting the development of a pan-European market. In 2014, France published the Charter for Euro Private Placements, and in 2015, the French market private placement committee released French law private placement documentation in hope that creating uniformity will increase activity in this market.
Since the financial crisis, the German market has continued to see an increase in activity as the market continues to offer attractive levels of liquidity. With the banks offering loans on favourable terms and the well-established Schuldschein agreement in place (standardised documentation for private placements for which no rating is required), the level of interest to establish a pan-European market to match that of the US, may not be as high as other European countries.
With respect to the UK, in 2012 the Breedon Report attempted to prompt a discussion of the need for alternatives to bank lending, particularly for smaller businesses. As highlighted in that report, by their very nature, smaller businesses often do not have the experience or resources to participate readily in what would previously have been regarded as relatively complex funding structures. In addition, regulatory uncertainty has also affected the willing-ness of smaller market participants to investigate sources of funding other than bilateral bank loans. The private placement however, is one source of funding which has benefits which smaller corporates may find attractive.
In that vein, the Loan Market Association ("LMA") published pan-European Private Placement Documents in January 2015 in response to market participants' requests to standardise the private placement documentation. The LMA is the first to acknowledge that, given the inherently flexible nature of private placement structures (for example in terms of covenant packages, distribution and disclosure) its private placement documentation is intended simply to provide a good starting point for the draftsman, and a common framework from which to tailor the specifics of a given transaction. In addition, the LMA has used as its base the documentation more akin to bilateral lending than pure bond structures. The documentation is drafted upon the premise that the debt which is issued will not be rated or listed. Appropriate amendments must be made to the pro forma documentation, and provisions added to enable third parties to carry out the requisite agency functions (such as paying agent) in the event of a listing. Nevertheless, the push towards providing a methodology to create a more streamlined private placement market both in the UK and across Europe is clear.
It is understandable that commentators and European regulators and market associations find it hard to describe the concept of a European private placement without mentioning the long-standing private placement market which we see in the US. It would be remiss however to fail to acknowledge the huge obstacles to a pan-European market, which simply do not exist in the US. The presence of disparate legal and regulatory jurisdictions within Europe, together with vastly differing sizes of national capital markets has necessitated small steps. Economic uncertainty throughout 2015 and the start of 2016, combined with heated debate surrounding the possibility of Grexit and now Brexit have not been the best environment for the lofty ideals of the union. Indeed, the European Commission's "European Stability and Integration Review", published in April 2016, acknowledges the extent of the difficulties in achieving the goals of the Capital Markets Union Action Plan which was launched in September 2015. Reluctantly, we must conclude that a functioning and practical pan-European private place¬ment market still seems a long way off, however in the meantime it is worth revisiting the basic principles which make private placement an attractive option for borrowers and funders alike.
Benefits and characteristics of the private placement
The benefits of private placements are well known; they include reduced disclosure requirements for those private placements which are unlisted, together with reduced advisory, marketing and legal costs and lighter documentation. The attraction of the private placement comes in large part from the flexibility which the model provides in sculpting the risk exposures sought by a discrete group of, typically, sophisticated investors, whilst retaining the ability of borrowers to meet their own be-spoke funding requirements. The impetus provided by the production of the LMA documentation and other models across Europe has recently been backed up (albeit in respect of relatively large exposures) by measures being taken at the level of the UK Government to introduce withholding tax exemptions for "qualifying private placements". The addition of tax concessions in the private placement sphere should be regarded as another small step towards the development of what remains a relatively nascent market.
It is a peculiar characteristic of the private placement structure that there are few commercial or legal criteria which are set in stone when it comes to structuring a new transaction. Some factors such as tenor and ratings may be of fundamental importance to a specific bond issue, whereas others (for example, listing or the provision of a guarantee) may be easily dismissed upfront, dependent upon investor appetite and the identity of potential subscribers. Such flexibility has perhaps been one of the reasons why a "private placement market" within Europe of itself may end up being a misnomer. A consistent flow of similarly structured bond products which we are used to seeing, for example, in the RMBS market, may simply never materialise in the private placement sector. As we have seen above, regulatory authorities and market leading associations are keen to highlight common themes via pro forma documentation, and such initiatives (supported by the European Commission) are welcome at a time of economic uncertainty, however an element of bespoke structuring on a case by case basis for each transaction mean that the term "private placement market" may only be applied loosely as an overarching term to a disparate number of structures and transactions which have perhaps as their common theme only their own diversity visa vis each other.
A different view
Bond issues which can be regarded as "typical" private placements are arguably unlisted, unrated and unsecured. At Bryan Cave we have been finding recently that more sophisticated hybrids between a fully-fledged publicly listed bond issue and a strict private placement are sometimes necessary in order to achieve the goals of the participants. As we have seen above, the pan-European private placement market remains an objective rather than a reality. We are not at the stage yet where commercial parties can achieve their goals simply by signing pro forma documentation. The irony is that the ability to take advantage of the differences in listing, regulatory, tax and legal regimes which are prevalent in Europe should perhaps be regarded as an advantage and an asset which is available to those parties wishing to enter into private placement arrangements. At this stage, participants are free to make use of the LMA documentation, or to draw up tailored agreements which deal with the niceties of the commercial requirements which must be dealt with. We can suppose that if a "private placement market" is to be identified across Europe at some point in the future, then it must surely stem from an active issuer and investor base which has in the meantime managed to turn the apparent obstacles to a pan-European private placement market into an advantage.
Addendum, 24th June 2016 - The Brexit Referendum
As this article was initially published prior to the UK referendum regarding membership of the European Union on 23rd June 2016, it does not address either the effect of the UK's vote to leave the EU or its impact on the application of relevant European legislation within the UK. However, it should be noted that the referendum result does not itself trigger any legislative changes and accordingly the law as stated in this article remains unchanged at this time. A specific legal process must be followed for a member to leave the EU and the timeline is hardly swift - it is already clear that notice to leave may not be given for many weeks, if not months, and that is just the start of a negotiation process which could take two years or more. Financial services market participants will undoubtedly be monitoring developments carefully as negotiations progress, but until the path forward becomes clearer a period of uncertainty and resultant volatility is inevitable. At least in terms of the EU legislative and regulatory framework for the financial services industry it is business as usual whilst negotiations are in play, and to draw any hard and fast conclusions at this stage as to the post-Brexit landscape would be premature.