London-based capital markets lawyers are prospering as the M&A market rebounds and corporates raise money for growth. Marialuisa Taddia reports.
Capital markets lawyers help companies and governments raise money. In the years following the global financial crisis, much of their work focused on restructuring and refinancing debt, but more recently there has been a return to raising finance for growth.
Global mergers and acquisitions activity has been increasing sharply, with 2015 set to be a record year. The value of M&A transactions during the first half of 2015 hit $1.7tn, according to Mergermarket.
Strong M&A activity is normally accompanied by new issuances of shares or bonds, explains Skadden partner Danny Tricot, as large corporates raise money for deals and to refinance their capital base. ‘Generally, the M&A market is a good barometer of where capital markets work is likely to head to,’ he says.
Mike Bienenfeld, a US partner based in Linklaters’ London office, says: ‘In debt and equity capital markets, we are seeing companies raising money for all sort of reasons. In my world it has been more on the positive side of the equation in the last 12 months. Whereas previously it was largely about rescuing and restructuring, now it has become more about funding acquisitions and growth.’
Corporates in Europe lag behind their US counterparts in borrowing from capital markets. On average, European companies relied on banks for three-quarters of their debt funding in 2014. Conversely, bank lending accounts for just a quarter of corporate borrowing in the US, according to a recent report by thinktank New Financial.
But this is changing. Following the global financial crisis, regulatory constraints on banks’ balance sheets have tightened. This has made it harder for companies to borrow from banks.
Between 2008 and the end of 2014 the value of bank lending to non-financial corporates across the EU fell by 11% or €665bn, according to New Financial, a decline that was counteracted by an increase of more than €725bn in the value of outstanding corporate bonds.
‘More and more companies are looking for alternatives to bank debt,’ says Bienenfeld. ‘The US private placement debt market, and the European and US capital markets for both investment-grade and high-yield debt are becoming a more popular avenue of finance.’
In debt capital markets, corporates looking to borrow money and investors looking for returns have been tapping the high-yield bond market, estimated to be more than $2.6tn globally and more than €750bn in Europe. This has kept capital markets lawyers busy with new issuances, advising issuers, sponsors or underwriters.
High-yield (‘junk’) bonds differ from investment-grade corporate bonds, which are less risky but carry a much lower rate of return. They originated in the US in the late 1970s. With transactions governed by New York law, US firms have traditionally dominated the market and many set up offices in London to respond to growing demand in Europe.
‘For English lawyers it has been a rocky ride because US law firms have a huge head start,’ notes Allen & Overy partner Charles Yorke. ‘Historically, bond markets in the US have always been bigger than bank lending markets, while in Europe most corporates have borrowed from banks. That has flipped in Europe. As corporates are using more bonds, including high-yield, the obvious place to go with the knowhow to do it was the US law firms because they had been doing it for longer.’
But now English firms are fighting back. Allen & Overy has seen ‘a huge amount’ of activity linked to high-yield issuance, and other magic circle firms have hired to build capacity in this area too. Responding to what they describe as the ‘extraordinary’ growth of the market in Europe – in the first quarter of 2015, European junk bond issuance was a record €27.1bn – Freshfields Bruckhaus Deringer announced in June the hire of high-yield expert Ward McKimm from US firm Kirkland & Ellis. He joins a specialist team in London that includes US securities partners Simone Bono and Denise Ryan.
Not that US-origin law firms have been idle. Adam Farlow, a New York- and English-qualified partner at Baker & McKenzie, says: ‘Most of the debt capital markets have remained open and vibrant [during the past 12 to 18 months], particularly the high-yield market in both western and eastern Europe.’ The exception is Russia, where activity was hit by EU and US financial sanctions.
‘In the early years after the  crisis, it was very much a refinancing exercise,’ Farlow observes. ‘Since then though, it has been much more of a capital growth story.’ For example, Baker & McKenzie has acted for Nyrstar, a Belgian mining and metal business on a €600m financing package, which included the issuance of a €350m high-yield bond and a €251.6m offering of new shares. The capital-raising exercise last year was partly to fund new investment.
With M&A deals at record levels, capital markets lawyers expect to be busy. ‘Most often the deal is done originally with bank financing that has a bridge loan that lasts for, say, six months to a year, that then has to be “taken out” with a high-yield bond,’ Farlow says.
One example is the recent acquisition by US Equinix Inc of Britain’s TelecityGroup in a deal worth £2.35bn, of which £875m was a bridge loan. ‘When the transaction closes [Equinix] will have some choice in terms of how they want to take that loan out,’ says Anthony Tama, a US partner in the London office of New York-based firm Cahill Gordon & Reindel, which advised JP Morgan, the lead bank that arranged the bridge financing. ‘They will look at a variety of options, including high-yield or a bit more bank financing,’ says Tama, whose practice focuses on leveraged finance and in particular high-yield.
It is not just the high-yield debt market that is clocking up lawyer fees, but also sovereign bonds – foreign-currency debt securities issued by governments.
This year, Bienenfeld has advised the Republic of Slovenia on three separate sovereign bond deals worth a total of €2.55bn. ‘They see it as a good source of finance,’ he says. ‘We have sovereign clients out of central Europe and Africa who are constantly looking at accessing the US and European capital markets.’
Freshfields’ senior associate Nick Hayday focuses on emerging market debt transactions: the firm is ‘on a push to expand its Africa profile’.
In August, Freshfields announced it had advised the joint lead managers on a $1.25bn sovereign bond issue by the Republic of Zambia, the third time the country had accessed the international debt capital markets since 2012.
‘Sovereign bonds have been popular among investors because of the high yield they are paying. The Zambia deal is paying a coupon [the interest rate on a bond] of about 9%,’ Hayday says, adding: ‘While Russia has been shut and Ukraine has been in turmoil, investors are hunting for yield. They want to put their money somewhere. They want coupon, they want return, so Africa is a place where international investors have been looking to invest, and central and eastern Europe.’
M&A levels may be driving debt capital markets activity, but a significant portion of Hayday’s practice focuses on liability management exercises, acting for corporates and banks on transactions such as standalone tender offers, exchange offers and consent solicitations. ‘That market has been, and will continue to be, very hot – especially considering the wall of debt that needs to be refinanced, particularly in some emerging economies,’ Hayday says. This includes Ukraine, which is in the process of restructuring its $17bn international debt.
The recent market volatility caused by events in Greece and China has also led to what Tama calls ‘opportunistic trades’ – for example, businesses taking advantage of lower interest rates to refinance debt.
Lawyers have also been kept busy with asset-backed securities deals – whereby loans such as mortgages, car loans and credit card debt are bundled up and sold to investors. The reputation of the securitisation market plummeted in the aftermath of the financial crisis, in which US sub-prime mortgage-backed securities played a crucial role. The market totalled €216bn in 2014, still down on the €594bn peak in 2007, according to the European Commission.
‘The volume of collaterised loan obligations [CLOs] has increased exponentially over the past two years, there has been a huge amount [of activity],’ Yorke observes. The reasons are twofold: the improving economy and stringent capital rules, introduced in 2010 with the Basel III global banking regulations, requiring banks to hold a much higher level of capital against investment in securitisation. Yorke’s focus as a tax lawyer has been to make sure that CLOs, which are the corporate vehicles holding the assets, are ‘tax neutral’, which is easier said than done. ‘It is difficult to get that to work because there are all sorts of tax rules in various [Organisation for Economic Co-operation and Development] jurisdictions.’
Hayday says: ‘While we are not seeing pre-Lehman deal volumes… the big securitisations are definitely reappearing.’ Acting for the lenders, Freshfields worked on debt-refinancing transactions for Center Parcs (£1.2bn) and the AA (£3bn) that blended high-yield and investment-grade bonds, and asset-backed securitisation financing.
Lawyers are also supporting the growing issuance in Europe of so-called ‘covenant-lite’ leveraged loans, which do not include standard, regular tests of a borrower’s finances, known as maintenance covenants. An example is the term-loan B or TLB, a popular US product which attracts a mixture of traditional bank lenders and institutional investors and which is now becoming more widespread this side of the Atlantic.
‘The covenant-lite structure is attractive for companies in that it actually shares a fair number of characteristics with high-yield bonds, which do not have maintenance covenants,’ Tama says. ‘We often see companies trying to make a choice between those two products.’ Compared with traditional bank loans, the ‘incurrence-based’ covenants in high-yield bonds are more favourable for borrowers.
$2.6tn – value of high-yield (‘junk’) bond market
$1.7tn – value of M&A transactions in the first six months of 2015
€725bn – EU increase in value of outstanding (non-financial) corporate bonds from 2008 to end of 2014
€216bn – value of resurgent securitisation market in 2014
A European union
On 30 September the European Commission launched the Capital Markets Union Action Plan to help build a ‘true single market for capital’ across the 28 EU member states. Key early actions include:
- New rules on securitisation
- New rules on Solvency 11 treatment of infrastructure plans
- Public consultation on venture capital
- Public consultation on covered bonds
- Call for evidence on impact of financial legislation
- Proposed changes to the Prospectus Directive before the end of the year, to make it easier for SMEs to raise capital
James Crooks, a UK partner at New York-based Willkie Farr & Gallagher (WFG), says: ‘Slowly, the banks that do have the ability, and on the right deals, are beginning to participate in the market again through US-style TLB “cov-lite” financing.’
The biggest expansion in Crooks’ practice over the past 12 to 18 months has been in direct lending by investment funds, including private equity and hedge funds, which are acting as parallel lending institutions to corporate borrowers, particularly at the mid-market level. Crooks predicts ‘continued growth of fund-based lending’, while junk bonds will continue to play a dominant role at the high end of acquisition finance.
What of law firms’ work in equities? ‘In our practice, we have seen a tremendous uptick in equity work over the last 18 to 24 months,’ says Tricot, who leads Skadden’s European corporate finance practice. The equity markets rebounded in the second half of 2013 and business has been brisk since.
Over this period, Skadden has seen its client base in equity markets become much more western European, owing to the improving economy in the eurozone, and witnessed a sharp decline in instructions from Russia and the CIS. One notable deal of the past year was the £1.4bn initial public offering (IPO) on the London Stock Exchange of roadside recovery provider AA – the biggest UK IPO in 2014. Skadden acted for Greenhill & Co and Cenkos Securities as financial advisers.
Freshfields’ equity capital markets practice in the UK and western Europe has been working ‘flat out’ for the last year on a number of new listings, Hayday says. And US firm Proskauer has also been winning mandates on the back of the equity market rebound, advising issuers and underwriters, according to partner Peter Castellon. Notable recent mandates include: acting for the issuer on the IPO of UK’s Intelligent Energy that raised £55m; the LSE flotation of Ireland’s Cairn Homes that raised €400m; and advising Belgian real estate company Cofinimmo on the launch of a €285m rights issue for new investments.
Farlow’s practice is split between debt and equity capital markets. ‘This year has been a little harder to get deals done [on the equity side] than in the past,’ he says. ‘The volatility in the market over the last few weeks is an example,’ he adds, referring to China’s economic woes – the effects of which extend far beyond its stock market.
Economic and regulatory developments
Capital markets lawyers say macroeconomic developments, rather than regulatory changes, are likely to have the biggest impact on their work.
‘There is a lot of market instability,’ Bienenfeld notes. ‘That can have a wide-ranging impact, in particular on equity capital markets. It is hard to do an IPO in an unstable stock exchange environment.’
‘There is a bit of “wait and see”,’ Hayday observes. ‘There is a very big pipeline, but there is not a huge amount of issuance at the moment in the debt and equity capital markets. [However] it can change very quickly.’ He points to ‘the huge uncertainty’ and ‘perfect storm of variables’, that include lingering worries about the Chinese economy and hints by Mario Draghi that the European Central Bank could expand its quantitative easing programme beyond its pledge to buy €1.1tn of mostly government bonds.
The US central bank announced on 17 September that it would not raise interest rates, sparking a negative reaction from stock markets. In a sign that capital markets could turn very quickly, barely a week after the decision to delay a long-anticipated move US Federal Reserve chair Janet Yellen said she still expected an interest rate hike later this year.
If the economy is weighing heavily on the minds of capital markets lawyers, regulatory developments in the US and Europe are also cause for concern.
There is increasing pressure from US banking regulators, including from the Federal Reserve’s recent proposals to increase capital requirements for the largest US banks. Tama says there has also been ‘a renewed emphasis’ on ensuring that banks implement leveraged lending guidelines, issued in March 2013, preventing them from making loans to companies at more than six times their operating profits.
‘That has put particular pressure on the leveraged buyout space,’ Tama says. LBOs involve a company being acquired, typically by private equity firms, by borrowing significant sums. ‘Even though those are US-focused regulations, for US banks that have a presence both in the US and Europe, their influence is making its way here,’ he adds.
At the EU level, there is the Markets in Financial Instruments Directive (MiFID II), which comes into force on 3 January 2017. MiFID II will affect the way bonds and stocks, derivatives and commodities are traded, cleared and reported. It is being introduced after the financial crisis exposed the weaknesses of its predecessor, MiFID, which has been in force since 1 November 2007.
MiFID II is part of a raft of EU financial services legislation, including the European Markets Infrastructure Regulation; the Alternative Investment Funds Managers Directive; the Capital Requirements Directive IV (which implemented the Basel III agreement in the EU); and the revised Market Abuse Directive, introduced after the financial crisis with the aim of harmonising and increasing transparency in capital markets, and to lay the foundations for a Capital Markets Union.
In February the European Commission issued a green paper, Building a Capital Markets Union, calling for a public consultation, which closed on 13 May. Speaking at a Law Society capital markets event in February, Verena Ross, executive director of the European Securities and Markets Authority, said that the commission had launched ‘a broad discussion on how to achieve genuinely integrated capital markets across the whole union’. The idea behind a capital markets union is to make the securities markets more easily accessible to Europe’s small and medium-sized companies, thereby reducing reliance on bank lending across the EU.
Lawyers have broadly welcomed the proposal, but warn that the devil is in the detail. ‘The concept of capital being able to flow across borders more freely than it does now is a positive one,’ Farlow says. ‘But like so many things that sound good in a vacuum, I am less enthusiastic about how I think it will play out in practice.’
The commission has set five priorities for early action, which include: developing the private placement market; reviving securitisation; and reviewing the current prospectus regime through a public consultation launched in February. Given that the drafting of the selling document for securities is a crucial aspect of their work in capital markets, lawyers are watching this latter initiative keenly.
When it was introduced on 1 July 2005, the Prospectus Directive provided for a single regime throughout the EU, governing the requirement for the content, format, approval and publication of a prospectus. ‘From a harmonisation point of view the directive was good,’ Castellon says. ‘It [meant] offering documents throughout Europe to the same standards, and those standards are the IOSCO [International Organization of Securities Commissions] guidelines,’ he says.
The US, too, follows the international disclosure standards for cross-border offerings and initial listings by foreign issuers set by the IOSCO. ‘The directive has been great in that the disclosure guidelines on both sides of the Atlantic have been relatively consistent for the past 10 years, and that makes it easier for European companies to offer securities in the US,’ Castellon concludes.
The directive was amended on 1 July 2012 with new requirements that made the regime more prescriptive in terms of the contents and format of the summaries, and the contents of the final terms.
A lawyer who prefers to remain anonymous is highly sceptical – not only about the latest proposals for amendments to the directive, but the 2012 revisions too: ‘There’s a logic behind the prescription. It’s to make the summary consistent from one to another, but it’s a kind of ugly approach to prospectuses, and so it makes them very formal. I haven’t come across anybody who has been enthusiastic
about those changes to the prospectus directive, so a lot of people are sceptical about [further] changes because nothing that we have seen has been an improvement.
‘There is no enthusiasm as far as capital markets are concerned because we already have the European Prospectus Directive; it is already maximum harmonisation. It is not obvious what the capital markets union is going to do.’
Amid the threats and opportunities, only the foolhardy would predict the fortunes of London-based capital markets lawyers, but for now business is in a better shape than it has been for some time.
Marialuisa Taddia is a freelance journalist