Contributed By Winston & Strawn London LLP
The economic picture in 2019 remains complex.
In the UK, as the political process and negotiations surrounding the UK's proposed withdrawal from the European Union (so-called "Brexit") have dragged on, businesses have increased their preparedness for a hard Brexit, while adopting a wait-and-see approach to transactions and investment. One significant aspect of Brexit has been the continued weakness in sterling, which has prompted opportunist approaches to larger businesses in defensible sectors, but this has not spread to more mid-market targets.
Business associated with government funding received a boost with the spending review announced by the government in mid-2019. This has yet to be felt, but austerity-ending increases have been announced across large parts of government business.
Corporate lending (as opposed to deposit taking) remains an unregulated activity in the UK. There has been discussion of introducing regulation of non-bank lenders but, for the moment, regulators seem to be focused elsewhere.
More widely, international markets are still grappling to find alternative rate-setting mechanics following the announced withdrawal of the requirement that London banks contribute to LIBOR rate setting, which will affect how interest rates are fixed from 2021. While a lot of work has been done, no replacement with equivalent functionality has emerged, and it seems that changes in interest rates are set to be far more volatile as a result.
Following a prolonged period where the high-yield market saw net outflows, the position reversed in 2019, with the market beginning to experience inflows. Despite the all-time highs in the stock market, the potential for a US recession caused investors to start re-balancing their portfolios of stocks and bonds. 2019 has also seen an element of quantitative easing return, with liquidity principally being taken out of the bond markets.
The alternative credit provider market is a mature market in the UK. There are debt funds covering not only loans of all sizes but, increasingly, a full suite of lending products, including many types of specialist property finance, infrastructure lending, asset-backed lending and receivable finance, as well as leveraged loans. These funds typically can call on managed accounts to top up fund commitments and provide substantial loan sizes.
Alongside this, peer-to-peer platforms are growing and expanding into areas such as SME lending and receivables financing, often backed by current edge credit assessment technology rather than traditional underwriting, which reduces cost and increases efficiency, in some cases challenging the traditional bank approach.
There are several emerging trends in the UK banking industry.
In the UK leveraged loan market, banks have been very concerned over how the market has developed. Due to their negotiating power, sponsors have gone from negotiating terms with the arranging banks, to insisting that deals are launched with their preferred terms, leaving the buyers to push back in syndication. Sponsors have agreed flex provisions to protect the arrangers, but buyers routinely can only make a limited number of points or risk not being given an allocation. It is now rare for broadly syndicated leveraged loans to have maintenance covenants at all: last year, 88% of such loans in Europe were covenant-lite. Coupled with a spread of sponsor-designated lender counsel to all areas of the market, this has further weakened terms, with sponsors achieving extremely favourable terms and conditions.
One area of significant recent growth has been the receivables sale and ABL sector of the market. While by no means only used by companies with limited financing options, increased use of asset-backed structures by companies may indicate difficulties in obtaining finance from other sources.
The regulation of non-bank lending, if it occurs, has the capacity to significantly affect the market. It is unlikely that regulators would wish to damage the investment which comes from this area and most European jurisdictions have been introducing rules to encourage non-bank lending. However, previously proposed regulations and regulations that can be seen worldwide (eg, universal lender licensing) could have a significant negative impact if introduced to the UK. There are initiatives designed to encourage SME lending and promote fairness in this section of the market, in a similar way to consumer protection.
Grumbles about the tax benefits of highly leveraged structures seem to be growing once more, with the potential for limits to be imposed on interest deductibility.
Following regulatory and academic recommendations for LIBOR reform, the UK Financial Conduct Authority (FCA) announced in 2017 that LIBOR would be replaced by alternative risk-free benchmark rates by 2021. Currently, work continues on developing alternative measures of short-term bank funding costs which would reform and replace the survey-based LIBOR with suitable reference rates for a range of currencies and tenors: SONIA for sterling, SOFR for US dollars, STR for euros, SARON for Swiss francs, and TONAR for Japanese yen.