Back in the machine – opportunity and threats amid much-changed debt markets

After years in the post-Lehman doldrums, the finance markets are springing back to life. Legal Business assesses the forces powering the upgraded ‘Doomsday machine’

‘Having gathered 100 different [sub-prime-backed bonds], they persuaded the ratings agencies that these weren’t, as they might appear, all exactly the same things. They were another diversified portfolio of assets! This was absurd. The 100 different buildings occupied the same flood plain; in the event of a flood, the ground floors of all of them were equally exposed… The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street, it was a machine that turned lead into gold.’

Michael Lewis, The Big Short

‘This is going to be our Glass-Steagall. It’s that fundamental.’

James Harbach, Linklaters

‘I always say the real strength of our leveraged finance team is that we’ve got more partners that people don’t hate than our rivals.’

Partner, Magic Circle firm 

 

If the cliché about banking busts is that market participants fool themselves into thinking that this time it’s different, then regulators could in theory relax. Because the broad-based revival in debt markets in 2013 – viewed from a distance – as yet looks little like the credit boom that ended so disastrously in the summer of 2007.

Mortgage-backed securitisation – the product that, more than any other, revolutionised modern finance, and was also directly implicated in the credit crunch and subsequent banking crisis of 2008 – is consolidating a steady recovery, but remains at historically anaemic levels.

The banking giants that were major players in the last crisis remain with us, like death and taxes, albeit with a few high-profile casualties and some surviving in much-diminished form. But the enforcement activity targeted at the major banks on multiple global fronts, not to mention tougher capital requirements, mean that these institutions are facing fundamental changes to their business models. This is already having a dramatic impact on financing activity and giving birth to a new breed of more lightly regulated financiers.

That shift has profound implications for legal advisers, who in the City had become thoroughly conditioned to believe that success flows from building their business around major banking clients. Having shaken up the well-established pecking order of the City legal market, there have been winners and losers as some advisers have found opportunity amid the shake-out.

But for all these substantial differences, a cursory glance at debt markets in Europe reveals much that is familiar from the boom years in finance. 2013 was the first year in which mainstream debt advisers saw robust activity levels since 2008 as a receding euro crisis, the continuation of ultra-loose monetary policy and the rise of alternative lenders drove the market.

With a breakthrough for junk bonds (rebranded since the 1990s as high-yield) in Europe finally arriving in the last two years and a seemingly endless stream of new credit providers lining up to fill the space vacated by banks, there is even talk of bubble-like conditions emerging.

This shift has been amplified by the much-touted ‘Americanisation’ of Europe’s debt markets as borrowers look to capital markets in general and US investors in particular to fill the space once dominated by bank lenders.

If the leveraged debt sector has been particularly frothy, 2013 also witnessed a wider pick-up, with asset-backed lending kicking back into life outside the mortgage-backed sector. Early signs last year were a run of auto-backed and project bonds, while collateralised loan obligation (CLO) issuance was back in force. A fully fledged rehabilitation of the ‘Doomsday machine’ of structured finance, as Michael Lewis memorably termed it in his 2010 book The Big Short, is underway. It turns out that structured finance – opaque, huge and having become utterly central to financial markets without much of the public knowing of its existence – is hard for western economies to live without.

Finance lawyers look set for a period that, while turbulent, will offer rich rewards to the advisers that adapt. As Latham & Watkins co-chair of banking Christopher Kandel puts it: ‘We’re going to have a head of steam. We’ve had a huge shake-out in the leverage finance market in the City, both the banks and the law firms. We’ve been moving along fine with two of the cylinders in the engine not working. Those cylinders will begin firing again and there’s going to be a shortage of finance professionals to handle it. I’m very bullish.’

Number crunching

If a wider revival is taking place in finance in general, Europe’s leveraged finance market is the place where the rebound is most striking. Figures from S&P Capital IQ’s Leveraged Commentary & Data (LCD) show that €67.4bn was raised in leveraged loans in 2013, the highest figure since 2007 and more than double the volume of deals seen in 2012.

Separate figures from Debtwire Analytics support this picture, showing the value of European leveraged loans rising from €70.16bn in 2012 to €95.85bn in 2013, while deal volumes surged from 91 to 158.

The picture is even more dramatic in the high-yield sector, which saw an explosion of activity against what have been historically active years in 2011 and 2012. European high-yield issuance, according to Thomson Reuters figures, hit €70.4bn in 2013 across 212 bonds, a record level of deals roughly twice the amount raised in the preceding two years.

Taking a wider view, global debt issuance, including securitisation, hit $5.5trn according to Thomson Reuters, edging up on 2012 in part due to record-breaking issuance of corporate debt. 2013 saw the two largest-ever corporate bonds: Apple’s $17bn issue and the $49bn deal by Verizon Communications. Global high-yield issuance was up 19% to $462bn according to Thomson, with the highest volume ever recorded.

While some expect a more subdued year for high-yield issuance, last month saw the largest-ever junk bond, when Numericable, the French cable unit of Altice, raised €7.9bn to help finance its €17bn acquisition of Vivendi’s mobile unit, SFR, outpacing the $6.5bn issue from Sprint Nextel in 2013. Ropes & Gray advised Altice with Latham & Watkins acting as underwriter counsel.

For obvious reasons, this shift has major implications, finally going some way to fulfilling the familiar predictions that Europe would develop a liquid bond market to support corporates comparable to the US, where capital markets drive corporate finance.

Investment-grade bond markets were also unsurprisingly robust, with an increasing vogue for European borrowers to deploy private placements as well as convertible and hybrid bonds.

As can be gleaned from the briefest of glances at the figures above, there has been a dramatic shift of Europe’s debt finance sector away from a market dominated by traditional loans with a select group of investment-grade corporates deploying vanilla bonds. In its stead is a more complex environment in which borrowers are increasingly turning to securities and a widening array of financing tools to distance them further from constrained bank lenders and closer to yield-hungry investors.

While less dramatic, asset-backed lending continued its revival in 2013, the fourth consecutive year of increasing issuance levels. Figures from Dealogic show that global securitisation, excluding residential mortgages, rose sharply to the region of $750bn in 2013. While activity remains a fraction of the pre-crunch years – equivalent global securitisation issuance was over $2trn annually through 2004 to 2007 – the figures being raised have more than doubled since the low point in 2010. There has been a noted interest in securitising a wide range of non-mortgage income streams, including old standbys such as auto loans and credit card debt, but also covering more exotic streams and whole business structures.

Even mortgage-backed deals saw something of a comeback. Issuance of paper backed by non-residential mortgages was over $100bn in 2013, against $4bn in 2009 when a vast market had effectively closed down in the wake of the banking crisis.

In addition, it was a strong year for ‘slice and dice’ products like CLOs, which are typically used to back leveraged buyouts.

The revival of the asset-backed sector underlines certain ironies about the image of securitisation and the industry excesses that were so effectively skewered by Lewis. That is, despite being at the centre of the credit crunch, in some regards the broader product could be viewed as a scapegoat.

At the heart of the credit crunch was not an alphabet soup of financial instruments – it was lenders badly loosening their lending standards, most notoriously in the US sub-prime mortgage sector. Securitisation’s primary contribution to the crunch was that it fuelled a mindset in which lenders disregarded the chances they would be paid back because they could easily sell on the debt. But the underlying problem was that lax lending contributes to boom and bust cycles in banking, not that the financing tool does not serve a valuable purpose.

Added to which, while many banks found they could neither value nor sell such ‘toxic’ securities once the crunch set in, most of the problems have turned out to be focused on defaulting mortgages and aggressive sales to debt investors, in particular in synthetic mortgage-backed CDOs put together with credit default swaps (the curious practice of using derivatives to replicate exposure to mortgage debt that investors don’t directly hold). Aside from sub-prime mortgage debt, securitisations in other areas have fared much better.

Finance advisers have noted that the mood music has changed in the last two years among regulators and governments, which increasingly want to rehabilitate securitisation as a means of getting credit flowing without huge central bank commitments. If anything, the need is far more pressing in Europe, whose banks have been less proactive in dealing with bad assets than US counterparts.

‘Post-Lehman, there was a knee-jerk reaction against securitisation and the whole industry was tainted, but we are sensing that regulators are realising the importance of it,’ observes Ashurst partner Michael Smith.

‘Securitisation and CLOs are an integral part of the capital markets in Europe. It’s essential to a functioning market. Of course, certain things did go wrong, but the product itself is good,’ adds fellow Ashurst partner David Quirolo.

‘The big story of 2013’

The curious aspect to the busy conditions in Europe’s leveraged finance market is that the recent run has been driven by intense competition among debt providers and comes despite a lack of actual leveraged takeovers.

Although last year kicked off with Liberty Global’s $23.3bn acquisition of Virgin Media and Dell’s Silver Lake-backed $24.9bn leveraged buyout, 2013 was the year of recapitalisations, as borrowers looked to take advantage of low interest rates and rising risk appetites from investors. It also marked a period in which the influence of the bank lenders that had traditionally dominated the European market waned as sponsors turned to alternative sources.

Despite a relatively low volume of deals, there were sizeable mandates to go around with CVC’s buyout of ista International; a €3.3bn debt package backing Joh A Benckiser’s buyout of DE Master Blenders; BC Partners’ acquisition of Springer Science+Business Media; Cinven’s buyout of CeramTec; and Hellman & Friedman’s $2bn acquisition of Scout24 from Deutsche Telekom. Meanwhile, companies going through $1bn-plus refinancings during the year included Tomkins, Kabel Deutschland, Ineos Group, ProSiebenSat.1 Media, Autobahn Tank & Rast and Schaeffler.

Aside from the much-discussed explosion in high-yield issuance, borrowers enjoyed a wider range of options. In particular this has meant tapping US investors, via either the public bond markets, private placements or via the increasingly popular Term Loan B arrangements, which are viewed as more flexible for sponsors than a standard European loan.

The vogue for such ‘Yankee’ financings’ – US-sold dollar-denominated debt for foreign borrowers – has seen a string of sponsors – among them BC Partners, Montagu Private Equity, Charterhouse Capital Partners and The Carlyle Group – use the structure to finance major European deals in recent months to benefit from the borrower-friendly terms.

While typical in larger deals, even mid-market deals have tapped US investors, with BC Partners turning heads last year when it financed its £382m takeover of mergermarket through the US markets. Even private members’ club Soho House felt able to issue a £115m high-yield bond last year.

This sea change has been evident for at least three years now and has been driven by a number of forces. For one, stalwart debt providers like The Royal Bank of Scotland (RBS), Barclays and Lloyds Bank have scaled back their commitments, in large part in response to pressure on strained banks to avoid riskier lending.

In their place, stronger US institutions such as JPMorgan, Citigroup and Goldman Sachs have expanded their influence, as has the increasingly US-centric Deutsche Bank. This shift in power has unsurprisingly supported a push towards US-targeted financing and has been echoed by the steady expansion of US private equity houses in Europe such as Kohlberg Kravis Roberts (KKR), Bain Capital, Blackstone and Carlyle.

While the push into Europe from US sponsors has been evident for years, a more recent development shifting the centre of gravity in the European leveraged finance market is the dramatic emergence of specialist debt funds.

‘The big story of 2013 was the breakthrough of alternative credit providers – these guys really took the market by storm,’ says Hogan Lovells finance partner Stuart Brinkworth. ‘It’s been a massive feature of the market.’

In September 2013, Hogan Lovells advised the unitranche and super-senior lenders on Exponent Private Equity’s £190m dividend recapitalisation of UK ticketing company thetrainline.com – the largest unitranche facility put together for a UK-based company last year and the second largest across Europe. Brinkworth led the team alongside partner Matthew Cottis, who provided separate advice to Barclays Bank and HSBC on the super-senior intercreditor terms.

Hogan Lovells also advised BlueBay on a joint venture with Barclays to provide unitranche finance, which has been viewed as a model for other banks to team up with new specialist providers.

This was something of a prophecy delayed as there had been much talk of a rising role for alternative finance providers during 2010 and 2011, but the onset of the euro crisis slowed the expected march of such houses until 2013, as nerves settled and risk appetites returned. (Linklaters and Freshfields Bruckhaus Deringer had both assigned partners at the time specifically charged with building the client base.)

Players in this market include Babson Capital, BlueBay and M&G Investments, as well as private equity players moving into debt, such as KKR and Carlyle. There is widespread agreement among finance advisers that 2013 represented a watershed for such alternative lenders. Like private equity houses, these outfits are typically lean operations and often staffed with former bankers.

Research from Deloitte tracked 55 such deals in the UK mid-market in the 12 months to the end of September. Such deals were most commonly used in leveraged buyouts (LBOs), in nearly half of deals tracked by Deloitte, though they were often also used in refinancing and to provide growth capital. These borrowers are also notable for popularising an increasingly dominant financing model: the clumsily dubbed unitranche.

Unitranche is a type of debt that combines senior and subordinated debt terms in one instrument. Unitranche was used in 48% of the deals tracked by Deloitte. Typically deployed in mid-market buyouts, the first lien product is claimed by its supporters to speed up the acquisition process, provide more flexibility, and the borrower benefits from having one interest rate and one counterparty. Alternative debt providers, however, often also provide senior debt, cited in 26% of the deals tracked by Deloitte, indicating that they are increasingly competing directly with conventional banks.

While new funds are regularly emerging, so far the lion’s share of deals are being executed by a handful of funds such as Babson, M&G, BlueBay, Intermediate Capital Group, Ares Management and the debt arms of the major US sponsors.

The popularity of unitranche lending is also being echoed in the investment-grade market, which during 2013 saw a vogue for hybrid bonds, often issued by utility companies. The bonds, which are typically junior debt and with long-dated maturities, effectively sit between debt and equity in the borrower’s capital structure and are popular for giving flexibility to borrowers and helping to protect credit ratings. PwC research found that a record €25bn in hybrid bonds were issued by European companies in 2013. Private placements from large corporates have likewise proved popular.

European high-yield – issuers counsel
Firm	2013 Rank	Value ($m)	Deal count	2012 Rank
Allen & Overy	1	14,596	24	1
Linklaters	2	13,819	32	5
Clifford Chance	3	10,162	30	3
Latham & Watkins	4	7,408	37	8
Simpson Thacher & Bartlett	5	6,148	31	6
Kirkland & Ellis	6	4,815	27	9
White & Case	7	4,257	18	13
Ropes & Gray	8	3,952	14	4
Freshfields Bruckhaus Deringer	9	3,758	12	2
Elvinger, Hoss & Prussen	10	3,753	10	51
Source: Bloomberg

European high-yield – managers counsel
Firm	2013 Rank	Value ($m)	Deal count	2012 Rank
Latham & Watkins	1	22,474	68	1
Allen & Overy	2	21,224	41	2
Linklaters	3	20,549	55	5
Shearman & Sterling	4	12,220	35	3
Davis Polk & Wardwell	5	7,278	27	8
Milbank, Tweed, Hadley & McCloy	6	6,663	7	26
Cravath, Swaine & Moore	7	5,421	33	6
White & Case	8	5,388	20	9
Clifford Chance	9	5,380	20	7
Cahill Gordon & Reindel	10	4,588	16	4
Source: Bloomberg

‘I like your watch’

The significance of the new debt providers and a wider pool of end investors has been substantial. Not only has it injected even more capacity into an already liquid market, it has brought renewed competitive pressure on the banks to sweeten the terms and pricing to retain market share.

By consensus, it has also led some banks to target the debt markets after having pulled back, with BNP Paribas and Bank of America cited as making a fresh push in the European finance market.

This is inevitably causing a more sponsor-friendly environment in which providers are forced to give more ground on pricing and terms – and leading to talk once more of ‘sponsor-facing’ lawyers.

This has led to the return of covenant-lite debt – a familiar and controversial feature during the boom – whereby the frameworks that lenders insist that borrowers stick to are largely dispensed with. This is most obvious on high-yield, which is a ‘cov-lite’ product, but as significant has been the influence on terms in traditional European leveraged loans as sponsors push for so called ‘cov-loose’ packages, which jettison one or two of the traditional core covenants. Likewise, leverage on acquisitions and refinancings has risen dramatically, while sponsors have been cutting the level of equity in buyouts, often as low as 25% against the 50% level that was common during the post-crisis gloom of 2010.

The benefit for sponsors in importing terms familiar from junk bonds and the US loans market into traditional European leveraged loans is clear: they get much of the flexibility, without the delays and cost of a full bond process.

Market views on this trend are split, reflecting the opposing perspective of sponsor-facing counsel that typically welcome such a move and the advisers to traditional bank lenders that take a more jaded view of private equity houses once again throwing their weight around.

Skadden, Arps, Slate, Meagher & Flom finance partner Clive Wells offers a wary perspective: ‘In 2006, it felt at times like a sponsor could have said: “I like your watch, can I have that as well please?” Banks were competing incredibly hard to win mandates and that had an inevitable effect on the terms on which deals were done. To an extent, the same conditions seem to have returned recently in the States. In Europe things remain a little tougher.’

His colleague, Mark Darley, picks up the theme: ‘If it’s a sponsor that’s got a good track record and a good relationship with the banks, it can still get pretty much anything it asks for in the current market. Banks have short memories.’

Mike Goetz, co-head of finance at Ropes & Gray, argues that the spread of US-style terms in Europe is still a long way from the US. ‘Covenant-lite in Europe is not there yet. At the end of 2013, we were representing companies where banks were saying they could underwrite $1bn in the US and only $100m in the UK – so there was a huge disparity in the levels of liquidity in both regions.’

The clearest indication of this shift to match US borrower-friendly terms in Europe’s credit markets happened in March when French group Ceva Sante Animale pulled off a €818m English law financing, hailed as Europe’s first fully cov-lite loan since 2008. Numericable’s record-breaking financing package also included a cov-lite Euro loan alongside bond and US term loans.

Much of the wariness regarding conditions in the leveraged finance market reflects the basic reality that there is still relatively little new money work, with 2013 being largely driven by refinancing as borrowers looked to take advantage of low interest rates or to bring in capital to cover dividends. For all the hype surrounding high-yield, such structures are mainly being used in refinancing: PwC found that only 16% of the European bonds issued in 2013 were directly related to M&A.

With improving economic conditions, rising business confidence and a rebound in public floats providing a new exit point for private equity sponsors, the expectation is that there will be a revival of deal activity, but veteran deal advisers bring a streak of realism to the buoyant mood.

‘Banks are cautiously getting back their underwriting appetite, but given the regulatory constraints applicable to leveraged lending, we will not see a rapid return to bank-funded mega deals anytime soon,’ says Ashurst finance partner Mark Vickers.

‘It would be delusional to think the leverage finance market in the near future would come back to anything close to the number or volume of deals done in 2007. We will see a gradual uptick in deal flow, against some reasonably strong headwinds. The medium-term outlook is positive with a gentle gradient rather than a rapid climb out.’

Likewise, not everyone is convinced that the new credit players will stay the course. Richard Roach, managing director, financial sponsors UK at RBS, sums up a common view: ‘The leveraged finance market, especially at the larger end, is currently very frothy with borrower-friendly terms and structures.

‘[There is] a material supply versus demand imbalance due to a lack of primary M&A activity, and fuelled by the emergence of significant pools of new debt liquidity via debt funds. It remains to be seen how some of these new entrants will react if and when they encounter a problem credit situation.’

Upgrading the machine

In comparison to the overheated conditions in pockets of the leverage finance market, the picture in structured products is more complex and nuanced. But once again, the most obvious revival is linked to the leveraged finance market: the belated rebound in issuance of CLOs, which pool together medium-to-large business loans to sell to investors and are usually deployed to back LBOs and leveraged loans.

Having sprung back to life in 2012, issuance sharply increased again in 2013 with $88.9bn in CLOs issued globally, making it the third most active year for issuance since the credit boom, according to S&P Capital IQ’s LCD. Europe accounted for around an eighth of the volume, at $10.1bn from 20 deals after a period of more or less no issuance in the last four years.

The early structures resurrected last year were relatively simple and deployed less leverage. According to Standard & Poor’s ratings agency, the typical European CLO in 2013 was single-currency with a €300m-€400m target and a four-year reinvestment period.

Of the 20 deals last year, Ashurst acted in 15, totalling just under €10bn of issuance. The firm told Legal Business that it aims to raise that figure substantially in 2014. David Quirolo says: ‘In order for the leverage loan market to be comfortable that there is liquidity in the market, there needs to be a robust CLO market. Things are moving in the right direction. There are many quality asset managers in Europe, so there is no reason why issuance should not increase.’

In March 2013, Ashurst advised arranger Credit Suisse Securities on one of the first European CLOs since the crisis, with Cairn Capital acting as issuer of €300m notes secured by a portfolio of loans and bonds. Milbank, Tweed, Hadley & McCloy advised Cairn; Baker & McKenzie represented Credit Suisse on Dutch law; and Allen & Overy (A&O) advised the bank as trustee.

More recently, Weil, Gotshal & Manges closed the €615.7m Richmond Park CLO transaction in January 2014 – the largest European CLO issuance priced in 2013. Weil advised Blackstone GSO as the collateral manager, led by co-head of the firm’s global structured finance derivatives practice Jacky Kelly, while A&O capital markets partner Franz Ranero advised the arranger, Citi. Weil acted on five CLO deals last year, including representing new client Carlyle as collateral manager on the Carlyle Global Market Strategies Euro CLO 2013-2 transaction.

However, views remain divided over whether CLO activity will be sustained this year, after an uneven start to 2014. Indeed, concerns remain in the leveraged market that CLO issuance will not keep pace with the level of redemptions as the last wave of funds from 2006-07 come to the end of their reinvestment window.

As with many structured products, a key issue will be the regulatory environment, with market watchdogs increasingly attempting to avoid the excesses of boom years while supporting a revival in securitisation to close the funding gap. In CLO, that has meant pressure to squeeze out the smaller managers in favour of larger institutions with a demonstrable track record.

Elsewhere, the picture for asset-backed securities (ABS) is mixed, despite a pick-up in the US in 2013 with primary issuance in Europe remaining at historically low levels. In Europe, the residential mortgage-backed securities (RMBS) market remains in deep hibernation as long as banks can access such cheap wholesale funding.

Comments one structured finance veteran: ‘If people are saying this year will be better, yes it may be, but if people are saying the market is coming back, then I completely disagree. Commercial mortgage-backed securities (CMBS) increased in the US, but were flat in Europe and I cannot see any real activity in Europe in terms of RMBS – there certainly isn’t any in the UK. Major structural issues remain and until they are resolved, the European market won’t be flat, but will have very low activity.’

‘An entirely new market’

If such sentiments strike a downbeat note, many partners cite moves to deploy structured finance techniques in a wider range of situations, for example to securitise revenue of non-financial businesses or in a refinancing context.

Comments Sidley Austin’s global finance co-head John Woodhall: ‘If structured finance means using structured finance techniques to repackage distressed assets and to restructure deals, then there is a huge amount of activity, but this is largely not public – it’s private, it’s not league table and it often doesn’t involve banks other than as asset sellers. This is an entirely new market, which will continue to grow, but will be difficult to get real information about.’

Many finance partners comment on this effective blurring of the lines of differing financing techniques, particularly in leveraged and structured finance as borrowers push to put in place flexible programmes where they can toggle between differing funding tools. Such a shift is also evident in the infrastructure market where there has been a similar revival in project bonds and moves to replace bank debt against infrastructure or real estate assets with securities.

Clifford Chance (CC) finance partner Kevin Ingram comments: ‘Some of the existing silos are having to break down. It’s not unusual to see acquisition finance connected with some of the securitisation, and high-yield is increasingly part of the mix. That arrangement where lawyers have to be cognitive and work around different techniques is definitely the way of the world going forward.’

Notably, Manchester Airports Group last year put in place a programme to replace bank debt behind its £1.5bn acquisition of Stansted Airport with a whole business securitisation.

The use of asset-backed bonds in projects has been further supported by governments and agencies like the European Investment Bank pushing bond guarantees to support infrastructure.

And as with the leveraged market, infrastructure companies have turned to the US private placement market, notable in the £595m refinancing earlier this year of docks operator Forth Ports.

Similar approaches have been deployed in commercial real estate deals, where owners have used revenue streams to shift from bank debt. One notable example saw Intu Properties, the UK’s largest mall owner, last year agree a £1.15bn refinancing to replace debt held by four shopping centres with secured bond finance as part of a wider debt programme, generating lead roles for Linklaters and CC in what was touted as a cutting-edge deal that combined whole business securitisation with traditional real estate finance.

In July 2013, Sidley Austin advised PIMCO and Marathon Asset Management on the Debussy deal, worth just over £263m, on the securitisation of a portfolio of Toys R Us stores in the UK. The deal, which securitised a loan made to Toys R Us to refinance its UK property portfolio, was the first CMBS not arranged by a bank and drew on investor guidelines issued last year by a group of major European CMBS investors, has been touted as a model for borrowers and investors to deal directly with each other. Sidley’s team was led by Jason Richardson. Kaye Scholer advised the issuing vehicle, Debussy, while Paul Hastings acted for the borrower.

‘This is the template of the future,’ says Woodhall. ‘The traditional arranging bank role, particularly in real estate, is being increasingly challenged. The big investors like PIMCO, Fortress, Marathon and Apollo are doing that. Whether or not it ends up as a refinancing deal through public CMBS – like in Debussy – or the restructuring of real estate assets and the refinancing of them through new private debt, this will be a significant trend from 2014 to 2016.’

Linklaters structured finance head James Harbach argues that this new strain of financing will drive the market, predicting two years of ‘phenomenal busyness’ as borrowers import funding techniques from different areas.

His Linklaters colleague Julian Davies echoes a related point about the evolution of the ABS market. ‘If you look back ten years ago, securitisation was very narrow. It was huge in terms of the numbers involved, but it was very narrow in the kind of financial assets that were being used. Now it has developed so that a much broader base of assets are being used by a wider range of companies.

‘It’s the multi-source platforms that are keeping our people busy where borrowers want the option of flicking between different funding tools.’

Ashurst finance partner Derwin Jenkinson picks up the point: ‘We are already busy with new issuances and it is a very active market. But it is the re-emergence and variety of bond and bank finance being used to fund projects that is the really exciting development.’

Nevertheless, if there is more work for the adaptable structured finance professional, considerable questions remain about how the sector will develop, not least the regulatory framework that will be used to support this notion of ‘securitisation 2.0’.

There is consensus that regulators and policy-makers have come around to the need for securitisation to fill the funding gap, with Bank of England head of financial stability Andy Haldane raising eyebrows in an interview in December when he made the case for a cleaned up ABS sector as a ‘financing vehicle for all seasons’.

Haldane was quoted, adding: ‘In a world where we are squeezing risk out of the banking system we would want a simple, safe, vibrant set of channels for non-bank financing to emerge and securitisation is one of those. We are talking about simple and safe structures, rather than complex and shadowy ones.’

The primary means of getting those structures right has been rules forcing lenders and intermediaries to keep some of the risk of the original loans on their books – which in theory should prevent slapdash lending practices. Regulators have also sought to discourage ‘re-securitisations’, where revenue streams from asset-backed securities are then themselves repackaged – the ‘CDO-squared’ deals seen in the boom years.

But it remains a tricky balance and finance advisers argue that until policy in the area is more settled, uncertainty will dog the market.

Value of European leveraged loan issuance

Source: ‘European Leveraged Loan Report’, Debtwire Analytics

Volume of European leveraged loan issuance

Source: ‘European Leveraged Loan Report’, Debtwire Analytics

The American question

If debt professionals agree that modern finance is facing a fundamental reshaping, the obvious question this raises – and which continues to divide banking lawyers – is the extent that much more pronounced American influence in Europe represents a decisive shift in favour of US investors, financiers and their lawyers.

The boosterish case for US law firms clearly has some substance. The leverage finance market has over the last ten years seen a process similar to what had already taken place in insolvency, where the bank-dominated ‘London rules’ have been swept away in favour of a much more diverse pool of players including hedge funds, specialist investors and private equity houses.

The existing hierarchy of senior lenders and UK sponsors has been further undermined by the drive to tap US investors (whether by high-yield, private placement or the leveraged loan market), the growing clout of US banks and related spread of New York law structures. Obviously, US law firms, having realised that the individual-driven nature of leveraged finance plays well to their model of assembling lean teams around expensively recruited big-name partners, have made sustained recruitment in deal finance for nearly a decade with considerable success.

Legal Business’s 2014 Global London report last month found a sharp annual increase in the number of US lawyers employed in the City, rising from 673 to 762 across the 50 largest firms, a move largely attributed to rising European demand for New York-law financing. Firms to increase their ranks of foreign lawyers in London included US leaders such as Latham & Watkins, Simpson Thacher & Bartlett, Shearman & Sterling and Cleary Gottlieb Steen & Hamilton.

Skadden’s Mark Darley offers a balanced take: ‘What a client is looking for in regards to its financing needs is a partner who understands all forms of acquisition finance, high-yield and debt, and advice on what the right route is for the deal. Not all but many of the large US firms have such partners. They are a far rarer commodity at the Magic Circle.’

Viewed during 2014, it is easy to make a case that a tipping point has been reached in favour of US players like Latham, Simpson Thacher and Kirkland & Ellis to the detriment of bank-focused firms like A&O, CC, Linklaters and Ashurst. The downbeat view on City firms is they will be relegated to handling relatively commoditised global loan and debt capital markets work for investment grade issuers and banking clients, leaving US firms to cover the more bespoke end.

It’s also inarguable that considerable ground has been made in favour of US law firms and that a fundamental shift in favour of bond-backed financing over loans has occurred that is likely to continue.

Latham’s Kandel puts the case forcefully as befits its strong transatlantic reputation in leverage finance. ‘I think we’re number one. [Latham partner] Richard Trobman always takes this piece of paper and puts four crosses against it for the US and Europe, loans and high-yield. We’re the only firm that has all four bases covered.’

However, the compelling narrative of the junk bond-fuelled supremacy is a little more debatable than the slick pitch of US advisers sometimes allows.

What some see as a takeover, others argue is a high-water mark or a blip. For all the talk of complexity, compared to big-ticket M&A, litigation or corporate tax matters, high-yield is hardly cutting-edge work. Arguably it looks complex in comparison largely because vanilla bond work has become so commoditised.

Indeed, the pitch is in part based on familiarity: as a New York law product, its clauses are well established and have been heavily litigated, and are familiar to the US investor base.

As one finance veteran at a Magic Circle firm comments: ‘Complex? The main section in high-yield documentation is a load of photocopied bumpf – they just change the name. A bond is an IOU and the documentation largely depends on who you are selling to. US lawyers argue the documentation is tested and is clear. I’d say the language is impenetrable. But one of the main things US lawyers are selling is that you can get criminal sanctions for violating US securities law and the US has terrible prisons that terrify bankers at Goldman Sachs.’

While you would expect a City law firm to make the above case, some of these points are privately conceded by US advisers. ‘It may seem that US law has taken over, but I think this is a temporary phenomenon,’ observes one UK finance partner with a leading US law firm. ‘It’s not like they’re going to take finance out of Europe.’

As a related point, the argument that the rise of such financing tools is inevitably a one-way process that works only in the favour of US market leaders is open to scrutiny. The evolution of high-yield from lucrative niche has already seen the area become colonised by a larger group of US advisers over the last 15 years than the original brand names like Latham, Cahill Gordon & Reindel and Cravath, Swaine & Moore.

And a true Americanisation of Europe’s debt markets could quite possibly lead to the emergence of a European investor base for public bonds and private placements, who may be far less wedded to New York law. In France, there has already been a push away from English law towards French documentation in more debt work, while there have been a handful of German law high-yield deals for bonds aimed at local investors.

Securitisation was also a US-born product that swiftly developed European documentation and investors.

There will be a renewed push to develop a truly European corporate bond market with the Loan Market Association this year setting up a working party to create an English law template for private placements. Sidley Austin’s Stephen Roith observes: ‘There is a demand for financing that sits in between the public bond market and the syndicated loan market. This is the gap that could be filled by an expanded and better-organised European private placement market, but the industry needs some leadership to get something off the ground.’

In short, it is entirely possible that the breakthrough of high-yield and associated financing into the mainstream will see it effectively nationalised as a product as more standardised European law documents are forged. ‘That’s the development US law firms are terrified of,’ laughs one finance partner at a leading City firm.

CC banking partner James Johnson comments: ‘Those firms with a reasonable sponsor and finance base will do well. It’s a clutch of American and British firms that have a two-tier deal system covering the large and mid-market that will perform well.’

Even if such debt remained a US-driven product, some neutral observers concede that firms such as A&O, Linklaters and CC have made more progress in US law bonds and have adapted to the new funding environment better than is conceded by some US rivals. Experience in the equity market also shows City law firms proved able to build up credible 144a capability to support their corporate practices after initial problems.

The biggest challenge for City advisers is likely to be less around resources and the impenetrability of US law firms, but may be around the baggage of having formed sprawling multi-product line teams around a sizeable group of major banks – the everyone-acts-for-everyone model, which is distinctive to the City. For related reasons the other weakness of City firms is their extreme specialisation in finance, which has proved a hard model to adapt against US advisers’ more flexible approach.

One banking head at a Magic Circle firm makes the point that leading City firms retain huge scale against US rivals: ‘Europe is 27 different jurisdictions and clients want one firm that can deliver on a cross-border transactional basis. And many of the US firms cannot do that.’

‘Our Glass-Steagall’

The fact that arguments are simmering about the direction of the market is a reflection of a basic truth: the finance industry is in the midst of a period of huge upheaval, which is shaking up the old hierarchies upon which City advisers have built their businesses.

The last two years have also, thanks to the Libor-related investigations and the current controversy around similar allegations regarding the vast forex market, overturned expectations that banks would soon return to their old ways, little disturbed by policy-makers.

Major banks retain huge influence and power – and regulators have made at best only modest headway in addressing the moral hazard issues – commonly dubbed the ‘too big to fail’ factor – at the heart of the last banking crisis. But the drive to more tightly regulate and police banks – shows no sign of abating, whether by forcing them to strengthen their capital buffers or toughen compliance.

It is also increasingly clear that the prediction that this would lead to dramatic growth of more lightly regulated alternative providers that are more able to take risks is coming to pass.

When we eventually reach the point that normalisation of monetary policy kicks in, the pressure to reshape modern finance looks sure to increase. Linklaters’ Harbach argues that the ring-fencing of regulated banking activity from riskier activities will play out for years.

‘There will be a huge increase in the issuance of debt securities in Europe over the coming years as banks scale back lending in general and particularly in relation to perceived “risky activity”. Non-banks funding through bonds will take the place of traditional bank lending. The effective ring-fencing of banks will also be very significant. It’s going to be our Glass-Steagall [the landmark 1933 US legislation that split retail and investment banking]. It’s that fundamental.’

Harbach’s point reinforces that this is arguably the biggest period of opportunity for finance lawyers for a generation. With the old hierarchies disrupted – and a new breed of less ‘institutional’ clients unencumbered by bureaucracy, panel reviews and decades-old relationships – there is real chance for the best finance lawyers to carve out potent practices.

In the short term that weakens the once unassailable position of top City firms. This is a genuine challenge to the business model of Magic Circle firms, which they will likely either come through strengthened or diminished.

Freshfields Bruckhaus Deringer global finance head David Trott argues that his firm is alive to the possibilities of new players. ‘These new debt funds create opportunities for us – whereas historically a lot of the high-end flow work was concentrated in a few banks and a number of firms with deeply embedded institutional relationships, now there are many more potential clients as these funds move into the spaces that banks are retreating from. And because these funds have very small teams – half a dozen people at the most – it’s all about individual rather than institutional relationships, which play to our strengths.’

US advisers, meanwhile, may well have to face a period in which the investor base and documentation shifts back to Europe if bonds in European finance truly go mainstream or more flexible loan terms tempt back sponsors. This process will likely not be smooth. The prospect of rising interest rates means a likely pause in bond issuance; the shadow banking sector itself is coming under increasing regulatory scrutiny.

But what does seem apparent is that it looks like – after five years of retrenchment – the next decade will be a great time to practise in a banking team in the City. Partners with an entrepreneurial eye and strong client skills will be in huge demand with a much wider array of finance clients to pursue.

This shift will be mirrored at the structured end. Ironically, finance has become more complex and securities-based in other areas as structured finance itself has become more straightforward, but is opening up to a broader group of players.

The rehabilitation of ABS will be controversial in some regards, but modern finance cannot do without it and in one major regard securitisation 2.0 differs from its predecessor. Many of the excesses of the credit boom were driven by middle men in the process – underwriters, traders and rating agencies.

The new finance market has been – so far at least – driven more by the corporate borrowers themselves and investors in closer dialogue. No doubt this approach will have its excesses and busts in the long run but the lawyers who can work this new machine look set to be turning lead into gold for years to come. LB

jaishree.kalia@legalease.co.uk; alex.novarese@legalease.co.uk