Banking and finance focus: Back to the future

‘The truth is no-one’s got the faintest idea what finance practices will look like in the future,’ shrugs Tony Bugg, Linklaters’ head of banking, when asked to describe a top City finance practice in 2030. Of the dozens of London finance chiefs and partners to whom Legal Business posed the question, Bugg’s take is at least one of the more candid.

If the last decade is any guide, the finance world will be girding itself for more wrenching change. The post-banking crisis environment has seen a dramatic increase in regulation and oversight of banks and helped encourage the growth of institutions filling the void as senior lenders retrench.

In truth, top London law firms struggle to think beyond their gut instinct to hug major banks – an instinct that served them well after the City’s Big Bang deregulation for more than 20 years. But in the far more complex and inter-connected world of post-Lehman finance, it is far harder for law firms to know where to focus their efforts and best lawyers.

The clubby days in which a select band of men could carve up the banking world are rapidly passing into distant memory – the ‘Titans of my youth’, as one wistful banking head notes of figures like Stuart Popham and David Morley.

‘Do people use NY law? Yes, but the skills are here in London. For cross-border, there are no obvious jurisdictions you would pick over English law.’
Charles Cochrane, Clifford Chance

Nevertheless, trends that have emerged in City practices have largely done so as a direct result of the crash. The regulatory crackdown on banks, the rise of alternative credit providers, the Americanisation of Europe’s credit markets – have all converged to reshape the industry at a material level in recent years.

Then there is the reality that finance is one of the areas of institutional legal services where technology and commoditisation looms most threateningly. Reflects Allen & Overy (A&O) co-head of finance Philip Bowden: ‘Everything we do starts high-end and, over time, can become commoditised.’

With a shifting hierarchy, the threat of increasingly disruptive technology and, of course, the impact of Brexit on the City all set to continue reshaping the credit environment, we asked leading finance partners how they are future-proofing their teams for the years ahead.

Death, taxes… regulation

‘Who was it that said that the only certainties in life are death and taxes? Now you can add regulation. It is front and centre of everything,’ says Kevin Ingram, Clifford Chance (CC) securitisation partner, channelling US founding father Benjamin Franklin in reference to the intense scrutiny facing banks in the wake of the financial crisis. ‘Banks have had to look at their own assets and dispose of non-core assets. The costs associated with regulatory compliance and the capital cost of keeping them on their balance sheet are major drivers,’ adds Ingram.

‘There is a role for AI in the ho-hum tasks – things that no lawyers want to do and no clients want to pay for.’
Denise Gibson, Allen & Overy

‘We do a lot more dealing with regulation and legislation changes for the big banks like Lloyds and RBS – massive projects to move loan portfolios. You have GCs getting their heads kicked in if he or she gets it wrong,’ notes one Ashurst partner.

There is little doubt that banks, once sure-fire generators of fees for big-ticket transactions, have become more cost-conscious and bureaucratic with the transactional work that was once bread and butter for finance counsel. By the same token, commoditisation has continued its march. The rise of automated document assembly, widespread boiler-plating of securities and now the dawn of regtech, a catch-all term for the rapidly emerging field of using technology to enhance compliance and regulatory activity, suggests such forces will tighten their grip in the next decade.

Freshfields Bruckhaus Deringer, while counting among its clients such banking giants as Citibank, Goldman Sachs, JP Morgan, Bank of America Merrill Lynch, Deutsche Bank, ING, Rabobank and Crédit Agricole CIB, is well-known among City peers as having tilted its business away from lenders to borrowers and sponsors. Alongside its leveraged business, the firm remains a potent force in restructuring under straight-talking veteran Ken Baird.

Such a shift reflects the narrow finance specialisms more common among US law firms and a step away from positioning Freshfields as a legal supermarket to major banking groups, a model associated with many City leaders.

While UK and European banks have lost some of their clout since the banking crisis, and most finance advisers agree they are unlikely to regain their former elevated status, they remain indispensable as originators, underwriters and syndicators of big-ticket transactions.

‘You have to be brave. We’re in a process of continual evolution, otherwise – you’re the proverbial dodo.’
Emma Matebalavu, Clifford Chance

‘Banks are still the key part of the distribution channel, given their strong connection with investors,’ says Stuart Matty, White & Case’s global head of capital markets. Mark Dwyer, head of London finance at DLA Piper, echoes the point: ‘Banks will still be part of big deals where there is the need to keep discussions confidential, as in a hostile takeover. That can only be done by big banks.’

Phil Spittal, Linklaters’ global loans chief, cites the increasing complexity of client relationships in recent years: ‘The way banks give instructions has changed significantly. It used to be you put a secondee in at a bank and that was guaranteed revenue. You can’t predict your return on investment any more. It is harder to know where the pipeline is.’

Linklaters’ leveraged finance head Adam Freeman says the issue reaches into diversification of a client base increasingly shaped by non-bank lenders. ‘Relationship management is changing. The points of contact are a lot fewer at funds and institutional investors than they are at banks.’

‘How banking used to be’

‘Disintermediation of banks’ is a phrase rarely uttered within the offices of the bank-centric law firms a decade ago, but such buzzwords are now common among younger partners scanning the horizon.

The emergence of alternative credit outfits was initially led out of the US, as investors flocked to the more resilient US economy and credit markets, while also being increasingly willing to chase higher yields on offer through specialist debt funds.

Freeman echoes the majority when he says that alternative creditors have now firmly taken root in Europe and are, if anything, expected to build market share in the years ahead as ticket sizes grow and execution speed increases.

‘Alternative lending is the new normal. To call it “alternative” has negative connotations – alternative medicine is medicine that doesn’t work – the market has gone beyond that now,’ argues Gareth Eagles, leveraged finance partner at White & Case in London and a favoured adviser to GSO Capital Partners, the Blackstone Group fund which has been making waves with increasingly big-ticket transactions.

A&O’s Bowden comments: ‘In leveraged finance, direct lenders are now mainstream participants. You might get two banks and two credit funds leading on a deal now. They used to have different return requirements so you wouldn’t see them in the same part of the capital structure. A second lien Euro deal [an increasingly popular form of secured debt, ranking just under conventional senior debt in the capital structure] is almost always led by a fund. Now some are also doing first lien.’

Not only are the number of funds increasing but their scope has too. Private equity outfits like KKR, Proventus, TPG, CVC, Bridgepoint, Partners Group and Permira are increasingly bulking up credit arms alongside core buyout businesses and are open to a wider variety of risk profiles. Adds Bowden: ‘Rather than saying, “this is a mezz fund”, some funds will have different allocations, including vanilla senior deals with pricing to match.’

‘We want our lawyers to be conversant with bonds and loans. It drives clients mad if they don’t have that knowledge in the room.’
Philip Bowden, Allen & Overy

In the US there have been a handful of examples of major deals entirely backed by direct lenders, a shift some expect to see soon in Europe. Says Scott Zemser, global co-head of Mayer Brown’s lending practice: ‘Direct and private credit lenders are acting a lot more like bank lenders – they are becoming more aggressive and competitive on certain key deal points.’

One partner at Freshfields, which counts Permira, Apollo and Blackstone as credit clients, notes the rewards of cultivating such relationships: ‘They are more sophisticated than ever and have bulked out their teams, they are writing bigger cheques. There is more freedom in what they will look at – they are not so constrained or bureaucratic. It reminds me of how banking always used to be before banks got so heavily regulated. It’s refreshing!’

Unsurprisingly, many bankers agree, having voted with their feet and moved to the less prohibitive environs of credit funds. Andrew Thomas, co-head of A&O’s global banking practice, reflects: ‘The market is more comfortable than it was with funds. That’s partly due to the shift in personnel from banks to funds. There’s comfort in the fact they’ve dealt with those people for years – they’re not so concerned about track record.’

Brex(it) and the City

‘Clients are saying: “Do not send me any more notes on Brexit. Just tell me how you can deliver more for less!”’ notes Ashurst head of banking Martyn Rogers, wearily citing the one major force in finance no-one was then able to predict or now able to ignore. But despite Brexit fatigue, the UK’s exit from the EU remains the most pressing of the unknowns facing the City. The European Banking Authority’s upcoming move from London to Paris and recent industry surveys suggesting that New York is slowly edging ahead of London as the key global centre illustrate that the City is expected to see some loss of influence.

Says Freshfields banking partner David Trott: ‘Questions are being asked as to whether English law will be so significant a force in the future. English law is stable and relatively creditor-friendly with a professional judiciary and speed of access to court decisions. But we shouldn’t rest on our laurels. This time next year, it could challenge City finance practices if NY law dominates.’

London is expected to have considerable resilience in the face of a lack of a single European challenger, even as some funds work shifts to Dublin and Luxembourg, while Paris and Frankfurt pitch for more mainstream Euro-denominated business. Most lawyers expect some pressure to bulk up civil law regulatory teams as well.

That said, the fundamental reluctance of many clients to risk being dragged before US courts and the decades-long proliferation of English law contracts are major comforts. CC’s Charles Cochrane echoes the more optimistic view shared by many veteran lawyers: ‘Do people use NY law? Yes, but wherever you are in the world, outside of New York, the concentration of skillsets is here in London. For cross-border, there are no obvious other jurisdictions you would pick over English law.’

Other anxieties stem from the event of a hard Brexit and the possibility that interest rate swaps currently clearing through UK-registered clearing houses like LCH will no longer be cleared through a registered EU clearing house. ‘If you are a director of an EU-headquartered bank with a large derivatives portfolio, that’s a real concern,’ says Dwyer.

Comments Spittal: ‘Most advisers would draw the line at attempting to predict how Brexit will have moulded the City practice of the future. The Brexit vote put a stop to a number of real estate transactions for a few months but then they carried on once the shock had eased. Who knows what will happen next year.’

As Legal Business went to press, Prime Minister Theresa May was fighting to secure Parliamentary approval for agreed withdrawal terms with the EU. While the deal has been hugely controversial, it has been generally welcomed in City circles, and is regarded as a relative win for the investment banking sector hugely concerned about passporting and market access to the EU.

Crisis at last

‘I’m not saying there’s another crash around the corner, but restructuring lawyers are looking happier,’ says DLA’s Dwyer. Despite some outwardly solid economic figures for the UK, turbulence on the high street helped 2018 be one of the most active years for the restructuring counsel who had grown sick of sitting on their hands post-crisis forlornly predicting the next downturn.

There is a reason why some M&A lawyers look down their noses at banking lawyers as boilerplate merchants… while regarding restructuring counsel as genuine corporate strategists. When the next crisis, or ‘correction’ happens, deals will be getting more complex as companies use a wider range of debt instruments. More buyers of the debt at various levels, all wanting their own advisers, and less dominant banks, continue to make restructuring more complex and lucrative.

Many of those interviewed flagged the importance of having a strong restructuring team as a hedge. And there is also a sense that the finance lawyer of the future will have to have a broader skillset as the distinctions between practice areas blur.

‘I tell young lawyers they’d be nuts not to have restructuring under their belts as well as lev fin,’ notes one New York finance partner. ‘In difficult recession times you can be doing restructuring. It’s very hard work and not precedent driven.’

‘We want our lawyers to be equally conversant with bonds and loans, and we are now also seeing crossover between leveraged finance and infrastructure deals. EQT, KKR and Blackstone are all doing deals borrowing technology from the leveraged world. It drives clients mad if they don’t have that knowledge in the room,’ says Bowden. ‘We were interviewing an infra guy in the partner selection and were grilling him – what are you like with lev fin?’

‘Things no-one understands’

‘The last ten years have been a challenging time around Libor. The next big regulatory challenges for banks will be an algorithm doing things in the background that no-one has checked and no-one understands,’ says Jonathan Kewley, co-head of CC’s tech group.

The chair of the Financial Conduct Authority and the Payment Systems Regulator Charles Randell’s talk in July on ‘Big Data’ and the invisible threat it poses to financial services underlined such concerns.

Kewley notes that financial institutions are increasingly seeking advice on bolstering their resilience. With tech extending rapidly into business models (see fintech), compliance and enforcement (regtech) and financing techniques themselves may see wrenching change.

‘Relationship management is changing. The points of contact are a lot fewer at funds and institutional investors than they are at banks.’
Adam Freeman, Linklaters

‘Fintech is in its infancy but will work its way through. Regulators are rightly concerned blockchain doesn’t cause systematic risk,’ points out another CC partner. ‘It’s a back-handed compliment – regulators taking note suggests it is becoming big enough they want to keep an eye on it.’

Kewley strikes a similar note: ‘It is definitely on the agenda. Banks which are increasingly dabbling in fintech see what’s happened with Facebook and say: “We don’t want another Cambridge Analytica, thank you very much!”’

Ben Regnard-Weinrabe, partner in A&O’s financial services regulatory practice, says that the firm’s tech accelerator Fuse is currently home to regtech ventures (some finance observers believe this emerging field will become far more significant than its more hyped fintech counterpart). ‘Some are early stages but are showing tremendous promise.’

The use of tech in derivatives is already well established with Linklaters showcasing its ISDA Create by Nakhoda AI data tool and A&O its Margin Xchange product. Both of which are driven by changes to initial margin rules implemented in phases under the European Market Infrastructure Regulation (EMIR), with significant numbers of derivatives participants required to comply in the run-up to 2020.

David Wakeling, head of A&O’s markets innovation group, notes the challenges of using tech to generate and automate contracts: ‘There is a proliferation of tech providers. Some are small; we need to check that they are good. Requirements around data integrity and security make this a huge undertaking.’

For now at least, most argue that machine learning and automation will largely impact on volume areas like document creation and management, rather than more bespoke structures. Says A&O banking partner Denise Gibson: ‘There is a role for automation and AI in some of the more ho-hum tasks – the things that no lawyers want to do and no clients want to pay for.’

On the other hand, Trott highlights the potential impact on the training of young lawyers in relying on technology for some of the more mundane tasks. ‘The challenge for us is – how do we train people if processes are farmed out? They have to develop that skillset they would learn from going through the processes. What’s the cost? How do you get clients to buy into it? When you do due diligence, that’s how you form your views about the deal.’

Whether or not the finance partner of the future will have to become a fully fledged technologist is open to debate (‘I’m dreading the day someone knocks on my door and tells me I have to go on a coding course!’ laughs Kate Sumpter, A&O’s up-and-coming financial regulatory partner), but most are in agreement that the finance practice of 2030 will be populated by fewer people, as fewer staff are ultimately required in the execution of agreed deals.

For optimists, this could herald many bankers (and lawyers) returning to previous eras that emphasised personal connections and broad judgement over the transactional banking of the 1980s onwards, defined by document crunching and sprawling financial ‘supermarkets’ carving up the debt markets.

After all, the past can be a useful guide to the future, however challenging to parse. As Bowden reflects: ‘I worked on the 3G licensing auctions about 20 years ago. We all read the prospectuses – they were talking about people being able to watch videos on their phones. We all laughed and said: “Who would want to do that? That’s never going to happen!”’ LB

nathalie.tidman@legalease.co.uk

For more on Linklaters, see ‘No blueprint’: ten years after collapse of Lehman, Linklaters vets look back at decade-spanning wind-up of its Euro arm