‘There are Formula 1 drivers and other drivers’ – who’s winning the race for London’s lev fin work?

Georgina Stanley and Ben Wheway cast an eye over one of the City’s most contested practice lines

‘Leveraged finance is an industry that thinks in American,’ notes one former veteran of the Magic Circle, now with a US outfit, reflecting on the much-changed dynamics of Europe’s credit markets.

Some may argue that this shift took hold so long ago now that it no longer needs discussion but according to many finance counsel, the ongoing Americanisation of Europe’s credit markets is a change likely to have an even bigger impact in the coming years than over the previous decade.

White & Case’s Jeremy Duffy sums up the outlook: ‘To succeed, you need headcount. You need to speak the language of bank, sponsor and fund all at the same time – with reference to different geographies and debt products. Hence you’re seeing a recurring list of firms acting on these deals.’

This volatility, the long-term shift to bonds and the growing clout of sponsors in a market once utterly dominated by senior lenders, have triggered huge upheaval among the legal advisers focused on high-end acquisition finance. At the top of that hierarchy sit two US-born 800lb gorillas in the shape of Latham & Watkins and Kirkland & Ellis and arguably three Magic Circle firms, Allen & Overy (A&O) certainly, and, more debatably, Clifford Chance (CC) and Linklaters.

Against this brutally-competitive market – and only private equity has seen more aggressive partner recruitment than leverage finance – firms are currently having to contend with credit markets taking a pause for breath. Debtwire data shows European volumes to be 10% lower over the first three quarters of this year compared with 2018. There have also been shifts in the type of work, with infra deals and repricing work cited by some in place of more mainstream deal finance work.

‘You’ve seen cheques for a billion from direct lenders. We’d be stupid not to try to be part of that.’
Adam Freeman, Linklaters

Linklaters banking head Adam Freeman (pictured above) comments: ‘The market is patchy – there have been a few large elephant-like transactions but syndicated lending volumes are down.’ Hogan Lovells’ Penny Angell, likewise, cites the turbulent outlook, noting the ‘lunar effect’ of Brexit on the ebb and flow of deals, in a market where sponsors still have huge capital to commit. ‘People are pretty aware the market is difficult so they’re trying to pick deals that will weather the storm. There’s more competition for deals with stable cash flows.’

With relatively few PE assets coming to market, public-to-private mandates make up a growing percentage of top firms’ work. For the firms with large practices operating across sponsor and lender clients – such as Linklaters, A&O, CC and Latham, it means that while auction processes still result in a feeding frenzy they are few and far between. In the meantime, debt counsel are seeing a shift in the matters they’re taking on to stay busy, and this is only likely to increase in the event of a downturn. But for acquisition finance veterans, it was ever thus.

Across all tiers of firm on the lender side it has become increasingly important to have strong ties with specialist credit funds, alongside the traditional banks. Indeed, the growing role of direct lenders, often touting ‘unitranche’ structures, has been a defining feature of the City market over the last five years.

When they made a splash post-financial crisis, these funds, such as Barclays’ offshoot Ares, were the focus of firms such as White & Case, Hogan Lovells and Ashurst. As the scale of lending they undertake – either alone, with peers or a bank – increases dramatically they have become coveted clients for firms of all sizes, with many large players such as Weil, Gotshal & Manges, Latham, Linklaters, CC and A&O trying to build their client bases.

Notes Freeman at Linklaters: ‘That market is getting bigger; you’ve seen cheques for a billion from direct lenders – they’re now a standard part of the financing solution for sponsors and we’d be stupid not to try to be part of that.’

Ashurst’s Helen Burton agrees that direct lenders are ‘here to stay’, adding: ‘The deal size and firepower of some of the funds means they’re absolutely competing with the banks.’

‘A lot more bonds’

The revival in high-yield activity over the last six-to-12 months, meanwhile, means firms also need to ensure they are able to offer bond coverage in addition to traditional loans. Certainly, flexibility has never been at such a premium in deal finance.

‘There’s no shortcut. You need a collection of the best people at every level – it can’t just be one person. We had to get high yield right.’
Suhrud Mehta, Milbank

Tom Richards at Weil comments: ‘We’ve done a number of deals recently where we’ve started with either an all loan or predominantly loan structure, but then the market/banks have dictated that, for best execution, we’ve ended up with more bonds than anticipated. Banks will push for optionality on deals of any reasonable size now and we’ll continue to see more bank/bond transactions as both banks and sponsors look to arbitrage the two markets.’

Over at Milbank, practice head Suhrud Mehta acknowledges the challenges for firms without established high-yield and US law coverage. Milbank already had a solid pedigree for leverage finance in the US, but its City credentials received a notable boost in early 2018 with the recruitment of high-profile bond veteran Apostolos Gkoutzinis from Shearman & Sterling. The firm this summer also hired A&O associate Sarbajeet Nag as a partner. Says Mehta: ‘There’s no shortcut. You need a collection of the best people at every level – it can’t just be one person. And you need to have the New York part, as well as the high yield element. It was clear to me when we decided to approach Apostolos that we needed to have the best in high yield to get that right. I was here before Apostolos joined us and I knew very well that we had to hire and get that right. There are only a handful of firms at the top end. There are Formula One drivers and other drivers – anyone can drive a Toyota Prius around Brands Hatch but they won’t be invited back.’

Most of the largest UK firms now have functional US law coverage in London and are therefore capable of taking on mandates requiring bond advice, especially as junk bonds are more boilerplate than the slick sales pitch admits. But the consensus remains that without deeper benches and genuine heritage in the US, it will be increasingly hard for City firms to maintain their position in sectors increasingly sensitive to US investors.

‘More and more deals have US and European syndication strategies; which means more work is being driven to US firms,’ says Kirkland playmaker Neel Sachdev. ‘The nature of the market now means it’s more difficult for UK firms to compete on financings. Unless you can be ambidextrous covering New York and English law, you’re at a real disadvantage. It’s being driven by the strength of financial sponsors and the US technology that is flowing into the terms in the European leverage finance market.’

‘Those that have an advantage are those that can credibly operate across both the Europe and NY markets – it doesn’t matter where the headquarters is.’
Denise Gibson, Allen & Overy

Chris Kandel, the former Latham partner who last year moved to Morrison & Foerster, comments: ‘If you look at the European lev fin market over the last ten years, it never recovered to its pre-financial crisis levels, unlike the US. The work for the large-cap deals has also clustered in fewer and fewer hands. It’s a small community now, and where it goes from here isn’t at all clear. That’s one reason why I was interested in tech and the direct lending market – you can see that’s mushrooming and becoming more relevant.’

Privately, some UK partners admit US rivals have a point, with one partner conceding, ‘If it’s a truly global deal and you need a dollar solution it can be a real issue for firms like ours – the bigger the deals get the more you need that US element.’

A&O partner Denise Gibson, however, maintains it matters less where the firm is based and more about its capabilities: ‘Those that have an advantage are those that can credibly operate across both the European and New York markets – it doesn’t matter where the firm is headquartered.’

Still, it will have escaped the notice of none that A&O has only recently abandoned its epic attempt to secure a US merger with O’Melveny & Myers, a struggle reflecting its determination to secure a US breakthrough.

Even in the City pecking order, leverage finance has been a challenging sector, with once-vaunted names like CC widely felt to have lost some potency, while the retrenchment of UK mid-market lenders has been tough for teams at Ashurst and DLA Piper. And seemingly everyone feels the Kirkland effect remains, with even the most lender-centric teams increasingly asking if they need a sharper profile with the sponsors driving deal structures, an angst felt even at the mighty Latham. The bottom line: this is not a market for any firm lacking commitment and it is not going to get easier any time soon.

The new UK edition of The Legal 500 is out now.