Italian private company bonds: what's expected

Author: Danielle Myles | Published: 1 Aug 2012
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Unlisted Italian corporates are a step closer to tapping the debt capital markets after the government’s capital raising reforms were passed by the lower house of parliament last week.

Local lawyers have long called for the improvements, introduced into parliament on June 22 as part of the so-called Growth Decree, which bring Italy’s debt issuance laws in line with European standards.

The two fundamental changes – elimination of withholding tax and interest deductibility upped to bank-loan levels – remove the obstacles that have stopped private company bond offerings.

“Limitations on the deductibility of interest paid by unlisted companies and investors having a 20% withholding tax effectively killed the market as they made it non-economic for both issuer and investor,” said Tobia Croff, a Milan-based Shearman & Sterling partner.

Given banks are deleveraging, giving private issuers the same tax treatment as public companies when issuing bonds means a quick uptake is expected once the reforms become law.

In addition to the withholding tax and deductibility changes, the decree intends to kick-start Italy’s commercial paper sector and encourages small and medium enterprise bond issuances by introducing a sponsor role.

Before approving the decree last week, the lower house limited the sponsor requirement to commercial paper issuances only. This was after some banks pushed back on requiring them to hold the bonds in their portfolio.

Unresolved issues
But it left untouched the key difficulty that must be resolved before the law can be utilised to its true potential.

The issuer’s deductibility benefit of 30% Ebitda (earnings before interest, taxation, depreciation and amortization) is subject to investor certification that they are a qualified investor and are not a shareholder in the issuer. This applies throughout the life of the security.

Latham & Watkins Milan partner Jeff Lawlis said this was the one pragmatic issue that would need to be resolved before the law could be utilised to its true potential.

“Hopefully we will get some clarity through a circular from the tax authorities, but if not immediately forthcoming, it will be left to the market participants to create a sufficiently strong certification mechanism that will ensure the issuer’s ability to deduct interest expense on the bonds,” Lawlis said.

This is where the Italian proposal diverges from European standards. It’s also the key aspect of the decree to be tested in practice. As the certification has no bearing on the investor’s tax benefit, the challenge is devising a system that encourages successive investors to make the required disclosures.

Antonio Coletti, also of Latham & Watkins in Milan said the crucial point is that the procedure must be investor-friendly and easy.

“Since non-Italian investors in Italian debt securities are accustomed to providing the Law 239 certification for withholding tax purposes, utilising a similar certification procedure regarding qualified investor status may simplify the process,” Coletti added.

However this manner of certification should not extend to the investor’s shareholding in the issuer. It’s thought this is best managed directly between the two entities.

Refinancing and LBOs
The decree promises an end to the financing conundrum faced by the majority of the country’s corporates.

When bank finance started to dry up in 2008, private companies sought to issue bonds through offshore vehicles and repatriate the funds back into Italy to avoid the country’s tax barriers. But tax advisers became nervous when Italian tax authorities started investigating these structures. As a result, few of them were then established.

With banks deleveraging, now is a prime time for small corporates to be able to tap the bond market – particularly to refinance their maturity debt.

As Europe’s high-yield market has been performing well, despite the eurozone crisis, many expect the instrument to help with the upcoming debt maturity wall.

However, one London-based bankers’ counsel told IFLR the big challenge would be getting this rolled out to the corporates in Europe.

Those in Italy now have a step-up in this regard, however Croff predicted a degree of caution.

“Corporates may be reluctant to resort to bonds at the beginning, as I think for cultural reasons it’s perceived to be easier to deal with a bank rather than the market,” he said.

“But I think in reality it will be used as an alternative, and they will be enticed to do so by banks which will be happy to have an alternative,” Croff added.

Leveraged buyout (LBO) financing is another likely use.

Once converted into law, Lawlis said a big difference was likely to be seen over the medium and even short-term as Italian private corporates and sponsors considering LBOs of Italian companies will know they can issue bonds directly without having the added expense of grossing up investors for the withholding tax while being able to fully deduct the interest expense.

Croff also expected the new regime to be picked up as a new form of LBO finance.

The reforms are in decree-form until approved and passed into law by the parliament’s upper house.