Cross-Border Financing Report 2017: UK
Craig Jones, Sullivan & Cromwell
SECTION 1: Market overview
1.1 Please provide an overview of the cross-border financing market in your jurisdiction.
Despite the British public voting to leave the European Union in June 2016 and the resulting climate of political uncertainty, London remains a global financial centre and thus far the loan and bond markets have remained resilient. Liquidity in the loan market in particular has been strong, with interest rates low, and there has been a supply/demand imbalance creating a strong environment for borrowers/issuers. Indeed, the first half of 2017 was dominated by opportunistic repricing and refinancing transactions, in many cases on substantially enhanced terms for borrowers.
The market is becoming increasingly accepting of covenant and terms flexibility. This is in part driven by the changing investor base. Lending is no longer dominated by banks; institutional investors and direct lenders are also key players, have different credit concerns and are often agnostic between bank debt and bond debt.
Senior-only financing predominates, however in-built flexibility to raise additional financing at any level of the capital structure is common place.
1.2 What have been the key trends or developments in cross-border financing in your jurisdiction over the past 12 months?
Convergence between the European covenant-lite (cov-lite) market and the US term loan B (TLB) market is a trend that has been observed for some time now as a result of institutional investor agnosticism between bank debt and bond debt, and the past 12 months have been no different. There has though, been little consistency in the manner in which US terms have been incorporated into English law documentation. Some deals, often labelled "high yield in disguise", have adopted wholesale New York-law governed high yield (HY) style incurrence packages (often plus a springing financial covenant for the benefit of the revolving facility or other undrawn facilities) without material modification to reflect a secured bank loan. Others import provisions substantially equivalent to those in US TLB documents, while another subset features a combination of these approaches peppered with other terms, which while not common in the US TLB or HY markets, have cleared the market in other European deals.
As noted above, the market is becoming increasingly accepting of covenant and terms flexibility. In particular, cov-lite deals are now becoming the norm, no longer attracting a significant pricing premium. EBITDA add-backs to financial covenants are common, and the ability to raise additional indebtedness and make distributions is no longer as tightly controlled.
1.3 Have there been interesting changes in the structure of the banking sector in your jurisdiction?
The investor base is diversifying. Direct lending is no longer confined to the mid-market space; some of the larger funds are competing against banks for mandates and winning deals at the top end of the market. Also, banks and direct lenders are collaborating, with direct lenders helping to arrange loans that banks would be unable to underwrite alone.
Brexit is of course a wild card and no one knows yet what the ultimate impact of the expected withdrawal from the single market and potential loss of passporting rights will be.
SECTION 2: Financing structures
2.1 Briefly outline some recent notable transactions involving your jurisdiction, highlighting any interesting aspects in their structures and what they might mean for the market.
Examples of direct lender activity in the big ticket space are the unitranche facilities provided to Soho House, Zenith and Consolis, and the second lien facilities for Diaverum, Parkdean Resorts and Corialis.
The Eircom refinancing of late 2016 was a good example of a borrower using an opportunistic refinancing to substantially amend its terms.
2.2 Have there been any significant developments in the way cross-border financing transactions are structured or in the way borrowers and/or lenders are participating in the market?
The European Central Bank (ECB) published its final guidance on leveraged transactions on May 16 2016. The guidance provides that underwritten transactions with a total debt-to-EBITDA ratio of more than 6x should remain the exception rather than the rule, and must be justifiable. The impact on the market remains to be seen, but given that most affected institutions were already subject to the Leveraged Lending Guidelines in the US which impose similar requirements, it may well be minimal.
The increased flexibility afforded by cov-lite loans and the continued convergence with the US TLB market has caused many sponsors to opt for loan financing rather than bond, or to refinance existing bond debt with loans. Investors are attracted not only by the flexibility of the product, but also lack of call protection and public disclosure requirements.
SECTION 3: Legislation and policy
3.1 Describe the key legislation and regulatory bodies that govern cross-border financing in your jurisdiction.
The Financial Services and Markets Act 2000 (FSMA) establishes the framework for financial services legislation in the UK. The Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) are the two UK financial services regulators. The FCA is responsible for the conduct of all firms authorised under FSMA. It is also responsible for the regulation of conduct in retail and wholesale financial markets, supervision of trading infrastructure that supports those markets, and the prudential regulation of firms not regulated by the PRA. The PRA is responsible for the micro-prudential regulation of systemically important firms, including banks and insurers. The loan market itself, however, is not a regulated market in the strict sense – loan agreements are not regulated products under FSMA.
The City Code on Takeovers and Mergers is relevant to the extent that financing relates to the acquisition of a public company.
ECB guidance as noted above is relevant.
3.2 Have there been any recent changes to regulations or regulators that may impact the cross-border financing market and what impact do you expect them to have?
See above regarding ECB guidance and above and below for Brexit.
3.3 Are there any rules, legislation or policy frameworks under discussion that may impact lenders or borrowers involved in cross-border financing in your jurisdiction?
Brexit will of course impact the market in a myriad of ways, but in the absence of clarity as to the final shape Brexit will take, in exactly what ways it will impact is still difficult to say. One area of concern for non-EU lenders licensed in the UK is the potential loss of passporting rights and consequent access to the single market. To maintain access, such lenders will likely seek to become licensed in another EU jurisdiction, but the extent to which a substantive physical presence in the new jurisdiction is required (for example whether there will be a need to set up a fully-fledged subsidiary and locate decision-makers there) is still unknown.
SECTION 4: Market idiosyncrasies
4.1 Please describe any common mistakes or misconceptions that exist about the financing market in your jurisdiction.
There is no Chapter 11 equivalent in the UK. In the UK investors assume contractual rights through an intercreditor agreement (ICA). The relationship between them is not governed by statute. It is important to be cognizant of this when structuring a transaction and importing US HY and TLB concepts into English law governed documents, because some concepts when imported wholesale will have unintended results. Take for example the debt incurrence covenant. In the US debt incurrence flexibility is accepted in part because if all debtors are American, there is generally no concern about being able to deal with unsecured creditors or junior secured creditors in a bankruptcy or restructuring process as it is regulated by statute. This is different in England where the intercreditor relationship is governed by the ICA. This has led to the debt incurrence covenant in Europe being constrained by caps on unsecured or junior debt, unless the relevant creditor signs up to the intercreditor agreement, and 'evergreen' intercreditor agreements, which contemplate at the outset flexibility to incur future indebtedness at various levels.
4.2 Are there frequently asked questions or often overlooked areas from parties involved in cross-border financings in your jurisdiction?
Despite convergence and importation of US style terms there still remain areas of difference in market practice and documentation. At the time of press, these included Libor floors, flex provisions, most favoured nation provisions, ticking fees and transfer restrictions.
4.3 Are there any classes of assets over which security cannot be taken or regulations specific to your jurisdiction governing the taking of security over certain classes of assets that lenders should be aware of?
No, security can be taken over any asset or class of assets. However, asset-backed revolving lending arrangements similar to US ABL-facilities are not common in the UK market.
4.4 What measures should be taken to best prepare for your market idiosyncrasies?
The UK market is well developed and relatively straightforward to navigate when properly advised. It is useful to be familiar with the differences between loan and bond products on offer as well as general market terms. As choice of financing product is often driven by market demand and pricing, flexibility and adaptability in terms of product choice can be useful.
SECTION 5: Practical considerations
5.1 Briefly explain the downstream, upstream and cross-stream guarantees available in your jurisdiction, with reference to any specific restrictions or limitations.
A company incorporated in England and Wales can grant downstream, upstream and cross-stream guarantees. To do so, it must demonstrate that it has requisite corporate capacity and derive sufficient corporate benefit from the transaction. Demonstrating corporate benefit is straight forward for downstream guarantees (and is generally dealt with in board resolutions). For upstream or cross-stream guarantees, in addition to a specific reference to corporate benefit in board resolutions, it is also prudent to obtain a shareholders resolution. If a company is in financial difficulties, the director's duty to act in the best interests of the company shifts from being shareholder focused to creditor focused, and so particular care is required. Guarantees may be capable of being set aside if the company is, or as a result of the guarantee becomes insolvent and subsequently goes into liquidation or administration during the relevant hardening period.
Under the Companies Act 2006, a prohibition on financial assistance (which includes the provision of guarantees) applies where a public company gives financial assistance for the acquisition of its own shares or those of a parent company; or a private company gives financial assistance for the acquisition of shares in its public parent company.
5.2 Are there any specific issues creditors should be mindful of regarding a bankruptcy and restructuring situation?
English common law upholds the principle established in the Gibbs case (Gibbs & Sons v Société Industrielle et Commerciale de Métaux 1890) that English courts will only recognise a discharge or release of an English law governed right or obligation if the discharge/release is also governed by or effective in accordance with, English law. The court will not recognise a variation of English law rights / obligations arising as a result of an overseas proceeding if the creditor party has not submitted to and is not present in the overseas jurisdiction.
5.3 Do foreign debt quotas apply in your jurisdiction and is offshore financing to domestic entities monitored?
5.4 Describe your jurisdiction's relationship with non-performing loans (NPLs), including volume of outstanding NPLs and techniques/challenges in managing them.
SECTION 6: Outlook
6.1 What are your predictions for the next 12 months for cross-border financing in your jurisdiction? How do you expect legal practice to respond?
A continuation of the trends seen over the last 12 months. Flexibility in covenant terms and no financial covenants are likely to remain constant given institutional investors' agnosticism between bank and bond terms. Practitioners who can advise on a multitude of structures and products are likely to be sought out. Creativity and flexibility on the part of the legal community as the market responds to Brexit in real time will also be required.
About the author
Craig D Jones
Partner, Sullivan & Cromwell
T: +44 20 7959 8900
F: +44 20 7959 8950
Craig Jones is a partner based in the firm's London office. He is admitted to the bar in England and Wales and in New York. Jones pursues a broad-based finance and corporate practice, and has acted for financial institutions, private equity sponsors and corporate clients across a range of industries. His work has included new money financings, refinancing transactions and restructurings. His transactions include investment grade borrowing, leveraged financing and project financing.
Jones's most recent experience includes: advising Philips on the financing for its Spectranetics acquisition; Swisscom on infrastructure financing arrangements with the European Investment Bank (EIB); GLAS in connection with the reorganisation and recapitalisation of the Hibu Group; the coordinating committee of bank creditors to Abengoa during its restructuring; Coca-Cola HBC on the replacement of its revolving credit facility (RCF) – having advised on the original financing arrangements in connection with the client's re-domiciliation; and Reykjavik Geothermal on a convertible loan facility.
In addition to his financing work, Jones has advised on a number of corporate acquisitions and divestitures, usually involving private equity. He has significant experience of equity co-investment and fund structures.