Jeremy Lucas Tong is an associate in the Bank Finance practice based in Paris.

Jeremy Lucas represents a range of banks and other financial institutions in domestic and cross-border transactions. He has a particular focus on acquisition finance, including syndicated finance, leveraged finance and mezzanine financings.

Prior to joining White & Case, Jeremy Lucas worked at Rothschild & Co. providing legal coverage for the M&A and Financing activities in Small and Mid-caps.

Jeremy Lucas also worked, in London and Paris, at leading international law firms in Banking and Structured Finance.

On January 24, 2019 the Italian Ministry of Economy and Finance ("MEF") published a press release announcing that the Italian government has readied a set of measures necessary to ensure full continuity for financial markets should the United Kingdom leave the European Union without a deal.

Background

In a no-deal Brexit scenario, the United Kingdom would become a third country to all intents and purposes under EU law starting from March 30, 2019. This would have disruptive effects on the services rendered by UK financial institutions currently operating in Italy under EU passporting rules and on investment and financial activities carried out by Italian firms on a cross-border basis in the UK.

For example, UK banks, insurance companies, asset managers or investment firms operating in Italy under the freedom to provide services or through local branches would no longer be allowed to carry out their business in Italy without an authorization by the competent authorities, and UK firms' access to trading venues might be discontinued.

Proposed Measures

The proposed measures aim to ensure financial stability and business continuity, as well as to safeguard depositors and investors by introducing a transition period during which UK and Italian financial services firms may continue to operate without disruption (the "Transition Period"). According to the MEF press release, the Transition Period should be similar to that provided in the draft withdrawal agreement between the United Kingdom and the European Union published in November 2018.

It may accordingly be expected that the Transition Period will last at least until the end of 2020, although this is not specified in the press release.

During the Transition Period it will be possible for financial institutions to continue to carry out their business under the current regulatory framework. This regime will apply both to UK entities operating in Italy and to Italian entities operating in the UK – as far as the Italian rules are concerned in this latter case.

With regard to trading venues, the new rules would also envisage the application of a Transition Period during which current operations may continue in accordance with the relevant EU regulatory framework. Specific provisions will be enacted in respect of Italian pension funds, allowing them to continue their investments in collective investment undertakings established in the UK during the Transition Period.

The new legislation will regulate the specific requirements that market participants will have to fulfil in order to continue to operate after the Transition Period. The goal is to introduce a reliable framework that would allow financial firms to adapt to the new institutional and operational environment following the end of the Transition Period.

Next Steps

Based on the MEF press release, the proposed measures will be introduced through an emergency governmental decree (decreto legge), the adoption of which remains subject to future Brexit developments. No draft decree has been made available yet and therefore it is not possible to fully assess the impact of the Italian rules.

The decree will have to be converted into law by the Italian Parliament within 60 days of its publication, otherwise it will become retroactively ineffective. Consequently there may be further amendments introduced by the Italian Parliament, as well as legal uncertainty arising from the possibility that the decree is not converted into law.

While the MEF clarified that the measures have been prepared in close collaboration with the regulatory authorities, the question that remains open is whether and to what extent a national transitional regime would comply with EU law, which in some sectors already regulates third country firms.

Furthermore, the possibility for each EU Member State to tailor its own post-Brexit regime might lead to a fragmentation of the EU single market in financial services. For example, other EU Member States, including France and Germany, have already published their own draft proposals for temporary regimes in the event of a hard Brexit. The German proposals seek to preserve market access for UK firms offering financial services for a transitional period – a separate client alert will follow on this topic. The French proposals seek to permit UK firms to conduct certain life-cycle events for existing legacy trades without needing to obtain local French authorization.

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Global law firm White & Case LLP has advised Cassa di Risparmio di Asti S.p.A. and Cassa di Risparmio di Biella e Vercelli – Biverbanca S.p.A., as originators and underwriters, and UniCredit Bank AG as arranger, on the approximately €1.2 billion restructuring of a multi-originator revolving securitization of fondiari mortgage loans, ipotecari mortgage loans and unsecured loans issued by the originators to Italian SMEs.

The restructuring involved, among other things, the extension of the revolving period during which the securitization vehicle may purchase further portfolios of receivables from the originators, and the adoption of certain other structural amendments.

The White & Case team in Milan which advised on the transaction was led by partner Gianluca Fanti and local partner Giuseppe Barra Caracciolo, and included associate Francesco Scebba and lawyer Ioana Gaga.

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Global law firm White & Case LLP has advised Pitagora S.p.A., as originator, and Banca IMI S.p.A., as arranger, on the restructuring of a receivables securitization.

The receivables were originated by Pitagora and consist of the assignment of up to one fifth of the borrowers' salaries, pensions, or payment delegations. The restructuring was carried out through the issuance of a €670 million unitranche note by the special purpose vehicle Geordie SPV, which replaced the two classes of senior and junior notes Geordie SPV had previously issued.

The White & Case team which advised on the transaction comprised partners Gianluca Fanti and Giuseppe Barra Caracciolo, associates Riccardo Verzeletti and Rocco De Nicola and lawyer Ioana Gaga (all Milan).

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Global law firm White & Case LLP has advised Credito Fondiario S.p.A. and Fire S.p.A. on the acquisition of a €698 million non-performing receivables portfolio from Banca Monte dei Paschi di Siena S.p.A. and MPS Leasing & Factoring S.p.A.

The White & Case team in Milan which advised on the transaction comprised partners Gianluca Fanti and Giuseppe Barra Caracciolo, together with associates Angelo Messore and Riccardo Verzeletti.

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European Leveraged Finance Alert Series: Issue 1, 2019

New Polish laws, effective 1 January 2019, have reformed the tax treatment of a number of different taxable business activities. In particular, the Ministry of Finance has addressed the considerable uncertainty surrounding Poland's current withholding tax regime. For issuers who can meet the relevant requirements, direct issuances by Polish entities are now possible without withholding, so long as the legal requirements are met, eliminating the need for structuring using finance company structures. While the laws bring welcome certainty to bond issuers, the reforms also strengthen anti-avoidance rules, and questions remain about the treatment of structures that pre-exist the new reforms.

New Exemption for 20% Polish Withholding Tax

On 1 January 2019, Poland enacted a new tax regime that introduced sweeping changes in a number of areas. Most importantly for international bond issuances, these new laws provide a framework for Polish issuers to issue international bonds directly with no obligation for issuers and agents to collect Polish withholding tax ("WHT") and a Polish income tax exemption for interest paid to non-Polish tax residents.1 The bonds may be issued by either Polish joint-stock companies (Spółka Akcyjna (S.A.)) or limited liability companies (Spółka z ograniczoną odpowiedzialnością (sp. z o. o.)).

In order to qualify for such beneficial treatment:

• The bonds must be issued in 2019 or later and have at least a one-year maturity;
• The bonds must be admitted to an EU regulated market (such as the main markets of the Luxembourg or Irish Stock Exchanges, which we would expect to qualify, or an alternative trading system, as defined in the Act on Trading Securities of 29 July 2005, in Poland or in a country that is a party to a double taxation treaty with Poland).2 The bonds must be listed and admitted to trading by the first interest payment date;
• Polish and non-Polish corporate or individual tax residents may be bondholders; however, only non-Polish tax residents can benefit from an income tax exemption (other than non-Polish tax residents who, on the day on which income is received, are entities affiliated with the issuer of the bonds and hold, directly or indirectly, together with other affiliated entities, more than 10% of the nominal value of such bonds);
• The remitter (issuer or agent) is released from the obligation to collect WHT in Poland regarding a particular issuance of bonds (which covers payments to Polish and non-Polish tax-residents), on the condition that the issuer:
  • informs related parties of the conditions under which an income tax exemption applies; and
  • no later than the day when the first interest or discount on the bonds are paid, the issuer submits a statement to the Polish tax authorities that the issuer has exercised due care in informing related parties about the conditions of the income tax exemption related to those entities (such statement can be submitted only once for a given series of bonds).

Previous Approach to Withholding Tax

Before the changes to the law, Polish companies issuing bonds directly would be required to pay 20% WHT on any interest payments to non-Polish bondholders. To structure around this requirement, the Polish company ("PolCo" in the below diagram) would typically set up a finance company ("FinCo") in a jurisdiction that did not apply withholding tax to payments of interest. FinCo would issue bonds to non-Polish bondholders with payment for the bonds made to FinCo, which would then transfer the funds to PolCo in the form of intercompany loans or bonds. Payments of interest and re-payments of principal would be made via back-to-back payments to FinCo on such intercompany loans and then paid onward to bondholders.

So long as FinCo was a resident of an EU country or a country that signed a double tax treaty with Poland with an exemption applicable to interest payments, and had satisfied the necessary Polish conditions and formalities, the practice was that interest was paid from Poland to FinCo (as shown below) without Polish WHT (FinCo has offer located in Sweden or Luxembourg). This structure could reduce the WHT payable significantly (from the original 20% to 5% or a full exemption), making issuing bonds a viable option for Polish companies. However, legislative reforms, such as the July 2016 amendments to the Tax Ordinance Act, instituting the General Anti-Avoidance Rule ("GAAR"), gave the Ministry of Finance the right to reject any structure or arrangement where tax savings were the primary purpose. This meant that from 2016, even though the Polish tax authorities did not explicitly reject these structures, those structures were under considerable doubt, unless significant investments and other actions were taken. This uncertainty had a dampening effect on both the ability of Polish issuers to issue bonds and cast doubt on existing structures as the legislation did not "grandfather" in existing structures.

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Anti-avoidance Rules Also Strengthened

In exchange for clarity on Polish direct issuances, the Polish government has strengthened the 2016 GAAR regulations with the incorporation of both fiscal and custodial penalties and additions to the list of factors the tax authorities consider when scrutinising a transaction. The list of factors under the GAAR regulations now include: an unjustified division of operations; the use of intermediaries despite a lack of economic or commercial grounds for their presence; and the creation of an entity which does not conduct actual business activity. These additions enlarge the number of pre-existing transactions that the tax authorities are entitled to review.

If Polish tax authorities find a GAAR violation, they are now permitted to impose greater fiscal and even custodial penalties. The fiscal penalties are calculated as a percentage of the unjustified tax benefit, and Polish tax authorities are able to impose, among others, penalties ranging from 10% to 40% of the unjustified tax benefit.

Effect on Existing Structures

The new tax regulations do not "grandfather" existing structures (subject to some limited transitional measures that may apply, as detailed below). Given that the new tax regime also includes stricter penalties for structures that GAAR considers "artificial," we would advise analysing all existing structures where a bond has been issued by an issuer with substantial Polish operations to determine whether there are any concerns under GAAR.

Real Financial Centre

To address GAAR concerns where bonds have been issued by a FinCo and then on-lent to other Polish group companies, issuers can consider whether it is appropriate to add substance to the FinCo by endowing it with staff, assets and capabilities sufficient to allocate economic risk to the FinCo. It is essential to emphasise that a non-Polish SPV created specifically for the purpose of transferring proceeds from the bond issuance to the Polish operation in a "back-to-back" mechanism would be insufficient. The FinCo undertaking real financial activities with its own assets and personnel will be key to determining whether the FinCo would qualify as a real financial centre.

Refinancing

So long as there are good economic reasons, as opposed to just tax savings, bond issuers can consider refinancing as a means of complying with the new GAAR requirements and benefitting from the new tax reforms.

An issuer could refinance its existing bonds using bank loans from financial institutions, as most of Poland's double taxation treaties include a 0% withholding tax rate on payments of interest to banks. As bank loans to non-financial institutions (for example, to funds) may not be covered, we believe that refinancing via a bond structure that complies with the new Polish tax law exemption may be more straightforward for large international refinancings where issuers would like to access non-bank investors.

Transitional Provisions of the 2019 Tax Reforms

Certain bond issuers may benefit from transitional provisions incorporated in the 2019 tax reforms. These transitional provisions provide relief for Polish companies regarding their bond structures with non-Polish FinCos, which allows them to pay a lump sum 3% WHT instead of the standard 20% WHT. The new tax reform establishes a comprehensive list of additional requirements which include, among others: (1) the Polish issuer's loan or issue of bonds to the FinCo has a repayment day or maturity date no shorter than one year; (2) the Polish issuer and the FinCo are affiliated entities as defined by Polish law; and (3) there is a legal basis for the exchange of tax information between Poland and the FinCo's tax residence. We believe that these requirements, and others, could significantly limit the number of issuers able to benefit from this transitional provision; so each situation should be analysed on a case-by-case basis.

Conclusion

Overall, we believe the long-awaited new tax reforms bring much-needed certainty. In the period after the 2016 reforms, Polish companies considering new international bond issues were faced with a large number of unpalatable risks. These new reforms now provide Polish companies with a clear and regulatory compliant means to once again issue bonds internationally. However, questions still remain about the treatment of existing structures. The introduction of new penalties under GAAR means that the Polish tax authorities continue to look carefully at structures they consider artificial or created for tax avoidance purposes.

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¹ Payment of interest on bonds issued by Polish issuers or discount on bonds are treated as Polish source income; with the issuer or its agent obliged to pay WHT, subject to applicable WHT relief under the EU Interest-Royalty Directive or double taxation treaties.
² The requirement to list on an EU-regulated market at closing would represent a change to market practice for most European high-yield issuers, who tend to choose exchange regulated markets, such as the Global Exchange Market (GEM), Euro MTF or The International Stock Exchange, but we believe that that transaction parties should be able to comply with the requirements without major increased costs or timing implications.

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2019 White & Case LLP

The Lawyer magazine has named White & Case partner Gareth Eagles (London) to its 2019 "Hot 100" list of top lawyers working in the United Kingdom.

Compiled in association with AlixPartners and LexisNexis, The Lawyer's Hot 100 "gathers together the standout lawyers in the UK over the past year – the most daring, innovative and creative lawyers from in-house, private practice and the Bar," according to The Lawyer. "All those on the 2019 list are shaping the legal profession right now; though many already have a distinguished career behind them, no one is included because of past glories."

Included in the "Dealmakers" category, Eagles has "successfully carved out a niche as the go-to lawyer in the private debt space, a fast-growing area in the leveraged finance sector,"The Lawyer reported in its profile of Eagles. "Through a long list of deals he has done for non-bank lenders such as GSO, he has gained a reputation for reinventing and shaping the private credit market for large-cap and upper-mid-market transactions."

Eagles' practice focuses on international leveraged finance, direct lending and financial restructurings. Offering clients a global perspective, Eagles is based in the United Kingdom, but he has also worked in Singapore and New York. He is a member of the Editorial Board of Butterworths Journal of International Banking and Financial Law and is also a member of the Documentation Committee of the Loan Market Association.

Global law firm White & Case LLP has advised China Molybdenum Co., Ltd. (China Molybdenum) on its issuance of unrated US$300 million 5.48 percent guaranteed bonds due 2022.

China Molybdenum is a leading global diversified mining conglomerate principally engaged in the mining and processing, smelting and deep processing of non-ferrous metals and minerals including copper, cobalt, molybdenum, tungsten, niobium and phosphate.

The joint global coordinators, joint lead managers and joint bookrunners for the issuance are Standard Chartered Bank, Industrial Bank Co., Ltd., Hong Kong Branch, China Everbright Bank, Hong Kong Branch, China Minsheng Banking Corp., Ltd., Hong Kong Branch and Ping An of China Securities (Hong Kong) Company Limited.

The bonds were issued by CMOC Capital Limited, a wholly owned subsidiary of China Molybdenum, and guaranteed by China Molybdenum. The net proceeds will be used for general corporate purposes, including refinancing of certain existing debt of China Molybdenum and its subsidiaries. The bonds are listed for trading on the Hong Kong Stock Exchange.

"We have advised long-standing client, China Molybdenum, on its debut offshore bond offering," said Beijing-based White & Case partner David Li, who co-led the Firm's deal team. "The level of investor interest in this issuance demonstrates market recognition of China Molybdenum's strategy and operational efficiency in the global mining and metals sector."

Hong Kong-based White & Case partner Jessica Zhou, who co-led the Firm's deal team, said: "This transaction demonstrates our ability to provide effective and efficient services to high-caliber clients in their important, milestone transactions."

The White & Case team which advised on the transaction was co-led by partners David Li (Beijing) and Jessica Zhou (Hong Kong) and included partners Kaya Proudian (Singapore) and Catherine Tsang (Hong Kong), with support from associates Enlin Jiang (Hong Kong), June Chun and Mengbi Xu (both Beijing) and Christina Lui (Singapore).

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Sherri Snelson is a partner in White & Case's Bank Finance group, focusing on debt finance transactions.

She has extensive experience acting as lead counsel for lenders, private equity funds and their portfolio companies in connection with leveraged finance and fund/portfolio finance transactions across numerous jurisdictions and industries.

Global law firm White & Case LLP continues to expand its Global Banking Practice with the addition of Sherri Snelson as a partner in New York. Snelson will work closely with the Firm's Financial Institutions and Private Equity (PE) Industry Groups.

"Sherri is a talented lawyer with an impressive background in complex financial transactions," said Eric Leicht, Head of White & Case's Global Banking Practice. "She will play a key role in helping us further expand our practice and strengthen our capabilities, particularly in the lending and private equity spaces." 

Snelson has extensive experience working with private equity portfolio companies, lenders and private equity funds in connection with financing transactions, with a focus on leveraged financings.

Snelson was previously a finance partner at O'Melveny. Over the course of her career, she has acted as lead counsel on hundreds of finance transactions that span a wide array of industries and jurisdictions throughout the Americas, Europe and Asia.

"Continuing to grow our Global Banking Practice is a key pillar of the Firm's strategy," said Jake Mincemoyer, Head of White & Case's Americas Banking Practice. "As the global financial landscape changes, so do our clients' goals. Adding a highly experienced attorney such as Sherri further reinforces our commitment to serving our clients' evolving needs."

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Global law firm White & Case LLP has advised SoftBank Vision Fund on its investment in British unicorn OakNorth, in what will be the largest ever European fintech fundraising.

The investment will value OakNorth at around US$2.8 billion.  Closing of the investment will take place subject to regulatory approvals.

OakNorth is a challenger bank that specialises in lending to small and medium-sized businesses. It has lent over US$3.7 billion to British businesses, and has licensed its automated lending system to other banks and lenders around the world.

White & Case also advised SoftBank Vision Fund on another significant mandate in January.

"We are proud to be working with SoftBank Vision Fund as we focus more and more on investing in and working with fast-growth and tech-enabled businesses," said White & Case partner Ian Bagshaw, who co-led the Firm's deal team. "This is our second Vision Fund deal in a month. We are truly committed to tech and it is fantastic to have now advised on the largest ever fintech investment in Europe after advising Avast last year on the largest ever software IPO in Europe."

The White & Case team in London which advised on both the OakNorth deal and the other investments was led by partners Ian Bagshaw, Emmie Jones and Daniel Turgel, with support from associates Joseph Bradley, Elena Ruggiu and Disha Chandrachud. The team also included London partners Lindsey Canning, Nicholas Greenacre, Hyder Jumabhoy, Helen Levendi, Prabhu Narasimhan, Patrick Sarch, Michael Weir and Stuart Willey, Washington, DC partner Farhad Jalinous and London counsel Paul Harrington.

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After the shock of the financial crisis a decade ago, a new landscape emerged across debt markets and has continued to mature and develop over the past decade

A boom in M&A activity over the past three years has boosted the market, with the volume of leveraged buyouts (LBOs) reaching levels seen pre-crisis—alongside the debt needed to fund the deals.

Investors, far from eschewing the riskier end of the lending spectrum, have been tempted up the yield curve, seeking out higher returns than those on offer in safer markets where quantitative easing has depressed yields. Encouraged by investors' desire for yield, riskier issuers/borrowers have started to demand looser terms on loans, knowing that investors, needing to deploy capital in competitive markets for deal allocations, would be more likely to accept.

For the moment, leveraged loans are in the ascendancy over high yield bonds, but large M&A deals in 2018 needed both sets of instruments to get across the line, with high yield bonds often required for that extra layer of debt. In addition, the continued growth of direct lending helped to provide financing packages that may not have been available in the syndicated or high yield markets. All the while, a backdrop of infrequent corporate defaults—assisted by low base rates—has comforted markets. Some pushback on pricing by investors was met by issuers, then reversed as the need for yield rebounded. In particular this year, investors have welcomed the return of syndicated debt instruments—2018 was a record year for collateralised loan obligations (CLO), with CLO markets breaking new issuance records in both the United States and Europe.

_74%
The percentage of the European leveraged finance market accounted for by leveraged loans in 2018

In the aftermath of the financial crisis, low interest rates and quantitative easing (QE) squeezed fixed income investment portfolios to their thinnest margins in developed markets in recent years. In the United States, ten-year treasury yields fell to record lows of 1.4 per cent in 2016. A year earlier, German bunds, alongside government debt from some of their European neighbours, were trading at negative yields.

Major institutional investors such as pension funds and insurers — traditionally the main customers in sovereign and investment-grade markets—needed to move further down the credit curve to find satisfactory returns. Once on the fringes, the leveraged finance market is now a mainstay of many investors' portfolios. New buyers, sellers and advisers have made their way onto the field and the global market has doubled from US$1.2 trillion (in 2008) to more than US$2.4 trillion (in 2018), according to a report from the Bank of International Settlements.

_81%
The proportion of institutional loans in Europe accounted for by "cov-lite" deals in 2018

The rise of loans and cov-lite deals

In the five years since the first White & Case leveraged debt outlook was published, investor interest has skewed towards the leveraged loan market, which has increased its market share against high yield bonds. For example, the percentage of the European leveraged finance market accounted for by loans grew from 54 per cent in 2014 to 74 per cent by 2018.

In addition, borrowers have had greater sway in setting market terms, which has led to an overwhelming number of so-called "cov-lite" loan deals — i.e., those with a lack of financial maintenance covenants. Lenders today have less bargaining power as they embrace greater risk in search of higher yield, with covenant and security protection often being weakened. The cov-lite phenomenon was imported from the US to Europe, which historically had much stricter terms. The cov-lite term once meant to indicate an outlier in Europe has now become the norm. Cov-lite accounted for 81 per cent of institutional loans in 2018 in Europe.

One of the key changes is that financial maintenance covenants for European borrowers, once a staple in the sector, now appear only once in every five issuances. This means lenders increasingly do not have the default triggers related to operational underperformance which signals a potential problem with the borrower's ability to pay and this may delay an inevitable debt restructuring.

What a difference a decade makes

Fears that the market would be unable to absorb debt maturity walls have so far turned out to be baseless. While at the start of 2009, in the US, the sector faced a wall of debt that would mature by the end of 2015 totalling US$1.4 trillion; some five years later, after lenders and borrowers met in the market to refinance ahead of this deadline, this 'wall' had been reduced to approximately US$350 billion according to Fitch—meaning the 2015 deadline passed without incident.

Overall, markets have matured and become established. In the past, when shocks hit, markets would shut down for three to six months. These days, they are less reactive to perceived crises and have been able to maintain stability. For example, despite the upheaval and political uncertainty wrought by Brexit, the UK dentist chain My Dentist was able to issue a GBP bond within a month of the UK's unexpected decision to leave the EU.

However, the market did experience a hiatus in the final days of 2018, as the US high yield market saw no issuance in the whole of December for the first time in a decade. This pause was broken in the US in early January, with the sale of a US$750 million bond by US gas pipeline company Targa, which sits at the riskier end of the credit spectrum. The deal was so popular, in fact, that the issuer added an extra maturity tranche and doubled the amount issued. In Europe, while there were some early-year deal launches, the market had a relatively slow start to 2019, though a pipeline of deals, including M&A, is beginning to emerge.

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Ten years on: The surprising resilience of European leveraged finance

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_28%
The fall in leveraged loan value in 2017 compared to 2018

_{€71.2 billion}
The value of high yield bond issuance in 2018—down 37 per cent compared to 2017

From protectionism to trade wars to uncertainty over Brexit, 2018 was characterised by uncertainty and volatility. All the while, a divergence in policy between the world's major economies caused lenders and borrowers to sit up and pay attention. In Europe, the UK's withdrawal from the EU, concerns over a new government in Italy, disruption and protests in France and the rise of populism in a number of EU states took the shine off what had been set to be a bumper year in the leveraged debt market. In addition, growth forecasts for the EU fell in 2018. The European Commission estimated the eurozone would grow by 2.1 per cent in 2018, down from the 2.4 per cent growth recorded in 2017. In a report in July, the Commission estimated that growth in 2019 would fall to 2 per cent.

The story in the US has been a different one, with a central bank determined to stop the economy from overheating. Despite having a similar growth rate to Europe in 2017, the world's largest economy looked set to finish 2018 on a 3 per cent increase. This upturn took place despite four interest rate hikes from the Fed, with much of the momentum coming at the end of the year.

Meanwhile, regulators on both sides of the Atlantic have begun sounding the alarm on the amount of leverage in the market. While some observers think there will be intervention, it seems that most believe that regulators may be content to wait for nature to take its course, with a substantial blow-up being enough of a trigger to all market participants to dial down the level of gearing that will be used going forward. This has all led to a change in the dynamics of the market.

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A key driver of the downturn was the fall in refinancing activity, as many issuers had completed deals in 2017 and thus did not need to return to the market in 2018

_{€27.2 billion}
The value of new issuance of CLOs in Europe in 2018—a new post-crisis record

Slowing down but not stopping

The leveraged finance market started 2018 at a feverish pace but slowed down considerably in H2. Overall, European leveraged loan issuance was down 28 per cent year- on-year to €202.5 billion. Meanwhile, high yield bond issuance dropped to €71.2 billion—down 37 per cent compared to the previous year. While the leveraged loan pullback is, perhaps, a correction on the meteoric rise of the instrument, the decline of high yield issuance reflected the continued migration of high yield issuers and new deals to cov-lite loans and direct lending. At €71.2 billion, the volume of high yield issuance for 2018 was way off the €113.9 billion issued in 2017.

A key driver of the downturn was the fall in refinancing activity, as many issuers had completed deals in 2017 and thus did not need to return to the market in 2018. This resulted in high yield bond refinancing activity dropping by 47 per cent year-on-year to €36.8 billion.

At the start of 2017, US interest rates were at just 0.75 per cent. In that year, borrowers in both the US and Europe rushed to market, eager to refinance debt. In 2017, €153.8 billion in leveraged loan refinancing was pushed through in Europe. This helped volume beat previous record levels. However, the story was beginning to change by the end of the year, as the US federal funds rate reached 1.5 per cent. A further 25 basis points was added the following March. As 2018 ended, rates hit 2.5 per cent. This continued increase in the cost of borrowing translated into a 44 per cent drop in leveraged loan refinancing in Europe in 2018—down to €86.7 billion— compared to a year earlier.

However, outside of the refinancing context, the European market benefitted from a number of public-to-private deals and an increase in corporate and sponsor activity—45 per cent of the leveraged loan issuance was used for leveraged buyouts (LBOs) and acquisition activity compared with only 26 per cent for refinancings. There was a spate of bumper deals, including Advent's acquisition of Zentiva and Carlyle's purchase of AkzoNobel—both carried out alongside large institutional investors. For more on LBO activity, see page 9.

The slowdown in the second half of 2018 was more pronounced in light of a bumper first quarter, which saw some 'jumbo' M&A deals that required significant financing from all corners of the debt markets. Despite some predicting 2018 to be an 'all-time high' for M&A, the winds of uncertainty blew through markets, leaving sponsors and other potential acquirers opting to wait for calmer waters. While 2018 did not match the heights of 2017, there needs to be some perspective— overall issuance was still up on issuance in 2016.

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The split between leveraged loans and high yield bonds skewed in favour of loans in 2018. Loans accounted for 74 per cent of European leveraged finance in 2018, according to Debtwire research

Loans in the ascendancy again

As noted above, the split between leveraged loans and high yield bonds skewed in favour of loans in 2018. Loans accounted for 74 per cent of European leveraged finance in 2018, according to Debtwire research. Compare that with a more even split in 2014, when 54 per cent of European issuance was leveraged loans and the rest composed of high yield bonds.

Rising interest rates have been one of the main factors driving investors towards loans, given their floating-rate basis (compared to high yield's typical fixed rate basis), which protects investors when central banks hike. In June, the US Federal Reserve announced its seventh interest rate hike since 2015, with a further two rises in both of the following two quarters. In the UK, the Bank of England increased rates to 0.75 per cent (their highest level since March 2009) in August, after an initial 25 basis-point hike in June.

The uptick in loan pricing has been one of the reasons for investors to favour loans. With the gap between bonds and loans narrowing, the potentially looser cov-lite loan terms, as well as more favourable financing features such as control of transfer, the soft-call protection of a loan compared to the hard-call protection of a bond and the non-public nature of loans have enhanced the attractiveness of the loan product. Additionally, loans can be quicker to bring to market and close, and do not require a detailed offering memorandum, which permits a lower outlay on costs and fees.

The growing division between the two parts of the leveraged debt market was also driven by the demand for collateralised debt obligations (CLO). The growth of CLOs has been a decisive factor in the growth of leveraged loans since CLOs favour floating rate products. In Europe, the CLO market set a new post-crisis record, with €27.2 billion of new issuance in 2018, up from €20.1 billion in 2017. The trend for reset/ refinance transactions also continued in 2018, driven by competitive pricing, with a further €18 billion of issuance.

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Ten years on: The surprising resilience of European leveraged finance

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The rise in loans backing LBOs in 2018 compared to 2017

Loans backing LBOs have driven the market in Europe this year, with volumes reaching €56.5 billion, up 37 per cent from €41.3 billion in 2017. By the middle of 2018, total loans in the US breached US$100 billion, up a third on the same period a year earlier. Encouraging signals from the Federal Reserve, which said it was comfortable with the level of risk banks were taking when financing LBOs, helped bring megadeals to the fore. Even in October, when markets had slowed down slightly, KKR's US$5.6 billion buyout of Envision Healthcare Corp. added to the large deals in 2018.

This was also the case for high yield bonds. Bonds backing LBOs accounted for €10.5 billion of new issuance in Europe in 2018, up from just €2.2 billion in 2017. One major addition to this high yield bond pile was Spanish company Cirsa Gaming's €1.56 issuance backing its buyout by Blackstone. Another was the €1.3 billion bond issued by CVC in October for its majority take- private of the Italian pharmaceutical group Recordati.

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As the volume levels dropped from a bumper 2017, borrowers still found an eager market as lenders remained hungry for yield

Still an issuer's market

As the volume levels dropped from a bumper 2017, borrowers still found an eager market as lenders remained hungry for yield. However, perhaps due to the number of deals seeking to borrow from the market, there was a pushback from lenders in early summer, pushing up pricing by between 25 and 50 basis points. Some borrowers—and their backers—had to decide whether to compromise on terms or pay a little more for flexibility. By the end of the summer, though, the power had shifted back to the issuers, with downward flexes returning as the norm. In September, downward flexes outpaced those moving upward by seven to zero. Notably some of the deals that flexed in September were jumbo loans such as Akzo Nobel, with lenders still keen to stay with the market.

The record amount of dry powder in private equity coffers looking to be put to work—estimated to be approximately US$1.14 trillion by Moody's Investor Services—combined with an increasingly sophisticated set of debt and credit investors who have become used to cov-lite terms, suggests a market likely to continue favouring borrowers/issuers for some time to come. In the US, for example, Bloomberg reported that some US$4.9 billion was repriced in October of 2018, as issuers demanded better deals from lenders in the year's leanest month for issuance so far.

This supply/demand imbalance meant looser terms, and better pricing for borrowers was on offer in the loan market than for the high yield bond market. Meanwhile, the search for yield means that these same investors are willing to move towards riskier credits. In Q3 alone, 59 per cent of European loans were rated B+ or below. Meanwhile, high yield bonds rated B+ or below accounted for 46 per cent of total European issuance in the same period.

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Following a collapse in issuance after the crisis, the post-crisis CLO 2.0 has found favour again. CLOs reached a new post-crisis record, with €27.3 billion issued in 2018

CLOs are go

Liquidity in the market has been given an additional boost through the resurgence of the CLO market.

Following a collapse in issuance after the crisis, the post-crisis CLO 2.0 has found favour again. CLOs reached a new post-crisis record, with €27.2 billion issued in 2018. As well as new issues, the trend for reset/refinance transactions also continued in 2018, driven by competitive pricing, with a further €16.1 billion of issuance.

Due to the increased presence of CLOs in the market, banks are able to syndicate deals widely and hold less on their balance sheets, enabling a greater volume of deals to be done. While still only at half the volumes seen before the financial crisis, these structured instruments are finding increasing favour with investors. New US CLO issuance was a record US$150 billion in 2018, surpassing the previous US$124.1 billion high set in 2014.

Although a much bigger market in the US, CLOs in Europe seem set to grow as investors' hunt for yield continues, thereby increasing the demand for additional paper from borrowers. Default rates for CLOs continue to be low, as diversification within each CLO should dampen the risk of default in a market stress scenario.

Moreover, the growth of CLOs has contributed heavily to the overwhelming preference for loans over bonds. CLOs only invest in floating rate instruments, which means that loans would be their preferred investment.

A corollary effect of the emergence of CLOs is the increased demand for floating rate bonds (even though overall issuance of HY bonds has diminished) since CLOs often retain some space in their portfolios for a limited number of floating rate bonds. A typical European CLO usually has a maximum bucket of 30 per cent for high yield.

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The rise of direct lending

Direct lending funds have emerged in Europe and the US to provide financing to the smallest SMEs and even larger mid-market companies. Direct lenders are often able to offer a bespoke financing package that may not be available in the syndicated loan or high yield markets. From less than €8 billion raised in 2013 by nine such funds, some €32.5 billion flooded in from investors in 2017, filling 25 vehicles in Europe. Volumes in 2018 reached only €22 billion in 19 funds, as those raising capital took a break to allocate their assets.

Where once these managers traditionally stuck to US$100 million deals or below, larger funds are able to offer more substantial loans, with single funds offering US$500 million or more on an increasing basis. This is mainly due to the amount of capital they have to deploy. Ares, one of the largest managers in the sector, closed the largest fund of its type in the past 18 months in Europe at €6.5 billion. Intermediate Capital Group was not far behind with a €5.2 billion close.

Some of these managers seek a single layer of debt or unitranche. Ares struck one of the largest deals in this sector in 2018, with a €364 million loan to UK veterinary group VetPartners, which was also topped up with an equity stake. This funded a management buyout (MBO), although the company was scooped up by private equity giant BC Partners just a few months later. The secondary buyout has been a theme for direct lenders. Some five of the top-ten deals in the past year have funded such acquisitions, with just one refinancing, one MBO and three LBOs being funded by unitranche lenders.

Since 2007, these funds’ assets under management grew from approximately US$200 billion to close to US$650 billion by the end of 2017, according to Preqin. With such huge amounts of dry powder, it is likely that more of these buyout deals in 2019 will involve direct and unitranche lenders, who have the money already on tap, rather than by new capital raisings in uncertain political and economic territory.

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Sector watch

In 2018 in Europe, services (€21 billion), industrials products and services (€18 billion), and consumer: foods (€16 billion) were the top-three sectors, accounting for around 27 per cent of leveraged loan issuance.

On the high yield side, services (€8 billion), last year's top sector financial services (€7 billion) and energy (€6.5 billion) were out in front. Financial services tops the list by number of deals, with 29.

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Ten years on: The surprising resilience of European leveraged finance

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Acquisitions and LBO financing will continue to account for a large share of issuance in 2019. Corporate portfolio management and a surfeit of dry powder at PE funds may well keep the leveraged debt market going.

As noted in the report, times have changed, and 2018 has seen a different dynamic than in the previous two years. The rise in US interest rates has had a significant impact on the market, with the move from bonds to loans speeding up and the pace of refinancing activity slowing markedly.

In addition to those shifting dynamics, macroeconomic and political factors such as Brexit, further interest rate rises and continued volatility in a number of EU markets could all have a bearing on the market and drive its development for the year ahead. While it's difficult to chart an exact course, there are several tendencies that may play out and, indeed, possibly co-exist in 2019.

A deep and mature market

While economic volatility and events such as Brexit could hurt issuance levels, the market has evolved in the past decade into a robust and diversified market that caters to the needs of a variety of lenders and borrowers. There are more products and more options available than ever before, and it is difficult to predict which of those will be in the ascendancy in 2019.

Acquisition and LBO financing should continue to account for a large share of issuances in 2019; most issuers that want to refinance have already done so. A strong M&A pipeline, corporate portfolio management in response to changing economic times and a surfeit of dry powder at private equity funds may well keep the leveraged debt market going. Meanwhile, demand from investors will likely sustain the issuance for the foreseeable future.

The renewed growth of CLOs also look set to keep refreshing bank balance sheets as investors seek yield. This should ensure the flow of capital continues until interest rate increases hit underlying issuers and potentially cause investors to return to safe havens.

And if interest rates stabilise, demand for fixed rate instruments could begin to reassert itself and we could find bonds coming to the fore once again.

A test for funding providers

The broadening of the leveraged finance market to include asset managers and other debt providers has been a notable development in the post-crisis world. They have stepped into the breach at times when banks have been in retreat, succeeded in gathering assets and become a key part of the lending ecosystem—but that is only half the battle. As a relatively new phenomenon, certainly at such scale, direct lenders and relevant debt providers have not been tested in a true market downturn. That test may emerge in 2019.

With billions in capital to put to work, they have entered deals at pace and often with high leverage levels. Should the market hiccup or hit a severe correction, many investors in these funds may find their holdings with lower recoveries than other leveraged finance sectors.

Watch for defaults

One development that has the potential to destabilise the market would be a marked increase in default rates. The continued supremacy of cov-lite could be delaying defaults and shielding poor credits.

So far, the story has been that if the covenant is not there to breach, there is no danger of default. With interest rates as low as they have been, it has been hard for companies to run into difficulties outside of a liquidity crisis, as there are no covenants that give lenders an early trigger. However, should economic conditions worsen or interest rates rise further, default rates could spike.

It may take just a couple of distressed situations in which a lender loses its investment to shake investor confidence in the burgeoning new market. This could have a knock-on effect for those accepting the looser terms in the term loan B market.

The Bank of England Financial Policy Committee has expressed concern about the rapid growth of leveraged loans and pointed out just how far lending terms had loosened in the UK, with maintenance covenants currently featuring in only approximately 20 per cent of loans versus close to 100 per cent in 2010. The IMF is the latest to voice its concern: "With interest rates extremely low for years and with ample money flowing through the financial system, yield-hungry investors are tolerating ever-higher levels of risk and betting on financial instruments that, in less speculative times, they might sensibly shun."

With a more diverse range of financial products, it is less clear where the risk in the market ultimately lies. We saw with the US sub-prime crisis that risk in the market can be concentrated in unexpected locations. As investors have been chasing yield for the past decade, an unexpected downturn in the leveraged finance market could ricochet into other areas and compound any slowdowns.

With so many factors in play, market participants will be reluctant to make any hard and fast predictions for 2019. However, if history is any guide, the market is likely to continue to evolve to meet the needs of issuers and borrowers and, macroeconomic shocks aside, will continue to offer a wide range of options for all participants.

FULL MAGAZINE
Ten years on: The surprising resilience of European leveraged finance

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White & Case partners Colin Chang and Jeremy Duffy discuss how the European leveraged finance market has changed over the past 12 months and what lies ahead for 2019.

FULL MAGAZINE
Ten years on: The surprising resilience of European leveraged finance

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2019 White & Case LLP

Global law firm White & Case LLP has advised Greentown China Holdings Limited, a Chinese luxury residential property developer, on its subsidiary's Regulation S offering of US$400 million senior perpetual capital securities callable 2022 and US$100 million senior perpetual capital securities callable 2022.

The joint global coordinators, joint lead managers and joint bookrunners for the offerings are Credit Suisse (Hong Kong) Limited and The Hongkong and Shanghai Banking Corporation Limited.

The perpetual capital securities were issued by Champion Sincerity Holdings Limited, a wholly-owned subsidiary of Greentown China, and guaranteed by Greentown China. The US$400 million perpetual capital securities are also supported by a keepwell deed and deed of equity interest purchase undertaking of China Communications Construction Company Limited, Greentown China's significant shareholder. Net offering proceeds will be used to refinance existing indebtedness of Greentown China and its subsidiaries and for general working capital purposes. The bonds are listed for trading on the Hong Kong Stock Exchange.

White & Case partner David Li who co-led the Firm's deal team, said: "The record level of investor over-subscription for these securities demonstrates significant market recognition of Greentown China's leading position in the Chinese real estate sector."

The White & Case team that advised on the transaction was co-led by partners David Li (Beijing) and Kaya Proudian (Singapore) and included partners Jessica Zhou (Hong Kong) and Baldwin Cheng (Hong Kong), with support from associates June Chun (Beijing), Enlin Jiang (Hong Kong) and Christina Lui (Singapore).

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Global law firm White & Case LLP has advised BNP Paribas and UniCredit Bank AG on the financing of the acquisition of American Dehydrated Foods LLC, International Dehydrated Foods LLC and IsoNova Technologies LLC (ADF/IDF) by Symrise AG (Symrise).

The banks provided a total financing volume of €800 million to Symrise through a combination of bridge facility and term loan facilities, as well as a capital increase in the amount of approximately €400 million. The new shares were issued under exclusion of shareholders' subscription rights and exclusively placed to institutional investors in a private placement by way of an accelerated bookbuilding process. The net proceeds from the capital increase will be used to partially refinance the bridge facility. On February 11, 2019, the new shares were admitted to trading on the regulated market segment of the Frankfurt Stock Exchange (Prime Standard).

Symrise is a global MDax-listed supplier of fragrances, flavors, food and cosmetic ingredients. ADF/IDF is a leading supplier of clean label natural ingredients for pet food based on meat and egg products.

The White & Case team that advised on the transaction was co-led by local partners Matthias Bochum (Hamburg) and Thilo Diehl (Frankfurt) and included partners Florian Degenhardt (Hamburg), Rebecca Emory, Alexander Kiefner and Karsten Wöckener (all Frankfurt), local partner Cristina Freudenberger (Frankfurt) and associates Robert Nachama (Frankfurt) and Max Sergelius (Hamburg).

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Global law firm White & Case LLP has advised Goldman Sachs, as financial advisor to Credito Fondiario and structuring agent to Elliott, on their successful bid to acquire a portfolio of non-performing loans (NPLs) from Banco BPM for a nominal amount of €7.8 billion, and establishing an NPL servicing platform to manage the acquired portfolio and 80 percent of any new NPLs originated by Banco BPM in the next ten years.

The NPL portfolio has been sold to an Italian securitization vehicle and securitized through the issuance of various tranches of asset-backed securities. The senior tranche will be subscribed by Banco BPM and may be structured to benefit from the Italian government's guarantee on the securitization of NPLs pursuant to Law Decree no. 18/2016 ('GACS'). Elliott funds will purchase 95 percent of the mezzanine and junior tranches.

The White & Case team in Milan which advised on the transaction comprised partner Gianluca Fanti and local partner Giuseppe Barra Caracciolo, together with associate Riccardo Verzeletti.

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