Fund managers are among those touting opportunities for Asian asset owners to participate in Europe’s private placements market, but admit there needs to be a regulatory driver to increase market liquidity.
The sector provides investors with the opportunity to lend directly to small and medium-sized companies (SMEs) whose size precludes the high costs and tough rating requirements of issuing in the public bond markets.
“As a senior lender you can earn Libor plus 5-6% on these type of loans. When you compare the same quality credit in securities, you get Libor plus 2-3%,” says Philippe Lespinard, co-head of fixed income at Schroder Investment Management.
He believes investors with long investment horizons – such as sovereign funds – or fewer regulatory hurdles on investment – such as private banks and family offices – should be watching the sector.
Private placement deals are typically €100 million to €200 million in size spread between 10 to 20 investors. Of course, for institutions this is a minor investment, meaning the costs of direct research are prohibitive “and no rating agency could do it because the fees are so small”, notes Lespinard.
He adds that maintenance and restructuring in case of default – restructuring security for the loans and rewriting covenants – also creates costs.
As a result, he advocates funds as the best route for investing, allowing investors to diversify. “Owners can put that €10 million into a fund of €2 billion, where the risk is spread across the capital structure, from senior secured to unsecured to mezzanine,” he says.
But the sector will be of limited appeal to many Asian investors, on the grounds that regulations in several countries preclude retail and institutional investors from private instruments, and loans have long lock-up periods and poor liquidity.
Lespinard puts the size of the market at just $50 billion to $100 billion, meaning a lack of liquidity that would preclude many institutions from investing. He believes that with regulatory support the market could reach $300 billion.
One of the obstacles to its growth is structural. In particular there is a big difference in how long bankruptcies are resolved by the courts in different European countries. Where an investor might expect a resolution in a few weeks in the UK, in Italy they might wait up to two years.
As they appreciate the need for alternative funding sources to replace bank lending, regulators are attacking the delays. The French regulator has focused efforts at speeding bankruptcy resolutions in the courts.
It has also launched the Novo fund, a direct lending fund backed by 18 insurance firms and three pension funds, managed by BNP Paribas Investment Partners. The €1 billion fund will target lending to SMEs and seek to service the investment needs of life insurers and long-term asset owners.
“Even the European Commission is starting to point out that some of the impediments to clear valuations of these instruments are ‘home made’ and could change,” says Lespinard.
Achieving critical mass in Europe would provide Asian investors with the depth of a more mature market. In the meantime fund managers will be hoping to attract the attention of those that can stomach poor liquidity and the hazards of the private markets.