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During the depths of the financial crisis, many European companies found they could no longer rely on banks for lines of credit. With balance sheets under stress, banks were unwilling or unable to lend to companies. Many businesses decided, therefore, to bypass the banks and go to the capital markets. In 2009, €305m was raised in the European corporate bond market, twice the amount in either of the previous two years, according to data provider Dealogic.
Even though the crisis is over, banks have spent the past few years building up their own capital, leading to this reduction in lending becoming entrenched. Bank lending in the eurozone returned to growth only in March 2015 after three years of decline, according to the European Central Bank. But for lawyers, this shift represents an opportunity.
Innovation in the structure of securities allows lawyers’ corporate clients to tap new sources of funding for credit-constrained businesses. At the same time, new forms of lending, often online, create legal challenges to be solved. Businesses now have many funding options beyond bank debt and maybe a little equity, says Lucy Tarleton, director of capital markets at consultancy PwC.
Virgin Atlantic, the airline, prompted one innovation. In the US, using take-off and landing slots as debt collateral has long been a staple of airlines’ bond sales but had never been successfully employed in Europe. International Airlines Group, the parent company of British Airways, attempted to launch such a bond in 2012 but withdrew it because of its complexity. In 2015, Virgin aimed to become the first European airline to borrow against its slots at London’s Heathrow airport.
Borrowing in this way is tricky, says Herbert Smith Freehills, which acted for Virgin. An airline does not own and can lose its take-off and landing slots if it does not use them or if it fails to comply with the many regulations that govern their use. “How do you provide security for investors at the same time as allowing the huge complexity of the Virgin Atlantic scheduling process to go on unhindered?” asks Michael Poulton, head of Herbert Smith Freehills’ structured finance and debt capital markets practices.
The solution was to create a special purpose vehicle — an entirely new airline, Virgin Atlantic International, that only ran flights between London and the Caribbean — which held the slots in trust and could issue bonds. In the event that Virgin Atlantic went bankrupt, the new airline would be able to take over the Heathrow slots and sell them to repay investors.
This innovation allowed Virgin Atlantic to borrow from bond investors, including from infrastructure funds that might not otherwise consider an airline, Mr Poulton says. “It is a structure that is specifically designed for the capital markets.” The borrowings that the company secured raised £220m for the purchase of new aircraft.
Such a scheme would not be suitable for a small company, since selling debt can carry high fixed costs. Moreover, many investors might be unwilling to buy small debt offerings because of the difficulty of selling on these bonds. Avoiding such problems required ingenuity.
PrimeRevenue is a US-based supply-chain finance platform that allows suppliers to trade their sales invoices for advance payment. The company wanted a way for the invoices to be securitised and thus be tradeable in the capital markets.
Securitisation is a means of packaging together small loans into a bigger, standardised, bond-like security; the loans are then sold on to investors. The practice was common before the financial crisis as a means for banks to fund their lending, but has declined in recent years because of regulation aiming to prevent a repeat of the 2008 crisis.
The challenge for lawyers at Baker & McKenzie was to adapt PrimeRevenue’s US business for Europe to accept a more diverse range of invoicing arrangements and attract a wider range of investors. The law firm’s answer was to create a Luxembourg-based special purpose vehicle with multiple compartments to give investors a choice of debt securities to buy.
Technology is opening up other avenues for law firms. Giannissis & Partners, based in Greece, came up with the idea of using bitcoin, the electronic currency, to circumvent capital controls imposed by the Greek government in the summer of 2015. The scheme involved the currency as collateral to allow the client to buy products from overseas while the restrictions on capital movement were in place. Once these had been lifted, the client could convert the bitcoin back at a predefined rate. This allowed Greek companies to continue trading as before despite the capital controls.
A more common method of using digital technology to raise finance is peer-to-peer (P2P) lending through online platforms that connect investors and borrowers. The latter can range from those looking for a consumer loan to businesses that want to expand. The sector has grown dramatically over the past few years as these sites step into the space vacated by banks; in the UK alone the value of loans and investments made on P2P and crowdfunding sites grew 84 per cent in 2015 to £3.2bn, according to the innovation charity Nesta and the University of Cambridge.
For start-up CrossLend — which aims to match savers in low-interest-rate countries with borrowers in high-interest-rate countries — law firm Latham & Watkins came up with a new type of bond that allowed for high-volume issuance with total principals of just €5,000 per bond.
Europe’s banks are gradually coming out of their decade-long funk following the financial crisis, but the world has changed. The long-term impact of the financial crisis has been to remake the landscape for raising finance. Banks will have to compete with, and learn from, the innovations that have sprung up in their absence. For lawyers, that promises even more new and interesting work.
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