For traditional banking clients and their legal counsel, 2016 has been a challenging year. As political uncertainty, a continually evolving regulatory environment, poor growth and low interest rates continue to place strain on financial institutions still looking to regain their balance sheets, the preponderance of alternative capital lenders has ensured that power remains firmly in the hands of borrowers. A push towards American-style loan documentation has seen leveraged lending move towards the high-yield bond market and law firms with strong teams in this area have found themselves increasingly busy. The trend towards covenant-lite or covenant-loose terms has played into the hands of US firms and, as such, Magic Circle firms – who continue to dominate our research given their strength in the European market – have found themselves on the back foot in the market.
The London and New York markets are once again highlighted in our research as the chief destinations worldwide for top-class banking legal counsel, given their importance as two of the world’s key financial centres. The result of Britain’s unprecedented referendum to leave the EU on 23 June sent shockwaves through the European financial services community, causing the pound to crash to a 31-year low and economic uncertainty to grip European financial markets. Given that Article 50, the formal mechanism for leaving the EU, has yet to be triggered, it remains to be seen exactly what Britain’s relationship will look like. Despite the economic uncertainty and the possibility of major financial institutions moving their headquarters to other European centres, many London-based lawyers remained fairly upbeat about the long-term effects of Brexit given London’s importance on the global stage.
Although Donald Trump’s presidential election victory fostered a belief among his supporters that the billionaire businessman will be good for the economy, the shock result also triggered a bond selloff that could spell disaster for equities. Trump’s election promises – namely, to go ahead with much-welcomed interest rate hikes, loosened regulations and an economic stimulus package resting on an ambitious countrywide infrastructure project – have done nothing to stop S&P 500 bonds in the telecommunications, real estate and utilities sectors falling by 7.5, 4.2 and 4 per cent respectively since October 2016, according to marketwatch.com, citing data from FactSet. Lawyers were anxious when questioned about the consequences of a Trump victory as it was something that few had predicted or planned for. Ultimately, as with Brexit, lawyers and clients will undoubtedly need to monitor the market situation closely and put contingency strategies in place to deal with any potential economic fallout.
Given that 2015 ended on a high for big-ticket transactional work, the beginning of 2016 was a slow period for lawyers. Uncertainty surrounding Brexit and the US presidential election muddied the waters for both investors and lenders and a number of practitioners reported that 2016 has been a slow year in terms of refinancing, acquisition financing and syndicated loan work more generally. That said, some lawyers, particularly those dealing with Chinese clients, reported that there has been a lot of movement in terms of outbound and inbound investment. One source that “Chinese corporates are looking to move abroad and are carrying out a lot of acquisitions.” ChemChina’s US$43 billion takeover of Swiss agribusiness Syngenta AG, for example, highlights that Chinese companies are looking to make significant gains in the current market. Indeed, some practitioners reported that Chinese corporates listed in the US are looking to privatise and this is bringing in a substantial amount of work. This, coupled with the fact that China’s financial institutions are seeking options to raise funds and liquidity, highlight that there are still significant deals taking place in the current climate.
Refinancing – bread-and-butter work, in the eyes of many banking lawyers – has also been choppy in 2016, given that a number of corporates had already taken advantage of the low yields in the market in the years following the financial crisis. That said, some lawyers highlighted the fact that refinancing was cyclical in nature and may present opportunities in the coming years, in response to the increasingly loose terms. One interviewee summed up market sentiment thus: “With money so cheap, why wouldn’t you take advantage to refinance?”
Continuing on from last year’s trend, leveraged finance and the convergence of loan terms on both sides of the Atlantic continue to lead activity in the market. Although overall sales of leveraged loans appear to be slowing in 2016, the proportion of these loans with more flexible documentation appears to be rising. As of September 2016, Moody’s Investors Service report recorded that over three-quarters of new loans were so-called covenant-lite instruments offering looser terms, up from 46 per cent in 2013. Indeed, one respondent characterised 2016 as “the European reaction to increasingly flexible US documentation”. This trend, in part spurred by the European Central Bank’s decision to extend its quantative easing programme until at least March 2017 and the desire to attract corporates with more attractive covenants, has ensured that US issuers and sponsors, eager to take advantage of the European markets have permeated the landscape bringing with them their attractive documents. Of these instruments, Term Loan B remains the most appealing structure and uptake in Europe has been exponential.
The increasing tendency towards covenant-lite loans has pushed US firms into the ascendency in the finance market, particularly as US sponsors continue their high levels of activity across Europe. The most popular of these documents, Term Loan B, is a product of a large amount of capital trying to find loans with the lion’s share of this capital coming from funds and institutions used to lending in the high yield bond market. Naturally, this convergence of debt products seems to be playing into the hands of US law firms, with these firms increasing their share at the higher end of the market. Lawyers in London echo this sentiment: “US firms are at a distinct advantage, as they have been familiar with these terms for a number of years and are able to sell these products to clients.”
Anxiety on the part of the banks and the relaxation of terms has also contributed to the proliferation of new lenders in the market. Lawyers reported to us that funds used to operating in the high-yield market were increasingly turning their attention to the finance space, generally contributing to the “excess of liquidity in the market”. With banks struggling to lend in the same way as they did before the financial crisis for fear of losing their balance sheets, funds are now stepping in to fill the void and this a development that has not gone unnoticed by large swathes of the market. According to sources, some second-tier firms were focusing their efforts on mid-market funds in the hope of replacing their streams of finance work. Ultimately, lawyers will need to monitor this development closely in order to provide corporate clients eager to access capital with a comprehensive picture of all the options available to them.
Understandably, the aftermath of the 2008 financial crisis led to wholesale regulatory reform worldwide and lawyers are still continuing to spend a large portion of their time advising banking clients on regulatory compliance issues. Financial misdemeanours remain a highly volatile and politicised topic, with regulators worldwide keen to promote investor protection by “looking after the man on the street”. Regular stress tests by the European Banking Authority (EBA) are now commonplace and investigations still continue to plague banking clients. The US Department of Justice (DOJ), in particular, is aggressively pursuing major European banks over the mis-selling of residential mortgage-backed securities with RBS and Deutsche Bank two of the DOJ’s largest targets.
Ultimately, given the sensitivity and public desire to “see justice done”, banking clients are spending more and more of their resources on ensuring that they go above and beyond in terms of updating their compliance framework and implementing comprehensive governance programmes. As one lawyer commented, “Given the scale of the regulatory changes, it is unsurprising that, six years on from the Dodd-Frank Wall Street Reform and Consumer Protection Act, banks are only now beginning to put the finishing touches on their regulatory reform.” Clients face the difficulty of maintaining their balance sheets in an increasingly complex regulatory environment and are ploughing resources to maintain their compliance requirements. As such, many law firms now consider regulatory compliance work as a mainstay of their practices and anticipate that this fruitful source of work will continue for the foreseeable future.
Technological developments and newfound risks are also placing further strain on clients. Financial crime seems to be top of the list for all financial institutions at the moment. Anti-money laundering, bribery, corruption and fraud are all areas of increasing importance which clients and, by extension, their legal counsel must take into consideration. As banks, competing with fintech companies and other online lending platforms, look to increase their online presence and technological capacity, cyber risk and data protection are beginning to pose an ever-present danger for banks. One source commented, “The nature of cyber threat is continually evolving and banks need to stay vigilant.” As such, with clients looking for more comprehensive advice from their counsel, there is greater scope and opportunity for law firms and lawyers with competence in data protection compliance and regulatory expertise to stand out from the rest of the market.
The financial market remains dominated by the magic circle firms, who consistently operate on the largest transactions and can provide clients with a wealth of expertise across related practice areas. Clifford Chance continues to stand out in our research with the highest number of ranked individuals; Allen & Overy and Linklaters follow closely behind. That being said, the emphasis and convergence of looser loan terms on both sides of the Atlantic plays into the hands of the larger US firms and has seen them increasing their market share in London. Many lawyers reported that US firms, Latham & Watkins being one example, have been looking to enhance and expand their practices in London given the trend towards US-style loan documentation.
The tendency towards more flexible, hybrid loan structures – particularly those taking advantage of the high yield bond market – has ensured that firms with strong teams in that space can utilise this expertise to force their way onto the larger finance transactions. Some lawyers were wary of this development, maintaining that they needed to strengthen their expertise in this area to ensure that they kept apace of market developments.
The “multiplicity of lending instruments and multiplicity of lenders in the market” is also an important development affecting the market. Not only has this trend ensured that there is an “excess of liquidity” in the market, it has also changed the way lawyers interact with their traditional client base. Lawyers are broadening their practices and their relationships with lending institutions to ensure that they are able to develop strong relationships with alternative capital lenders. Some firms also reported that they were now sending their banking lawyers on secondment to private equity funds to keep abreast of this new stream of work. As one lawyer explained, there are too many lawyers chasing too few deals. With competition as fierce as it has ever been, lawyers need to ensure that they can maintain high levels of service at competitive rates, as well as ensuring that they can provide the full plethora of services needed in the modern market.
We end this year’s research at a time when the political landscape means uncertain times ahead for banking clients worldwide. Although stock markets seem to be on the rise and the price of commodities has stabilised, the falling value of the pound, rising prices and the climbing rate of inflation has led to fears of a UK slowdown in the aftermath of Brexit and the impacts on the City of London could prove cataclysmic should financial institutions look elsewhere in Europe to headquarter their services. Ultimately, it remains to be seen how Brexit negotiations and Donald Trump’s shock US presidential victory will affect the market in the coming months and years and what consequences these could have for legal practitioners.