Research: Trends & Conclusions

By summer 2013, the financial media worldwide was speaking as if the post-recession era had reached a turning point. Although widespread economic revival and extremely low interest rates have recently inspired the growth of capital raising, this position has been widely viewed as unsustainable. As a result, observers are concerned with how the market will cope with rising interest rates and the quantitative easing policy of central banks, as they try to navigate their way out of crisis management.

Debt

In the developed debt markets, the most immediate effect of this was commonly anticipated. After quite a prodigious year, activity has become generally less rapacious. For much of 2013 the deals were not only numerous, they were huge. The famed $17 billon bond issue by Apple was dwarfed by Verizon, who sold $49 billion in bonds. However, these deals nevertheless failed to convince the corporate world that this activity is maintainable, since they stand at each side of a summer and winter of particular uncertainty. Overall, the full year revealed that global DCM activity totalled $5.6 trillion, a decline of 2 per cent from 2012. It should be noted that this figure looked set to surpass the previous year up until the fourth quarter, which was the slowest quarter for debt issuance since the beginning of 2012. Therefore, the market last year, as well as having great successes, was also capricious, ending on a lull.

This has given 2014 with a less than exceptional foundation. However, that said, deals do not appear to be thin on the ground, nor have a majority of our respondents been devoid of work. In fact most DCM lawyers reported that the negativity felt at the end of last year has not adversely affected 2014. The most recent quarterly report has supported this notion, with a reported 18 per cent increase on the previous drab quarter. In the US investment grade debt faired particularly well as issuers looked to take advantage of the low interest rates while they still can. It was the strongest initial showing for the asset class since records began in 1980.

In Europe, on the other hand, practitioners have almost universally noted that the volume of high-yield corporate debt is quite staggering, which is backed up by the figures from last year. The trade in “junk” bonds totalled $462 billion over 2013, a 19 per cent increase compared with 2012, and the strongest annual period for high yield since 1980. Since market conditions remain favourable, with corporate default rates below historical averages, investors are willing to overlook the weaker credit quality of these bonds in exchange for higher returns. It seems that this sentiment has remained consistently strong in 2014 from 2013. In fact, European issuers provided $42.7 billion of the market during the first quarter of 2014, up 31 per cent compared with last year.

In the emerging markets, the story is more erratic. When the US Federal Reserve looked to pull the plug on its stimulus package in the previous summer, investors largely abandoned these markets. However, once the package was revitalised, debt markets were sold off heavily in a flurry of pent-up demand, stemming the tide of emerging market ill sentiment. In sum, corporate debt from emerging markets issuers had a decent year, particularly in Russia, India and Mexico, which raised as much as half by themselves. However, rumours that predict the sudden demise of the emerging markets persist. The overall issue, from the point of view of the lawyers we have spoken to, seems to be that these jurisdictions face the continuing threat of withdrawal from investors uncertain of the strength of their portfolios. Each country faces its own domestic struggles that have, generally, amplified this trend. The fringe of Europe was until recently a relative safe haven for investors looking to reduce exposure to these risks, but now the Ukrainian crisis has caused investor sentiment in the CIS to plummet. Corporate debt from issuers in Russia is down 70 per cent this year so far. Similarly, Turkey, a highly promising market with plenty of liquidity, has suffered political instability for longer than stakeholders care to be comfortable with. Uncertainty over the outcome of elections in vital markets such as India and Brazil has also drawn reservation from investors.

So far in 2014, the overall outlook is somewhat negative. During the first quarter new corporate debt from emerging markets suffered a 29 per cent decrease. Nonetheless, sentiment in certain markets remains. Respondents have observed that Africa – in particular Nigeria and South Africa – hold immediate promise. In the Middle East, there is also a huge amount of liquidity in the Arabian peninsula, but this capital still remains largely untapped by the Western market. Otherwise the main players, apart from Russia, have remained the same with more than half of all emerging markets corporate debt being raised by issuers in Brazil, Mexico and India.

 

Equity

The fluctuating strength in the debt market is paralleled by the sharp rise in the equity markets. In many jurisdictions there are more IPOs, right offerings and better deal completion rates. The nervousness that paralysed certain institutions from going public has seemingly receded. In April, a respondent from England quoted the claim that “ECMs are at their most active in 10 years”, while another claimed there has been “10 times as many deals”. Indeed, IPOs during the first quarter of this year were up 98 per cent from the same time last year. The US$47.2 billion total is the strongest annual start for four years. The story is even more compelling for Europe, which accounted for a combined 35 per cent of IPO volume this year. Overall, it is the best annual start for the continent since 2000. Continued optimism among companies and investors has also translated into higher equity underwriting fees for investment banks.

The fortunes found in the equity market at present is welcomed by most equity driven lawyers who point out that even though this source of financing was not the responsible party for the financial crisis, it has suffered significantly over the last six years. Companies have been reluctant to enter the market, feeling that the price would not be right. The thought of selling off stock too cheaply as well as devolving control to shareholders has been far less appealing for those looking to raise capital than the debt market. At this moment, however, the influence of correct pricing has caused a surge in IPOs which has remained unabated so far this year.

However, the strength of the transatlantic equity market is not indicative of the market as a whole. ECM is particularly sensitive to political and regulatory uncertainty. In Brazil, for example, respondents claim that the market is “frozen” with a complete lack of high-grade cross-border work, which is particularly affecting international firms based in the country. Reform is almost unanimously advocated, with practitioners looking towards policymaking after the elections to produce the desired results. In the Middle East equity remains subdued; $1 billion was raised from two IPOs during the first quarter of this year, $600 million less than the same period last year. Moreover, there were no follow-on or convertible offerings in the region, which means that overall activity has declined by half. The Asian market naturally holds a lot of promise. A 2011 report by PwC predicted that China will be home to most of the new issuers by 2025, providing the largest pool of equity capital. But in 2012, after more than a third of new issuers lost money after their initial listing, the regulators shut the Chinese IPO market. Following this, in November 2013, the China Securities Regulatory Commission announced a package of reforms aimed at modernising the country’s inefficient IPO process. As the market was only reopened earlier this year with hundreds of companies waiting to be listed, the regulators have – little by little – had to feed the market for fear of flooding it. The equity market of the world’s second-largest economy essentially remains fastened for now. 

Reservation is also seen in the REITs arena. In years gone by it was the busiest area of work in the US equity market. REITs practices have become vital for a number of firms and their lawyers, who regularly represent issuers, underwriters and purchasers in equity offerings. However, the real estate side of the market has not been as acquisitive in the first quarter of 2014. The threat of interest rate rises is more unstable for these high-yielding equity securities, which has started to make them less appealing for long-term investors.

 

Structure Finance

The world of securitisations has also seen a sharp rise in recent times. Over the last few years regulatory uncertainty has stifled the market. New restrictions placed on structured models from central government agencies worldwide are abating, and respondents claim that this has had a positive effect on the market. For the first time practitioners claim they are able to see past the short term, and it is with greater certainty that lawyers can take on serious discussion as to how to structure new deals.

Further boosts to this area have been the endorsements received from leading economists. Both the European Central Bank and the Bank of England have reinvigorated structured finance as a medium of gaining private capital. During the recession the main commercial banks have had to rely on funding from central banks; now, however, the traditional forms of financing in this area, namely CLOs and CDOs, are again providing alternative credit to commercial institutions, which are in turn deleveraging their balance sheets.

However, the sentiment towards this market is certainly not all positive. The signs that CLOs and CDOs were returning at the start of 2013 was met despairingly by some in the media. When Deutsche Bank launched a two-tranche $8.7 billion CDO, which reaped strong investor interest, observers began to worry that this could signal a return to the avaricious environment of the previous decade. Conversely, many leading lawyers have noted that, as long as CDOs are not mispriced as they were prior to the crash and the market subscribes to the transparency and due diligence that new regulatory policy dictates, there should be no cause for concern at this point. Indeed, when one respondent was asked to summarise the current mood, he noted, “The dog is back in the house, if not quite on the settee.”

All this ultimately means that structured finance lawyers are now restructuring new deals. There is a clear optimism and appetite coming from our respondents in the legal field, who are assured that the pre-crash volume will eventually return.

 

Islamic Finance

Advocates of Islamic finance have been extremely energetic. This has been more or less matched by its performance; the financial segment’s recent growth is in excess of 20 per cent and the market is now maturing at an exponential rate. Although there remains a lack of standardised and up-to-date data on the industry, an increasing number of firms are providing key statistics, as the need for transparency increases due to its burgeoning global status. Most notably, Thomson Reuters produced its inaugural Islamic Finance Development report in 2013, which found over 1,000 Islamic finance institutions worldwide, with collective assets in excess of $1.3 trillion.

The huge amount of liquidity in the market has understandably driven appetite from non-Muslim economies. Last October David Cameron, attending an Islamic finance forum, announced the creation of a sukuk in a strategic decision to enhance London’s Islamic finance credentials. The UK government plans to issue a £200 million five-year sukuk this summer, the first such bond to be issued by a Western sovereign. The sukuk will use an ijara structure: a shariah-compliant sale-and-leaseback contract, which is a popular format among both sovereign and corporate issuers. This effort on behalf of the UK government will look to divide the dominant 94 per cent share of the world’s Islamic finance assets, which are currently concentrated in only 10 Muslim majority countries.

However, it is not all good news. Many outside observers remain sceptical of its global appeal and adoption. This is perhaps due, in part, to the niche techniques involved in its application; however, people also cite the relative success of traditional forms of financing over the last few years. Controversy and arguments also abound over the hybrid instruments it employs. Academic disputes over preference shares are one of a few examples that have burdened the market. Indeed, Islamic finance lawyers emphasise that, at the end of the day, shariah will not compromise on grey areas. Essentially the governing rules of the market are not commercially based. Whether or not this will prevent a truly global uptake remains to be seen.

 

 

RAWR

 

 

 

Legal Marketplace

As has been stated in earlier editions, the sub-specialism in the capital markets sphere, in tandem with the differing nature of its practice internationally, makes it difficult to draw definitive conclusions. However, since this edition marks the second time the capital markets publication has been split into three distinct sections, it gives us the formative ability to explore data trends in the market more effectively. Our research conclusions are based on the number of lawyers identified as world-class in a particular area or locality, which reflects the sectors that provide the most lucrative work.

In terms of the individual market segments there has been no extreme change over last year, but some developments have begun to emerge. Structured finance sees the most notable jump, obtaining a 28 per cent share of the market (a 3 per cent increase on last year). This aptly parallels the recent growth of structured finance instruments. Indeed it can be expected, with the support of investors and financing institutions, this increasing share will continue. Even a year ago not many experts could have predicted growth of any kind. Islamic finance sees a small but unremarkable increase. This is most likely due to the incredibly niche techniques needed for its practice. Indeed, even as the Islamic market continues to bloom, those that can be described as truly excellent in this area will not increase as dramatically. The debt and equity markets remain difficult to separate, for in a large number of jurisdictions attorneys specialise equally in both areas. However, judging from time spent speaking to lawyers across the world, those spending their time on equity seem to have risen relative to debt, a trend that should continue throughout 2014 as the equity market remains particularly active.

Overall there has been a small increase in the numbers of lawyers listed. This is typical of the gradual market recovery from the worst of the recession years. Ultimately, the transatlantic legal market is becoming more active, and some leading national and global firms have chosen this moment (despite its relative insecurity) to actively expand their capital markets practices with lateral hires, taking on partners that have strong banking relationships. We have noted a particular desire from some elite firms, outside the traditional leading capital market players, to promote a strong and reputable DCM and ECM practice. Sources have explained that it is “unsuitable” nowadays for an elite firm not to contest in such a dominant and lucrative practice area. On the other hand, as the market is certainly expanding the fiscal reasoning behind this recruitment drive is perhaps self-evident as well.  

A trend from the last few years can be seen in the relative strength of the emerging markets compared with the developed markets. It has now been two years since this publication last observed a decrease in the number of lawyers recommended in our research; since then the legal market has recovered well. During this time the traditional powerhouses of the market have taken the lion’s share of the growth. In 2012, England and the US, the two leading countries, had 72 per cent of the leading lawyers in our research compared with Brazil, Russia, India, China, Mexico, Indonesia, Nigeria and Turkey. They now have a 75 per cent share. However, the fact that these emerging nations have not as yet significantly deepened the pool of legal excellence in this sphere may come down to the short-term, compared to long-term, patterns of growth expected from the BRIC and MINT countries.

The commercial world has become increasingly centred on a few localities over the last decade, which is very notable in the capital market sphere. For example, the English capital yields 57 lawyers, more than any other city; this is followed by New York with 46, and Toronto with 28. These macroeconomic centres are testament to a wider economic trend. Despite the general crisis in the West and a search for innovative ways of financing, the market has been consolidating its traditional roots in terms of the countries that issue the world’s capital. An explanation is surely found in the fact that countries like China and Brazil have encountered problems in this space in recent times. On the other hand, there are signs that the debt, equity, structured finance and Islamic finance segments are simultaneously improving for the first time since the meltdown. Therefore if impending issues, such as interest rate rises, are navigated successfully then this area should in due course become much more spread out, both in an economic and legal sense.

 

 

WQR

 

 

 

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