The UK private placement market—starting 2015 on a high note

Why has the UK private placement market started the year on a high note? Sophy Lewin, financing support lawyer at Slaughter and May, considers the UK government’s recently proposed withholding tax exemption for qualifying private placements, and the Loan Market Association’s (LMA) new suite of private placement documentation, and looks at why these latest developments are also positive signs for the pan-European private placement market in 2015.

Speed read

Removal of barriers

The barriers to the development of an active UK private placement market have included the lack of favourable tax treatment and standardised documentation. Notable strides forward have now been made on both fronts, with the provision of a withholding tax exemption for the market in the Chancellor’s Autumn Statement in December 2014 and the publication of the LMA’s suite of English law private placement documentation at the start of January 2015.

Growth of a pan-European private placement market

The last few years have seen a growing momentum to establish a pan-European private placement market to complement the established US private placement market. The drive, post-financial crisis, for long term returns and diversification has resulted in clear demand from both European borrowers and investors.

Until now, the European private placement market has been an expanding but fragmented market, with pockets of regional activity, most notably in Germany, France and the UK.

Favourable amendments to tax legislation in certain European jurisdictions, the introduction of template documentation, and the imminent launch of a market guide, are all positive developments for the further development of a pan-European private placement market in 2015.

What is a private placement?

Private placements are privately placed debt instruments issued directly to institutional investors (such as insurance companies and funds).

The US private placement market is a mature market and investors (mostly US insurance companies and pension funds) have many years’ experience of investing in private placements, and have highly trained credit review functions. European borrowers account for a sizeable proportion of that market. Unwelcome features for European corporates issuing in this market include swap costs and the US-centric model form documentation.

The European private placement market, by comparison, is generally less well developed. In the UK, there are a number of significant institutional investors, such as M&G Investments (the asset management arm of insurer Prudential) which have provided UK style private placements to a number of UK companies in recent years. However, as the Breedon Report concluded in March 2012, the UK does not have an established private placement market. Although recent years have seen significant progress in the well-established German Schuldschein market and the nascent French private placement market, the European market has remained fragmented.

What is the significance of the announcement of a withholding tax exemption?

The UK government announced in its recent Autumn Statement (released 3 December 2014) that the Finance Bill 2015 is to include a new exemption from withholding tax on interest on private placements. Further detail, including draft legislation, was published on 10 December 2014.

The issue

Under existing UK rules, a corporate borrower is required to withhold tax at 20% from payments of interest on all but very short-term debt, unless an exemption applies or there is a double taxation treaty in place and the borrower has been directed by HMRC to pay the interest gross. While the ‘UK corporate’ exemption generally applies to UK investors, none of the current exemptions apply to interest payments on unlisted debt issued by non-banks to lenders resident outside the UK. Even where a tax treaty applies to a payment to a non-UK lender, obtaining the necessary direction from HMRC is typically a complicated and lengthy process, and the borrower may not have sufficient time to obtain a direction from HMRC to pay gross before the first interest payment becomes due.

The risk that a borrower will be required to ‘gross up’ interest payments to non-UK investors which are subject to withholding tax through a gross up obligation has been highlighted by the Association of Corporate Treasurers and others as a hurdle to the effective development of the market. The position for private placements currently contrasts unfavourably with that in the bank loan and quoted Eurobond markets where interest paid receives a favourable treatment for withholding tax purposes.

Government’s response

Draft legislation published by HMRC on 10 December 2014 is intended to come into force with the Finance Bill 2015. It provides that a payment of interest will be exempt from withholding tax if it is interest on a ‘qualifying private placement’.

A ‘qualifying private placement’ essentially means an unlisted debt security, issued by a company, which has a term of at least three years.

However, the government also intends to introduce regulations imposing further conditions for the exemption to apply. Those regulations will be developed in consultation with stakeholders, but HMRC currently propose to restrict the application of the exemption to non-convertible, unsubordinated securities that:

  • raise between £10m and £300m
  • are issued by trading (as opposed to investment) companies
  • are held by ‘regulated financial institutions’ (not defined), and
  • have a maturity of less than 30 years

There remain a number of uncertainties around the draft legislation which need to be resolved with HMRC. The consultation period ends on 27 February 2015. It is hoped the further conditions will not unduly restrict what is in general a welcome move to help develop the UK’s nascent private placement market.

What has led to the development of private placement documentation by the LMA?

Another key barrier to market development has been the lack of standardised documentation. The development in the US of the American College of Investment Counsel’s model form note purchase agreements 20 years ago is accepted as one of the contributory factors to the successful standardisation and growth of that market. Those forms have become industry standard in the US market and are adapted for use in cross-border transactions.

With that in mind, in 2014 the LMA established a working group to develop some recommended form English law governed documentation intended to be a starting point for negotiation for the European market. The suite of documents, published on 6 January 2015, consists of both a loan format (facility agreement) and a note format (subscription agreement) for the parties to choose between, as well as a term sheet for use with either format. A user’s guide and confidentiality agreement completes the suite.

The documentation is based on the LMA’s investment grade facility agreement (for the sake of market familiarity), but adapted to reflect the specific characteristics of a private placement.

The subscription agreement takes the form of a note purchase agreement with the terms and conditions of the notes set out in a schedule thereto. The subscription agreement is intended to be aligned to the facility agreement in order to ensure that the private placement is viewed by the market as one product rather than two, and to avoid commercial arbitrage.

Both loan and bond format are unsecured, and rank pari passu with the other senior unsecured debt of the corporate.

Notable features of the LMA documentation include:

  • it is a single drawdown or issuance of term debt with a bullet repayment
  • the debt is not expected to be listed, rated or cleared
  • the debt is expected to be registered, with the register open for inspection by investors to enable them to know each other’s identity
  • the interest rate for the debt can be either fixed or floating (with break costs an option for floating rate debt)
  • the terms provide for investor prepayment/redemption rights on the occurrence of a change of control, issuer optional prepayment or redemption, and prepayment or redemption on change in tax law (or interpretation) or as a result of an illegality
  • a framework for call protection is included, ie an optional prepayment fee or make-whole amount—the formulation of any make-whole amount or prepayment fee is left for negotiation and may in part be driven by investors’ regulatory requirements (invariably, optional prepayment is likely to be expensive for a borrower, particularly in a low interest rate environment—break costs will remain an option for a floating rate loan)
  • the debt is transferable (subject to amongst other things, prior consultation with the company)—the expectation, however, is that the investors in this market will largely invest on a buy and hold basis, and
  • no facility agent is provided for, but provision is made in both formats for an optional paying agent and/or calculation agent (as agents of the corporate) to assist with debt administration, eg to assist with the calculation of floating interest rates, performance of ‘know your customer’ checks and payment mechanics

The representations, undertakings and events of default package (in both formats) is drafted on the assumption that the company is an investment grade credit. Exactly where this package ends up on the scale between bond debt style and bank debt style remains to be seen. If more of the bank debt end then serious consideration will need to be given by corporates to future initiatives in which amendments/waivers may be needed. Institutional investors, in some instances, may be less well equipped than banks to respond to amendment requests, making it important to achieve a covenant package on day one that will give the corporate the strategic flexibility it needs over the life of the debt. It is usually advisable for a corporate that has issued private placement debt to actively engage with its investors to develop an ongoing relationship. In the absence of ancillary business and/or frequent refinancing discussions, this might take greater effort to sustain than a bank relationship.

Are we seeing the development of a pan-European private placement market in 2015?

The importance of these latest developments is not limited to the UK market. The development of a pan-European private placement is looking closer, with the publication of template documentation (not just by the LMA but also by the Euro Private Placement Working Group which has published French law governed private placement documents to complement the French Charter for Euro Private Placements released in April 2014). Beneficial amendments to tax regimes in France, Italy, and soon the UK, may encourage other European countries where withholding tax may pose an issue to follow suit. The International Capital Markets Association’s Pan-European Private Placement Working Group is on track to publish its descriptive market guide to best practice in the near future, which should aid the further development and standardisation of market practices and provide a framework for the documentation of private placements on a pan-European basis.

There remains work to be done—not least in terms of developing appropriate tools for credit evaluation and resolving continued regulatory uncertainties under Solvency II. However, 2015 looks promising for the further development of both the UK and the pan-European private placement markets.

Interviewed by Miranda Campbell.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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