Fuelled by cheap borrowing, according to the Institute of International Finance, global debt reached unprecedented highs at over $237 trillion in 2017. Although the ratio of global debt-to-GDP continued to fall for the fifth successive quarter, this is still an eye watering amount of debt and the largest portion is owed by non-financial corporates. How will all this borrowing be repaid, refinanced or restructured? How much of it will need to be written-off?
Current European corporate default rates are low – around 2% – and expectations are that it will remain around that level throughout 2018. But if inflation rises faster than expected, likely so too will interest rates – and against this backdrop, the raised levels of zombie companies in Europe (those who spend more on interest than they earn) suggest that rehabilitation in respect of this addiction to debt could be painful.
Helping to form the ever-growing mountain of debt, European leveraged finance rebounded in 2017 following two years of falling activity. According to Thomson, some $393 billion in leveraged loans and $242 billion in high yield bonds were issued by European entities, much of it used for refinancing purposes. As their investor base converges, the documentary trends in loans and bonds are also converging. In the competitive search for yield, investor protections have suffered with Standard & Poor's suggesting that the value of cov-lite loans issued in Europe doubled in 2017 to €78.6 billion. Investor protections have suffered. Many deals have seen loosening restrictions on further debt incurrence and while some may still have a leverage covenant, it may only be springing – tested if the revolving credit facility (RCF) is drawn above a certain percentage (even then, borrowers may be able to repay and re-borrow around quarter end to avoid testing). Investors have also allowed aggressive adjustments to pro-forma EBITDA calculations impacting ratio tests (where used) and there is greater opportunity for value to be extracted to pay dividends or repay junior debt. Are these deals storing up problems for the next downturn?
It seems likely that future restructurings of the recent wave of leveraged finance deals will play out differently from the last round. Liquidity issues will be exacerbated with lender protection and enforcement rights weakened.
The problem of non-performing loans (NPLs) is one common to much of Europe and Asia (particularly China and India). Having a highly leveraged corporate sector sitting alongside a stressed banking sector is a dangerous mix. That explains efforts in 2017 (likely to continue in 2018 and beyond) to address NPL levels through improved restructuring and insolvency regimes, speeding up enforcement procedures and encouraging the development of secondary markets for their disposal and workout. Recently, for example, the European Commission published a set of measures, comprising a draft Directive and Regulation, aimed at accelerating the reduction of NPLs in Europe. Opportunities for distressed investors look set to grow as NPL reforms gather pace globally, although not all jurisdictions offer the same level of attraction.
2017 also saw the continuation of trends towards greater judicial co-operation in cross-border insolvencies, insolvency reform and forum shopping.
The new recast EU Insolvency Regulation began to apply to insolvency proceedings opened from June last year. It provides for cooperation and communication between insolvency practitioners and courts and looks to encourage better coordination where there are insolvency procedures opened in more than one Member State relating to different companies forming part of a group.
In 2017, Singapore, the District of Delaware, the Southern District of New York, Bermuda, the UK, the BVI and New South Wales, Australia, all adopted a set of judicial cooperation guidelines available for use in parallel cross-border insolvency proceedings. They were put together by the Judicial Insolvency Network in October 2016.
The recent Ocean Rig restructuring saw the agreement of a practical court-to-court protocol between the US and Cayman courts. It is also a powerful example of how similar restructuring technology can be applied from jurisdiction to jurisdiction. A pre-appointment centre of main interest shift to Cayman, a Cayman court sanctioned scheme of arrangement in respect of foreign incorporated debtors and US Chapter 15 recognition – technology not that unusual to UK practitioners perhaps, but a first for the Cayman Islands. Ultimately, it ensured value was maximised for creditors.
Recent years have also seen a steady stream of restructuring and insolvency laws moving in the same general direction and sharing similar features (cram-downs, stays, debtor-in-possession (DIP) finance, pre-packaged deals). Last year was no different, with bold changes seen in Singapore looking to transform itself into a leading Asian restructuring hub and continued discussions in Europe on proposals for an insolvency harmonisation directive. But as Brexit negotiations, the recent turmoil in the equity markets and the bursting of the bitcoin bubble show, events can move rapidly, expectations can be upset and directions of travel can shift. What is less clear is predicting why or when. Could we see protectionism start to creep into areas outside of trade – even into insolvency reform?
The idea of a global trade war seemed untenable several years ago, but the prospect of a stand-off between the US and China (not to mention tensions with Russia) at least shows formerly unthinkable questions still need to be asked. With political actors – and electorates – ready and willing to upset the conventional, knowing what is around the corner becomes much harder. But a quiet year ahead? Don't bet on it.
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Rebecca Jarvis Global co-head of the restructuring and insolvency group, Linklaters London, UK T: +44 207 456 4466 E: rebecca.jarvis@linklaters.com Rebecca Jarvis is joint global head of the Linklaters restructuring and insolvency team, comprising specialists throughout Europe, the Americas and Asia and handling the world's most challenging and significant domestic and cross-border assignments. She has outstanding experience in all aspects of non-contentious restructuring and insolvency work acting for banks, financial institutions, other creditors, corporate clients and insolvency practitioners in relation to recovery, reconstruction or distressed debt problems. With a remarkable breadth of practice, Jarvis has acted on a wide range of work-outs, business recoveries, stressed refinancings, restructurings and insolvencies. |
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Paul Sidle Counsel PSL in the restructuring and insolvency group, Linklaters London, UK T: +44 207 456 4698 Paul Sidle is a counsel professional support lawyer (PSL) in the firm's restructuring and insolvency team. His focus is on English and international restructuring and insolvency, including the resolution of financial institutions. |