After Basel: what 2006 holds for structured finance lawyers

There are plenty of new revenue streams for City law firms, reports Lorraine Cushnie

Structured finance. Capital markets. Securiti-sation. Call it what you will, but the structured end of the law firm finance practice is a hotbed of activity. Once bespoke and lucrative products have become run-of-the-mill, leading lawyers will be on the look out for a new revenue stream.

The Lawyer has questioned the City’s structured finance lawyers to find out what they are placing their bets on this year.

The Basel II accounting procedures, which will be coming into force at the end of the year, have impacted on capital markets as banks and institutions clear up their balance sheets through securitisations.

Collateralised loan obligations
At the end of last year, the synthetic collateralised loan obligation (CLO) market picked up steam as banks sold billion-pound chunks of CLOs, including ABN Amro’s E22bn (£15.09bn) deal, advised by Clifford Chance, and Barclays Bank’s £5bn issue, advised by Simmons & Simmons.

The trend is set to continue this year according to Cadwalader Wickersham & Taft capital markets partner Christian Parker. “There’s been a big growth in the CLO market and there’s a huge quantity of them in the pipeline,” he says.

In addition to the reactions to Basel II, Parker says increased liquidity due to a widening investor base has helped drive up volumes. “Ten years ago no trading in loans took place, but now the secondary loan market is very liquid. There’s vast demand for this stuff coming from insurance companies and pension funds, as well as US funds which are increasingly getting into the European loan market,” he says. And, as with most structured products, the hunt for yield always plays a role.

Cadwalader’s London office is advising on what it thinks is the first CLO to be established by a hedge fund. Last year it acted for Prudential Financial on its first European CLO.

Synthetic deals will not be limited to the CLO market, according to Clifford Chance capital markets partner Debashis Dey, with new asset classes set to come online. Dey points to the securitisation of loans to small and medium-sized businesses that started last year. Property-related securitisations
Balance sheet clean-up is also helping to drive the property-related asset classes, with many predicting that 2006 will be the year that commercial mortgage-backed securities (CMBSs) come into their own.

Alan Newton, head of structured finance at Freshfields Bruckhaus Deringer, says the development of the UK market, as well as the emergence of the product in new jurisdictions, will add up to a bumper year for the product. “A lot of property was financed through CMBSs last year and there will be even more to come as companies divest themselves of assets,” he says. “For example, many of the banks have also set up their own conduit programmes and more are looking to do so.”

Newton points to Italy as one of the new jurisdictions where CMBSs will take hold as publicly owned properties are being sold off.

Insurance securitisations
Freshfields’ Newton and Day at Clifford Chance also think insurance sector securitisations are set to see real demand. Embedded value or value-in-force transactions provide insurance companies with up-front capital based on the projected profit on a book of policies. The proceeds can also count as tier one regulatory capital. Deals such as Clifford Chance’s £200m Norwich Union Life & Pensions and the Gracechurch Life transaction, advised on by Freshfields, are examples of this type of deal.

High yield
High yield lawyers are waiting to see which way the market will go in 2006. High-yield transactions in Europe have rocketed since their introduction, but volume levelled out last year. The market was also fuelled by a few large transactions, such as those from Ineos and Hertz, while smaller trades failed to materialise.

John Connolly, head of Clifford Chance’s US securities group, is hopeful that the market will mature in Europe and that high yield will be seen as more than just a method of financing acquisitions. “In the US, it [high yield] is not just used for acquisition finance, but it’s also one of the accepted alternative forms of long-term funding. The hope is that the market will develop along those lines in Europe,” he says.

As reported by The Lawyer (21 November 2005), high yield issues have also come under threat from mezzanine debt, which offers greater call protection. A partner at one US firm with a high yield practice thinks this convergence will be the deciding factor for 2006. “Investors of mezzanine and high yield are the same,” he says. “Core features on high yield will have to come more in line with mezzanine debt to make it more attractive.”

Islamic finance
The groundbreaking pre-IPO convertible Sukuk issued by DP World to help fund its acquisition of P&O brought Islamic financing to greater public attention at the end of 2005. Denton Wilde Sapte finance partner Farmida Bi predicts that this year the demand for sharia-compliant instruments will be even greater.

“We’re going to see more pre-IPO convertibles, because IPOs in the region are oversubscribed, so anything that allows investors to get in on the act early will be popular,” says Bi.

Bi also points to an increased interest in sharia-compliant securitisations as the investor base grows and the market becomes more sophisticated. “Last year there were more vanilla Sukuks, whereas this year there’s likely to be a lot more innovation,” she explains.

This is a point reiterated by Dechert global Islamic finance partner Abradat Kamalpour. “We’re going to see more structured Islamic bond products and interest in Islamic securitisation is on the increase,” he says. “The demand will not just come from Islamic financial institutions and corporates that want to securitise and raise funds, but also from Western institutions and corporates that want to tap the Islamic finance market.”