Leveraged finance: where did it all go wrong for UK firms?

Imagine you’re the general counsel of London-based private equity investor BC Partners. You’re sipping on your coffee, hashing out the details of your imminent £382m investment into UK-based business publishing company Mergermarket. 

Historically, you’ve turned to Dickson Minto as your external borrower’s counsel, and the firm has been instructed again this time round – arranging a traditional European-style bank loan to fund the transaction. 

Then the underwriting banks step in with an interesting offer. Apparently, if you invest into the US market you can do so with less covenants, and at more attractive rates. In essence, you’ll get a better deal if you set your sights stateside. 

This raises a number of questions, including that of legal advisers. While Dickson Minto is a great firm, it simply doesn’t have the US expertise necessary to guide you through this particular transaction. 

So, you pick up the phone to US high yield supremo Latham & Watkins. Once the deal is signed, Latham will take over on the financing front, advising on the necessary shift to a New York-governed Term Loan B. Dickson Minto will retain the lead corporate counsel role, but lose out on work related to the European loan.

While it’s unusual for a transaction’s debt financing arrangements to change so late in the day, European businesses utilising US debt structures has become a marked trend in recent years. 

Polish mobile telecoms company Play is just one example. The business issued its inaugural dual-tranche high yield bond issue alongside a new super senior revolving credit facility in February 2014. 

French telecommunications equipment company Alcatel-Lucent, UK-based animal tagging business Allflex, British automotive safety equipment manufacturer Britax and Paris-based tech company Oberthur are further examples of European companies that have recently opted to take a US-oriented financing route. 

This poses a challenge for UK firms, who need to persuade clients that they’re flexible enough to bend a deal into whichever structure suits their best interests. And that is often a battle to be won before the deal has even creaked into action. 

A major hurdle is that UK firms, and the magic circle in particular, are the wrong size and shape to take full advantage of the increasingly fluid global debt markets. Over the course of their history, they have grown into a mould that fits the UK’s traditional lenders such as RBS and Lloyds – large machines with a broad finance bench, excelling in producing a high volume of top quality commoditised work. 

Incoming US firms, on the other hand, have a sleeker model and a smaller headcount. Those which entered the market on an acquisition finance ticket, such as Latham and Weil Gotshal & Manges, have a clear strategy firmly directed at plucking the richest deals and raking in the largest client fees. 

That strategy lends itself to US borrower financing work, and high yield corporate bonds in particular. The very structure of a high yield bond prevents it becoming commoditised, to an extent – partly due to the complexity of its covenant package. 

And this is another area where UK firms find themselves falling behind – US expertise. US firms in London are bolstered by an enormous bench of US-qualified lawyers on the other side of the pond. 

In contrast, UK firms have found it tricky to establish a meaningful presence in the United States. As the managing partner of one US firm in the City put it: “In the past, UK firms have led the way on international expansion and English law is commonly used for financial corporate transactions. But UK firms don’t have as much of a toehold in the US as the US has in London. It is a hard nut to crack, and it’s one hole in their armoury.” 

These issues are compounded by UK firms, and again the magic circle in particular, losing the leveraged finance talent that they do they do have on their books. This has been particularly noticeable in the world of private equity – often seen as the holy grail of lateral hiring, due to the portability of these partners high value client-base. 

Recent moves include Ian Bagshaw and Richard Youle from Linklaters to White & Case (17 October 2013). David Walker, Tom Evans and Kem Ihenacho quit Clifford Chance for Latham & Watkins (18 February 2014). Derek Baird jumped ship from Allen & Overy to Simpson Thacher (8 November 2012), and Gil Strauss moved from Freshfields to Weil (7 December 2012). Each pitched up at their new firm with a number of valuable sponsor-side relationships. 

As these defections mount up, there are few – if any – leveraged finance or sponsor-side private equity associates being made up to partner at the other end of the spectrum. 

Ultimately, the magic circle’s flexibility is coming under strain. If the UK’s best-renowned firms are to maintain their footprint in the European acquisition finance markets, they’ll need to demonstrate they have the talent, expertise and durability to advise on financing deals – regardless of whether they take a traditional or a US-oriented structure.

See this week’s feature, Has the lion lost its roar?, for further analysis of how law firms’ are tackling the current leveraged finance landscape.