A growing number of European fund managers are engaging in loan origination and securitisations as regulatory capital requirements under Basel III force banks to scale back these activities, according to K&L Gates.
European regulators have made it no secret that they would like to see less bank involvement in lending to small to medium sized enterprises (SMEs) as part of their Capital Markets Union (CMU) initiative.
“Fund clients are increasingly investing in infrastructure, and originating loans to both corporates and consumers. We have seen fund managers embrace securitisation as well. Asset managers are looking for yield. Admittedly, the US is further ahead than the EU, but we are seeing growing uptick in asset managers participating in these asset classes,” said Sean Donovan-Smith, partner at K&L Gates, speaking at the International Bar Association’s (IBA) Private Investment Funds Conference in London.
“Policymakers and regulators want to kick-start additional financing for SMEs and reintroduce high-quality securitisations. There is a realisation that more needs to be done to enable SMEs to obtain financing,” added Donovan-Smith. Some firms are going further.
Data from AlixPartners indicates there are around 50 non-bank lenders such as asset managers providing mid-market leveraged loans to indebted companies and private equity. These loans typically range from €20 million to €300 million.
Loan origination funds and securitisations have been given a boost by EU regulators. The Central Bank of Ireland (CBI) has pushed for loan origination vehicles in the form of Qualifying Investor Alternative Investment Funds or “QIAIFs”. BaFIN in Germany has scrapped requirements that domestic funds restructuring or issuing loans hold a credit license in what should also boost interest. Novo funds, which are fund platforms that invest in SME French companies have also been given the green light.
There is speculation as to whether EU-wide rules will be imposed on loan origination funds as these investment vehicles are not included in the Alternative Investment Fund Managers Directive (AIFMD). Some have recommended loan origination funds be included in the AIFMD passport rather than having regulators create a whole new fund passport.
The Alternative Investment Management Association (AIMA), the hedge fund industry group, predicts private debt funds could see their role in SME financing increase dramatically over the next five years. Such developments would also bring Europe into line with the US where about 80% of corporate financing is carried out in capital markets through bond and equity issuances.
Securitisations have also been given a boost by the EU’s Simple, Transparent and Standardised (STS) initiative. STS aims to reduce the capital charge for those who hold or issue vanilla asset backed securitisations. This is designed to revive a market which has shrivelled in Europe following the crisis. However, there are challenges. One lawyer highlighted the STS framework had caused major disagreements among EU policymakers and there were doubts the rules would be on the books anytime soon.
One of the challenges has been defining what exactly an STS securitisation is. It is likely that issuers will be required to assess whether their securitisations fit into the STS category although the definitions will be probably be highly subjective. The fines for incorrectly attesting an STS securitisation could be up to €5 million or 10% of a firm’s annual turnover, according to regulatory proposals. The uncertainty around definitions could result in market participants seeking external valuers or consultants to provide impartial advice.
Another growing phenomenon is fund managers investing into P2P lending businesses, added Donovan-Smith. P2P lenders are online platforms connecting borrowers with investors. These organisations tend to have limited infrastructure and overheads – unlike a bank – and have proliferated in recent years.
Some managers are lending through these infrastructures while others are buying tranches of loans, attracted by the fixed income payments they accrue. The latter, which often take the form of securitisations, has caused particular concern among industry participants who warn there are parallels with sub-prime and collateralised debt obligations (CDOs). Lord Adair Turner, former chairman of the then UK Financial Services Authority (FSA) warned that the growth of P2P could result in significant losses.
Many are alarmed at the lack of regulatory oversight and warn some P2P providers may lend to SMEs and consumers with insufficient credit quality or ratings. P2P operators argue they conduct thorough credit risk assessments on prospective lenders. The P2P lending sector is growing. PricewaterhouseCoopers (PwC) estimated the P2P market could grow in excess of $150 billion by 2025, up from $5.5 billion in 2014.
The market is larger in the US. Lending Club, one of the biggest P2P lenders, went public in December 2014, while others have sold equity stakes to asset managers. Marshall Wace, the London-based hedge fund, has been particularly active. It acquired 90% of Eaglewood Capital Management, a New York asset manager with a focus on P2P loans, having purchased Exchange Associates – another P2P lender – in 2013. Meanwhile, hedge fund Arrowgrass acquired a stake in Zopa, the UK P2P platform.