International Financing Review February 29 2020 11For daily news stories
@ visit http://www.ifre.comWeWork as an example of a
governance problem in a paper
titled “Do your ‘G’ work”
written by Martin Jarzebowski,
the fund managers’ director of
responsible investing in January.
The report said that the
company had taken its eye off
basic governance matters.
WeWork’s US$47bn valuation
crashed after its public offering
imploded last year.DIRECT LINE
The connection between
covenants and governance is
arising in ESG integration for
more sophisticated investors,
and the question of whether
weak covenants are a credit or
governance issue – or both – is
being actively debated in credit
committees.
Recent leveraged buyout
loans, including a £1.3bn
leveraged loan for UK forensicsciences group LGC, a £2.193bn
loan for UK theme park and
attraction operator Merlin
Entertainments and an
€820m-equivalent buyout
lNANCINGûFORû'ERMANûINSULATIONû
foam maker Armacell have all
had weak covenants.
“Documents and covenants
are at their weakest point that
we’ve seen for a long time,” said
Jane Gray, head of European
RESEARCHûATûCREDITûRESEARCHûlRMû
Covenant Review.
Investors have been
protesting about documentation
and covenants for years, but
have still been buying the deals,
as excess demand and little
supply has allowed private
EQUITYûlRMSûTOûPUSHûTOûSECUREû
MAXIMUMûmEXIBILITY ûWHICHû
THEYûSAYûISûTHEIRûlDUCIARYûDUTYû
to shareholders.
Fixed-income investors use
ESG integration scoring toassess companies and draw a
direct line from ESG issues to
credit risks and spreads, and see
favouring one set of
stakeholders over others as a
POTENTIALûlNANCIALûRISKûFORûTHEû
companies they invest in when
rating for governance.
Funds are using ESG scores to
inform investment decisions about
how much of a credit they will take,
and where they invest in the capital
structure of private equity-owned
companies, as ESG continues to
lLTERûINTOûTHEûLEVERAGEDûMARKETû
from its origins in the corporate
investment-grade world.
“How companies score on
governance can have an impact
on how much default risk and
volatility contribution we want
in the portfolio associated with
that single name,” Reznick said.
“What you’re trying to get out
of governance is longevity, stable
shareholders and thesustainability and viability of the
business so that all stakeholders
CANûBENElTû#OVENANTûSTRUCTUREû
gives a good indication.”INDUSTRY FOCUS
ELFA has launched several
initiatives to address ESG issues
in the leveraged loan market,
including a recent survey of 100
investors, which found that 72%
are already addressing ESG
considerations.
“We are providing investors
with as many tools as possible to
engage – that’s ELFA’s remit,”
said Sabrina Fox, executive
adviser at ELFA. Reznick is also a
committee member of ELFA.
ELFA is working on a
standardised ESG disclosure and
will hold an investor roundtable
in conjunction with the UN-
supported Princples for
Responsible Investment in Aprilto discuss the issue. (^)
FIERCE SCRAP
The increase in cross-border
M&A, which more than doubled
from 2013 to peak at over
US$1.5trn in 2018, has helped
fuel the growth of the deal-
contingent market. A
concurrent slump in currency
volatility has also cheapened the
cost of these derivatives for
clients, even as it leaves less
room for error for the banks
selling them.
So far, that hasn’t deterred
bankers generally short of
PROlT
MAKINGûOPPORTUNITIESûINû
THEûNOWûHIGHLY
ELECTRONIlEDû&8û
business.
Some of the trades – and so
potential gains and losses – are
huge, such as the deal-
contingent hedge sources say JP
Morgan provided for Takeda
Pharmaceutical’s £46bn
acquisition of Shire, which
closed last year. JP Morgan
declined to comment.
#OMPETITIONûISûLESSûlERCEûONû
these jumbo M&A trades given
the higher risks involved. But
there has been a sharp
compression in prices in the
private-equity segment of the
market, with the cost of these
derivatives declining by around a
third in recent years to about 20%
of the cost of a regular FX option."ANKSûMUSTûlGHTûHARDûTOûWINû
this business, with sponsors
likely to be unimpressed by
anyone not competing on price,
terms and speed, said Mark
Beaumount, head of risk
management for Europe at
consultancy PMC Treasury.
“We know from [banks’]
reaction times and behaviour that
those approval processes internally
can be very different,” he said.
Bankers can take some
COMFORTûTHATûPRIVATE
EQUITYûlRMSû
are professional investors
strongly incentivised to get deals
over the line. Their failure rates
average 10% per year over the
past decade compared with 19%
for corporate cross-border deals,
ACCORDINGûTOû2ElNITIVûDATAû%VENû
so, this is still a risky business.
“Ultimately there is always a
portion of risk that isn’t hedge-
able,” said Sabine Chappard,
EMEA head of strategic FX at
Credit Suisse. “You can be as
diligent as you like, but some
deals will fail that you can’t
possibly foresee.”DEAL FAILURES
There are no shortage of
examples of failures. It could
involve another investor
swooping in with a higher offer,
such as in Temenos’ doomed bidFORû5+ûlNANCIALûTECHNOLOGYû
group Fidessa in 2018, or Apollo
Global Management’s failed
takeover of plastics giant RPC
Group (the latter resulting in a
windfall gain for banks thanks
to currency moves).
Banks have also been blindsided
by failed deals re-emerging later
on, confounding so-called phoenix
clauses designed to guard against
such eventualities.
53ûPRIVATEûEQUITYûlRMû
HabourVest didn’t have to pay
for a deal-contingent option
accompanying its initial failed
bid for SVG Capital in 2016,
according to sources, by instead
LATERûBUYINGûTHEû5+
BASEDûlRMSû
investment portfolio (which
made up the vast majority of its
assets). The pound fell against
the US dollar during that period,
effectively making the option
worthless.
The risks facing banks
providing these hedges was
again shown when a contingent
option linked to Bain Capital’s
investment in Germany’s Stada
timed out after a failed bid, only
FORûTHEû53ûlRMûANDûCO
INVESTORû
Cinven to succeed with a
follow-up offer later on.
Banks can “end up with large
concentration risk” on their books
from deal-contingent options, saidBenoit de Benaze, a director at
consultancy Chatham Financial.
“Trades are often in the same
currency pairs, same direction
and some are jumbo trades.”RISKY BUSINESS
Faced with such risks, some will
only bid on deals they think are
sure things. Differences in risk
tolerance were apparent in the
Montagu deal, where the
winning bid came at below 20% of
the price of the option, sources
said, while another bank priced it
at over double that level.
“[We] won’t trade unless we
are comfortable with the risk,”
said Antoine Jacquemin, global
head of the market risk advisory
group at Societe Generale.
Others say trying to get some
MEASUREûOFûDIVERSIlCATIONûISûTHEû
right approach given the
likelihood that some deals
won’t get over the line.
“If individual banks are doing
a meaningful number of deals a
year, it’s almost certain a few of
those are going to fall over,” said
Logan Campbell, global head of
FX derivatives at Deutsche Bank.
“That’s why we feel it’s about
having a portfolio approach to
spread your risks around. We also
need to be active in hedging a deal
when there are warning signs.” 4 IFR Top news 2322 .p 4 - 14 .indd 11 28 / 02 / 2020 19 : 41 : 47