Changes to insolvency and restructuring regulations
One of the biggest themes in the global restructuring market is the number of countries that are reforming their legal frameworks against which non-performing credits can be restructured.
In some countries that have historically been borrower friendly (e.g. India), legislation is changing and giving more power to creditors. In other countries that have historically had blunt insolvency tools, the restructuring regime is being developed to allow for more turnaround and recovery, with new legislation often being based on a combination of UK Insolvency Law and US Chapter 11 provisions.
The UK has traditionally been a world centre for global restructuring, due to its strong insolvency framework and restructuring flexibility (e.g. Scheme of Arrangement). Whilst further reforms have recently been announced and will help to sustain the UK as a leading restructuring regime, the implications of Brexit create uncertainty as to how cross-border restructurings might be implemented.
The Netherlands is fast tracking legislation to allow cross-class cramdown, DIP financing and release of third party guarantees. Dutch schemes will automatically benefit from EU recognition under European Insolvency Regulation whilst the position for the English Scheme of Arrangement remains unclear.
Further afield, Singapore is also seeking to become a global restructuring hub with more borrower friendly options and global reach provisions.
Focus on excessive NPL levels in banks around the world
Levels of non-performing loans (NPLs) have remained high across developed and emerging markets. Many countries have introduced legislation and regulation to address this, with regulators setting deleveraging targets.
The introduction of Basel III, which increases the capital adequacy requirements on banks, increases the cost of holding NPLs. Meanwhile, the introduction of IFRS 9, as well as actions by some governments, are forcing banks to recognised NPLs earlier, resulting in higher provisioning.
The requirement for banks to recognise NPLs, provide for them and allocate more capital, combined with increasing liquidity in secondary debt markets, is leading to credit funds acquiring NPLs earlier and, increasingly, providing rescue financing. As banks are offloading NPLs they are decreasing the size of their workout teams and leaving the credit funds to lead restructurings. The result of this is a change in stakeholder behaviours, with credit funds increasingly driving the agenda in distressed situations.
Currency depreciation against the USD
There has been a rise in the prevalence of USD borrowings since the global financial crisis of 2008. As the US Federal Reserve tightens monetary policy, the value of the dollar is increasing, leading to devaluation of many currencies against USD.
Most immediately this impacts global trade balances and the relative performance of exporters and importers in different countries. It is a particular challenge, however, for companies that have issued USD debt and rely on local currency revenues. In order to be able to service debts, many are focusing on operational improvements, working capital optimisation or seeking to restructure debts.
Although a broad range of developed and less developed markets have been affected, currency movements have been exacerbated in certain countries due to local political and economic factors, notably Turkey (where the Lira has devalued by 49% against the USD over the last year) as well as Venezuela, Russia, India, Brazil and Argentina.
Global trade policies and tariffs - US trade policy and Brexit
The tension between US and its neighbouring countries, as well as some of its biggest trade partners like China and the EU has caused concern in sectors and economies directly and indirectly. Stock markets in the main affected areas dropped notably when the US announced additional tariffs worth $200bn on Chinese products, only days after bringing levies on $34bn worth of Chinese goods.
The direct impact of these global trade tensions is hard to quantify; it is difficult to speculate with any accuracy if rising prices, which typically decrease demand, will cause a drag in general growth. Global supply chains mean that the impact of tariffs could be multiplied as components cross borders multiple times. The indirect impact is potentially more extensive. Business confidence declines under deteriorating financial conditions. A sustained negative impact on equity prices and widening credit spreads would likely adversely impact business and household spending. Furthermore, a worsening of sentiment (especially in tariff-affected sectors) could cause companies to scale back on investment and reduce capital expenditure, further impairing global growth.
Beyond the well-documented economic impact already caused by the prospect of Brexit, particularly due to the depreciation of Sterling over the last two years, investors’ confidence is suffering from the political uncertainty around the final form of Brexit.
UK insolvency legislation and practice is regarded as world class, with initiatives in recent years to streamline insolvency processes and prioritise business rescue - indeed the UK government recently announcing its intention to significantly change the restructuring regime with the introduction of restructuring moratoria and plans. Brexit raises much uncertainty over the status of the UK's insolvency regime and whether automatic recognition across the EU will prevail. The timing of Brexit coincides with significant focus by many EU members on harmonising insolvency and restructuring regulations across member countries such that there risks damage to the UK's reputation as a “hub” for complex, cross-border restructurings.
The impact of online retail is being felt around the world, with bricks and mortar retailers suffering the consequences. Customers have embraced online shopping and payment technologies, shifting more transaction flow to platforms.
Not only are traditional retailers suffering from large store portfolios and high fixed costs (e.g. rent and business rates), but their product offering is also far behind the innovators. Increasingly, simply having an online presence is not enough as retailers compete to make the online and offline experience as seamless as possible. Those who cannot keep up are suffering from declining market share and a dwindling value proposition.
Although in some countries retailers have found temporary fixes to manage costs, fundamental shifts in customer behaviour continue to drive restructuring activities and insolvencies in the sector across the globe.
Read more about challenges faced by UK retail stores in our recent Restructuring Trends: Trouble in store - how can retailers deal with the headwinds?
Shipping and Offshore
The tanker market remains weak as the supply of vessels (as well as the large orderbook of new vessels under construction) continues to outstrip demand. The containership market remains uncertain pending the trading patterns the new liner alliance develop, and the impact these will have on the tonnage providers.
The recent oil price recovery to low USD 70s did not translate into a similar improvement in the offshore sector. Whilst the mid-water drilling segment shows signs of slow recovery, the deepwater drilling remains volatile.
The offshore support vessel sector remains weak due to large overcapacity of vessels. Several companies are about to start a 2nd (or 3rd) round of restructuring.
Read more about shipping and offshore in our recent Restructuring Trends: Keeping off the rocks? Navigating restructuring in shipping & offshore
Construction and capital intensive sectors in emerging markets
Emerging market economies (EMEs) that have enjoyed domestic economic growth over recent years are seeing growth slow under pressure from local currency depreciation and lower government spending. These have had a particularly adverse impact on capital intensive sectors such as construction, infrastructure, manufacturing and steel.
In certain markets, the construction sector is particularly at risk because of rising building materials costs and weakening real estate prices. The use of fixed rate contracts increases the risk of underperforming contracts, with projects overrunning (both in time and cost), putting pressure on already thin margins.
Companies in these at-risk sectors have previously spent considerable amounts of capex on expanding their capacity, with a large proportion of the investment funded through raising USD-denominated debt. As economic growth has slowed, these companies have not been able to realise the expected revenue and profit. Recent USD appreciation caused by the Federal Reserve tightening their monetary policy has also put extra pressure on these companies’ ability to service the debt.
Trends in debt documentation
Over the last 12 months, there has been a marked increase in borrower / sponsor friendly debt documentation in new debt deals (e.g. cov-lite, cov-loose, wide permitted baskets, “J Crew clause”, whitelists). This has been driven by excess liquidity competing for a limited number of deals.
There has been a convergence between the terms seen on high yield bonds and leveraged loans, with Europe increasingly adopting the looser documentation seen in the US.
As an illustration of this, cov-lite volumes now account for 78% of outstanding leveraged loans in Europe according to S&P.
Lenders in these credits have arguably lost essential lender protection. The lack of triggers will start to impact the flow of restructurings unless borrowers proactively approach lenders for help.
In the last 3 months, a number of investors have started to push back on loose documentation, although not yet sufficiently to change the underlying trend.
Read more about recent debt market development in documentation in our recent Restructuring Trends: Debt market conditions continue to favour borrowers: what comes next?