Alternative lenders established themselves as key partners in troubled times
To address clients’ needs in Luxembourg – the number one jurisdiction for debt funds, EY is happy to announce the creation of the Private Debt sector. Vincent Remy, Partner, walks us through the main takeaways on the sector.
How do debt funds positively contribute to the European (and beyond) economic system?
The performance of the European economy is by and large driven by the financial health and growth of Small and Medium sized Enterprises (SMEs). One should remember that they represent approximately 99% of EU businesses, employ two out three employees and generate three fifths of the EU value-added.
Since the Global Financial Crisis (GFC), these EU SMEs have struggled to secure external financing from traditional lenders to invest, grow and provide more jobs in the EU.
Enter the private debt funds which provide the alternative financing sources EU businesses long needed.
This is of course not limited to Europe as the US has long been a mature sector for alternative lending solutions.
What is the evolution of the private debt sector in Europe and the rest of the world?
Key factors for the development of the private debt markets since the GFC are still there: (1) contraction of traditional lending (i.e., bank) solutions due to increased regulations; (2) political push where alternative financial support to SMEs has been largely backed by EU policymakers via the EU Commission’s Capital Markets Union (CMU) initiative, the COSME program or recent relaxation of the EU securitization framework; and (3) returns outperforming the high yield and leveraged loan markets for the satisfaction of yield-starving institutional investors.
With the covid crisis, it was feared by some that certain closed-ended loan funds could have liquidity issues and that the sector was never put to the test and how it could fare against challenging credit cycles. On the contrary, alternative lenders have established themselves as key partners in these trouble times and have been lauded for continually helping / financing mid-market business whilst effectively limiting downside risk.
As the US / EU / Asian economies have reopened, alternative lenders focus on new deals and are well-placed to still deliver superior returns to other fixed income classes. Even with the current (albeit low) rise of EU’s inflation, the floating rate model of many private credit structures should help mitigate the impact on ultimate returns.
What is the role played by Luxembourg?
Managers operating these debt funds need the speed, flexibility, and breadth of solutions to market these structures whilst being able to lend in all markets. These Luxembourg solutions are very well-known to investors and managers. This explains why it is today the #1 jurisdiction for credit managers for an EU-oriented credit fund. As the EU marketing passport is a key factor, the country should remain favored to tap into the EU investors’ money.
What prompted EY to create a team dedicated to this sector?
Our Luxembourg office has long served credit fund managers under the leadership of Olivier Coekelbergs (CMP of EY Luxembourg) and Laurent Capolaghi (Private Equity Leader at EY Luxembourg). As we have seen a vast increase of the number of professionals in our firm dedicated to credit funds (tax structuring, reporting, audit, valuation, advisory, etc.), we decided that it was best to put forward that experience even more visibly on the market with a dedicated “task force”. EY virtually assists managers – across their debt strategies – from thought to finish. The creation of this new sector is best placed to support our clients’ ambitions and exceed their expectations.
What are the challenges ahead for credit fund managers?
Well, there is a lot on their plate. From a current inflationary environment to a possibly slowing economy. The follow-up to the ESMA recommendations to provide for a pan-European loan origination framework that credit managers could abide by on top of the AIFMD. The impact of the ELTIF review and the continuous changes in the tax rules (after BEPS and the ATAD 1 and 2, the next round of new tax measures is round the corner with BEPS 2.0 Pillar 1 and 2; ATAD3; a follow-up to DAC 6; DEBRA; etc). Granted, it is generally expected that these measures should be of less relevance to credit managers.
Also, what model UK managers will generally use to market their funds post Brexit. The impact of the UK AHC regime (which should also be limited with respect to credit managers that want to market in Europe as there should be limited purpose / benefits in using a UK company below a Luxembourg fund).
This is by no means an exhaustive list. I would finally mention ESG criteria and how credit managers assure that businesses manage these alongside more traditional financial metrics.