Key themes from ELFA’s Annual Conference held 8-9 November 2022 at Bloomberg
Sabrina Fox, CEO ELFA
ELFA held its inaugural conference recently to bring together its members from the leveraged finance buyside at a very interesting time for the industry. ELFA has grown its membership from 15 individuals to 62 member firms since its inception four years ago, representing nearly 1,000 individual members across four asset classes.
ELFA has made a significant impact in pursuing its mission to improve the strength and resilience of the leveraged finance market for the benefit of investors and other market participants. Notably, helping to improve transparency and disclosure by borrowers to meet the new ESG data needs of investors, and their end-investors, to inform investment decisions and risk assessment. And for borrowers, improving ESG reporting is now key to market access and fair pricing.
There was a clear consensus at the conference that the macro outlook is worsening significantly, following a very challenging 12 months for the leveraged finance industry. Defaults are at zero now with no defaults in Europe over the last 20 months and despite the rising proportion of stressed and distressed debt Bloomberg estimates do not predict defaults to rise above 2% in 2023.
The implications for the leveraged finance industry (and ELFA) over the next 3 years are profound and four topics dominated the conference: covenants, transparency and disclosure, debt restructuring, and diversity.
First, covenants. Covenants and the protection they afford investors has deteriorated over the last 10 years of ‘easy money’. Leveraged loans were once lent by banks before the GFC, but as they were forced to retreat from lending post-GFC so non-bank lenders stepped in. As Central Banks continued to lower interest rates the hunt for yield attracted a wide variety of investors. Capital structures changed and today cov-lite is the norm. What happens when corporate issuers, under pressure from the worsening trading environment, want to incur new debt, but that new debt is reluctant to come in behind other creditors?
In the U.S., the long shadow of J. Crew lingers, and more liability management transactions of even greater creativity have since emerged. This has been wake-up call for investors who must be proactive in discerning whether the covenants governing the debt in their portfolio might permit this type of behaviour, and it is an open question whether some of the U.S.-style transactions would pass muster under English law.
Second, debt restructuring. This time around, investors and borrowers can and should take lessons from the last crisis. It’s still early stage on defaults which are expected to be further out as I mentioned, however, there is often no trigger or early warning ahead of a borrower's inability to pay coupon or principal at maturity, and no second chance to restructure once a default has occurred. Being proactive and collaborative when things do go wrong was a strong message from investor panellists at the conference. There is already some active restructuring happening, and constructive collaboration amongst managers who think that refinancing can and should be handled differently this time around. Issuers too will need to engage and act fast to start a constructive dialogue with investors and creditors. The new EU Directive on Restructuring and Insolvency and lessons from the U.S. on liability management will no doubt help manage the expected challenges of 2024-25.
Third, transparency and disclosure. ESG remains at the top of the agenda. Leveraged investors are saying they cannot invest blind on ESG, they need to understand and price related risks. They must fully understand ESG criteria to satisfy their endinvestors who are under growing scrutiny from stakeholders on ESG. Companies that don’t disclose the ESG data required by investors run a risk of restricting their market access and impacting the price of their debt; conversely companies who take control of their ESG narrative will benefit on pricing and access to capital. ELFA has been active in developing ESG tools to help managers and we are moving towards an industry-wide initiative on transparency in early 2023. It will also be interesting to watch when and if ESG ratings agencies become regulated.
Last and no longer least is diversity. We heard a compelling case at the conference for creating diversity of teams to fuel diversity of thought that can reflect the diversification of geographies, strategies, assets and people happening amongst corporates and investors. Different voices, perspectives and cultures are vital for institutions and companies to survive and thrive. Further, there’s less loyalty from young people to employers these days and they are less likely to stick around if they disagree with values and behaviours so it’s important to give people the space to be themselves and contribute. ELFA is supporting undergraduates and graduates from non-target universities in their pursuit of a career in credit through access to CV and interview training programmes, and we will continue to raise awareness about the importance of truly inclusive work environments over the coming years.