With a host of restructurings taking place last year, law firms were never without work. But there are signs that the era of refinancing and workouts is now over. Helen Castell reports.
Law firms thrive on upheaval, and many trade finance lawyers have never found themselves more in demand than over the course of the last 12 months.
“It was actually a very good year,” says Geoffrey Wynne, partner at Denton Wilde Sapte (DWS) in London. According to Wynne, if financiers chose their deals carefully, they were rewarded with good margins in secure transactions, and did “rather well”. Wynne notes that for law firms, “there are still some workouts and enforcements but there is more new business around. We’ve got many more new deals”.
The financial crisis has raised the profile of lawyers in trade finance, with banks now requiring a long list of legal opinions for deals that involve multi-borrowers or that cross borders, says Robert Parson, partner at Reed Smith in London. “There is real reverence being shown to in-house legal departments at banks,” explains Parson, adding that because they are over-run, more work is being farmed out to external firms.
“It’s been a busy year for us,” says Andrew Gamble, partner at Lovells in London. Lack of liquidity, especially in the secondary market, has forced many companies to roll over existing debt rather than raise fresh financing, he notes. However, “there have been some big new deals out there”.
“We’ve been extremely busy – probably busier than any of us can remember,” says Celia Gardiner, partner at Watson, Farley & Williams (WFW) in London. And on top of restructurings, the firm is seeing a lot of new lending, primarily from banks to big traders.
Trade finance lawyers, especially those with ECA experience, are more in demand now that borrowers are turning to trade structures to tap liquidity that is not necessarily available elsewhere, says Michael Foundethakis, partner at Baker & McKenzie in Munich.
On the litigation side too, liquidity issues have triggered a “massive amount” of lawsuits and there remains a “long line of disputes waiting to be resolved before various arbitration tribunals”, says Michael Sullivan, attorney at law at Sullivan & Worcester in New York.
New business streams
Restructurings have proved to be the life blood of transactional lawyers since the financial crisis slammed the lid on new lending. And although big, messy workouts could take much longer to wind up, new business is finally being signed, albeit with tighter structures and largely top-table borrowers.
At Ramos e Zuanon Advogados in Sao Paolo for example, 80% of the deals on partner Christian de Lima Ramos’s desk are new business and just 20% restructurings.
Brazil is attracting a lot of interest in the international market, mainly for its agri-business and soft commodities, but also oil and gas, says WFW’s Gardiner. “They’ve consolidated their position quite effectively over the last few years.”
Rising commodity prices have triggered the re-emergence of pre-export financings in Brazil, although borrowers are paying as much as 200 basis points more, tenors are shorter and amortisation requirements are heavier, says Michael Bassett, partner at Linklaters in New York. “We’ve seen more highly structured deals for smaller, less credit-worthy suppliers, sometimes involving credit support from their large trading company customers.”
Local products like advance on foreign exchange contracts (ACCs) and bank credit certificates (CCBs)are increasingly being used by local branches of foreign banks as well.
The key benefits of ACCs are that they are the first credit to be repaid if a borrower goes broke. Also, as with CCBs, the documentation is simple, well-tested and often quicker to put in place than international alternatives.
In Brazil, even acquisitions are being structured as trade. By using export receivables from the target company to pay down the acquisition finance, the buying company can take advantage of the tax benefit offered to trade deals in Brazil as well as enjoy a natural currency hedge.
Russia has remained a strong market for Lovells, with November 2009’s Novolipetsk Steel financing of particular note. The €524mn club deal financed the purchase of imported equipment under 19 commercial agreements from seven European engineering firms with coverage from four ECAs.
The deal reflected market trends where large corporates have opted for ECA or trade finance-related financing, in the absence of other forms of liquidity.
ECAs have been particularly active in China, with Sinosure providing US$116.6bn of credit insurance and guarantee business in 2009, up 85.8% year-on-year, notes Trevor Clark, partner at Linklaters in Hong Kong. China Exim approved CNY801.1bn (US$117.35bn) of loans in 2009, an increase of CNY398.7bn (US$58.37bn) on 2008.
Turkey is one country benefiting from a more active China, with more outward bound financings by PRC banks, says James Douglass, co-head of the Linklater’s Turkey desk in London. Linklaters is advising Chinese banks on a Sinosure-backed facility to part-finance a power plant in Turkey being built by a Chinese contractor with a total project cost of US$1.35bn.
In Kazakhstan too, Chinese investment is notable, says Mirthe van Kesteren, co-head of Linklaters’ Kazakhstan and Ukraine desks in London. One example is the US$2.7bn financing from China Development Corporation to Kazakhmys through Samruk-Kazyna.
The completion of a US$900mn syndicated pre-export deal for Egyptian General Petroleum Corporation (EGPC) in October proved to be a turning point for Reed Smith. With more than US$500mn oversubscribed, this “beacon deal signalled the re-emergence of the syndication market after a virtually year-long hibernation”, comments Robert Parson, partner at the firm. New deals now account for 100% of Parson’s workload, compared with 30-40% a year ago.
A “have and have not” divide has emerged between trade borrowers amid a flight to quality for what liquidity there is. Borrowers at the bottom end of the market are being squeezed down to a handful of financiers, pushing up pricing considerably. In contrast, top-end borrowers that can provide attractive structures and reduce capital-weighting costs for banks are in a position to strike some good deals.
Part of the funding gap suffered by lower-end trade borrowers is being plugged by big commodity traders who are more willing than banks – from whom they themselves have borrowed at attractive rates – to stomach the risk of lending on to smaller corporates.
Commodity traders “made that market their own when banks stopped lending and they were the only show in town”, notes Parson.
A combination of general risk aversion but stiff competition to finance top-table borrowers has polarised the way deals are structured. For mid-market borrowers, banks are tying up structures tightly, using hard asset security and other back-ups like mortgages. “This is a very good thing,” says Amy Dulin, partner at Hughes Hubbard & Reed in Miami.
For investment-grade companies, there are less restrictive measures being implemented, as banks compete to get top-tier credits on their books.
Ownership-based structures are finding favour with banks, because finally “they are worth the effort”, says David Lacey, partner at Stephenson Harwood in London. “You often get a better capital adequacy treatment if you can say you own the assets.”
As trade finance structures gain popularity outside their traditional context, invoice discounting has also benefited, he says. Previously seen as the finance of last resort, it has now entered the mainstream.
Last year was certainly big for restructurings, many of which are still in progress. One of the first major financial restructurings out of Russia was of steel giant Mechel, which completed mid-2009. As the first successful restructuring of internationally syndicated debt by a major Russian corporate since the credit crisis began, it showed that a major financial restructuring could be done, and could in fact be done in a realistically short time-frame, says Christopher Czarnocki, partner at Gide Loyrette Nouel in London.
Most financial restructurings have been on a consensual basis, with lenders taking a long-term view on recovery. “They would rather see things to their conclusion in the mid to long term, and recover most or all of their investment, than push the borrower over the brink and potentially only recover a portion of investment from any enforcement action,” comments Czarnocki.
A sea-change in the trade investor base has, however, changed the dynamics of many restructurings since the last financial crisis. Secondary-market sales, either direct or via CDSs, now mean that when a restructuring occurs, the existing lender pool can be very different from the original one.
“It’s like musical chairs – when the music stops, it freezes who’s left holding things,” Dulin at Hughes Hubbard & Reed notes. “And in this market it’s more often than not that the sellers of CDS protection have ended up in the roles of work-out people.”
In contrast with traditional bank lenders who typically take a longer-term view on debt recovery, today’s hedge fund investors tend to seek shorter-term gain, she notes. Although the CDS market “generally serves a very good purpose”, and conflict of interest “creates tension in determining the best restructuring format”.
The biggest restructuring story of the year was undoubtedly Kazakhstan. With the workout of banking giants BTA and Alliance, the trade community has anxiously monitored whether trade finance debt would receive its usual – but unwritten – preferential treatment.
With Alliance, “a certain defined category of trade finance debt was given priority and will be paid in full”, says Wynne at DWS, who advised the steering committee and helped craft the definition of trade finance used in the restructuring.
However, the fact that investors had to fight for trade finance’s special status will remind them of how tenuous it actually is.
“What this concentrates the mind on is that if you want priority for your debt, structure it in a way that you have priority,” says Wynne. “Don’t rely on the fact that somebody is prepared to grant you that voluntarily.”
While the Kazakh restructurings show there’s a will to look after trade finance in some way, the issue of what constitutes trade finance is difficult – and tends to be defined differently for every workout.
As the first successful restructuring of a Ukrainian bank’s international loan portfolio since the financial crisis, First Ukrainian International Bank (FUIB) is considered a benchmark deal, says Foundethakis at Baker & McKenzie, who represented the lenders’ steering committee on the workout.
Pure trade finance debt did win preferential treatment in this restructuring, in line with common practice. This was a result of trade finance being treated as the lifeblood of international commerce – and hence important to Ukraine’s economy – but is something that cannot be taken for granted.
The FUIB restructuring shows that pure trade is generally retaining its special status, but it must be remembered that “an unsecured trade creditor is legally just as exposed as any other unsecured creditor”, Foundethakis cautions.
It is also too early to know how trade debt will fare in the Ukraine’s other big bank restructurings. “Every bank is different – there is no cookie-cutter approach,” Foundethakis notes.
Litigation is to some extent a choice, and at the height of the financial crisis when corporates were tighter with cash, activity was slow at some law firms. Since then, however, litigation appears to have rebounded more quickly than pure transactional work.
New litigation cases continue to pop up as the shock waves of the credit crunch filter through, says Charles Williams, partner at Thomas Cooper in London. “Companies that didn’t go down straight away are now beginning to wobble as there’s much less credit available.”
The lack of liquidity has also laid bare deeper problems. “It’s much easier to hide things when there’s money flowing around the system,” Williams notes.
Some syndicated structures have also proved more difficult to litigate. “If you’ve got a deal which has a variety of securities, a number of parties and often guarantees as well, then you’re looking at a variety of scenarios,” Williams says. “The more complex the deal, the more difficult it is to unravel.”
The private trade credit insurance market is another relation to trade finance that has found the recent meltdown unlike former financial crises.
Most of the tsunami of claims hitting the market this time round come from banks – markedly different from previous downturns when trading companies were the typical insureds, says Tony George, partner at Ince & Co in London.
Many banks are struggling to navigate a market that they still have little experience of and which operates in subtly different ways from their own. Moreover, employment volatility at banks means that the person who buys the insurance is rarely the person responsible for claiming if things go wrong, he notes.
Some of the stumbling blocks hit by banks include failing to understand the different interpretation used in insurance of terms like ‘waiting period’ or ‘due diligence’, plus inaccurate or tardy reporting of deal terms when they are renegotiated. Mistakes like this can lead to delay in settlement or even escalate into disputes.
Important regulatory and legal changes have occurred in a number of countries, most notably China and Russia.
Amendments to the Russian pledge law – which came into effect in early 2009 applies to a variety of assets including commodities and receivables – significantly broaden the scope of enforcement options available to secured creditors in relation to out-of-court attachment and disposal of pledged assets, says Dmitry Suschev, partner at Linklaters in Moscow.
In late 2009, the Moscow state commercial court also issued a number of rulings recognising the unilateral right of finance parties under a loan agreement to initiate proceedings against borrowers in a Russian court, even if the borrower has already applied for international arbitration.
Although Russian courts are not obliged to recognise and enforce foreign court judgements, there has been at least one precedent in the past year where Russia’s highest state commercial court ruled that a foreign judgement – in that instance from a Dutch court – can still be recognised and enforced in the country on the basic principles of public international law.
Chinese law brought itself into line with other major civil law countries with the introduction in May 2009 of a hardship provision that allows for contracts to be changed or terminated if previously unforeseen events mean continuation of the contract in its current form causes “obvious unfairness” to one party, says Peter Murray, partner at Ince & Co in Shanghai.
“With Chinese law being accepted increasingly as the governing law of commercial contracts, it will be interesting to see how this provision is applied in the future.”
DLA Piper is meanwhile monitoring a UK private members’ bill aimed at limiting the ability of vulture funds to profit from the purchase and recovery of distressed heavily indebted poor countries debt. The bill could have had repercussions on wider debt markets but as of March appeared to be “dead in the water” following opposition from the country’s Conservative Party, says James Willcock at DLA Piper in London.
The biggest issue facing trade banks, however, continues to be capital adequacy, as banks anticipate a toughened up Basel III by 2012.
The current Basel II is already unpopular in the trade community, failing as it does to reward the lower-risk nature of trade debt with proportionately lighter capital adequacy requirements.
Part of the problem is that Basel II uses a one-year assumed maturity for capital adequacy calculations, whereas trade finance lending typically has a 90 to 180 day – and hence lower risk – maturity. While there’s some discretion available for financial regulators to waive that, not everybody does.
Trade lenders are already lobbying the Basel committee to win more lenient terms for trade under Basel III.
However, while “it obviously wasn’t trade finance that brought the markets down”, notes WFW’s Gardiner, “now is not really the time politically-speaking for banks to lobby for more lenience”.
As 2010 gets into full swing, what lessons has the trade community learned from the financial crisis?
Lawyers now have a better understanding of the strengths and weaknesses of trade products – many of which were relatively new – and can apply those lessons to current deals and structures.
The economic downturn has encouraged banks to look again – even at standard documentation for plain vanilla products like LCs and trust receipts, aiming to make them water-tight.
Examples of their more rigorous approach to legal detail include the pursuit of stronger rights in the event of insolvency and on the enforceability of security, particularly for goods in transit.
Standard documentation reflects a new awareness of risk.
“Five years ago, if you said you wanted to put in clauses that deal with what happens if one of the lenders goes broke, or the agent defaults, people would have laughed at you,” notes Stephenson Harwood’s Lacey. “Now, the Loan Market Association has published a set of standard clauses dealing with exactly that.”
Bankers have now become aware of those risks that people thought weren’t a risk. GTR