Private placements may have the potential to offer investment opportunities for long-term investors and to broaden financing options for small and medium-sized enterprises (SMEs). While the Action Plan for Capital Markets Union (CMU) acknowledged the potential for growth in European private placements, it also identified a lack of standardised processes and documentation as barriers to further development.
Key aims of CMU are the elimination of barriers to cross-border investments and reduction in the cost of funding. It is expected that the European Commission’s efforts in this area will include a focus on the tax and regulatory barriers to cross-border private placements. In addition, the focus on SME start-up and venture capital funding may compliment these efforts to promote private placements in those sectors.
Changes to the prospectus regime
A clear advantage to private placements is that they avoid the need for a prospectus and ongoing disclosure requirements that accompany public offers. As a result, private placements often have a short turnaround time and are less costly to set up.
On July 20, 2017 the new Prospectus Regulation (EU) 2017/1129 (PR) came into force. The bulk of its provisions will apply from July 21, 2019, after which time the existing Prospectus Directive (PD) regime will cease to have effect.
The PR will keep a number of the PD’s exemptions from what constitutes an “offer to the public”, therefore keeping the following safe harbours from the “public offer” prospectus requirement:
- issues with denominations of at least €100,000 (or equivalent)
- issues of debt securities solely to qualified investors
- issues to fewer than 150 non-qualified investors
- issues with a minimum commitment of €100,000 per investor.
Currently under the PD, issues of securities fall outside the legislation altogether where the total consideration in the EU is less than €5 million (calculated over 12 months). The minimum issuance carve-out has been retained in the new rules, albeit at a lower threshold of €1 million (calculated over 12 months).
Member States will have the discretion to exempt from the prospectus requirement (or instead impose minimum disclosure requirements on) domestic issues of securities with total consideration over 12 months of up to €8 million (up from €5 million). Under this approach, the threshold at which an issue requires a prospectus or other disclosure document depends on whether the issue is cross border or, if domestic, in which jurisdiction, since the threshold will vary according to national law. This perpetuates the very fragmentation that this redrafting exercise seeks to avoid.
Addressing the fragmented market for private placements
Tax treatment is often a significant consideration in deal structuring, and withholding tax is an important driver. In addition, transfers of debt securities may attract stamp duty. The applicability of withholding tax on bond payments may depend on the location of the issuer and investors, and availability of exemptions. Tax treatment of private placements is determined largely along national lines, and as a result the European market for private placements remains fragmented.
In some Member States, there may be exemptions available. For example, on January 1, 2016 a “qualifying private placement exemption” took effect in the United Kingdom. The UK generally imposes a 20 per cent withholding tax on payments of interest made by a UK borrower where that interest has a UK source (and some foreign borrowers where the interest has a UK source). The qualifying private placement exemption allows UK corporate borrowers to pay interest gross on a cross-border basis, provided that certain conditions are met. First, the interest must be in respect of a privately placed debt security (i.e. a bond), that is not listed on a recognized stock exchange. Secondly, the securities must:
- have maturities not exceeding 50 years
- have a minimum value of £10 million at the time they are issued, and
- be issued for genuine commercial reasons and not as part of a tax advantage scheme.
In addition, certain formalities must be met, such as requiring the issuer hold a “creditor certificate” for each investor setting out information relating to the investor’s residency and beneficial interest in the securities.
The Commission recognizes that tax is an area to be explored to find ways of addressing barriers in respect of withholding tax procedures for example, or problems of double taxation. National divergences in the treatment of withholding tax have been identified as a potential obstacle to the development of a deeper cross-border market for private placements.
Collaboration with the private sector
To a certain extent, the perceived lack of standardised processes and documentation has been addressed by the private sector. A number of industry bodies have published industry market guides and standard form bond documentation, adapted for use in pan-European private placement (PEPP) transactions. While this has occurred independently of any public sector initiatives, the Commission applauds the efforts of private industry, and considers their efforts to fall under the CMU umbrella.
The use of standard form documentation has been partly credited with the success of the US non-bank lending market. In order to reduce barriers to non-bank lending in the Europe, the Loan Market Association (LMA) in early 2015 published standard form bond documentation adapted for use in pan-European private placement (PEPP) transactions. The LMA PEPP documentation is intended to be used for corporate lending to investment grade issuers on a guaranteed and unsecured basis.
In France, the French Euro Private Placement Working Group (including Banque de France, the French Treasury and the Paris IDF Chamber of Commerce and Industry) has also recently issued standard form PEPP bond documentation agreement governed by French law.
In Germany, the German insurance industry worked with BaFiN to develop a standardised regime for German Schuldscheine (private placements), to enable insurers to better assess credit and compliance risk relating to Schuldscheine. Standardised PEPP and Schuldscheine processes and documentation provide a useful framework and are positive steps towards promoting private placements to the widest possible investor base across a large geographic area.
In addition, the International Capital Markets Association (ICMA) collaborated with major institutional investors, international banks and key industry bodies to produce the European Corporate Debt Private Placement Market Guide, which is generating interest in the European private placement market.
Will it work?
In December 2017, the Commission published its study “Identifying market and regulatory obstacles to the development of private placement of debt in the EU”, which assessed the growth potential of private placement markets in the EU, potential regulatory obstacles to further development, and the effectiveness of CMU initiatives aimed at promoting private placements as a funding tool.
The Commission recognised that not all European private placement markets have fully realised their potential, with a disparity between old and new Member States and a large gap in the depth and size of the private placement market when compared to markets in the US. The study noted significant increases in issue volumes came from the German Schuldscheine market, which is largely loan-based, and the French “Euro-PP” market. However, private placements in Germany and France were typically limited to companies with annual turnover of between €75 million and €5 billion, and a strong credit rating. The study identified Spain, Italy and the Netherlands as having the most potential, as they have undertaken the first steps towards preparing their domestic markets for growth in private placements.
According to the Commission, market participants who responded to the study did not see any significant regulatory obstacles specific to the development of such private placement markets. Rather, in each of these markets, the potential obstacles typically identified were those which also affect the bond markets as a whole, although such obstacles can comprise a bigger challenge for the SMEs looking to tap such markets.
While the Commission identified CMU initiatives such as document standardisation and tax exemptions as important drivers for the development of private placement markets, it acknowledged that they have not gained traction evenly across the EU. The Commission’s study also failed to measure how effective each individual measure has been in markets in which they were adopted. Crucially, the Commission concluded that there was no immediate need for further regulatory or legislative actions. Perhaps after a period of regulatory stability, the Commission will be better placed to assess the effectiveness of CMU on European private placements.