Research Trends and Conclusions: Capital Markets 2009
Tom Barnes -
It is perhaps no exaggeration to say that of all 30 areas of commercial law covered in our publications, none has been so badly affected by the global recession as capital markets.
The story that has emerged from our research stands in stark contrast with that of the last edition in 2007, when lawyers in this field were among the busiest of all practitioners. Now in the face of the economic downturn the picture has changed across the board, with certain types of work now almost completely absent and lawyers and their firms quickly adapting their practices to survive. Lawyers are refocusing their expertise in new areas, learning innovative techniques and changing to meet the demands of their local markets. While recent events have proved the folly of trying to predict too far ahead, these leading practitioners are in the unenviable position of having to identify which areas are likely to recover and aiming to position themselves in what will inevitably emerge a much changed marketplace.
CURRENT STATE
In the words of Boyan Wells, former head of Allen & Overy LLP's global international capital markets group and now a member of the global board, it is "amazing how suddenly it kicked in". Across Europe and the US the years leading up to 2008 had seen incredible levels of activity, levels that had been progressing on an upwards trajectory. Ian Tokley of Kromann Reumert in Denmark described 2008, at least in its early stages, as the "busiest out of four very good years". Firms were looking to expand their capital markets practices, both numerically and geographically, and huge sums of money were being generated. That all changed in a matter of months, and in contrast 2009 is a "silent time for capital markets" according to Jan Waselius of Waselius & Wist in Finland. In this and all other sectors, the world is facing the reality of a steep economic downturn and a potential future of a long-term economic depression.
Historically, the debt market at least has not been particularly cyclical; a relatively constant level of deals and consequent refinancings meaning the sector was less volatile. This has now changed. The current downturn differs from its recent predecessors in that it has infected the whole financial system; it is both globalised and systemic. A pattern has emerged whereby insolvencies that began in the financial sector - Lehman Brothers, Bear Stearns and Iceland's Landsbanki spring to mind - have now moved into the corporate sphere with household names and high-street chains going under. These inhospitable trading conditions continue, and, as numerous commentators have identified, the market is unlikely to improve until the expectations of buyers and sellers fall into line. In the words of Clifford Chance's Peter Voisey, "There are issuers out there, and investors. However, the investors are bruised and demand prices that the issuers won't offer. Until that gap is closed the deal flow will remain more or less closed, and banks will have to continue to provide liquidity."
The downturn has had a huge effect on many of the types of work that had previously been so active. The crippling lack of liquidity has taken its toll, and in many areas the buyers have simply dried up. IPOs have dropped sharply, with PricewaterhouseCoopers reporting a five year low in activity and a 58 percent drop in European IPOs in 2008 compared with the year before, while total offering value in 2008 was down a massive 82 percent on the in the previous year. As Richard Weaver, partner in its capital markets group, noted of the last quarter of 2008, "There were only two transactions of any note ... Had it not been for those transactions, the IPO market would have been effectively closed for business last quarter." The picture in the US was similarly grim, with the US exchanges likewise experiencing a huge decline in IPO activity.
The derivatives market has been the subject of a great deal of criticism for its perceived role in the financial crisis. Wells suggests that perhaps certain instruments became too complicated and he queries whether the risks of such complicated instruments were fully understood and identifies a distinct possibility that, unfortunately, derivatives generally could become tainted by recent events. Wells believes that there needs to be a wide recognition among regulators and market participants that derivatives are an essential and integral part of treasury management and general financial engineering including managing risk but, like all complex instruments, they need to be used properly with the risks fully understood. While hedge funds are still seen by some as "terrific clients" and a source of business, the sector as a whole has been the target of negative press, and David Galainena of Winston & Strawn sums up a general feeling that "structured finance went too far".
NEW AREAS OF PRACTICE
These seismic changes in the world economy are taking a corresponding toll on the providers of legal services. Leading capital markets lawyers across the globe are being forced to adapt their practices. In jurisdictions where exclusive specialisation in capital markets work was previously impossible this can prove less traumatic, with individuals able to refocus their practice in relation to shifts in the volume of work, for instance with a greater concentration on M&A or other types of deal. In addition, lawyers and their firms are emphasising other areas of their expertise to tide them over until deal levels pick up again, and many are finding that their clients are calling on them to provide new services. Breadth of practice is proving important for law firms, for when certain types of work dry up specialists in those fields can be left in a perilous situation.
The current situation has meant lawyers have shifted from doing "new listing work for new clients to ongoing work for listed clients", in the words of one lawyer we spoke to. The consolidation in certain sections of the market can provide public takeover M&A work for lawyers, as do the capital markets components of M&A deals, especially in the US. In addition, as governments react to the fallout of recent events, regulation and compliance move further up the agenda. European regulatory codes have also recently got tougher and April's G20 summit pledged to make them even more so.
Recent legislation changes in areas such as South America are being matched in Europe; Andreas von Planta of Lenz & Staehelin highlights the planned total amendment of the listing regulations of the Swiss Stock Exchange and suggests that trading in Swiss blue-chip companies will move from the UK back to Switzerland. Clients are relying on their capital markets counsel to keep them abreast of, and in line with, these ongoing developments as well as for other related work; Richard Mann of Gross Kleinhendler Hodak Halevy Greenberg & Co in Israel suggests that regulatory and investigatory matters have replaced IPO work to a large extent, and as the valuation of companies goes down many risk losing their qualification for public listing. "Time and energy that would previously have been dedicated to raising new capital in the public markets is now being used for these matters, as well as to ongoing reporting requirements."
Indeed, many of the experts we surveyed reported how these straitened times are improving their relations with their clients. Some have found that they are now dealing directly with CFOs and the most senior figures at the company, rather than the general counsel, reflecting the level of importance these matters have assumed for the future of their clients. Firms are now positioning themselves as general corporate advisers, rather than specifically equity counsel, and "now more than ever" are making further increased efforts to stay close to clients, helping them with research and development, to identify new products and in other new sectors. These efforts are appreciated - Christoph Wolf, executive director at Morgan Stanley Bank in Frankfurt, relies on his outside counsel for market intelligence and remains in a constant dialogue with them, asking for ideas. He sees no variation in quality of service in a downturn, in fact he finds firms "even more responsive".
RESTRUCTURING
As circumstances change, the restructuring and renegotiation of existing deals is providing a valuable revenue stream for corporate firms. Sanjev Warna-kula-suriya of Slaughter and May in London has seen an increase across the board, noting that "many deals have broken or are close to breaking their triggers and need restructuring" and many further deals are due for renewal this year.
Elsewhere, for many firms the leverage practice becomes a restructuring practice in a downturn, "it's much the same techniques, albeit for considerably more unhappy clients" a source says, and this pattern was repeated internationally in the course of our research.
In addition, some former clients continue to provide work, albeit of a different kind. Despite its bankruptcy, Lehman Brothers is still proving a valuable source of business with several firms working out existing deals and assets. While this work is short-term, other banks are trying to learn the lessons from the issues faced by those that failed, for instance in relation to the difficulty others have found in retrieving assets, and are applying it to their own existing deals, which in turn leads to further restructuring work for their counsel. It is a "complete review and revision of how things were" in the words of one source.
GOVERNMENT LOANS
The scale and depth of the banking crisis has necessitated the involvement of central banks to help alleviate the situation and try to reintroduce liquidity in the markets. Governments have dealt with the crisis in a variety of ways, which in turn requires innovative techniques from law firms. Those lawyers with banking clients are finding themselves particularly busy in this area, with loan eligibility work in relation to the European Central Bank, and the Federal Reserve and numerous other central banks brought to the fore. In some cases, national governments and the ECB are the only sources of liquidity available - in the UK alone the banks have borrowed a total of £185 billion from the Bank of England in just nine months under the Special Liquidity Scheme - so law firms are increasingly being called on to assist their clients in this sector. This has led to record levels of securitisation activity; the Daily Telegraph reported that the volume of UK securitisation in 2008 was almost double the €130 billion issuance in 2007 and €123 billion in 2006, both of which were record years. Similarly, across Europe issuance jumped from €521 billion in 2007 to €750 billion, but significantly only a very small fraction was actually placed in the market.
Sanjev Warna-kula-suriya, whose firm has seen high levels of activity from clients such as the UK Treasury in recent months, predicts that "central bank funding will probably need to continue until the market opens up", although at the same time others warn that "this kind of work cannot last forever". Will this current work tide firms over until the market picks up again? "Good question," says Peter Voisey of Clifford Chance in London, "but I expect so".
PREDICTIONS
What does the future hold in this sector? According to ratings agency Standard & Poor's, US financial and non-financial firms are facing $794 billion in debt maturities they will potentially need to refinance over the next 15 months, and other countries are facing similarly elevated levels. Some way will have to be found to make this happen to avoid economic catastrophe, and it is, in the words of Boyan Wells, "a strong incentive for deals to get done". He continues, "there will be new deals or there will be insolvencies - there can't be nothing - although which it will be is unresolved at the moment." In general terms, the status quo is untenable. It is generally expected that rights offerings will continue, as financial institutions and others need capital, and with interest rates hovering around zero new forms of investment have to be found. Tom Troubridge, head of the capital markets group at PricewaterhouseCoopers LLP, believes that "capital raising in 2009 is almost certainly going to be dominated by secondary offerings, as companies look to rebuild their balance sheets and reach out to their existing investors with rights issues. This means there will simply not be enough money for significant IPO investments." Warna-kula-suriya suggests that insurance and pension related structured products might be the first to pick up, although in his view "the world of structured credit is going to be very different going forward with some products suffering terminal damage."
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The world's leading capital markets lawyers are currently living through the proverbial "interesting times". Traditionally profitable areas and skill sets have now been rendered obsolete, for the moment at least. The market is changing in an unprecedented fashion, in terms of speed, geographical breadth and depth of impact. The majority of analysts failed to predict the crisis, and it is similarly difficult to see an end to it with any accuracy. While several sources we spoke to identified the last quarter of 2009 as a likely date for a potential upturn in fortunes, opinion was divided as to how quickly any turnabout would come. Some see the emerging markets - hugely active before the downturn - as likely to be the first to pick up, while others see them lagging behind the curve. Some factors will take years to make themselves felt; one lawyer pointed out that a sustained lack of deals can lead to firms suffering a "generation gap" in relation to new associates. In summary, the one thing that is certain is that the innovation and creativity that the world's leading lawyers have demonstrated in dealing with the crisis thus far will have to be matched in years to come.