Europe’s private debt markets are seeing heightened levels of emerging markets activity. India’s Reliance Industries raised a €405m Schuldschein earlier this year, while CEE borrowers have also entered the market in recent years — particularly from the Czech Republic and Hungary. In addition, Etihad Airways became the sector’s first Middle Eastern borrower.
But a broader push is also under way. EM-focused private credit vehicles raised $9.4bn in 2018, according to the Emerging Markets Private Equity Association (EMPEA), the highest level it has recorded since the inception of its data programme in 2006.
More than 50 EM funds closed last year, EMPEA reports, up from 14 in 2008.
Battling the banks
“A typical source of financing for most borrowers is the local banks, though we are making inroads and showing corporates why we are a better solution than banks in some cases, primarily because of our flexibility in structuring deals that may be more suited for direct lending instead of bank financing,” says Jaime Prieto, founding partner at Kartesia, a specialist direct lender with a particular interest in central and Eastern Europe and based in London.
“For example, with us, borrowers may pay less amortisation every year,” he says. “They may have a more flexible cash coupon so they could get equity upside, as opposed to having everything as a contractual return.”
The funds aim for a 12%-13% return. This is far higher than they would expect in western Europe. In addition, terms may also be an incentive. Fierce competition in western Europe has weakened financial covenants and tightened pricing. There is little sign of either trend in EM yet.
Traditional lenders claim to be unconcerned about the prospect of competition from private credit. “We see increased activity by non-bank investors across EM in various sectors, but it’s still a fraction of overall loan volumes,” notes Ben Constable, director, head of loan syndication distribution, Europe, Africa and Americas at Standard Chartered in London.
“Many funds are unfamiliar with loan formats and may be prevented from investing in loan format. Further hurdles for non-bank investors include lack of secondary liquidity, limited two-way markets and pre-payment protections.”
“For most IG credits that gather strong traditional bank appetite, there is simply no space for anyone else to enter,” adds Rizwan Sheikh, co-head of loan syndication EMEA at Citi in London. “Funds will operate in less crowded spaces, in structured finance or leveraged situations.”
New financing models
The appearance of private equity players in some EM sectors has led some to anticipate new financing models. For example, Abu Dhabi National Oil Company (Adnoc) signed a $4bn pipeline partnership with BlackRock and KKR that provided the firms a stake in Adnoc Oil Pipelines that Adnoc will repay via tariff over 23 years. Some $3.275bn of the total was funded via a syndicated loan.
This combination of private equity and bank financing could lead to similar infrastructure-based partnerships, some argue.
“This could be a very good business model for similar entities in the Middle East, allowing them to attract infrastructure equity investors to stable businesses in order to raise cash. It could also lead to non-bank debt investors expressing more interest for these sorts of loans in due course,” says Zvi Wohlgemuth, head of project, asset financing and emerging markets syndicate EMEA at Société Générale in London. “We could see a lot more deals like this, but it will take time.”
‘Specific structure’
Nonetheless, the link between PE and private credit may not be direct. Adnoc, one of the stronger credits in the Middle East, is sceptical about private debt despite the success of its PE deal.
“When it comes to borrowing, we would not use private equity or private debt funds. Private credit providers are typically more expensive than bank credit, so it only makes sense to use private equity or institutional money for equity financing in the type of structure we have with BlackRock and KKR,” says Michele Fiorentino, chief investment officer at Adnoc in Abu Dhabi.
“It is difficult to see how private debt can be more attractive or pricing more competitive than bank lending or capital markets. This only happens when there is a specific structure with a clear risk transfer. Then, some private credit institutions may be better placed to manage the risk transferred than banks or capital markets.” GC