Mainland Europe has still not recovered from the global financial crisis. Although the Eurozone’s economies grew by 0.3% in Q4/14, which was higher than expected, expansion was largely driven by stronger growth in Germany and Spain — both 0.7%. Moreover, this growth pales beside GDP growth of 2.2% in the U.S. While optimism increases about the Eurozone’s future, its growth rates are forecast to be low for 2015 and 2016 — 1.5% and 1.9%, according to the European Central Bank. At the same time, U.S. GDP is forecast to grow by 3% in 2015, alone, according to a survey of economists by the Wall Street Journal in January 2015, despite reports of a disappointing 0.2% expansion in Q1/15.
One of the biggest problems for the Eurozone is the low level of bank lending. For Europe’s banks, replenishing their capital reserves has become a top priority, resulting in constrained and cautious capacity for lending. The quantitative easing announced by the European Central Bank earlier this year will take time to feed into the banking sector. Outside the Eurozone, the UK is recovering but even there, bank lending is not providing sufficient working capital for companies to grow, especially the small to medium-sized enterprises. So could asset-based lending be a catalyst for economic recovery in Europe?
ABL and Alternative Finance
Although alternative forms of finance have become more widespread in Europe over the last 10 years, most of the growth has been confined to factoring and invoice discounting. Asset-based lending is lesser known. It has a variety of meanings depending on whom you talk to, and is not well-understood. In the UK, where it was first introduced into Europe, asset-based lending has tended to cover receivables finance with some inventory tacked on, or focused on physical assets such as property plant and equipment.
Few financial institutions have developed a platform to provide an asset-based lending facility including receivables and fixed assets. However, this scenario has begun to change, as more companies wake up to the possibilities of full asset-based finance as it is practiced in North America. In the rest of Europe, it is still a relatively new concept because it is not a resource that is commonly used.
Interest in all forms of alternative finance in the Eurozone has been increasing over the last two years, primarily from financial institutions and corporate entities. The sectors of this market seeing the biggest growth are the securitization of receivables and asset-based lending.
Asset-based lending has caught the attention of banks and non-banks, and there is a growing trend for these institutions to work together. For some banks, especially those in the UK, the primary motivating factor is retention of clients. The UK market has become so congested that anything offering the prospect of client retention or client capture is invaluable. For other banks, the allure of asset-based lending stems from the lack of interference with Basel agreement compliance. As banks look to convert overdrafts and unsecured cash-flow loans to more secured facilities, their development of asset-based lending products will ramp up.
For non-banks and their investors, interest in asset-based lending has skyrocketed. The increasing participation of hedge funds in this market has become a key factor in its growth. In funds’ search for yield, asset-based lending is now firmly in their sights, as a way to increase returns. Whether the funds are hiring personnel to set up new lending arms or buying whole lenders as a ready-made offering, they cannot be ignored in this market. Their appetite to lend is strong and, with cheaper money behind them, they can be very competitive.
Many companies in the Eurozone are stifled by a lack of working capital. Access to asset- based finance would mean more businesses could leverage their assets — including intellectual assets — to find greater liquidity, and ultimately, growth.
While there is a wealth of opportunity for asset-based lenders in Europe, considerable challenges exist. Five key hurdles include:
1) The need to understand how to secure a lien in foreign jurisdictions
2) The multi-jurisdictional nature of many European businesses, and associated variations in security laws
3) Educating companies about the product; companies will not utilize a form of financing they do not fully understand
4) Size constraints since asset-based lending is usually only available on the larger deals, typically those north of €20 million
5) Competition from other alternative sources of finance, such as the private equity market
Understanding the necessary legal structures and procedures to conduct asset-based lending are the most time-consuming challenges to deal with. Having good lawyers on your side is indispensable for those operating in the European asset-based lending market. Even lenders with in-house lawyers turn to expert lawyers in the field for advice, given the complexity of commercial law across Europe.
Differences Across the Pond
The biggest difference between structuring asset-based lending in Europe and the U.S. is the concept of a blanket lien. This is more developed and available in the U.S. and UK. However in Europe it is more difficult and sometimes not possible to have a blanket lien against the assets. In these circumstances, the lender will ask that the account stay in the name of the borrower but be assigned to the lender, so that funds falling outside of the lending agreement cannot be touched or moved without meeting certain stipulations. This is known as a “blocked agreement.” This kind of agreement is standard in the U.S. market and some others, but it is not so elsewhere, especially in many European countries. As such, European banks have to become comfortable with such agreements and in getting them approved.
There’s a major difference between U.S. and UK commercial law and what is practiced in most of Europe when it comes to security. Under U.S. and UK law, security can be taken on floating — as well as fixed — assets whereas in much of Continental law, only fixed assets can be secured. This can become a problem when inventory will form a major part of an asset-based package. Determining the legal owner of inventory can also pose challenges because it may not be clear whether the company that possesses the inventory owns it if the inventory has not yet been fully paid for. Bank account security is also common in the UK, but less so in mainland Europe, creating potential issues.
In the U.S., determining the ownership of secured assets is relatively easy to find out from the UCC register; however, no similar register exists in Europe. Information on assets is often dispersed across various locations.
While similarities exist between U.S. and UK legal practices and insolvency law, variances among European countries, and between mainland Europe and the U.S complicate matters. Insolvency in Continental Europe can also be a lengthier process than in the States, especially if court-driven, which is the norm in some European countries (e.g., France). The court might question the fairness of a security held over an asset on the grounds that the benefit to both parties was unequal.
Handling Legal Challenges
Legal challenges, though awkward, are rarely insurmountable, and can be met principally by three strategies:
1) Stringent due diligence at the earliest possible stage of a deal
2) Creating a contractual framework everyone understands and is comfortable with, and avoiding forms of contracts that are unfamiliar to some lenders or not recognized by certain countries
3) Redistributing assets to a country with more friendly asset-based lending laws, if necessary and feasible
Evolving ABL Landscape
Currently only a handful of lenders offer a complete asset-based lending solution in Europe. However, that number is set to increase, and as experience goes, so will asset-based lenders’ reach in the market. At the same time, this type of lending is getting the attention of corporate entities. That, too, will grow the market.
The Eurozone is faced with many issues but the most serious may be the low level of business credit available. Lack of credit is the single biggest factor that can hold back an economy from functioning healthily. Without access to credit, businesses cannot operate effectively and grow. When the lending environment becomes fearful, this communicates itself all the way down through the business world, adversely affecting decision-making. Asset-based lending, with its increased transparency and controls, offers an alternative and often a more acceptable solution where traditional lending facilities fall short. Obviously, it cannot solve all an economy’s financial problems, but it does provide more options for lenders and borrowers — a positive in troubled times.
Asset-based lending, therefore, could play a significant role in rescuing the economies of the Eurozone. Increasingly, Europe’s corporate entities know this and are starting to take alternative finance more seriously. However, for that to happen, more financial institutions in the market need to offer a complete asset-based lending solution.
David DiPiero is president and CEO of FGI.