Firms are now drawing up contingency plans if eurozone breaks up ...

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December 5, 2011

Buyout firms prepare eurozone disaster plan
Buyout experts are predicting that more than €400bn of European private equity funds are expected to flood into alternative currencies, including US dollars or sterling, if the eurozone breaks up.

Firms are now drawing up contingency plans amid forecasts that funds will face a dramatic restructuring if the currency collapses. Funds are already writing a special clause into new fundraising documents reserving the right to switch currencies in the event that the 17-member eurozone fractures.

Lawyers said firms were exploring options including converting entire euro-denominated funds into other currencies, with the US dollar and sterling the most likely alternatives.

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Buyout firms have raised an aggregate €311.4bn worth of euro-denominated funds since 2007, and firms are currently attempting to raise a further €109.5bn for euro-denominated vehicles, according to data provider Preqin.

Andrew Sealey, managing partner of advisory firm Campbell Lutyens, said: “Nobody understands how one party leaves, never mind the whole break-up.

It is a big concern... [We are] seeing a huge slowdown in investments and exits and it is likely to slow down the fundraising process. Even if the euro does not break up, it is already having a material impact on the industry.”

One of the main practical issues relates to debt restructuring. Jonathan Guise, managing partner of debt advisory firm Marlborough Partners, said an orderly dismantling of the European Monetary Union and the euro would most likely bring with it some over-arching legislation and controls around currency-related issues relating to loan agreements, which would be complicated and costly.

Figures from Standard & Poor’s Leveraged Commentary and Data show that about €69.5bn of leveraged buyout debt will mature in Europe by 2015.

Guise said that in virtually all cases, the departure of a country from the euro would trigger a default – be it non-payment or a material adverse condition change within the loan agreements of the companies within that country.

Enforcement of any event of default against the assets of such entities within the departing country would be another issue altogether.

“Whatever scenario one conjures, be it partial or complete euro withdrawal, orderly or disorderly, it would be an absolute fee frenzy for the lawyers and restructuring advisers and a total nightmare for everyone else,” he said.

A sequel to that nightmare would be in the collateralised loan obligations market, the largest end buyers of syndicated leveraged loans used to fund new buyout investments.

Guise said these investors would face losing their investments in countries leaving the euro if they did not convert to a local currency. CLOs in Europe are typically euro-denominated and unable to hold non-euro-denominated debt.

This issue is heightening existing fears surrounding the ability of CLOs to acquire leveraged loans. In June, mezzanine debt provider Intermediate Capital said demand among CLOs was decreasing as they approached the end of their reinvestment periods. ICG said this would potentially lead to a €50bn drop in mainstream debt availability.

Private equity funds also face restructurings. Bridget Barker, a partner at law firm Macfarlanes, said converting the currency of a euro-denominated fund could be problematic, with any potential redenominations requiring a vote by advisory boards and investors.

She said difficulties could arise if investors were divided over what action to take and could lead to firms forming sub-pockets of investors with exposure to different currencies.

Jeremy Bell, a partner at law firm Ashurst, said some of the biggest potential problems for older funds surrounded exchange rate risk, which he said could affect returns and the amount of an investor’s commitment: “To pre-set those [fund] terms in a meltdown situation would be very difficult.”

A split in the eurozone could also impair longer-term fund raising. Non-European investors are expected to reduce their exposure to the region.

According to Preqin, non-European investors accounted for 21% of the euro-denominated private equity funds raised so far this year. They accounted for 19% of capital committed, or an estimated €4.7bn.

Philip Buscombe, chairman of UK buyout firm Lyceum Capital, echoed the concerns. He said: “You have got to be saying how much euro exposure do I want versus Asian currencies and sterling.”

Guy Hands, chairman of buyout firm Terra Firma, said: “Worldwide, investors are trying to reduce risk and increase liquidity. In such circumstances, investing in European private equity is not high on many investors’ lists.

The question is not what the denomination of the fund is, but what the strategy is. Where is it investing and what is it investing in?

“Until there is some clarity as to the future of the eurozone or markets learn to live with uncertainty, only the brave will invest in European private equity. They will be selective as to the strategies and firms that they invest in,” he said.

Hands said the long-term effects would be that many private equity firms in Europe would be so focused on sorting out their portfolios of legacy investments that their ability to raise new funds to take advantage of the crisis would be limited.

He said: “The number of European funds that would be able to do a successful fundraising would be very small and the European private equity industry would shrink, leaving the landscape free for mainly US firms to take advantage of the opportunities that would exist in Europe from a break-up scenario.

“However, the ability of US firms to understand the many cultures within Europe and how the different regulatory and legal environments in various European countries work has never been great and post-break-up that still would become much more important,” he said.

Investors steering clear of private equity investment is part of wider concerns in the investment management industry.

Asset managers are already reducing their eurozone exposures, for fear that capital controls would freeze euro assets.

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