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George Washington once famously warned the people of his new country to avoid becoming too engaged with the governments of Europe. With the passage of the Sarbanes-Oxley Act and other new corporate governance and accounting initiatives in the US, many European companies must wonder whether they risk undesirable entanglements of their own by accessing the US capital markets. Yet these markets remain the largest single potential source of capital in the world, and eschewing them could prevent European companies from meeting their capital needs efficiently.

Is there a way to access US investors and yet avoid unwelcome entanglements with US regulations? For investment-grade borrowers, the debt private placement market offers an attractive option.

In a typical transaction, the issuer works with a placement agent to prepare a private placement memorandum that discusses the business and financial affairs of the issuer and the major terms of the proposed placement. The memorandum is similar to a prospectus or offering circular but generally less elaborate because there are no prescribed disclosure requirements. Debt is offered in the form of senior, unsecured notes, which are often guaranteed by other entities in the issuer's corporate family. The notes are issued through a note purchase agreement between the investors and the issuer. A model form of note purchase agreement has developed and forms the basis for all transactions in the market.

Agents market the deal to selected institutions on the basis of the memorandum. After the marketing process, investors place bids and, based on these, the interest rates, maturities and other substantive terms of the debt are agreed, or "circled", with the issuer. Approximately three to four weeks after circle, the transaction closes. The entire process usually takes about six to eight weeks. Because of the investor base and the limited marketing of the transaction, it is exempt from registration under the US securities laws and therefore will not bring the issuer within the ambit of US-style corporate governance and disclosure rules, although, as with any security issuance, general anti-fraud rules apply. Also, advisory fees tend to be lower than they might be for a public transaction or a Rule 144A sale (another type of exempt offering that is often used for high-yield investments).

The debt private placement market initially developed as an investment opportunity for US institutions, particularly life insurance companies, that wanted investment-grade, medium to long term assets with a healthy spread over returns from US Treasuries. These investors were not concerned about high levels of liquidity because they viewed their purchases as "buy and hold" investments. Issuers, at first mostly US companies, found the market to be a valuable tool for diversifying their capital structure, particularly maturities of outstanding debt.

Over the past several years, the US private placement market has grown and internationalized significantly. Whereas several years ago, a $75 million placement was considered large, now the market absorbs placements in the $500 million to $1 billion range. Non-US issuers are now major players in the market: cross-border sales, predominantly from Europe, are expected to comprise approximately 60% of total dollar issuances in the traditional private placement market in 2003, according to Thomson Financial and JP Morgan estimates. Whereas, according to JP Morgan, in 1990 there were 3 known transactions in the traditional private placement market in amounts of $1 billion or more, there are expected to be approximately 15 such transactions in 2003. Notes are also issued in multiple currencies, including Euros, Sterling, Swiss Francs and Japanese Yen, among others.

The process of internationalization has also led to pragmatic alterations in the model form documentation to accommodate the needs of new jurisdictions and the demands of larger, sophisticated issuers. Deal terms have also changed to fit particular regulatory exemptions. A recent $300 million transaction by Campari, for example, was structured to allow a direct issuance out of Italy without imposition of withholding tax.

What has led to these changes? On the investor side, the available capital of US institutional investors continues to increase, as they amass the retirement savings of millions of Americans. Meanwhile, volatile equity markets and declining rates of return on traditional, highly-rated debt have made these alternatives less attractive. Cross-border transactions offer an opportunity for portfolio diversification. Rather than relying only on the US market, investors can tap into the vast number of profitable, well-capitalized companies that exist in Europe.

For issuers, the advantages are even more numerous. These include:

• continuing low interest rates in the US market;
• speed and low cost of execution;
• reduced dependence on bank loans;
• ability to place high volumes of debt at once; and
• limited US regulatory involvement.

All of these elements have combined to produce record results in the private placement market. Issuances of traditional private placements during the first half of 2003 increased to over $21 billion, with nearly 140 issuers tapping the market, compared to approximately $11.2 billion in the same period in the prior year. Overall private issuances (including 144A and equity transactions) increased to over $315 billion in the first half of 2003, an increase of 31% over the comparable period in 2002. [fn1]

The future of the cross-border private placement market looks promising. Despite rising interest rates, private placements are expected to retain their many advantages and be an increasingly important tool for European and other non-US companies seeking to raise capital and diversify their funding sources.

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This article first appeared in Real Finance (www.realfinance.net).

Footnotes

1: Thomson Financial, 12 August 2003.