- Private placements
A Priority Moving in Reverse?
14.01 This chapter looks at recent initiatives in the context of the European Commission’s flagship plans for a Capital Markets Union (CMU) designed to encourage a pan-European private placement market. It is generally recognized, also by the Commission, that small and medium-sized enterprises (SMEs)1 are challenged in the sources of funding available to them. SME’s predominantly rely on short-term funding such as bank loans, overdrafts, credit cards, crowdfunding, or venture capital for their start-up phase and once they have an operational history they may add leasing or factoring as additional funding sources. Loans from alternative lenders such as pension funds, insurance companies, asset and fund managers, family offices, and high net worth individuals are typically beyond their reach, as are loans from hedge funds, private equity and debt funds and other alternative debt/equity providers. This means that as these companies mature and seek further growth, their long-term financing needs are not met. Their lack of experience and resources means that they cannot engage in relatively complex funding transactions.
14.02 In reality, private placements (whether in the US or in the EU) are mainly available as a funding tool for medium-sized and larger companies. In the discussion below we will touch upon this threshold issue. Nonetheless, private placements are regarded by the CMU’s policymakers as an alternative source of long-term funding which is simple enough for smaller corporates and SME’s and with benefits that they might find attractive (see section II.3). As (p. 301) we shall see in section IV the Commission’s initial intention in the design of a CMU was to enable a greater use by SME’s of private placements.
1. Proposed definition
14.03 As privately placed loans are also confusingly called private placements, it is important to devise a workable definition of a private placement for purposes of the CMU. On the basis that the CMU must by definition deal with capital markets, it is to be assumed that the Commission is referring to tradable securities. Because the issuance by SMEs of equity to venture capital and other specialized funds is dealt with elsewhere in the CMU, it is also assumed that the securities referred to are debt securities. It is unfortunate that the Commission does not provide a definition anywhere of ‘private placement’; it seems to assume that everyone understands the meaning.
14.04 Surveying the general literature on private placements and combining the various definitions used therein, one can arrive at the following usable definition for purposes of the CMU agenda. A private placement is:
A medium or long-term, preferably unlisted, private debt securities transaction between a (listed or unlisted) company (typically without a public rating) and a small number of non-bank institutional investors (such as insurance companies, pension funds and investment funds), based on deal-specific documentation negotiated between the borrower and the investor(s), generally, but not necessarily, with the participation of one or more bank intermediaries as arranger(s) usually acting in an agency capacity (not as underwriter) and without general solicitation or advertising. It typically offers the end investors higher returns than are available on publicly offered bonds and the debt securities rank pari passu with unsecured bank loans.
14.05 It is clear from this definition that private equity, privately placed loans, and even privately placed tranches under medium term note or eurcommercial paper programmes (MTN or ECP) programmes2 are excluded from this definition. Equally, the definition excludes those bonds issued by smaller companies on specialized exchange segments.3 The words ‘preferably unlisted’ are used to indicate that most issuers would avoid a listing if possible as it is not consistent with the nature of private transaction that the instruments are listed. As we shall discover in section V, however, there are various tax and other barriers which force about half of all EU private placements to list.
14.06 What the CMU aims to achieve is a pan-European market for private placements. This cannot be understood to mean a patchwork of domestic markets with a harmonized set of rules; it must mean instead that an issuer in one Member State can offer its debt securities (p. 302) in several other Member States as part of the same private placement transaction and with minimal or no regulatory obstacles. Such a true pan-EU private placement shall be referred to as a ‘PEPP’. The question dealt with in this chapter is whether the measures proposed in the CMU Action Plan will be able to bring this about.
2. Market size
14.07 In various places in the CMU policy documentation one finds comparisons between the strong US private placement (USPP) market and the fledgling European equivalent. The USPP market is large, integrated, and standardized and is increasingly tapped by European corporates above a certain threshold size. The aggregate annual volume of new issuance averages between EUR 50 and 55 billion. By contrast, European private placements largely take place on national markets where the sources of funding are mainly local in origin. In 2015 the volume of new issuance was estimated to be approximately EUR 35 billion.4 Of these fragmented markets two in particular are dominant: the ‘Euro PP’ market and the ‘Schuldschein-darlehen’ (SSD) market. The SSD market takes the lion’s share of market volume in the EU and grew from EUR 20 billion in 2015 to EUR 26 billion in 2016.5
14.08 The first is basically a French market and the second is a German market with origins in the nineteenth century; both are open for non-local issuers. They tend to cater for larger deals for more established issuers (with a good credit profile (on average a net leverage of no more than 350 per cent)6). Legal documentation has been developed locally, although the SSD market does not have a set of standard form agreements. Since 2015 issuers on these markets can also choose to follow the templates and best practice guides issued by the Loan Market Association (LMA) and the International Capital Markets Association (ICMA) (see below in section II.2). The investors on these markets are mainly local (for the most part insurers, savings banks, and pension funds) and the issuers are predominantly local too, although non-local issuers are also active. On the whole they are mid-cap sized companies.
14.09 There are local idiosyncrasies such as an automatic (ex lege) collective representation of noteholders for French private placements and an SME credit register maintained by the Banque de France supporting the market.7 The German market originally used an instrument confirming indebtedness (a ‘receipt’ or Beweispapier), but this has become outmoded.8 SSDs are bilateral ‘bond-like loans’ and not traditional securities subject to securities laws. They are transferrable by way of assignment or transfer of contract9 and unrated (p. 303) and unlisted. Although this would bring the SSD market outside the private placement definition provided above, the Commission apparently believes this market is a form of private placement for CMU purposes, in view of its discussion in various documents.10 The SSD market’s investors (estimated at between eighty to 100 firms) are mostly banks, which is not surprising in view of the loan format. The Euro PP market’s investors are more of a mixed group. Neither the French nor the German market has active secondary trading in the instruments.
3. Private placements: benefits and disadvantages for issuers
(i) they can achieve a diversification of funding in terms of sources, maturities, and terms and conditions compared to regular bond markets;
(ii) no formal credit ratings are generally required (contrary to public bond offerings);
(iii) private placements generally allow for a smaller issue size (the average being EUR 16 million with a minimum of between EUR 15 and 20 million11), but the disadvantage is that there is no secondary market liquidity because of the smaller size (and the bespoke terms and conditions); as a general rule the market is regarded to be a ‘buy-to-hold’ market;
(iv) the maturities for the bonds placed issued in the private placement market extend typically beyond the five-year mark (where bank finance typically stops for SMEs);
(v) investors in the private placement market are typically institutional investors as a result of which there are fewer disclosure requirements or investor protection duties (unless the issue is listed; see section V.2), there are no ongoing public reporting or transparency obligations, and the issuer obtains swift access to funding;
(vi) the terms of the bonds can be tailor made because the offering is privately negotiated between the issuer and the ultimate investors, but a drawback is that more extensive covenants are usually found in a private placement compared to a public bond issue;
(vii) private placements usually involve lower costs for the issuer compared to public bond offerings mainly as a result of reduced advisory, marketing, and legal costs and lighter documentation, but there is a threshold issue size as a result of the due diligence needed on the part of the ultimate investors (the deal threshold being, as mentioned, between EUR 15 and 20 million);
(viii) as the transactions are private, they are confidential but the drawback is that there is no public track record, meaning that there are no historic performance data for (p. 304) investors and there are no pricing benchmarks allowing issuers to determine if the pricing offered on the notes is in line with the market;
(ix) in private placements it is generally easier to communicate with investors and also to control transfers of participations.
14.11 In general terms, private placements are able to achieve maximum flexibility by staying clear of regulatory requirements (unless the bonds are listed, see section V.2) and using exemptions and safe harbours applicable to public bond markets.
1. US private placements
14.12 USPPs are private offerings of unlisted registered notes marketed without general solicitation or advertising and only to ‘accredited investors’ and otherwise in accordance with Rule 506(b) of Regulation D under the US Securities Act of 1933.12 They benefit from a safe harbour from onerous US public offering registration requirements, that is no SEC compliant offering document is required for a Regulation D offering.13 The accredited investors who are eligible to participate in private placement offerings typically include pension funds, insurance companies, investment funds, broker/dealers, and other institutional investors. The National Association of Insurance Commissioners (NAIC) provides a scoring of the bonds which determines the regulatory capital treatment for insurers as investors in the bonds.14 The market also relies on standard form documentation which consists mainly of New York law governed note purchase agreements.15
14.13 A result of Regulation D is that the securities remain subject to transfer restrictions until maturity and because there is no listing bonds cannot be publicly traded. A further feature of the market is that investors conduct their own due diligence due to the absence of underwriters in the offering process. The issuer achieves a reduced civil liability for disclosure deficiencies as a result of agreeing so called ‘Big boy letters’ with the investors.16 The issue can have any size provided the bonds are offered to fewer than thirty-five sophisticated non-accredited investors in addition to (an unlimited number of) accredited investors. It would seem appropriate to conclude that the USPP market is as vigorous as it (p. 305) is due to a combination of an easy-to-use securities law exemption, a simplified system for regulatory capital treatment for the ultimate investors, and standardized issue documentation on top of, obviously, a single, integrated capital market.
2. Private placements: European market initiatives
14.14 In the years immediately preceding the launch of the CMU proposals, several private sector initiatives had already occurred that were aimed at promoting European private placements through standardization of documentation, which is one of the USPP market’s strengths.17
14.15 The key development that jumpstarted the French private placement market was the liberalization of French investment restrictions for insurance companies in July 2013, permitting a greater participation by French insurance companies in alternative investments such as unlisted debt instruments. This was followed by the publication in March 2014 of the so-called Charter for Euro Private Placements18 by the Euro private placement working group.19 The Charter is intended as a guidance and best practices document to enhance the standardization of the issue process and the documentation20 and to strengthen investor confidence.
14.16 Simultaneously, AMAFI published the Code of Best Practice for Euro PP arrangers providing a description of the arranger’s role and responsibilities. Nearly a year later Euro-PP working group published two model agreements (subject to French law); one for private placements of loans and the other for private placements in (registered) note format.21 The majority of Euro PPs is currently unlisted.22 Those that are listed are using a ‘technical listing’ where the notes are not traded on exchange and there is no liquidity provider supporting trading.
14.17 Almost at the same time as the French working group, the LMA published its standard form English law private placement documents for both loans and bonds in January 2015. The bond documentation published by the LMA consists of a recommended form of a subscription agreement, a recommended form of term sheet, a confidentiality agreement, and a user guide. This documentation proceeds on the basis that the notes will be senior/(p. 306) unsecured, unlisted and non-cleared, that they will be in definitive registered form (with a register of noteholders being maintained by the issuer). The documentation furthermore assumes that (a) the borrower will have an investment grade rating although the documentation can be adapted to lower credit profiles and (b) no intermediation is involved so the issuer contracts directly with the ultimate investors. Subsequent to January 2015 the LMA also published a Schuldscheindarlehen Product Guide23 which aims to introduce those market participants less familiar with SSDs with an introduction to that market and also aims to adapt the LMA’s documentation to the SSD market.
14.18 In February 2015 the ICMA PEPP Joint Committee published its Pan-European Corporate Private Placement Market Guide (subsequently updated in October 2016).24 The Guide, which evolved out of the Euro PP Charter, consists of a non-binding framework for common market standards governing the PEPP market and aims to develop that market through those standards. It acknowledges that the PEPP market is geared towards providing medium to long-term finance to medium-sized companies (and therefore not to all SMEs as a group). The Guide furthermore includes a description of the key characteristics of PEPPs, a list of the main parties and the customary documents, recommendations on the information that a borrower must provide to investors, recommendations on the due diligence to be conducted by such investors, and points to consider if the notes are to be listed. It also contains templates of an information memorandum and a non-disclosure agreement. Finally, the Guide explains the particularities of the SSD market.
14.19 In the first year after their publication, the LMA and ICMA documentation was estimated to have been used in 13 per cent of all new deals.25 This means that, as confirmed by another industry publication, the bulk of European private placements continue to be done using either the Euro PP or the SSD documentation.26
3. Credit rating agency developments
14.20 Over the same period discussed above, a number of credit rating agencies developed their rating technologies to cover SME’s, no doubt due to demand for this product from investors and issuers in the new market. Thus, Moody’s launched its UMPPR (Unpublished Monitored Private Placement Ratings),27 S&P its Mid-Market Evaluator (for mid-sized companies),28 and DBRS and Fitch also followed suit with their own product offerings for this segment.
14.21 Although the movement towards greater document standardization takes away one advantage that USPPs enjoy over their European counterparts, other issues will continue to form impediments for the development of an integrated and deep market in Europe. A common set of documentation is not enough to create such a market where none exists. There are substantial regulatory, capital, and tax barriers to institutional investment in privately placed notes all of which would need to be removed in a harmonized way in order to create a PEPP market equal to the USPP market. These impediments will be discussed in more detail in the next section.
1. February 2015 Green Paper and consultation
14.22 Following the market initiatives referred to in the previous section, the Commission (in its Green Paper29) made PEPPs a policy priority. It aimed to put in place—together with the private sector—a PEPP regime to encourage direct capital markets investment in smaller businesses such that these would be less reliant on bank finance and could offer debt securities to a small group of investors (or even a single investor) outside the public markets and subject to less onerous disclosure requirements.
14.23 The Commission acknowledged that there were several obstacles to the development of a PEPP market. Firstly, there were different market practices and rules across the EU which resulted in fragmentation of private placement markets and the balkanization of the investor base for the product (the SSD market and the Euro-PP market were mainly targeted at German and French investors (as already noted in section II.2)). As a result, there was an insufficient pan-European investor base and this allowed the USPP market to be strongly competitive with its European counterpart being both a more liquid and a deeper market with a larger degree of standardization. Further drawbacks that impeded the development of a PEPP market were the difference in national insolvency laws, the lack of standardized processes and documentation, and the absence of harmonized credit information on the sector across the EU.30 Finally, the Commission mentioned the lack of secondary market liquidity, although, as we have seen, this is a normal feature of private placements.31 (p. 308) In the Green Paper the Commission also announced that—based on a consultation that it launched simultaneously within the Green Paper32—it would conduct a review of the Prospectus Directive33 (PD) regime in order to make it easier for smaller issuers to raise funding and reach investors cross-border.
2. Consultation responses to the Green Paper
14.24 In the responses to the consultation34 most respondents confirmed that they favoured market-led solutions to fostering a PEPP market although these should preferably be endorsed by the Commission.35 Nonetheless, there were a number of proposals for EU regulatory action:36
(i) the Commission, should issue guidance on the regulatory treatment of PEPPs;
(ii) echoing the Commission, it was suggested to improve the availability of credit information on SMEs and medium-sized issuers across the EU;
(iii) some respondents suggested that PEPPs should be facilitated by permitting investment through dedicated funds (eg specialized SME UCITS) or by using credit support or default insurance mechanisms (eg a guarantee or co-investment from or insurance by the European Investment Bank or the European Investment Fund) in order to attract a broader range of investors;
(iv) a further suggestion was to amend the PD regime to create more exemptions from its prospectus requirements and to add a defined term for private placements;
(v) the Commission was also urged to loosen the Solvency II capital treatment in order to foster greater investment by insurers.37 Under the Solvency II regime there is a punitive capital treatment for investment in securities that lack daily pricing.38 As a result of this, EU institutional investors which are subject to Solvency II face capital charges that are multiples of those applicable to US insurance companies under the NAIC rules for comparable USPPs;39
(p. 309) (vi) another proposal was to remove withholding taxes on interest40 for private placements;
(vii) in a number of jurisdictions issuers apparently are restricted in issuing bonds as a result of the national implementation of European banking regulation concerning deposit taking; some responses therefore argued for a uniform safe harbour in banking regulation for corporates issuing bonds ‘to the public’. This must be a reference to divergent implementation by the Member States of the exemption under Article 9(2) of the Capital Requirements Directive IV (CRD IV) from the deposit taking prohibition;
(viii) some Member States still have banking monopolies precluding or discouraging non-banks from engaging in lending activities, which clearly forms an obstacle for private placements when the SME borrower is located in such a country;41
(ix) finally, many respondents urged the Commission to support the establishment of indirect funding vehicles to diversify risk and create a wider EU investor pool. The principal idea is for a special purpose vehicle (SPV; similar to the issuing entity used in securitizations) to invest in SME bonds and notes with different credit quality and fund that acquisition by issuing exchange-listed asset-backed securities to end investors. This would attract institutional investors to SME bonds and notes through a diversification of risk (the bundling of many different SME securities in the SPV), bigger transaction sizes and lower transaction costs (no due diligence for each SME issuer; this would be done by the SPV and the arranger). This technique of pooling SME debt securities would overcome the hurdle of inadequate institutional investor demand for SME securities caused by a lack of liquidity; the asset-backed securities giving those investors an indirect exposure to SME bonds would normally be listed and traded. This is a strong argument in favour of a greater role for collateralized loan obligation (CLO) transactions that could either directly fund SMEs or buy SME bonds or loans from bank or non-bank investors or originators. In this context, the use of alternative investment fund (AIF) debt funds (where the end-investors would hold equity instruments) was also mentioned.
14.25 When the Commission published its September 2015 CMU Action Plan,42 it was noticeable how far private placements had been downgraded. Among the twenty measures announced in the Action Plan, it had a far lower priority than in the Green Paper. The emphasis in the Action Plan was mostly on the development of simple, transparent, and standardized (STS) securitizations43 and on promoting infrastructure investment. Private placements were mentioned only in the context of other innovative forms of non-bank finance such as crowdfunding, credit unions, and loan originating funds. Although there is a reference in the Action Plan that the Commission intends to continue to promote best practices on PEPPs through ‘appropriate initiatives’,44 it was left unspecified what these would be.
14.26 A reform related to the development of a PEPP market is insolvency law harmonization. A consultation on this topic was launched in March 2016 by the Commission Services45 and this resulted in the draft Directive on insolvency, restructuring and second chance in November 2016.46 Obviously, the diversity of insolvency regimes is an impediment to the development of a PEPP market; it is not, however, as critical as other obstacles to be discussed below.
14.27 To bridge the information gap (see sections II.3(viii), IV.1, and IV.2(ii)); between SME’s and their potential investors, the Commission announced that it would instigate a series of measures during 2016 and 2017 for example by developing (or supporting the creation of) pan-European information systems. These systems could use the mandatory feedback that banks must provide when they decline SME credit applications (a requirement of Article 431(4) of the Capital Requirements Regulation (CRR)). At the time of writing, no such measures had been announced.
14.28 Based on the PD review it had announced in the Green Paper, the Commission would publish proposals to modernize the PD regime to achieve greater convergence of EU prospectus and disclosure rules, reduce the administrative burdens associated with issuing prospectuses, and facilitate capital raising by European companies (in particular smaller businesses and SMEs). This was followed up quite rapidly with a proposal for a new Prospectus Regulation published in November 2015 (to be discussed in section V).
14.29 Disappointing those who had urged prompt action in this field (see section IV.2 (v)), the Commission announced that it would assess the prudential treatment of private equity and (p. 311) privately placed debt under Solvency II during 2018. It would assess at that time whether changes to the prudential treatment of privately placed debt would be justified and if so whether these would be included as part of the Solvency II review.
14.30 Finally, during 2017 the Commission would review the regulatory barriers to SME admission on public and SME Growth Markets (a sub-category of multilateral trading facilities (MTFs) to be created under MiFID II47) to make sure that the regulatory environment is ‘fit for purpose’.48 Although referred to again in its Communication of the Mid-Term Review,49 this review had not yet been published at the time of writing, although it appears to be concerned most of all with equity instruments and thus of little relevance to PEPPs.
4. Private placements in the April 2016 CMU Status Report and the September 2016 CMU Acceleration Communication
14.31 In its April 2016 Status Report on the CMU50 the Commission confirmed that work had started on a study to identify regulatory and other barriers for PEPPs from the point of view of issuers and investors. This study would also attempt to understand why a private placement market had not developed in Member States (other than France, Germany, and the UK) that have large institutional investors and borrowers requiring funding of at least EUR 20 million.51 Finally, the study would focus on the successful Euro PP, SSD, and USPP markets so as to create optimal conditions for the growth of the PEPP market. The results of this study are expected in Q4 2017 and will then form the basis for a Commission Recommendation on private placements.52
14.32 In its September 2016 CMU Acceleration Communication,53 the Commission confirmed that it would accelerate delivery of the next phase of the following CMU action points (insofar as relevant for private placements):
(i) lending its support to its co-legislators (the Council and the European Parliament) in finding agreement on the PD reforms (see section V) before the end of 2016;
(ii) the proposal on business restructuring and second chance (the proposed Restructuring Directive which was eventually published in November 2016);
(iii) a benchmarking review of loan enforcement regimes to evaluate the delays, costs, and value recovery; and
(iv) a review of withholding tax refund procedures across the EU. Apparently, the Commission had at this time concluded that harmonizing or abolishing withholding (p. 312) taxes within the EU would be an impossible task given the state of European law in this area54 and that it would simply try to speed up a refund procedures in order to reduce the cost for investors. The only way to achieve this is through persuasion, which means issuing best practices.55
14.33 It is not proposed to discuss the PD’s reform extensively in this section as it is analysed in Chapter 11 by Professors de Jong and Arons. Suffice it to say the Commission has recognized that the PD’s prospectus regime penalizes SMEs disproportionately as a result of which SMEs continue to be reliant on financing in the form of credit facilities from banks.
14.34 This CMU action point resulted in the November 2015 legislative proposal for the reform of the PD regime.56 Under these proposals, the existing PD would be replaced with a new Prospectus Regulation (PD3). On 8 December 2016, the Commission announced that the changes to its original November 2015 proposal had been agreed between the Commission, the Council, and the Parliament. Following approval by the Parliament57 and endorsement by the Council, PD3 was published in the Official Journal on 30 June 2017,58 so that its rules will apply in full from the summer of 2019.
14.35 To evaluate whether the PD3 regime will improve the regulatory position of PEPPs, it is necessary to understand which difficulties PEPPs have historically experienced under the current PD regime. First of all, except for SSDs which are not subject to the PD, private placements have not been able to be structured to fall outside the PD’s scope because: (i) they do not use non-transferrable securities, and (ii) the Member State option to allow domestic offers (listed or unlisted) without any prospectus (or with a locally regulated prospectus) for a total consideration across the EU of less than EUR 5 million over twelve months59 has not been very useful for PEPPs as very few Member States exercised this (p. 313) option60 and those that did do so did not harmonize their national prospectus requirement. This meant that an issuer which wanted to borrow EUR 5 million in four Member States was at risk of being required to prepare four prospectuses. Because neither carve-out from the PD’s scope was useful, private placements were required to rely on the PD exemptions, that is those categories of securities offerings that are exempt from the PD’s prospectus requirements.
14.36 Two of the obvious exemptions are: (i) offers with a minimum denomination of EUR 100,000 (Article 3(2)(d) PD); and (ii) offers exclusively to qualified investors (Article 3(2)(a) PD).61 At first glance these two exemptions appear promising,62 but in practice this only proved to be the case for private placements that managed to be offered without a listing on a regulated market. Roughly half of all non-SSD private placements need a listing on a regulated market, because of investment restrictions and regulatory capital rules binding on institutional investors or in order to benefit from a favourable withholding tax treatment (eg the UK’s ‘quoted Eurobond exemption’).63 It goes without saying that a listing is entirely incompatible with the nature of private placements. This anomaly meant that a significant number of non-SSD private placement issuers using the EUR 100,000 minimum denomination exemption were forced to prepare a PD-compliant prospectus.64 Private placements with lower denominations but restricted to qualified investors could not be listed, because regulated markets do not as a rule permit restrictions limiting trading to qualified investors.
14.37 Hence, only a securities law reform that would allow a listing on regulated markets for EUR 100,000 private placements with a far lighter disclosure regime than the ‘wholesale prospectus’ may have been the optimal answer, but that unequal treatment would have clashed with investor protection concerns.65 This meant that the only real solution involved, firstly, (p. 314) the reform of tax regimes in certain Member States to make listing unnecessary and, secondly, the liberalization of regulatory capital rules and investment restrictions impeding investment by institutional investors in unlisted debt instruments.
14.38 It is conceivable that SME Growth Markets, that is MTFs which can opt for that label once MiFID II takes effect, might improve the disclosure position for private placements. This is because Article 33(3) of MiFID II allows each SME Growth Market to set its own minimum disclosure requirements which are to be evaluated by the national competent authority (a discretionary decision) under rules implemented by each Member State.66 However, to be fully effective as a solution for PEPPs this does require that listing notes on an MTF qualifies for the investment restrictions and regulatory capital rules binding on institutional buyers as well as for applicable withholding tax exemptions.
14.39 We must therefore examine whether PD3 will introduce a new and workable exemption for listed PEPPs. The two existing safe harbours under the PD regime (qualified investors and EUR 100,000 denominations) will continue unaltered under PD367 and will only be helpful for unlisted PEPPs.
(i) public offerings (eg through crowdfunding) up to EUR 1 million over twelve months68 will not require a prospectus at all; this provides SME issuers with the possibility of offering securities for a total consideration of up to EUR 1 million over twelve months without a prospectus (and without a passport to other Member States), but national disclosure standards can be set by each Member State provided these do not constitute a disproportionate or unnecessary burden (Article 1(3) PD3);
(ii) the following issuers, provided they do not have securities admitted to trading on any regulated market, can offer securities across the EU by using a simplified ‘EU growth prospectus’69 (Article 15 PD3): (a) SMEs;70 (b) smaller mid-cap issuers71 whose securities are (or are to be) traded on an SME Growth Market; and (c) issuers other than either (a) or (b), provided they are unlisted,72 have fewer than 499 employees, and the public offer does not exceed a total consideration of EUR 20 million in the EU over a period of twelve months. Once approved by a competent authority in accordance with PD3, an EU growth prospectus can benefit from the regular passporting regime; and
(p. 315) (iii) finally, the Member State option to exempt smaller domestic issues (listed or unlisted) is expanded in PD3 to public offers where the total consideration is between EUR 1 million and EUR 8 million in the EU over a period of twelve months (Article 3(2) PD3).73
14.41 Unfortunately the exemption under (i) does not facilitate a true PEPP as it fails to create a pan-European offering model. The EU growth prospectus (exemption (ii)) may well be useful if it could be combined with a listing, but this only seems to be the case for the second category of issuers and then only if the listing is on an SME Growth Market. This means that the reservations expressed at the end of section V.2 may well make this exemption a dead letter.
14.42 Finally, the type of offer under (iii) will not benefit from the EU passport under the PD3 regime and will therefore remain a local offer, unless the offeror voluntarily draws up a prospectus (the ‘opt-in’ prospectus) and obtains the approval of the relevant competent authority (Article 4 PD3). As Article 3(2) is a Member State discretion, this safe harbour also does not pave the way for PEPPs (unless all or a majority of the Member States utilize it, which the history of its predecessor shows to be unlikely).74
14.43 In conclusion, as long as there is an incentive to list private placement bonds on an EU regulated market in order to attract institutional investors (from either a regulatory capital or an investment restriction perspective) or to avoid withholding taxes, none of the old or the new safe harbours offered under PD3 are likely to result in the creation of a true PEPP market.
14.44 If one compares the suggestions from market participants in response to the 2015 Consultation (section IV.2) against the EU's achievements so far, it is no exaggeration to conclude that only very limited progress has been made in facilitating PEPPs as an alternative funding source. As noted, the PD3 regime will only benefit unlisted private placements, but will not be of much use to those private placements that must have a listing on a regulated market. On its own, without further reforms, PD3 will be incapable of fostering PEPPs.
14.45 These other crucial reforms include amending the Solvency II regulatory capital regime to open up PEPPs for investment by insurers. The Commission has postponed this to 2018 when it intends to start the Solvency II review. Consequently, this fundamental reform will probably only become a reality in 2020 at the earliest.
(p. 316) 14.46 As to the removal of withholding taxes on interest, the second most important reform, because the EU’s constitutional restrictions do not permit Brussels to interfere in Member States’ tax affairs,75 the most the Commission can do is to ‘nudge’ Member States (eg by publishing best practices) to remove these taxes or at the very least to improve their withholding tax refund procedures (see section IV.4.4(iv)).
14.47 The use of dedicated funds to invest in PEPPs in order to broaden the EU investor pool has not received much priority from the Commission; only a few Member States have so far created safe harbours in their banking or consumer credit regulations permitting loan origination76 by AIFs (inter alia Germany, France, Ireland, and Italy77), but a pan-European regime which would harmonize the restrictions applicable to AIFs in this regard has not got off the ground. The Commission has deferred its evaluation of the need for a coordinated approach to AIF debt funds until a later date.78 As far as indirect funding vehicles investing in PEPPs (ie acting as direct investors in PEPPs or as buyers of PEPP notes from banks and institutional investors) are concerned, there is still a risk that the trilogue negotiations on the draft Securitisation Regulation,79 will result in the suffocation of CLOs by either setting a very high retention percentage or by disallowing the use of third party funded retention vehicles.80
14.48 In terms of creating a uniform safe harbour in European banking regulation to allow corporates to issue bonds to the public, the new CRR II and CRD V proposals launched by the Commission on 23 November 201681 show that the opposite is now being proposed. The proposed amendment in CRD V to the exempt categories in Article 9(2) of CRD IV means that except for credit unions only entities licensed in accordance with EU law will in future be permitted to obtain repayable funds from the public.82
14.49 In the final analysis it is not surprising that PEPPs have moved so far down the ladder on the CMU agenda since the launch of the Green Paper. The measures that would really help the development of this market are either outside the EU’s competence (withholding taxes and investment restrictions on institutional investors) or will only be reviewed at a later stage (loosening the Solvency II capital requirements; a common regime for AIF debt funds). The Commission must have realized this early on and it therefore lowered the priority of PEPPs in the CMU reforms. The much awaited study on barriers to PEPPs (see section IV.4), which the Commission should have carried out before it highlighted PEPPs in the CMU, is very likely to confirm that the real impediments are those mentioned in the consultation responses (see section IV.2 above) and discussed in this chapter. Once this study has confirmed what is common knowledge, the question then becomes: will the Commission accelerate what is within its competence and if so pave the way for a true PEPP market? If not, there will simply be a continuation of the status quo of several big local private placement markets (Euro-PP and SSD) combined with smaller private placement markets in other Member States (possibly nudged by the Commission to remove their tax barriers). A continuation of the status quo seems to be the more likely outcome.
1 The MiFID II definition of an SME is: a company with an average market capitalization of less than EUR 200 million on the basis of year-end quotes for the previous three calendar years (Art 4(1)(13) MiFID II), but this is supplemented from issuers whose equity instruments have been admitted to trading for less than three years by additional criteria specified in Delegated Regulation 2017/565  OJ L87/1 (see Art 77) whilst for SME issuers that only issue non-equity instruments the definition defaults to that under the Prospectus Directive (Art 2(1)(f)), being a company which according to its last annual or consolidated accounts meets at least two of the following three criteria: an average number of employees during the financial year of less than 250, an annual net turnover of less than EUR 50 million and a balance sheet total of less than EUR 43 million There is a lengthy User Guide to the SME Definition available from the Commission’s website: <http://ec.europa.eu/growth/tools-databases/newsroom/cf/itemdetail.cfm?item_id=8274&lang=en> 7 July 2017.
3 There are several of these across Europe. For example in France there is the Initial Bond Offering, in Germany the five markets for rated ‘Mittelstand’ bonds issued by unlisted SMEs and targeted at retail investors (Entry Standard in Frankfurt, m:access in Munich, Primaermarkt in Dusseldorf, and similar segments in Hamburg and Stuttgart), in Spain the MARF (an Alternative Fixed-Income Market) and in Italy the ExtraMOT Pro MTF, a market for ‘mini-bonds’ issued by Italian unlisted companies which was created by Borsa Italiana and on which access is limited to professional investors. For a global overview of trading venues for SME’s, see the IOSCO Report ‘SME Financing Through Capital Markets’ (July 2015).
8 Modern SSD bilateral loan contracts often do not comprise a separate borrower’s receipt certificate (‘Schuldschein’); the loan agreement sometimes contains it or it is omitted entirely. Even when it was used, the borrower’s receipt did not constitute a security within the meaning of the German civil and commercial law or within the meaning of the German Securities Trading Act or the Securities Prospectus Act, according to the LMA’s Product Guide for SSDs (2016 version).
9 In fact this is the method used for placing the SSDs with end investors; the borrower concludes the loan with the banking institution acting as broker. This bank makes the loan amount available to the borrower and subsequently places it with different institutional investors by assigning parts of the total claim to them.
10 It is also possible that the Commission was mistakenly referring to another German private placement market which does use registered securities (in the broader sense); this is the ‘Namensschuldverschreibungen’ market. These registered bonds also do not qualify as securities within the meaning of the relevant European directives; the transfer of interests is not effected by handing over the certificate but by contractual assignments in denominations of EUR 1 million, followed by notification of the paying agent.
11 Based on industry publications. The Commission puts the threshold at EUR 20 million; see European Commission, ‘Action Plan on Building a Capital Markets Union’ COM (2015) 468 final 11 <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX per cent3A52015DC0468> accessed 7 July 2017 and Commission Staff Working Document, ‘Capital Markets Union: First Status Report’ SWD (2016) 147 final 7 <http://ec.europa.eu/finance/capital-markets-union/docs/cmu-first-status-report_en.pdf> 7 accessed 7 July 2017.
14 Clifford Chance Response to the Green Paper 13 May 2015 (answer to question 4). <https://ec.europa.eu/eusurvey/publication/capital-markets-union-2015> accessed 26 October 2017. The NAIC scores start at NAIC-1 down to NAIC-6. See <http://www.naic.org/documents/svo_naic_public_listing.pdf> accessed 7 July 2017.
15 This is the Model Form Note Purchase Agreement produced by the American College of Investment Counsel (ACIC). See <http://aciclaw.org/forms> accessed 7 July 2017.
16 Big Boy letters are common in connection with the private sale of securities and loans. They are typically entered into prior to or at the time of such a sale and contain, among other provisions, representations that (a) the investor is a sophisticated purchaser that has not relied and does not need to rely on the issuer of the relevant securities or on the issuer’s agent and (b) the investor is entering into the transaction regardless of any information disparity or its potential effect of the value of the investment. They are also used to bar or mitigate liability in private litigation based on section 10b-5 of the US Securities Exchange Act of 1934.
17 These private sector initiatives were referred to in the first Commission documents describing the CMU initiative. See European Commission, ‘Building a Capital Markets Union’ COM (2015) 63 final 11–12 (Green Paper) <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015DC0063>, accessed 7 July 2017, and the Commission Staff Working Document, ‘Initial Reflections on the Obstacles to the Development of Deep and Integrated EU Capital Markets’ SWD (2015) 13 final 16 ( Green Paper Working Document), <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015SC0013> accessed 7 July 2017.
18 Available at <http://www.euro-privateplacement.com/charte_en.htm> and <http://www.fbf.fr/en/files/9HLKDR/Charter-for-Euro-PP-March-2014.pdf> accessed 7 July 2017.
19 A French group comprised of nine professional organizations comprising borrowers, intermediaries, and investors with the support of the Banque de France, the Tresor, and the Paris Chamber of Commerce.
21 The model agreements are freely available at <http://www.euro-privateplacement.com> accessed 7 July 2017.
24 Available at <http://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/Primary-Markets/primary-market-products/private-placements/the-european-corporate-debt-private-placement-market-guide/> accessed 7 July 2017.
26 ‘Private Debt Markets’ (n 5) 6.
30 On the lack of SME credit and business information, see the, ‘Green Paper Working Document’ (n 17) 25 and in addition the very recent Commission Staff Working Document, ‘Addressing Information Barriers in the SME Funding market in the Context of the Capital Markets Union’ SWD (2017) 229 final (6 June 2017). In many jurisdictions this kind of credit information is restricted to (local) banks. The need for more widespread availability of credit information on SME borrowers becomes apparent when one considers that institutional investors are unlikely to be prepared to establish their own credit analysis capabilities for SMEs. This hurdle impedes their direct participation in PEPPs, but also hinders direct lending by for instance non-bank lenders like loan originating funds. This is why there is much emphasis on making SME credit information more accessible to a wider range of finance providers in a standardized way. Others have advocated the introduction of a simple form of credit scoring in relation to SMEs, such as risk assessment indicators or other measures outside the formal ambit of the credit rating regulations. See Clifford Chance Green Paper response (n 14) 7.
31 For a brief discussion of these obstacles, see the ‘Green Paper Working Document’ (n 17) 16, 25.
32 See <http://ec.europa.eu/finance/consultations/2015/prospectus-directive/index_en.htm> accessed 7 July 2017.
33 Directive 2003/71/EC of the European Parliament and of the Council on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC  OJ L345/64. The PD together with the Prospectus Regulation (Commission Regulation (EC) 809/2004) provides for a single regime throughout the EU governing the content, format, approval and publication of prospectuses.
34 These are summarized in Commission Staff Working Document, ‘Feedback Statement on the Green Paper ‘ “Building a Capital Markets Union” ’ SWD (2015) 184 final (30 September 2015) (the ‘Green Paper Feedback Statement’).
36 The below is based on, inter alia, ibid (answers to Question 4) and the ICMA Response dated 30 April 2015 (available from the ICMA public website, <http:///www.icma.org> accessed 7 July 2017; ‘ICMA Green Paper Response’).
37 The precise change requested is a revised final calibration of the spread risk capital weightings in the Solvency II Delegated Act (Commission Delegated Regulation (EU) 2015/35  OJ L12/1), in particular the focus on volatility risk as opposed to default risk. These calibrations presently assume that investors trade in private placements and are exposed to market volatility, whilst in reality, as noted in section II.3 above, most investors are buy-to-hold investors in this market. Their exposure is not to market volatility but to the risk of the borrower’s default. This crucial difference is not adequately recognized in Solvency II. ICMA calls this the ‘single most important policy measure’ for PEPPs (see ‘ICMA Green Paper Response’ (n 36) 11).
38 European Commission, ‘Green Paper Feedback Statement’ (n 34) 21.
39 ‘ICMA Green Paper Response’ (n 36) 6.
40 See the answers to Questions 5, 10, and 30 in European Commission, ‘Green Paper Feedback Statement’ (n 34). ‘The most frequently quoted problem related to the application of withholding taxes on a cross-border basis.’ A number of EU countries impose withholding tax on interest paid to non-residents and although most have tax treaties with many jurisdictions, the procedural formalities to take advantage of these treaties can be cumbersome and delays in refunds are common. The costs and the foregone tax relief amount to staggering annual figures; see Green Paper (n 17) 21. In addition, there are many instances where the tax treaty reduces but does not remove the withholding tax rate. In rare cases, Member States have created a domestic exemption from withholding tax for private placements; this means that investors who could previously only achieve a partial exemption from withholding tax are then able to obtain a full exemption outside the treaty because the relevant country has fully exempted certain types of loans/private placements from withholding tax. This has occurred in Italy in 2012 (with an extension in 2014) and more recently in the UK with effect from 1 January 2016. In Italy an exemption was created to the 20 per cent withholding tax for payments in bonds issued by non-publicly traded Italian companies provided the bonds are listed (on a regulated market or MTF) or held by professional investors unaffiliated to the issuer and not resident in certain tax havens. In the UK, subject to a number of simple conditions (corporate borrower, issue size per placement at least £10 million, only non-listed securities with a maturity less than fifty years and each investor/lender must be resident in a non-tax haven jurisdiction), interest under qualifying private placements can be paid without any withholding tax. The LMA documentation for private placements was adjusted to facilitate use of this ‘QPP’ exemption. See <http://www.legislation.gov.uk/uksi/2015/2002/pdfs/uksi_20152002_en.pdf> accessed 7 July 2017.
41 Also mentioned at European Commission, ‘Green Paper Feedback Statement’ (n 34) 39 (see Impediments to Non-bank direct lending to companies under (ii)).
42 See European Commission, ‘Action Plan’ (n 11). A most interesting accompanying document is the Commission Staff Working Document, ‘Economic Analysis’ SWD (2015) 183 final, to be found at <http://ec.europa.eu/finance/capital-markets-union/docs/building-cmu-economic-analysis_en.pdf> accessed 7 July 2017.
44 See European Commission, ‘Action Plan’ (n 11) 11.
45 See <http://ec.europa.eu/newsroom/just/item-detail.cfm?item_id=30544> accessed 7 July 2017.
46 Officially: Proposal for a Directive on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU COM (2016) 723 final; to be found at <http://ec.europa.eu/information_society/newsroom/image/document/2016-48/proposal_40046.pdf> accessed 7 July 2017. See Michael Veder and Anne Mennens, ‘Preventive Restructuring Frameworks’, ch 25 in this volume; Bob Wessels, ‘On the Genesis of the Proposal for a Restructuring Directive’ (2017) Nederlands Tijdschrift voor Handelsrecht 1.
47 These MTFs, which can voluntarily opt for the label of SME Growth Market, are dealt with in Art 33 MiFID II and Arts 77–79 of Commission Delegated Regulation (EU) 2017/565. See the critical discussion by Andrea Perrone, ‘Small and Medium Enterprises Growth Markets’, ch 12 in this volume.
48 The intention was to create a proportionate regime for SMEs seeking to access capital markets and to explore how the Commission could support SMEs with the listing process through European Advisory Structures (such as for example the European Investment Advisory Hub). It would also scrutinize regulatory barriers for SMEs seeking to access public markets.
49 COM (2017) 292 final 11–12. See <https://ec.europa.eu/info/sites/info/files/communication-cmu-mid-term-review-june2017_en.pdf> accessed 7 July 2017.
50 Commission Staff Working Document, ‘CMU Status Report’ (n 11).
51 This supports the view that PEPPs are only feasible if the issue size is above that threshold; see section II.3(vii) above.
52 Announced in the European Commission ‘Mid-Term Review of the CMU Action Plan’ (n 49) 7.
53 ‘Capital Markets Union—Accelerating Reform’ COM (2016) 601 final <http://ec.europa.eu/finance/capital-markets-union/docs/20160914-com-2016-601_en.pdf> accessed 7 July 2017.
55 In a more general report on national barriers to cross-border investment flows that the Commission adopted on 24 March 2017, there is a more detailed discussion on burdensome procedures for withholding tax relief and refunds. See European Commission, ‘Accelerating the Capital Markets Union: Addressing National Barriers to Capital Flows’ COM (2017) 147 final 10–12.
56 See the Commission’s Press Release at <http://europa.eu/rapid/press-release_IP-15-6196_en.htm?locale=en> accessed 7 July 2017and the November 2015 draft text of the Prospectus Regulation as proposed by the Commission at <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015PC0583> accessed 7 July 2017.
57 For the European Parliament approved text see <http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//NONSGML+TA+P8-TA-2017-0110+0+DOC+PDF+V0//EN> accessed 7 July 2017.
58 Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC  OJ L168/12.
59 Technically, as these offers are outside the scope of the PD (see Art 1(2)(h) PD). Member States had a choice to permit or disallow such offers or to make them subject to a local prospectus requirement (which would have no passporting rights within the EU). The amount was originally EUR 2.5 million over twelve months but this was doubled by the Amending Directive 2010/73/EU (mentioned below in n 65).
61 The exemption for securities offered to fewer than 150 non-professional offerees per Member State (Art 3(2)(b) PD) is not relevant for private placements as these are typically offered exclusively to institutional investors, not to retail. See the definition above in section II. This particular exemption was generally a dead letter anyhow as it was impossible to monitor or control the number of offerees per Member State.
62 And aligned with the Regulation D regime that benefits USPPs. See section III.1.
64 Albeit a so-called ‘wholesale prospectus’ subject to a lighter content regime, but still a significant burden for smaller issuers. Bonds listed on a regulated market with a minimum denomination of EUR 100,000 benefit from a lighter disclosure regime and an exemption from the prescribed format summary requirement. Listing private placement notes on non-regulated markets such as the London-based Professional Securities Market (PSM) or Luxembourg’s Euro-MTF was also not a viable solution as the tax benefits may well be achieved, but these non-regulated markets typically imposed prospectus and disclosure requirements similar to those under the PD. See Clifford Chance Briefing Note (n 12).
65 In 2010 a reduced prospectus disclosure regime (known as the ‘proportionate disclosure regime’) was introduced into the PD for SMEs and issuers ‘with a reduced market capitalisation’ (see Art 7(2)(e) PD). See Amending Directive 2010/73/EU  OJ L327/1. Member States were required to implement this Directive by 1 July 2012. Also see: Stephen Revell and David Cotton, ‘The Prospectus Directive Amendments’, (2011) 2 Journal of International Banking and Financial Law 82. However, for practical reasons, very few issuers have taken advantage of this reduced prospectus disclosure regime mainly because investors were expected to want more disclosure rather than less from an SME issuer. From the CMU Green Paper and PD review consultation it is clear that the Commission considers that this regime has not met its objectives. See European Commission, ‘Green Paper Working Document’ (n 17) 28 and PD Impact Assessment SWD (2015) 255 final (30 November 2015).
66 The fragmentation that Prof Perrone criticizes in chapter 12 may well be a benefit for PEPPs looking for an accessible listing venue below the regulated market. The lack of liquidity that he is concerned about is also perfectly suited for PEPP notes for which there is typically no secondary market trading.
69 This exemption is the successor to the ‘proportionate disclosure regime’ in the current PD. The ‘EU growth prospectus’ is a document with standardized format, written in simple language and which is easy for issuers to complete. It will consist of a specific summary based on Art 7 PD3, a specific registration document (see Annex V PD3) and a specific securities note (Art 15 PD3). Content, format, and sequence requirements are to be set out in a delegated act by the Commission.
73 This is the successor to Art 1(2)(h) PD. Hence an issuer could not combine offers in several Member States (that have exercised the discretion) which offers in aggregate exceed EUR 8 million or by issuing over the threshold by successive issues over a twelve-month period.
74 If Member States A, B, and C were to exercise the option and implemented a full exemption for offers between EUR 1 million and EUR 8 million, a single issuer could make a simultaneous offer of listed or unlisted securities of up to EUR 8 million in aggregate across these Member States by dividing the amount of the offer among them. This would qualify as a sort of mini-PEPP, but it is still not a true PEPP. As we have seen above, the issue size above which the due diligence costs become economical is typically EUR 20 million, well above the upper limit for this Member State option.
75 See Carpentieri and Micossi (n 54).
77 ESMA has mapped the different national regimes for AIF debt funds and expressed its opinion on a European framework for such funds in April 2016 (<https://www.esma.europa.eu/press-news/esma-news/esma-publishes-opinion-eu-framework-loan-origination-investment-funds> accessed 7 July 2017). Also see EIF’s paper on debt funds as bond investors: EIF, ‘Institutional non-bank lending and the role of debt funds’ (EIF Working Paper No 25, 2014, <http://www.eif.org>) and IOSCO’s report ‘Findings of the Survey on Loan Funds’ (February 2017) <https://www.iosco.org/library/pubdocs/pdf/IOSCOPD555.pdf> accessed 7 July 2017.
78 See Commission Consultation Document, ‘Mid-Term Review 2017’ (20 January 2017) 8. Here the Commission states that this work is ‘ongoing’ and next steps and ‘under consideration’ <https://ec.europa.eu/info/sites/info/files/consultation-document_en_0.pdf> accessed 7 July 2017.
79 COM (2015)472 final <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015PC0472> accessed 7 July 2017. The Securitisation Regulation is discussed by Kastelein (n 43).
80 This is a structure where the CLO manager establishes separate funds (or other special purpose vehicles) to acquire and hold the mandatory risk retention (of their own deals or those of other managers) using third party funding. This is a very attractive alternative to holding these risk retentions on the manager’s own balance sheet, especially for medium and smaller CLO managers.
81 See: Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/36/EU (COM (2016) 854 final), available at: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM:2016:854:FIN, accessed 7 July 2017.
82 Currently Art 9(1) CRD IV requires Member States to prohibit anyone other than a credit institution from ‘carrying out the business of taking deposits or other repayable funds from the public’. Article 9(2) allows exemptions for inter alios ‘cases expressly covered by national or Union law, provided that those activities are subject to regulation and controls intended to protect depositors and the public’. A number of Member States rely on this to exempt issues of debt securities from this restriction on the basis of the regulation that applies to offers of securities. Proposed Article 1(5) in CRD V amends this to restrict the exemption to ‘persons or undertakings the taking up and pursuit of the business of which is explicitly covered by Union law’.