Australian Symon Drake-Brockman is on the front line of a revolution in European finance.
The former head of global debt markets at Royal Bank of Scotland now runs Pemberton Asset Management in London’s genteel Belgravia, several miles from the “Square Mile” City of London financial district where bankers work.
He spends his days making deals in partnership with British insurer Legal & General but by lending, rather than investing, its cash.
Drake-Brockman is one of a growing number of financiers who are teaming up with insurers and pension funds to build loan books to rival banks, turning some fund firms into banks in all but name.
“We operate more like a lender … we are constantly meeting with borrowers, developing relationships in a similar way to how we would if we were sitting within RBS or ING, where I was before,” Drake-Brockman said.
“You will see a number of us develop what I would consider as large regional lending businesses, where the scale of what we do will be not dissimilar to some of the banking groups active in mid-market corporate lending,” he added.
Investors in the United States already out-lend domestic banks by buying huge volumes of corporate, municipal and government bonds and the European Commission is looking to broaden Europe’s sources of funding in a similar way by launching a Capital Markets Union to lessen the region’s reliance on bank finance.
EU Financial Services Chief Jonathan Hill is due to set out an action plan for the project this autumn, with a view to laying foundations for a union by 2019.
Drake-Brockman believes private firms like Pemberton will be responsible for 20-50 billion euros ($21.8 billion-$54.6 billion) of lending in Europe by 2025, as asset managers opt to lend more of the trillions of euros they manage for pension funds and insurers.
Strict capital reserve rules aimed at preventing a sequel to the 2007-09 financial crisis mean blue-chip banks, once dubbed “masters of the universe” because of their dominance of European lending, cannot supply debt as freely as before.
Public pension funds, insurers and other institutional investors are now stepping into the breach, supported by some regulators and spurred on by record low interest rates and sub-zero yields on many staple bond investments.
The banking retreat has seen lending to businesses fall by more than a quarter since a 2008 high to 4.31 trillion euros, data from consultants EY showed.
By contrast, demand for private debt has more than tripled in size since 2006 to $465 billion at end-June 2014, figures from data provider Preqin showed.
In a separate report studying the investment intentions of 263 public pension funds, Preqin found almost two-thirds wanted to raise their exposure to European private debt in the next year.
With non-bank lending to corporates in Europe below 20 percent, compared with 70 percent in the United States, even a move to 30-40 percent would equate to “very, very significant growth,” said Drake-Brockman.
Jo Waldron, director of alternative credit at M&G, the 260-billion-pound ($400-billion) asset management arm of global insurer Prudential, is another player helping to fill a gap in the market for money left by capital-constrained banks.
“We’re certainly seeing great investment opportunities … coming for asset managers because there were areas of the financial markets that banks once dominated and now no longer do in the same way,” she said.
After setting up a private finance group in 1997 with four people, M&G now has more than 90 people striking deals across the private debt spectrum, from social housing to student accommodation and leasing.
The London Pensions Fund Authority, which runs a 4.8-billion-pound pension fund for around 250,000 people, last week appointed Apollo Global Management to oversee its maiden allocation to alternative credit, including private lending.
“We have been vocal in the past year about increasing our exposure to illiquids and alternative assets. It is an area that we are keen to grow,” an LPFA spokesman said.
Safe or Sorry?
Not everyone is happy to see the attempt by asset managers and insurers to replace banks in Europe’s private debt market.
The Group of 20 (G20) economies’ regulatory task force, the Financial Stability Board (FSB), has debated whether asset managers and funds, like banks, are “too big to fail.”
This reflects broader worries that a further accumulation of fund firm assets resulting from a push into lending could make financial markets less stable.
Critics claim investors who put cash into funds that make loans to private or corporate borrowers are particularly vulnerable because unlike banks, the fund responsible for assessing credit risk bears no loss in the event of a default and unlike depositors, they don’t get their money back.
There are fears that a part-time approach to lending could lead funds to write loans for borrowers otherwise unable to secure finance through other means, increasing the possibility of losses for pension funds who have stumped up the cash.
“Direct lending was a popular hedge fund strategy in 2005 and in the aftermath of the credit crunch, we saw banks had kept all the top quality borrowers,” said Alasdair Macdonald, head of the UK portfolio advisory team at pension consultant Towers Watson.
“New entrants who thought they were taking market share were actually only accessing lesser quality borrowers and when things downturned, those funds suffered disproportionately,” he said.
The International Monetary Fund has also warned that large flows of money into relatively illiquid asset classes has raised risks of “fire-sales” if investors opt to exit similar positions at the same time.
At Reuters’ Global Financial Regulation Summit this month, the chair of the International Organization of Securities Commissions (IOSCO) said the case that big asset managers pose systemic risks had yet to be made.
Fund firms themselves insist they have all the necessary skills to spot good borrower from bad. The bigger challenge for alternative lenders in Europe, however, is trust, said Pemberton’s Drake-Brockman.
“Borrowers may not love banks for one reason or another (but) in a market where you can source funding from distressed funds, hedge funds and special situations funds, they are not clear who is the reliable long-term business partner and who is an opportunistic credit fund.” ($1 = 0.9148 euros) ($1 = 0.6501 pounds) (Editing by Peter Millership)
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