One of the interesting characteristics of the private placement market is its steadiness. According to data from Private Placement Monitor, an average of £6.2 billion of debt was privately placed every month in 2022 globally.
Due to the private nature of the market, we think these data actually understate the volume of capital raised via non-public debt. And if we take into account the full breadth of European deals including loans and Schuldscheine (German loan notes), the private placement investment universe looks considerably larger.
By contrast, as you can see from Chart 1, the public UK corporate bond market saw virtually no issuance in October in the wake of the Truss/Kwarteng 'fiscal event' and its subsequent shockwaves.
Chart 1: GBP public market and private placement market 2022
"GBP Public Market and Private Placement Market 2022
Source: Bloomberg, Private Placement Monitor
Chart 2: GBP Corporate Bond Spreads and Gilt Yields
GBP Corporate Bond Spreads and Gilt Yields
Source : ICE BofA, Bloomberg
As we can see in Chart 2, the days and weeks following the so-called mini-budget were challenging for UK public credit investors. Capital values fell, yields soared, and flows into the asset class were highly unpredictable.
Meanwhile, private placement teams remained busy, continuing to originate, structure and underwrite a high volume of deals throughout the mini-budget period. Private placement managers with the right experience and skillset were able to avoid compromising on credit profiles while maintaining a healthy and consistent illiquidity premium over public market benchmarks.
The investment case
The general investment case for private placements is well understood by insurers: more diversification, better credit structures and higher credit spreads from illiquidity and complexity.
On top of these benefits, the strategy is also popular among UK life insurers that are investing Solvency II balance sheets to match annuity liabilities.
Leading private placement investment managers optimise for insurance investors
It's no wonder that leading private placement investment managers optimise for insurance investors with the help of the following capabilities and processes:
- A comprehensive suite of ratings methodologies and frameworks that are regularly updated. It's critical that these map to the ratings methodologies and outcomes of ECAI (External Credit Assessment Institution) ratings
- A governance and oversight framework that ensures robust challenge to investment and rating proposals
- Embedded legal and transaction management expertise
- Disciplined and consistent processes for measuring illiquidity premia
- Frameworks and expertise in assessing environmental, social and governance (ESG) and reputational risk that may affect investments
- Ongoing monitoring of covenant compliance and credit ratings
- A detailed understanding of structures that work (or don’t) for Solvency II/Matching Adjustment portfolios.
Changes to the UK application of Solvency II
On the subject of Solvency II, the forthcoming changes to the UK application of the regime should, in our view, make the private placement market more compelling for insurance investors. Whilst it may take some time for these reforms to be implemented, the direction of travel is promising.
Broader market participation
Broadening the practical scope of the matching adjustment to other forms of insurance (i.e. beyond annuities) may mean investors other than the traditional life insurers are attracted to the private placement market. This is likely to be a fairly marginal increase in market capacity but it could act to broaden market participation.
Wider range of opportunities
A softening in the approach to certainty over cashflows may, in our view, significantly broaden and deepen the investment universe. Currently, most investors reject any instrument that has virtually any optionality in cashflows.
Any early redemption options need to be accompanied by penal 'make-whole' clauses that offset potential reinvestment risks. This means that accessing this pool of capital only works for borrowers who are willing and able to forego the ability to prepay.
By building in further flexibility, more borrowers are likely to issue to insurers. For instance, structured transactions that have calls followed by (usually penal) coupon steps should the calls not be exercised currently would not qualify under most insurers’ application of the matching adjustment.
If matching adjustment rules were broadened in order for investors to take a more common sense view of the predictability of cashflows, this would open a far broader range of investment opportunities and improve returns from private placements as a consequence.
Reducing the 'cliff effect'
Reducing the 'cliff effect' between BBB and BB-rated debt should also change investor behaviour. We don’t expect that less penal regulatory treatment of sub-investment grade debt will tempt insurers to plunge into the world of High Yield. In fact, as we understand it, the cliff is likely to be reduced to accommodate downgrades rather than to accommodate direct High Yield origination and/or investment. However, it may tempt investors to stand a little closer to the cliff-edge if the risk and/or pain of falling over it is reduced.
Again, this is likely to create a marginal increase in risk tolerance rather than a wholesale repositioning of portfolios into riskier assets, but it should (at the margin) increase returns and broaden the range of investments that are considered viable.
Final thoughts
The relative stability exhibited by the private placement debt market and the cumulative effect of the individual marginal changes that are expected to Solvency II in the UK suggest a positive outlook for the asset class. We believe that given the right investment capabilities and processes, the opportunities for insurers are plentiful.