The Adaptive Capacity of Markets and Convergence in Law: UK High Yield Issuers, US Investors and Insolvency Law

AuthorSarah Paterson
Date01 May 2015
Publication Date01 May 2015
The Adaptive Capacity of Markets and Convergence in
Law: UK High Yield Issuers, US Investors and
Insolvency Law
Sarah Paterson*
This article examines the increasing access by UK issuers of high yield bonds to US investors
notwithstanding substantive differences in the approach to valuation of the issuer in financial
distress in US and UK restructuring law and, therefore, in anticipated return on default. It
examines the development of the market in the context of existing theories on the relationship
between law and finance and suggests that previous accounts have overlooked the adaptive
capacity of the finance market to legal environment and the implications of such structural
adaptation for the prospects of convergence in law. Three states are identified: where the market
is poorly adapted to the legal environment and reinforces other pressure for change, where the
market is adapted to the legal environment and is a neutral influence on, or even dampens, other
pressure for change and where both legacy and adapted structures exist, potentially pulling in
different directions at the same time.
US corporates have traditionally relied on debt raised in the capital markets to a
significantly greater extent than UK corporates. Sources suggest that US borrow-
ing has been split roughly 70:30 in favour of the debt capital markets, compared
with an almost diametrically opposed split 30:70 in the UK in favour of bank debt.1
However, following the most recent financial crisis there is increasing evidence
that this picture may be changing. European banks face economic, political and
regulatory challenges which make them unreliable as the sole source of finance for
corporate Britain. Private equity sponsored businesses rely on leverage levels
which may be unachievable in post-recession loan markets and cheaper institu-
tional money may be accessible through the debt capital markets.2
One aspect of the changing nature of UK debt markets is an increase in the
number of high yield bonds issued by UK issuers available for purchase by US
investors. A high yield security is a bond which is rated less than ‘investment
grade’ by credit-rating agencies. Credit-rating agencies assess the likelihood that
a company will default on its debt. Where the risk of default is low, the
*Assistant Professor in Law, the London School of Economics and Political Science. Earlier versions of
this paper were presented at the Insolvency Lawyers’ Academic Forum in 2014 and at the LSE Law and
Financial Markets Conference ‘Intermediated Securities and Investor Rights’. The author is grateful to
participants at both events for their comments. All views expressed are the author’s own and she is
responsible for any errors and omissions.
1 Bank of England, Trends in Lending, 2013 at
Pages/other/monetary/trendsinlending.aspx (last accessed 18 July 2014).
2 See AFME Annual Review 2013 and ‘Unlocking Funding for European Investment and Growth’
commissioned by AFME from Oliver Wyman June 2013, both at (last
accessed 18 July 2014).
© 2015 The Author. The Modern Law Review © 2015 The Modern Law Review Limited. (2015) 78(3) MLR 431–460
Published by John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA
credit-rating agency will provide what is known as an investment grade credit
rating for the bond. Where the risk of default is higher, the credit rating will be
below investment grade and investors will expect a higher interest rate and yield
on their investment to compensate for the higher risk. There are a number of
levels of rating and the high yield universe covers a reasonably wide spectrum,
from bonds rated just below investment grade to much riskier bonds which have
lost their credit rating entirely.3
A UK issuer seeking to issue securities for sale in the US market will normally
make a so-called Rule 144A offering.4Rule 144A provides a means for foreign
issuers to offer securities for sale to sophisticated investors in the US without
becoming subject to all US securities laws’ requirements for public offerings.5It
is popular as a means of persuading European investors that they will be able to
access the US secondary market in trading the securities which they purchase.6
The fact that a Rule 144A offering is included and that the bond is governed by
New York law does not, of itself, give any indication of the number of
purchasers who will actually be based in the US.7But even if the initial
purchasers are all based in Europe, European investors demand access to the US
secondary market when purchasing securities as a source of liquidity and financial
advisers advising on the terms of issues are therefore focused on delivering a
product which will be attractive to US investors.8The Rule 144A offering seeks
to assure investors that a broad and deep market will be available to purchase the
securities, should they decide to sell.
In addition to liquidity concerns, the investor is also likely to be focused on
the possibility that the issuer will not be able to meet all of its debt obligations
(the risk of default) and on the extent to which the investor’s value will be
preserved in any subsequent debt restructuring. In the 1990s, a group of scholars
suggested that strong laws for minority shareholder protection needed to be in
place within a jurisdiction before dispersed equity capital markets could develop
3 For a description see Standard & Poor’s Financial Services LLC, High Yield Bond Primer (2014)
at (last accessed 18 July 2013).
4 Under the Securities Act of 1933, s 5 all offers and sales of securities must be registered with the
SEC or qualify for some exemption from the registration requirements. Rule 144A is promulgated
under the Securities Act of 1933 and provides an exemption and permits the public resale of
securities if a number of conditions are met, including how long the securities are held, the way
in which they are sold, and the amount that can be sold at any one time.
5 See J. A. Fanto and R. S. Karmel, ‘A Report on the Attitudes of Foreign Companies Regarding
a US Listing’ (1997) (3) Stanford Journal of Business and Finance 51, 54–55.
6 For the benefits of accessing US capital markets, ibid, 52.
7 It merely enables the securities to be purchased by investors in the US but where the securities are
offered for sale in the US and in other jurisdictions it gives no indication of how many investors
in each jurisdiction will purchase.
8 For the role of the secondary market in providing liquidity see V. Bencivenga, B. Smith and R.
Starr, ‘Liquidity of Secondary Capital Markets: Allocative Efficiency and the Maturity Compo-
sition of the Capital Stock’ (1996) 7 Economic Theory 19. For the importance of US investors as a
source of liquidity for bonds issued by European issuers, see G. Yago and S. Trimbath, Beyond Junk
Bonds: Expanding High Yield Markets (Oxford: OUP, 2003) 89 and A. Huang, A. Guoming, M.
Kalimipalli, N. Subhankar and L. Ramchand, ‘Pricing of International Private Debt: Evidence
from the US 144A Secondary Bond Market’ Asian Finance Association 2014 Conference Paper
at (last accessed 2 December 2014).
UK High Yield Issuers, US Investors and Insolvency Law
© 2015 The Author. The Modern Law Review © 2015 The Modern Law Review Limited.
432 (2015) 78(3) MLR 431–460

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