American hedge funds and other non-bank credit investment groups now hold just over 50 per cent of all lending to risky European companies - pushing banks into a minority role in this sector for the first time.
This marks a dramatic contrast with the picture seen at the start of this decade, when banks accounted for 95 per cent of leveraged lending, or loans made to companies with a credit rating below investment grade.
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The shift has largely occurred in the past couple of years. As recently as 2005, banks represented three quarters of the market, according to Standard & Poor's Leveraged Commentary and Data, an industry newsletter. In the year to March 2007, however, their share was 49.8 per cent.
The trend highlights in an unusually stark manner how hedge funds and other non-bank investors are muscling into territory traditionally dominated by banks. Consequently, it may provoke new questions about the ability of policymakers to monitor borrowing trends, given that hedge funds are generally unregulated.
Non-bank investors have played a dominant role in the leveraged lending sector in the US for more than a decade. However, until re-cently, banks in Europe refused to relinquish control of lending in their region, since they feared it would undercut their close corporate ties.
What has changed the picture, however, is that a flood of US credit funds has recently established operations in London, including hedge funds and credit portfolio investors, also known as collateralised loan obligation vehicles.
These, together with local investors, have become eager to buy loans, not only by acquiring them from banks but also by participating in loan syndications.
At the same time, European banks have become eager to sell loans rated below investment grade because new rules make it expensive for them to keep these on their books.
Industry groups are already warning of problems when the credit cycle next turns.
The European High Yield Association, the industry body, has written to the UK Treasury asking for urgent legal reform to make the British bankruptcy code better suited for the change in lending pattern.
The EHYA argues that the present restructuring practices, based on out-of-court agreements between banks, is no longer effective, given that banks no longer dominate lending. It wants the adoption in Europe of some measures similar to the Chapter 11 system in the US.
"The next cycle of large corporate debt restructuring is expected to be substantially more complex than the previous cycle . . . the ab-sence of a predictable, supervised restructuring process creates a considerable layer of uncertainty [and] inc-reases costs," says the EHYA.
Meanwhile, the total pool of leverage finance has exploded amid a wave of private equity deals. The EHYA says Europe now accounts for a third of the global leveraged loan market, compared with less than a fifth six years ago.
