We reflect in this section on how our predictions for FY16 panned out, both to check what happened and put our FY17 predictions into context.
Consolidation
Prediction
We saw the start of M&A-led consolidation, which we considered would continue, if for no other reason than to build net present values and scale when necessary to access increasingly international markets. On a related issue, we predicted international funds (subject to FIRB approval) would exert greater control over operating assets.
Outcome
Consolidation across logistics, agribusiness and other sectors saw strong M+A activity. Before Emeco and, possibly, UGL, were announced as potential transactions, activity was noticeably slower in the mining sector as capital invested into equity via debt swaps, taking advantage of the highly leveraged balance sheets of many mining and mining services enterprises.
Good examples of the latter include KKR's swap of debt for equity in Bis Industries, Centrepoint in Boart Longyear and the TLB positions in Atlas Iron. Otherwise, funds from the US and Asia are very active, taking positions across operating assets in a range of special situations in Australia.
Cultural change
Prediction
We looked forward to boards embracing experienced turnaround specialists being brought into situations well before those entities became truly distressed.
Outcome
We have seen an upswing in the engagement of turnaround specialists in the last 12 months but, as with previous years, there is always more scope for boards and management to embrace an experienced turnaround practitioner at an early stage.
Funding challenges
Prediction
We anticipated a continued increase in the issuance of alternative instruments, such as 144A bonds or Term B Loans, among domestic and international financiers.
Outcome
We have seen our prediction play out. This is driven by interest rates remaining at historical lows, both domestically and in the United States, as well as continued downward pressure on the inner city residential property market. The residential property issues are threefold:
- an over-supply of new apartment blocks, particularly inner city apartments in Melbourne, Sydney and Brisbane;
- local defaults, by reason of the continued slowdown and an inability to make immediate profits by trading out of pre-sales;
- overseas defaults emanating mainly from China, by reason of (i) a reported increased preparedness to enforce capital outflow restrictions; (ii) a slowdown in its economy and (iii) local lenders' increased restrictions on lending to overseas buyers.
The reduced availability of debt has led to an increase in the use of alternative debt instruments.
Iron ore prices
Prediction
Forecasts for iron ore prices and a range of other commodities (except, perhaps non-coal energy) were subdued, and we forecast a gloomy start to FY16 for miners and their dependent contractors, transport operators, logistics owners, engineers, materials suppliers and service industries.
Outcome
In the current climate, iron ore transactions are still finding it difficult to attract new investments as the primary export market for this product continues to be shaped by China's long-term growth outlook. Prices were highly variable during the first half of 2016 for iron ore, led by speculative activity in futures markets.
Prices staged a surprise rally in April 2016, following a three year period of declining prices, then by 24 May 2016 went into a severe decline as port inventories of the commodity rose above 100 million tonnes. In its June 2016 quarterly commodities paper, the Department of Industry, Innovation and Science said that, despite the large movements in prices, the market fundamentals are broadly unchanged: demand growth is slow and the market remains well-supplied. It estimated the value of Australia's exports of iron ore to have declined by 10% in 2015-2016, falling to $49 billion.
The fall in the price of iron ore over the past few years has had the effect that many operations globally are running at a cash loss, some of which are expected to close, though, at current prices, few of these operations will be in Australia, as it is dominated by the world's largest and lowest cost operations.
Greece
Prediction
After defaulting on a 1.5 billion euro loan, Greece became the first country to default on its obligations to the IMF since Zimbabwe in 2001. A third bailout averted a crisis in the short term, but Greece's position remained precarious.
Outcome
We moved from a Grexit to a Brexit during the course of the last year.
The IMF finally concluded that Greece's debt had become unsustainable and that country could not retrieve the situation on its own. It followed that it was critical for medium- and long-term debt sustainability that Greece's European partners make concrete commitments, in the context of the first review of the European Stability Mechanism (ESM) program, to provide significant debt relief, well beyond what had been previously considered.
IMF staff participated in technical discussions in the northern summer of 2015 between the Greek authorities and the European Commission, European Central Bank and ESM on an economic program that could be financially supported by the ESM.
The Memorandum of Understanding that emerged puts in place far-reaching policies to restore fiscal sustainability, financial sector stability and a return to sustainable growth.
Debt relief is now firmly on the agenda, but is dependent upon Greece sticking to the program targets.
Two areas of critical importance for Greece's ability to return to a sustainable fiscal and growth path are:
- the specification of remaining fiscal measures, not least a sizeable package of pension reforms, needed to underpin the program's still-ambitious medium-term surplus target; and
- additional measures to improve confidence in the banking sector.
Whether Greece will be able to do so is an interesting question, given the deep-seated cultural forces of populism, political extremism, and deterioration in the rule of law, combined with a fiscal, economic and banking crisis.
The regulatory space
Prediction
At the regulatory level, we expected to see continued agitation for the introduction of safe harbour defences for directors undertaking workouts, a continuation of the debate on whether an equivalent of Chapter 11 should be introduced into Australian law, and the deeming of ipso facto clauses as void once a company goes into administration or receivership.
Outcome
The Productivity Commission's Final Report into Business Set-up, Transfer and Closure, released on 30 September 2015, called for reforms to the Corporations Act to:
- deem "ipso facto" clauses void when a business is controlled by an administrator; and
- introduce a "safe harbour" defence to allow directors of a solvent company to explore, within guidelines, restructuring options without liability for insolvent trading.
The Australian Government subsequently released a proposals paper, "Improving bankruptcy and insolvency laws", as part of its National Innovation and Science Agenda. It deals with both ipso facto clauses and the safe harbour defence.
Ipso facto clauses
The Government has advanced an "ipso facto model" with the wording "that any term of a contract or agreement which terminates or amends any contract or agreement (or any term of any contract or agreement), by reason only that an 'insolvency event' has occurred would be void". In this model an "insolvency event" would include:
- an administrator having been appointed in respect of the company;
- the company undertaking a scheme of arrangement for the purpose of avoiding administration or insolvent liquidation;
- a receiver or controller being appointed; and
- the company entering into a deed of company arrangement.
As an anti-avoidance mechanism, the Government proposed that "any provision in an agreement that has the effect of providing for, or permitting, anything that in substance is contrary [to the proposal] would be of no force or effect" noting, however, that nothing in the proposal would extend the operation of the provision beyond ipso facto clauses. That is, counterparties would maintain a right to terminate, amend, accelerate or vary an agreement with the debtor company for any other reason, such as for a breach involving non-payment or non-performance.
As to exclusions, the Government intends to carve out certain "prescribed financial contracts" to be set in the regulation where uncertainty around the ability to enforce that type of contract represents a material risk to the efficiency, stability and liquidity of the capital markets which depend on them. The Government also flagged its intention to include a provision that affected counterparties may apply to the court to vary contract terms if they can show they have suffered hardship.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
