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Direct Lending Markets in Europe and the US

2024-10-28

Many similarities and a few nuances

Michael Verhoeven

Product Specialist

Maria Milina

Research Analyst

IN A NUTSHELL

Direct lending has become an increasingly important component of global credit markets and expected to continue growing in the coming years.
The US direct lending market is a larger and more established ecosystem, with a longer track record and greater deal flow, when compared to its European counterpart.
In Europe, the market for direct lending offers significant growth potential, but remains fragmented and requires a strong presence and local network with private equity firms and advisors in the country where the business is located, and preferentially established partnerships with domestic commercial banks.
The competition from liquid markets has slowed down the growth of private credit in Europe, resulting in more aggressive pricing strategies and lower expected returns, albeit still at a clear premium compared to similar risk liquid markets.
Both regions have significant amount of capital that needs to be deployed, as the demand for deals that is anticipated to far exceed supply.
Despite the higher interest rates and macroeconomic uncertainty, the default rates have remained low in the US and in Europe.
ESG consideration play a central role in Europe, whereas in the US the information on the ESG attributes is collected but unlikely to be a key factor in the investment decisions at present.
Direct lending offers financing opportunities for the European transformation, such as in the digital transformation, where small- and medium-sized enterprises play an important role.

Introduction

Europe and the United States share many foundational values that underpin the ‘Western’ way of life. However, the regions often adopt unique approaches to various topics, including the private debt market, where they are at different stages of development. This paper aims to compare the European and the US direct lending markets. To provide a comprehensive overview, we first examine the political and macroeconomic landscapes of each region, which in turn influence the distinct characteristics of their direct lending markets. Then the article explores how ESG integration varies across the two markets. Finally, we discuss the importance of direct lending for transforming European economy. This paper also emphasises that investors may want to treat two markets as complementary in the portfolio, as they offer different growth, return, ESG integration, and diversification potentials.

1 / Political environment

2024 has been tumultuous for Europe on a political level. While migration, bureaucracy and common debt discussions have seemingly been on Europe’s political agenda for a decade now, only little progress can be reported on these issues. A notable exception is the Next Generation EU program, which is supposed to socialize the debt needed to stage a recovery. While the full impact of this program is still unfolding, it represents a significant step towards greater economic solidarity and resilience within the EU. In addition, the continent has been grappling with the war in Ukraine and how to deal with the political consequences of the battlefield reverberations. Despite these challenges, European nations have shown remarkable unity in their support for Ukraine, demonstrating a collective commitment to peace and stability.

All these topics have led to protests and volatile government approval ratings. Emmanual Macron saw the spiraling poll performance as a reason to call snap elections. In the aftermath of the election, he is forming a new government with a weaker mandate. However, this period of political reorganization also presents an opportunity for fresh perspectives and renewed efforts to address the pressing issues facing France. France’s neighbor Germany is going through a rough patch as well. Its government is unpopular, and its traffic light coalition has lost the faith of most voters, especially in the east of Germany. Some of Germany’s problems came to light during hosting the European Championship this summer when traveling fans had to face that Germany’s trains do not in fact run on time anymore or patchy cellphone coverage.

While it is understandable that the EU faces challenges in making decisions on foreign policy and other issues affecting all member states, policymakers are increasingly recognizing the importance of cooperation. In a world marked by growing geopolitical divides, working together towards a more unified continent is crucial for maintaining stability and influence on the global stage.

The United States has experienced its own share of political turbulence in the last few years, including just recent an attempted assassination of Donald Trump and an abrupt change in the democratic candidate for the November presidential election. In addition, the repeated political standoffs over the debt limit and last-minute resolutions have particularly contributed to concerns about fiscal governance. This resulted in Fitch Ratings downgraded the United States' long-term credit rating from AAA to AA+ in August 2023.^[1] Nevertheless, the two parties have been able to find some common ground on foreign policy. For example, the Biden administration did not do a U-turn on many of the hawkish China stances the Trump presidency implemented. The outcome of the upcoming elections may be pivotal in determining how the US approaches other geopolitical issues, including its commitment to the war in Ukraine and the conflict in the Middle East. A temporary standstill in some areas of governance and foreign policy, with many key decisions and policies on hold, should be shaken of after the elections, when the direction of the new administration is more apparent.

Direct Lending Markets in Europe and the US

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Direct Lending Markets in Europe and the US

IN A NUTSHELL

Introduction

1 / Political environment

Important information – EMEA, APAC, LATAM & MENA

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