A brave new world for PPs: digitalising private debt
The private debt markets may well be regarded as the final frontier for technology’s appropriation of the world of capital flows. After all, how can such a bespoke sector — reliant on face-to-face communication to tweak and nuance deals to suit issuer and investor — ever be run by machines? But after scratching below the surface, Craig McGlashan finds several areas where the robots may well be taking over.
Arguably the most traditional of private debt markets, the Schuldschein sector has been growing in popularity over the last few years, moving beyond its German base to attract investors and issuers from overseas.
So private is this slice of the capital industry that exact figures for issuance are hard to come by. But even the venerable Schuldschein market has not been immune to the introduction of new technologies.
“Schuldschein used to be a very domestic market, with Germany accounting for about 80% 10 years ago,” says Frederic Zorzi, global head of debt syndicate at BNP Paribas in London. “Even though Germany still has the lion’s share, now it’s a lot more balanced.
“Technology can increase the awareness of and access to this market through better communication with investors and a much quicker turnaround of transactions.”
Zorzi adds: “It’s quite fashionable to talk about technology, but we think there’s real benefit to having automated processes and quicker access to information.”
He points to the example of Ipreo, a tech company that has launched Investor Access, a platform where investors can electronically submit orders straight to syndicate banks on new bond issues. The first deals to use Investor Access came earlier this year.
“Investors putting orders directly into the book is already happening with Ipreo,” says Zorzi. “We’ve done it on public deals but there’s nothing to prevent it being done on a private deal.”
For technology to make a further impact, however, standardising documentation will be crucial.
“Direct investor access has only been tested for more straightforward transactions, so we’ll maybe have to start with the more industrial products, like Schuldschein or private Euro-medium term notes,” says Fabien Calixte, Euro PP specialist at BNP Paribas in Paris.
“It will be more difficult to industrialise quickly for a tailor-made or structured Euro PP transaction. But there’s no reason why it should not impact Euro PP. The real challenge will be the documentation because we need more standardisation. But technology can help us on that. At BNP Paribas we’re working on it.”
New Origin for MTNs
One effort to help automate much of the documentation process is in the Origin platform, which went live earlier this year. Aside from providing a one stop shop where issuers can send their funding targets, MTN levels and so on — and dealers can see them — the platform also offers standardised term sheet generation.
“It’s a very smart move from the Origin team,” says Zorzi. “There’s definitely a need, although it’s nothing revolutionary. It’s more to standardise the business and provide a better service to issuers and investors.
“What is clear is that in two years’ time the way we do the business will be different. It will be a lot more digital and industrialised.”
Late last year saw the launch of the European Private Placement Facility (EPPF). It has been designed with corporate, municipal and regional issuers in mind.
Users are provided with standard documentation. All the plumbing of capital market issuance — such as paying agents — are already within the system, letting issuers enjoy a ‘pay as you print’ policy.
“That’s very different to, say, companies with their own MTN programmes, which update their programmes at a large cost individually,” says Robert Koller, director of the EPPF.
“We update all our programmes regularly in one go, even if it’s just a technical update. So due to the standardisation there’s a huge cost saving in set-up and in running a programme. The documentation is automated and can be prepared on a per deal basis in a matter of hours. We’re also working on the possibility of making documentation machine-readable, which will make automated trading possible.
“We also have a direct link with the clearing systems so in theory we can issue at T+1. By the end of 2017 we’re in discussion to issue at T+0. That really blurs the line between primary and secondary. Investors can approach the banks and can buy in either secondary or primary, because settlement takes place on the same day.”
The private market may well change how it operates to fit the technologies as they develop.
“I can see the market changing to fit the technology systems,” says Zorzi. “There’ll be a lot more information, issuers will have more access to information and will be a lot quicker in the way they react. Some will have enough technology to spot, for example, an arbitrage opportunity in the Australian dollar market the next day.
“Our job will be different — the approach, the way we advise. But there will be more visibility, more data and more access to different markets.”
Technology may also be used to not just create more data but to make easier the access to information that already exists.
“Technology may have a part to play in addressing some of the outdated processes that exist from a regulatory perspective,” says Richard Proudlove, head of MTNs and private placements at ING.
“Base prospectuses are getting longer and longer, based on the concept that if investors have more and more information then they will therefore make better and better decisions. That’s wrong.
“If you have to read a 500 page prospectus to find the risk factors you identify as an investor, then you can’t see the wood for the trees. Writing a very dry, boring prospectus is not in any way the best way to communicate information.”
These prospectuses also need to be updated regularly, then take more time to be filed. Proudlove envisages a more efficient future.
“Surely we can have platforms where information, risk disclosures and up to date financials can all be published in real time and in an easier to access format,” he says. “I would challenge people to try to find certain issuers’ base prospectuses — let alone their most recent supplements — on some exchange websites.”
Sidestepping the banks
Not only are banks changing their approaches in the face of technological innovation, but new companies are using the latest developments to step into gaps left behind by traditional lenders — or even areas where banks have never really been involved — and creating the opportunity for investors to lend directly to small and medium sized businesses.
Funding Circle is one such example. Since launching in August 2010, the firm had lent over £2.5bn by December 2016.
“When investors wanted to lend to the real economy they would have to look at large ticket loans,” says Sachin Patel, chief capital officer at Funding Circle in London. “But now they can access much smaller business loans through us.
“Previously, this wasn’t available. The banks used to originate directly by having customer relationships — now that dynamic is less in play. Banks are stepping away, just as they’re stepping away from mid-market corporates.”
Aside from offering the chance to lend to companies that might be too small to attract the attention of banks, Funding Circle also claims to offer a speediness big lenders can’t.
“We credit assess all our loans in 48 hours, and 70% of them within 24 hours,” says Patel. “Banks can take longer — maybe three months.”
Technology is very much the driver of this rapid-fire lending approach.
“We have a database of all the companies in the country, along with a significant credit history going back decades,” says Patel. “We already know which firms will pass our credit process.
“By having all this data in advance, we’re able to more speedily assess those that will likely come through the tunnel, but also let businesses know very quickly and politely that they might not be eligible yet — rather than having them hang around.
“We also allow them to apply outside business hours — more than 50% come during those hours. That’s important for small businesses that don’t have a corporate finance team to do this for them.”
While technology throws up myriad new opportunities, it can in many ways also be a hindrance. One of the reasons some of the bigger banks struggle to put all their IT spend into new development is because much of it must go towards dealing with legacy technology systems — in many cases different platforms that have been mashed together after a takeover here or a merger there.
Not only can that create difficulties installing new systems, it also means that much money and resources is spent on making these legacy systems talk to one another.
One way of thinking about that is to imagine each individual system as a person that can only speak one language, then having it try to talk to the other individuals using interpreters.
That is not a problem faced by small start-ups that can begin with a clean slate. Some larger banks are making efforts to tackle the problem, however.
“We have a large amount of legacy systems and our board decided in the second half of last year that we would start a project to introduce a new core banking system, which will mainly consist of SAP programmes,” says Gerhard Kebbel, head of digitalisation at Helaba.
“That is of course a huge project that will cost a three digit million euro sum and will last for a couple of years. But it will serve as a much better basis and background for our front end digitalisation solutions.”
Despite these efforts, Kebbel believes that, far from facing large disruption to the traditional banking model, established lenders can work with small start-ups to further develop private debt market technologies.
“There’s a lot written about the fierce competition between start-ups and banks,” he says. “That’s maybe true in some areas of retail banking, but I don’t see it being particularly true in business to business banking.
“Start-ups have innovation power and know how to develop new technologies. They have ambition and speed and don’t have legacy systems, so can move forward in a way that is very difficult from inside a bank. But the bank can bring something too — mainly, its clients.
“If you can form a synergy between innovative fintech and banks with lots of clients, then something really interesting can be born. That’s why we approach fintech firms very actively to try to form coalitions.”