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Roundtable Discussion: Keeping the Schuldschein’s feet on the ground

Private debt markets have made inroads into European funding strategies over the past few years, taking transactions from syndicated loan markets, as well as public bonds. The Schuldschein market has been particularly vibrant, racking up €27bn of issuance in 2017 from more than 150 transactions.

Advocates argue the Schuldschein's unique selling proposition is its ability to combine attractive pricing, lean documentation and unparalleled flexibility. But the outlook is not all rosy, as doomsayers warn that pride may come before a fall through the market’s next credit cycle.

GlobalCapital invited some of the Schuldschein market’s leading participants, including bankers, investors, issuers and lawyers, to a roundtable in Frankfurt in mid-March to discuss the state of European private debt markets, and what the future might hold for them.

Participants in the roundtable were:

Klaus Distler, executive director of origination, Helaba

Oliver Dreher, head of debt capital markets practice, CMS

Michael Lamla, head of corporate banking, Agricultural Bank of China

Patrick Mannl, director, UniCredit

Johannes Mayr, economist, BayernLB

Stefan Scherff, head of corporate Schuldschein origination for Germany, Switzerland and Austria, Commerzbank

Thomas Schneider, head of European corporate loans, Allianz Global Investors

Felix Warmuth, group treasurer, RHI Magnesita

Zsófia Zséger, head of group funding, MOL

Silas Brown and Toby Fildes, moderators, GlobalCapital

GlobalCapital: Private debt has made some very good ground over the last four or five years in Europe. Is it continuing to rise up the agenda for corporate treasurers? And if so, where are we in its evolution?

Stefan Scherff, Commerzbank: Where we are going to be in a couple of years is a tough question. The rise in volume has been for good reasons, though. We have flexible products and I think that’s not only true for Schuldscheine but many private debt instruments. You can tailor them to your needs, in a way not possible with other instruments. Syndicated loans are fixed in that structure to a certain extent, and even more so corporate bonds.

Patrick Mannl, UniCredit: The prominence of the Schuldschein product in Germany is incredible. Ten years back there was a market size of €5bn and now you have some €25bn-€27bn — that rise gets it on to the agenda of every treasurer. One of the big lessons learned from the crisis was to diversify your funding base.

Klaus Distler, Helaba: Maybe one additional point is the policy agenda, right? There’s an additional push for these market segments, and especially smaller companies, as a result of the Capital Markets Union. We have to think more broadly about where the additional Schuldschein volume is coming from. Private debt has eaten into the loan market, and in particular the German loan market has declined, while the Schuldschein has gone up significantly.

Thomas Schneider, AllianzGI: When I started at Allianz, the Schuldschein was a product in the bottom drawer of investment bankers’ desks. But as it’s grown, institutional investors like us still play a very limited role, and we still have the Schuldschein market in the hands of banks. We still don’t have a real alternative lending market and this is something we should change, to make the product even more attractive.

Johannes Mayr, BayernLB: I agree it is still in the hands of banks, but it is different banks. It is not the traditional banks that you find in the syndicated loan — it’s rather smaller, regional banks like savings banks, or foreign banks who invest in the Schuldschein instrument. So from that point of view, yes it’s banks — but it’s still a diversification.

Schneider, AllianzGI: It is going to be very interesting to see how things work when things become difficult. Currently refinancing is not a problem because there is plenty of liquidity, but this could change once the credit cycle turns.

Oliver Dreher, CMS: Coming from the lawyer’s perspective, that is indeed what investors from other jurisdictions come and ask us. How can you make light documentation work? Then indeed the lawyer has to admit that it is not magic, but because there is still a certain hygiene in the market. Leading arranging banks are looking to keep this good level of credit quality. But you can never foresee what happens. We also remember the days of credit-linked notes. Bankers were saying: ‘Oh, the secret is you just pick the right ones’, but of course things can change.

GlobalCapital: It’s interesting that we have highlighted the negatives so early on in this discussion — let’s not forget the last three or four years have been very successful ones for this product. Maybe not for everyone, like an investor who has seen their yields being squeezed or failed to get into a deal, but from a corporate perspective it’s been good news.

Felix Warmuth, RHI Magnesita: Absolutely. The point about diversifying your funding sources definitely makes sense. The Schuldschein should not be the only instrument you have in your debt structure, but it is an additional and non-traditional funding source.

Of course there are positives and negatives to each product — not only the Schuldschein. But definitely one topic that could be an advantage or improvement going forward is to get institutional investors more on board, to have the optionality of longer tenors.

Zsófia Zséger, MOL: I very much agree with your point. Earlier in our portfolio, we mainly had syndicated loans, and we were present on the debt capital markets. We heard a lot about this product and our banks kept coming to us and saying: ‘you should try this, it’s more international’.

We were sure there was not that much to lose. Worst case, we would have ended up with a deal which we hadn’t been able to close.

We definitely wanted to diversify our portfolio, and we also very much liked the repayment option on floating terms. Another advantage is that you get access to longer maturities than your usual syndicated facilities.

GlobalCapital: So you now have Schuldschein bank lenders as well as your syndicated loan banks. How different are they? Are there more Asian banks in your Schuldschein, for example?

Zséger, MOL: Well, the Schuldschein lenders didn’t ask for ancillary business, most importantly. We don’t really have a relationship with them. And in terms of geographical location, it’s a different set-up. We do have Asian banks in our bank portfolio, but there is more focus on Asian lenders in our Schuldschein. Also, it was surprising on the documentation side that the banks who came into our Schuldschein deal were not demanding regarding contractual terms.

Scherff, Commerzbank: In a syndicated loan each bank provides maybe hundreds of millions of euros. That’s quite different to an average commitment of maybe €5m in a Schuldschein loan. So your level of protection is lower.

But if you look at the Schuldschein it is, by its very nature, not a native instrument for institutional investors. There are some things in a Schuldschein that do not cater to institutional investors’ needs. If you don’t have an investor that’s in a position to do the credit analysis, it’s not the product for that investor. On the institutional side there are only a limited number of investors who actually have that capability.

Also, the Schuldschein market doesn’t have a huge secondary market, because investors are usually buy and hold investors. And that’s another thing institutional lenders don’t really like. They want to be able to trade out if they want to.

So can we bring the two things together? Are there ways to bridge that gap?

Warmuth, RHI: But the question here is why is there no secondary market? Because actually the Schuldschein should be something that is common for a secondary market, right? Because any investor can sell it all the time.

GlobalCapital: Is it because the traditional Schuldschein investors are smaller banks that are typically buy and hold investors?

Mayr, BayernLB: You have a mark to market in the bond markets, and this drives buying and selling. We don’t have this in the Schuldschein, and this is one of the major reasons we don’t need to have an active secondary market.

Distler, Helaba: It’s part of the charm of the Schuldschein that you don’t have the mark to market, at least that’s our impression from many of these investors. Our strong impression is that part of the driving force behind the Schuldschein market is this quality. That it is illiquid for certain purposes but liquid for regulatory purposes. But as you say, it is buy and hold investors and what they need, in terms of, let’s call it, regulatory liquidity, is just to have the possibility to transfer it.

Mannl, UniCredit: But this could also be affected by the current low interest rate environment, right? When the cycle turns, I’m not so sure if we will be in the same setting or if the secondary market might develop a bit further.

GlobalCapital: You raise an interesting point. The Schuldschein market raised 25bn-27bn last year, and I think the US PP market $70bn. Even the Euro PP market had a good end of the year. But I wonder what will be the impact of the retirement of special central bank measures such as quantitative easing and financing operations on private debt markets. Would it be true to say that the private debt markets have benefited greatly from central bank liquidity and therefore once that central bank liquidity recedes, Schuldscheine and other private debt will begin to reduce in volumes?

Mayr, BayernLB: Not necessarily with the volume, but certainly it has an effect on the price. I would dare say there is a pricing effect of maybe 20bp or 30bp, whether the Schuldschein is ECB-eligible or not.

On the other hand, I think the effects those measures had on the related corporate bond market were much higher. So it’s really hard to say what we’ll see in the volumes. Our view is that we will have a strong year in 2018 again, so comparable to 2017 — but the forecast beyond this is a bit uncertain.

GlobalCapital: But do you think that the main reason why these private debt markets have had such a good two or three years is because of the ECB?

Distler, Helaba: No. We have to look back, beginning in 2016 without the Corporate Sector Purchase Programme. We had an excellent start to the year, also coming from 2015. New issuers. New investors. It also was, from my point of view, to a certain extent M&A-driven. And then we also had an interest rate environment, particularly in 2017, where some corporates decided to go ahead and pre-fund themselves, since the view was that interest rates as well as debts were going up the curve. I’m not sure if I would agree that 2018 will see the same volumes as 2017.

Scherff, Commerzbank: I agree — I would sign that statement if it was written down. A lot of last year’s demand was clearly due to the fact that issuers were expecting higher interest rates this year, and refinanced a lot of their funding needs early for 2018. And I think that is proved by the fact that right now the market is pretty much slowing down.

Mayr, BayernLB: Does that make a difference? Because in my view it doesn’t make a difference if the market is €20bn or €27bn — the most important thing is that we have a stable market, and we’ve had this stable market for the last five to seven years.

For you as a journalist, yes of course you want to write stories about the market’s overall volume. In early 2016 nobody knew what volumes we would have at the end of the year and I think the same is true also for this year. Because there might be different motivations at the multinational level, which make either the Schuldschein more attractive — or perhaps the only product to go for — or a bond.

Warmuth, RHI: I think one of the main motivations was diversification. As you already mentioned, Schuldschein investors are totally different from your traditional corporate banks or relationship banks. So you just diversify your funding base, you diversify your banks, and you don’t have banks that want additional business here and there.

Zséger, MOL: That’s true for us as well. Of course we read about the Schuldschein in the news a lot and our banks kept approaching us. We’re focused all the time on finding new opportunities to diversify and to innovate. To do something new which is completely unknown for the country, as one of the major firms in Hungary, definitely it’s a challenge.

In our case it was driven by the fact that we had a very strong liquidity position and we are an issuer in the bond market, but we are not a very regular issuer. We’re not out every year. We are issuing in every, say, second or third year. And we just didn’t need the benchmark size. That’s also a big advantage for the Schuldschein, that you can do €50m or €100m. You don’t need to shoot for €500m.

GlobalCapital: Did you contemplate doing other forms of private debt? A US rivate placement, for example, or Euro PP even or even something bilateral by nature?

Zséger, MOL: Not really, because we have quite a substantial syndicated loan portfolio thus enough liquidity. So far, the Schuldschein is a product which we like, but of course we are considering different alternatives as well, but when I ask my partner banks: ‘Would it be cheaper than a Schuldschein?’, if they say no, then basically, I’m sorry, but I lose interest.

GlobalCapital: So having done one Schuldschein, would you now say it’s probably going to be a permanent feature of your funding toolbox?

Zséger, MOL: It’s probably too early to tell. But we liked it and we believe it’s a good product. We need to consider, as mentioned, the pricing. At the time when we issued, the pricing was closer to loan pricing, but definitely lower than bond pricing.

However, during the year, pricing has really come down, and if we take a look now at the current yield for a potential bond issuance, then it’s probably now below the potential Schuldschein pricing, because Schuldschein investors do not react that quickly.

Warmuth, RHI: Similar from our side. We have issued three Schuldscheine already, and they were also driven by pricing. We did not have access to the rated bond market as we weren’t rated, so it was more a choice between an unrated bond and a Schuldschein.

As you mentioned, the pricing difference between unrated bonds and Schuldscheine has tightened. So looking into the future there’s a question on how the pricing will develop — in both the Schuldschein market and the bond market.

GlobalCapital: Just going back to my question about the ECB. Thomas, are you looking forward to the ECB getting out of your market?

Schneider, AllianzGI: We know from discussions with issuers that many of them are interested in diversification. They are not only going for cheap prices. The issuers who are only looking for tight margins are not the target group of institutional investors. We actually look for the companies seeking to diversify.

GlobalCapital: But do you think your time is coming, though? When central banks disappear from the markets, that will mean that syndicated loans should become more expensive and perhaps go to levels that we thought they were going to after the crisis, but didn’t. So that might be the opportunity finally for institutional investors to start taking market share?

Schneider, AllianzGI: Once liquidity dries up in the markets, then times might get better. That might take a while, and for the foreseeable future we have to take the product as it is. My idea is to introduce a kind of institutional Schuldschein, which can really help to diversify the lending base for companies interested in broadening their funding bases. But, coming back to the point that insurers are not really interested in the product — I would disagree. We have a €4.2bn portfolio in Schuldscheindarlehen. And we are looking to expand our business every year. So the interest is there and we are opening our Schuldschein business for third party clients and they are also interested in that product.

I don’t know what happens with the Schuldschein once you have more issuers like Carillion, Steinhoff and other companies getting into trouble. The loans we are making today have terms up to 10 years and there will certainly be defaults in that lifetime. So I think we have to anticipate what the future brings. One point is to maintain a kind of market discipline and another is to develop the market towards a separated issuing for institutional lenders, who can provide a lot of advantages. Diversification is one aspect. And institutionals like long terms. And you have the advantage that you don’t need too many lenders because institutionals can take big ticket sizes. In the way you can reduce the number of banks involved in a loan and the number of things you have to manage, cross-sell for example.

Scherff, Commerzbank: Firstly, I think I was misunderstood. I didn’t say there was no interest from institutional investors, I just said that most institutionals or potential institutionals did not have the analysts, the knowledge, inside to actually participate.

There are a couple of names, like Allianz and maybe Axa and Generali that actually have private debt teams, who can perform credit analysis.

Unless the issuer has a rating, where the institutional investors can come in on the basis of the rating, like we know from bonds — then it’s a different story.

But as soon as you have an unrated credit, the institutional investors do need to perform that analysis, and a lot of them just can’t do it. That’s my point. And I think the story with, ‘Oh, there will be a time when the institutional investors come in’ is as old as the M&A story in loans.

I have not experienced in almost 20 years a situation where institutional investors had a larger share of the Schuldschein market than they have today. It has always been around 1% or 2% of the total volume. It’s pretty stable, actually.

We have seen times when the documentation was much stricter. We have had times in Germany where almost all Schuldscheine issued had financial covenants and still no institutional investors were participating.

GlobalCapital: So what are you saying? We’re going to get that?

Scherff, Commerzbank: I don’t know. It is like we’re standing somewhere in the forest and shouting for a rating system and no one’s listening. Mr Schneider maybe can comment on that. We cannot force that — it has to come from the group of investors. We had roundtables and regular meetings with banks and institutional investors but the conversations all dried up over the years.

Michael Lamla, Agricultural Bank of China: If I understand Thomas’s point correctly, Allianz has the capacity to analyse the credit, and it’s increasing its exposure to the Schuldschein market, as well as stepping up its direct lending.

That is exactly what we are doing as well. In direct lending, we can provide the borrowers with more tailor-made solutions. We can focus on our capacity to do credit analysis, decide locally and draft the contracts. And we can be quick to react to specific situations; for example, mergers and acquisitions. Then you really need to be quick, and review a case, for example, a carve-out where you don’t have a full annual report, with a 700-page English LMA documentation and full credit approval in three weeks. That’s what we target.

Scherff, Commerzbank: And there’s a place for that, right? You are quite successful in doing that, and treasury departments also need that part of the financing. It is part of the mix.

Mahr, BayernLB: And on the other side, we have heard it from the horse’s mouth: your motivation to go for a Schuldschein as issuers, I understood, was the pricing, the leaner documentation, much more flexibility than in your syndicated loans, and diversification — but not necessarily the institutional investors. Would you have been willing, as a first time issuer or a third time issuer, to accept tougher documentation?

Zséger, MOL: In our case, of course it depends on the specific targets at that time. From the diversification point of view, it’s not necessarily important to have institutional investors. It’s important to have different banks and different investors from the ones in our syndicated loan portfolio.

The biggest advantage on the institutional investor side is probably the maturity, because usually those are the ones aiming for longer maturities.

If I may add one comment regarding defaults — defaults are natural and the risk premium is there because there is a risk of default.

Warmuth, RHI: But also, coming to your question regarding tougher documentation — tougher documentation would have to drive down the margins. And the second thing, which is difficult in terms of tougher documentation and Schuldschein in combination, is that you don’t have a majority lender clause. So that is really difficult on the fixed rate Schuldschein notes.

On the floating rate loans, it doesn’t matter, because you can cancel them at any time. But on the fixed Schuldschein terms, it’s really difficult because if you want to change something or you have to amend certain clauses, you have to seek the approval of each and every lender. And it can happen: there could always be something you have to amend.

Dreher, CMS: What we do from the lawyers’ side is effectively what you say. We translate syndicated loans into Schuldschein loans, which means we actually shorten the documentation.

On one hand, we make the clauses more flexible for the borrower, while on the other hand, we make them less complex. The reason is: you cannot ask for a waiver in the Schuldschein market every week, so the terms need to be fairly flexible.

In a syndicated loan a breach in covenants is a means to renegotiate conditions. That doesn’t work in the Schuldschein world. One result is that Schuldschein terms need to give the borrower more leeway, so that breaches do not occur as part of daily business.

At the same time, clauses in a Schuldschein must not foresee a constant exchange of declarations or actions between the parties, which would be similarly impractical. And that is what we see, at least at the moment, being clearly accepted by the majority of investors, wherever they come from. They understand that they cannot bind the borrower to something which could practically mean a hard default occurring for simple technical reasons.

If you wanted to change the current approach, a real paradigm change would be necessary. On one hand, you could of course introduce tougher documentation. However, without other changes, this would simply not work, as I mentioned. Hence, investors would also have to get used to the idea of majority clauses and related measures, to handle new necessities like frequent waivers and the like.

The question remains: will there be sufficient market pressure for such changes, and where would this market pressure come from?

Schneider, AllianzGI: Just to be clear, what I didn’t say is that financial covenants should be tougher — they should be in line with the syndicated loan documentation.

Warmuth, RHI: But if that’s the case, what is the difference from a syndicated loan?

Schneider, AllianzGI: Short term and long term — this is exactly the point here. With German issuers we currently see almost no financial covenants, though in syndicated loans there are still covenants in place.

We go for long terms, and the disadvantage that you get in the short term from not having covenants, it’s just huge. We invest money for insurers and are further away from the issuers compared to banks. Banks have more comprehensive information sources like current account information.

Distler, Helaba: I think this brings us back to one of the initial points, because the Schuldschein market is basically an investment grade market, and I think that is where we should continue to be. Because the advantage of the Schuldschein is that it has a lean documentation, proven documentation, and having a covenant only makes life more complicated for the issuers and investors involved.

This brings me back to the other point: where does the market go? Historically, the market was driven by the Landesbanks, because these banks tend to have investment grade clients. Now, seeing other arrangers in the market, I see the risk that there are other issuers coming, with lower-rated profiles. I’m, however, not too sure if this changes the market going forward, and if this would increase the default rates, which are non-existent pretty much, historically.

Mannl, UniCredit: Absolutely. A sanity check is so important. The last year has seen not only the two mentioned companies, Carillion and Steinhoff, but there have been other transactions with less success than expected. Sanity checks are very important, though of course I don’t see all private bank lenders going for the lower rated credits.

GlobalCapital: Can we stop the market evolving? I understand why you’re saying it and why you want to stop, perhaps, lower-rated issuers doing Schuldschein deals; but can we actually prevent it?

Mannl, UniCredit: No, there are too many people in the market, and of course too many investors not being able to accept the current price.

GlobalCapital:  Do you expect the market to calm down a bit?


Lamla, Agricultural Bank of China: Hopefully. This is something where you have to be very near the market to know about smaller transactions and special situations.

I think there might be a bit of reluctance for some investors to continue to go with lower margins and credit quality.

Mayr, BayernLB: Just one point regarding Landesbanks and their strong market position — when we think about how the market will develop, we should not forget that the investor base mainly buys these Schuldscheine to diversify their credit portfolios. So if we think about if it should be a market for institutional investors, we should not forget what the rationale behind a large part of the investor side is.

GlobalCapital: There is possibly a danger that the Schuldschein product is having too much of a good time, and that the development needs to be checked slightly to maintain its reputation for high quality and reliability. I think we all agree with that. But how do we do that?

Schneider, AllianzGI: Don’t you think that once there are too many defaults in the market, then nobody will want to be associated with the market any longer?

Scherff, Commerzbank: That’s a very important point, and that’s why I do not agree when we say we can do nothing about issuers, and particularly investors, moving down the credit spectrum; because we are in the driver’s seat. All of us as arrangers and all of the investors.

We need to step up and tell the clients: this is not a risk you want to see. We can’t play this with the market, and investors need to push back if they don’t like the risk.

Lamla, Agricultural Bank of China: To be honest with you, from an investor’s point of view, one of the first things we look at is which bank is arranging the transaction. There are one or two arrangers in the market today which have a yellow flag with us.

Clearly I can only tell an issuer to watch for the reputation of its arranger. You have new borrowers coming to the market, which posed a significant loss in the last year, without any special explanation by the research or by the bank.

I would understand if there was some restructuring, but sometimes they just tell you there is a restructuring without really giving details of the case. So that’s where I totally agree with the point that the arrangers have to do this sanity check.

Thus, we prefer bilateral or syndicated club deals where we have a better communication with clients.

Warmuth, RHI: Probably some of the guys sitting here would not be happy if I say this, but it definitely makes sense for a corporate to have one of the Landesbanks as an arranger for a Schuldschein, right? Because you get the diversity and access to those banks and Sparkassen that you normally don’t have access to.

The second topic, which is also important for investors, is that the arranger should have a close relationship with the company. Like, for example, doing other bilateral business, being invested in the Schuldschein or term loans and so on.

That also means the investor can be sure the arranger has sufficient information on the company, has knowledge about the company and its business model, and can also present and market its Schuldschein the right way.

So the arranger should have a good relationship and ongoing business with the corporate, and then also be able to market the Schuldscheine to the investor base.

Distler, Helaba: Yes, whether it’s a Landesbank or not, the arranger has to have this relationship with the borrower, and we are also telling international banks who try to get more into this market as arrangers, that they need to take on quite an active role with issuers. Not only in potential restructurings, which hopefully won’t be there, but investors rely on this implied active strong role of the arranger.

Warmuth, RHI: Although historically, the bank doesn’t have to be invested in our loans, but it could also just be a history of working together. Also taking tickets.

GlobalCapital: Does the Schuldschein market need to evolve? Can it take on features such as collective action clauses that you see in the public bond markets so that it becomes safer to use?

Scherff, Commerzbank: That’s interesting, because looking at the default rates, I wonder how safe it should be. I don’t think we need to talk about how we can make it safer right now — I think the question is: can we keep it that way?

And of course, that is maybe not possible, because once we have been through an entire cycle, we will see some sort of default rate established in the market.

Hopefully, we will have a low default rate; if not, the market will disappear.

But I don’t think it’s the right time to think whether we can make it safer — I think the important question is: can we keep it as safe and attractive as it is? Of course the product needs to evolve. I think we need to come to a more standardised documentation.

I don’t think it is possible to have majority clauses as a standard if you want to keep it a Schuldschein; I think that’s legally impossible. You would end up having an instrument that is almost like a Schuldschein but with majority wording.

Lamla, Agricultural Bank of China: There are issuers who have the majority clause with a Schuldschein, therefore want between five and 10 lenders and that’s it. Because this way they can keep the relationship with their lenders and if there is need they can talk to someone.

Dreher, CMS: I think technically you can still have it as a Schuldschein with majority voting, but you’re very right that the Schuldschein as we know it would be over if we brought in majority voting clauses.

We’re seeing a bit of a counter-tendency, interestingly. We see very big and strong borrowers that are very active in the bond markets, which are trying to introduce the opposite: they are trying to introduce quotas, for instance, for termination rights. This means a certain proportion of the investors would have to ask for a termination.

In other words, the issuers are not making it easier for the investors to handle stricter covenants. On the other hand, they are reducing the risk of sole investors triggering terminations.

So I think we have got various tendencies in the market, which come from it expanding and becoming interesting for different types of borrowers, big and small — which is a positive thing.

GlobalCapital: But from an investor’s point of view, do we have enough clarification regarding potential spillovers between the bond market and the Schuldschein market in difficult times? Let’s say a company has both instruments out there and gets into trouble; how does an investor look at this?

Dreher, CMS: The Schuldschein has always been a mix between the two worlds. A typical negotiation scenario when a deal is being documented is where one side, it might be the borrower or the banks, will pick up on something and say ‘this is something I know from the syndicated loan market. I like it, and so I want to put it in’.

Or if an issuer has got bonds out there on an MTN programme, you will have people wanting features from the bond side.

Frankly, a Schuldschein is a bit of a mix. I think many technical clauses like tax gross-up and so on might even be closer to the bond market than to clauses in the syndicated loan market.

Although clauses may be very similar, there are some big practical differences from bond documentation, including on topics like cross-defaults.

If you look at the cross-default clause on a liquid bond from a big, frequent issuer, you tend to forget that there is usually no information obligation in the bond terms. The reason is that, in the case of such issuers, the market expects that really bad things will be in the public domain anyway, whether for reasons of regulatory disclosure, market pressure or as a result of derivative transactions, like credit default swaps documented under ISDA.

By contrast, in a Schuldschein you usually find an information obligation, where the borrower has an obligation to disclose information on events that could constitute an event of default, or cross-default.

Nevertheless, many Schuldschein investors have got this constant question about whether they are subject to a kind of systematic subordination.

In practice, many Schuldschein investors rely on the information obligation that they expect will be in public markets. Of course, this works better with issuers that have public securities and hence have to disclose more information.

The bottom line is, in many situations the Schuldschein investors nowadays are piggybacking on the other instruments, the loan or the bonds, using their cross-default clauses and information obligations, which apparently the investors think will help them sufficiently. But of course there may come situations when people say, look, this has happened, and now we clearly see that this is a problem for us.

Schneider, AllianzGI: Yes, but the regulatory requirements for Schuldscheindarlehen are lower because they are not traded on regulated markets.

Dreher, CMS: Absolutely. Due to the legal and technical nature of the Schuldschein loans and the practical parameters of typical Schuldschein deals, a number of securities-related regulations do not apply to the Schuldschein as we currently know it.

And we can probably have extensive debates about whether these markets would work better with more regulation.

Even the regulators — you mentioned the Capital Markets Union — actually said the Schuldschein market works very well. And they recognise that partly it might work well because it’s not regulated in a similar way to other markets.

At the same time, of course, the regulators become more interested in the market, the bigger it gets. But I have to admit, from a lawyer’s point of view, that a lot of the regulation put in place over the last decade has not made the capital markets much safer. And therefore, I’m not terribly pessimistic about the Schuldschein market.

At the same time, the discussion about the regulation of the Schuldschein market is something that has not been carried out very loudly on public platforms.

But the Schuldschein market is often dubbed a soft path to the capital markets. I don’t mean it’s soft in terms of, ‘oh, it’s actually a bit bad and it’s shady’ — no, it is actually a very good way for companies to approach the capital markets, without triggering a number of otherwise typical capital markets requirements, such as a prospectus or the requirement for international accounting standards or frequent formal reporting.

I think we should be very careful that we do not destroy it or weaken it by adding formal regulation.

We are telling the arranging banks anyway, when it comes to contract liability and reputation, you should practically treat a Schuldschein issue as seriously as you would a private bond placement. You shouldn’t do less, but it’s still a practical and not so formal process as for a bond.

GlobalCapital: But does the market need to consider what happens in the next credit cycle, and whether it could make it easier for investors in any way to work through distress situations?

Mayr, BayernLB: One point: if it’s difficult to work out a deal in the Schuldschein market, then is this truly only an argument against the Schuldschein, or might this even become a more problematic issue for the bond market?

If I’m invested in a bond and the issuer has a Schuldschein outstanding which is a larger part of its external financing, what does that mean for the bond investor? The question of potential spillovers between the markets in case of defaults has yet to be answered.

Schneider, AllianzGI: A consequence should be that the market remains restricted to the upper end of mid-cap or large cap companies. We have to be really careful with the market. For example, to obtain better risk charges for Schuldscheine, because of the very low historic defaults in the market. If this is sustainable, then I think there could be lower risk charges for this instrument and this will further increase the interest of the institutional investors further.

GlobalCapital: So you wouldn’t have let Carillion into the market? It’s quite a big company.

Schneider, AllianzGI: We are not invested in Carillion or Steinhoff, so I cannot say anything.

GlobalCapital: But Carillion was a genuinely big company.

Scherff, Commerzbank: Yes, but size is not a quality in its own right.

GlobalCapital: I’m wondering how you could construct this safe market. Would you want non-German-speaking borrowers in there?

Schneider, AllianzGI: Yes. We are already invested in many non-German issuers. For example, from Austria, the Benelux, Switzerland, France. Actually, we have only about 60% German issuers, the rest are issuers from abroad. So it is absolutely possible to widen the market further to issuers abroad.

GlobalCapital: One thing we have seen in the last 12 months is a few US issuers start to access the Schuldschein market. Are we in favour of that? Do you think US issuers should be issuing Schuldscheine?

Mannl, UniCredit: We are currently in a marketing role, so my answer is yes, of course. Why not?

GlobalCapital: You could argue that US issuers are very well served by their home market, which of course includes the US PP.

Distler, Helaba: Well, it depends on the company’s situation, but there is interest building up on both the issuer and investor sides. It depends on the link to Europe the issuer has. I can imagine that we could see more of these kinds of transactions, with US issuers with European parents, or vice versa, coming to the market. However, if there is no link at all, I think there might be one or two issues, but not that much more.

Mannl, UniCredit: Let’s not forget that the spread in financing costs is huge, currently, between the US and Europe. We have record low rates in Europe and US rates are rising. That might be an additional argument to think about.  

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