The Schuldschein is a curious candidate for any plucky entrepreneur seeking to quicken processes in capital markets. German by birth, the market has spent centuries financing the family-run industrial companies of its native country.
But in the last few years, the market has grown popular beyond its borders, playing host to lenders from far-flung parts of Asia and borrowers from over the Atlantic. Yet, during this glamorous awakening, the market’s age-old processes still remained.
“The Schuldschein was a traditional market; every process was old school,” says Stefan Fromme, co-founder of VC Trade, an issuance platform launched in 2018. “We at VC Trade, alongside arranging banks, are taking on the challenge of moving these old school products into a new world.”
The push for digital platforms is a push for efficiency, in cost and time. Executing a Schuldschein deal can take six to eight weeks, and involves countless interactions between issuer, arranging bank and investors. Transaction costs, like arranging and legal fees, rack up.
Fromme believes this may be an impediment to issuance. “With tech improvements an issuer can save a lot of funding costs, especially fees,” he says. “This could mean borrowers coming much more often for smaller sizes, as well as smaller issuers too.”
But modernising this market is much easier than other markets in an important respect.
Under the German Civil Code — up until now the legal basis of a Schuldschein contract — the product is characterised as a loan, as opposed to a security, and thus neatly sidesteps the complexities of MiFID II and other regulations.
And yet, like bonds but unlike other loan products, most Schuldschein deals are marketed to hundreds of investors. Lenders spend weeks analysing borrowers that more often than not are unrated, and negotiating with arrangers over price and lawyers over terms.
So there is a lot of efficiency to be gained; which is why so many tech platforms are having a stab at it.
Crowded market
The marketplace is becoming as busy as a Marrakesh bazaar. Each platform is jostling for position, striving to stand out from the pack.
Seven Schuldschein issuance platforms have been launched in the past year. Five are promoted by banks — VC Trade, which is promoted by BayernLB and Helaba among others; LBBW’s Debtvision in partnership with the Stuttgart Stock Exchange; HSBC’s Synd-X; Erste Bank’s blockchain platform and NordLB’s Finpair. The other two come from fintech companies CredX and FinnestPro.
Predictably, most faith has fallen on the platforms championed by the leading Landesbanks in the market: LBBW’s Debtvision and BayernLB and Helaba’s VC Trade.
“Debtvision and VC Trade are the two to watch — and others are not worth mentioning in the same breath,” says a Schuldschein specialist at a German bank unaffiliated to either platform.
Roughly 26 transactions totalling around €2.7bn have been run through VC Trade since its inception in late May, which makes it the market leader in volume and dealflow.
Debtvision was launched by LBBW and the Stuttgart Stock Exchange in early June, and has a different focus: dial down the role of arrangers.
Turkeys vote for Christmas
Counterintuitively, the pioneering users of technology in the Schuldschein market are the institutions that will lose most from its success — the arrangers. Their role, and possibly their fees, could be substantially diminished.
LBBW’s Debtvision isolates the arranger’s position more than VC Trade, at least in principle. Issuers and investors are connected through the platform without the need of an arranger.
“If you asked me whether we are eliminating the arranger’s traditional role, I’d say yes, that’s right,” said Joachim Erdle, head of corporate finance at LBBW, when Debtvision was launched. “Our role will change. Sales [work] will become less important, and our role will shift to arranging, structuring and advising on Schuldschein transactions.”
This has brought up some scepticism from other arrangers.
“With Debtvision, the company just loads up with cash without the need of an arranger,” says a banker at a rival firm. “Then the question is: who will LBBW allow on their platform? Which issuers? Which investors?”
Repeat issuers with good credit metrics may be drawn to a platform where arrangers’ fees are set for heavy reductions.
“LBBW does not claim that this is a platform for debut issuers. Companies that are strong enough, confident enough to self-lead will be companies that are already popular in the market,” says a Schuldschein investor in Frankfurt. “For debut issuers, that may need guidance and introductions through arranging banks, VC Trade may be the one for them.”
VC Trade’s approach to the Schuldschein is deferential: its aim is to digitally reflect the traditional market.
Andreas Petrie, head of primary markets at Helaba in Frankfurt, says of it: “If you look at the technology that really impacts markets, it’s always products that are open, not something developed by a single bank — Bloomberg for bond trading, 360T for FX trading, et cetera.”
With VC Trade, everything from emails to spreadsheets to term sheets is bundled into one platform through which arrangers, borrowers, lenders and lawyers interact; which should save time and cost for all parties.
Too many cooks?
But this is just the problem. Will it? Bewilderment is bubbling up in the Schuldschein lender base, as ever more platforms designed to make the market more efficient crop up.
Each touts its credentials as a modernising influence on a centuries-old market, impeccably designed to mete out efficiencies in distribution and execution. But when does an accumulation of systems create a new inefficiency?
“I was like, do we have to register for yet another platform?” complained an investor when NordLB was set to launch Finpair, grumbling at the extra administration.
“We used to use email, telephones and Debtdomain,” says a Schuldschein investor at a German bank. “Now we still use those three, as well as all these new platforms!”
Buyers feel they have little choice but to go along with it. If an investor is not registered on a platform, it may not have the opportunity to see the deals run through it.
Under NordLB’s model, for example, a borrower uploads documentation and requirements — such as amount, margin and maturity — to Finpair, which informs only enlisted investors about the deal.
“Checking in and registering with all these platforms will be a nightmare, and particularly irritating if deals are then not run through them,” says an investor at a non-German bank.
He believes arrangers are partly creating the platforms for marketing purposes, and will still run traditional bookbuilding processes alongside the digital platforms. “There’s simply no way the platforms are going to convince all the new international investors to sign up to every platform.”
Bafin roadblock
Herein lies a hiccup. With the increasing internationalisation of the market comes more scrutiny.
A senior banker says Bafin, the German financial regulator, is seriously considering reclassifying Schuldscheine from loans to securities, as a consequence of the digitalisation of the market, as well as its growing internationalism.
That would threaten one of the Schuldschein’s unique selling points: its status as a loan means the holder does not have to mark it to market.
A reclassification could therefore sap demand and curb the pace of digitalisation.
As the market digitalises there is a push for greater transparency, and the distinction between Schuldscheine and public bonds becomes blurry.
According to the co-founder of one of the digital platforms, Bafin started a discussion about how to handle a digital Schuldschein in late 2017. “As the instrument’s grown its international appeal, as well as digitised, Bafin may start to consider it more similar to a bond,” the co-founder says.
“If I’m emotionless about the Schuldschein market — if I tokenise Schuldscheine, and I can trade it totally transparently — what is the difference between that and a security? I can assure you, having thought about it, there is not one,” the senior banker says.
Some are clinging to tradition, in the hope of not having the product reclassified. “What we are stressing [in our conversations with Bafin] is that a Schuldschein, by origin and from a legal perspective, is a loan,” the banker says. “But a digital platform would add a strong argument to the other side. I would say the chances that it will stay a loan and not become a security is 60-40.”
At another bank, there has been a push to use semantics to persuade Bafin not to make any reforms. “Some of our lawyers feel we should say ‘borrower’ instead of ‘issuer’ to make it clearer that it’s a loan,” says an official there.
Reclassification would compel German co-operative and savings banks to hold more collateral against Schuldschein positions, and would oblige digital platforms to operate under MiFID II.
But most in the market believe reclassification is implausible and unjustified.
There is widely held faith in the maxim “if it ain’t broke, don’t fix it”. There are so few defaults in the market, and investors take credit work so seriously, that there is little appetite in the market for further regulation.
“This market has been going on for centuries with very few problems,” says a Schuldschein banker. “The quirks are something to cherish, not to wipe clean with regulation.”