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Time for Schuldscheine to grow up

The Schuldschein market, traditionally a safe and stolid funding product for German companies borrowing from German insurers, has been on a tear of late, with extensive international interest on the buy- and sell-sides, booming issuance volumes, and a procession of digital initiatives to streamline the market. But it has not all been good news.

The market also had more than a few problems. Last year saw defaults from Steinhoff, Carillion, Folli Follie and Gerry Weber, and deep distress from Kier and Aryzta, which was eventually recapitalised. That’s €1.1bn of defaults, in a corporate Schuldschein market that UniCredit estimates is €89.1bn in size.

Perhaps 2018 was an especially rough year, but that’s still 1.2%. Depending how you count it, it’s arguably ahead of default rates in European leveraged loans. Nonetheless, the self-image of the Schuldschein market still assumes credit quality is good, defaults are rare, and documentation can remain light.

Existing defaults are considered aberrations, deviations from the core German business, or idiosyncratic accidents. That is true, but beside the point: all corporate defaults are idiosyncratic.

Most other markets, however, give investors more rights in a restructuring, more information about the companies they buy, and make it easier to sell assets which get into trouble.

Perhaps 2018 was a high point for Schuldschein defaults — and close to historic lows for leveraged loans — but the drivers of default ought to be similar in both. Low interest rates make life easier for borrowers in trouble, whichever funding instrument they happen to choose.

Happily, progress is at hand. Deutsche Kreditmarkt-Standards, an industry group, is working on tightening up Schuldschein documentation, amid broader questions about the German restructuring code. But the Schuldschein market also needs to adjust its rose-tinted spectacles whenever it looks in the mirror.

Defaults happen, credit risk exists, and that’s all OK — it’s all part of being a real market. As venerable as the Schuldschein market may seem, it will mature only when it accepts its own downsides.

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