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If retail investors can buy burrito notes, why not proper bonds?

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Retail investors who bought two minibond issues from Chilango, a London-based Mexican food chain, are set to lose their money, with either a 90% writedown or debt-for-equity swap heading their way. This was grimly predictable, based on a cursory glance at the deal documents, but the issue shows how messed up our investor protection rules are.

Is there a Mexican word for Schadenfreude? 

GlobalCapital isn’t sure, but some may have experienced this, if they envied seeing friends invest in the famous Burrito Bonds issued by Chilango, the UK Mexican restaurant chain, which promised to pay them not only 8% interest but free burritos into the bargain.

Now those who scoffed at Chilango, rather than scoffed Chilangos, have had the last laugh.

The chain is facing a debt restructuring, in which holders of the unregulated, unlisted, non-tradeable Burrito Bonds will lose most of their money or be given shares in the overstretched company.

The burritos in question are excellent, but it wasn’t a secret that the bond was shaky. 

News media including Reuters covered the bond's weak documentation when it was being marketed in June 2014, and asset manager M&G’s popular blog Bond Vigilantes posted an extensive critique of it.

That does not exempt the issuer from responsibility for peddling what turned out to be a highly risky investment, and arguably taking advantage of retail investors.

But the savage version of caveat emptor that the law seems to apply in this case looks out of kilter with the molly-coddling of investors elsewhere in the system.

In Chilango's case, there is a curious quirk, in that many buyers of the bonds are likely to have been financial experts, who probably ought to have known better.

The bonds were heavily marketed through Chilango's stores, many of them in the City of London. One is in Fleet Street, next to the old Goldman Sachs building, opposite Freshfields, a short hop and skip from Deloitte and KPMG.

Locations near Bishopsgate, Monument, and London Wall have similarly finance-heavy clientele. It’s hard to imagine a more financially savvy group of potential retail investors than Chilango’s City lunch crowd.

That even such luminaries could have been tempted by the whiff of burrito shouldn’t be a surprise to anyone who’s been around the finance industry a little while. Professionally, everyone talks a good game about sound underwriting, credit quality, reading the documents and so on — but when bankers and traders make “personal account” investments they often have a lot more hair on.

For every securitization banker who bought Granite bonds, the residential mortgage-backed securities issued by Northern Rock, in the depth of the crisis when they were trading at a fraction of their true value (virtually the entire industry, if you believe the tales), there’s an “adventurous” restaurant play that’s gone south, a vanity vineyard, a “sure thing” film tax dodge, and cases and cases of “investment” wine or “up and coming” art.

However well informed the gatekeepers of the global capital markets are in their professional lives, when bonuses are paid, some of that prudence goes out of the window.

But the fact that many of Chilango's investors had enough financial smarts to see through the marketing does not mean companies should be encouraged to dish out such instruments to the investing (or dining) public.

The real lesson to be drawn is the alarming inconsistency between the rules (or lack of them) surrounding such minibonds and those that shield the real, grown-up bond market in a thicket of legal protections.

A vast amount of effort goes into keeping super-respectable, properly documented, listed and rated bonds out of retail buyers' hands.

Rules on prospectuses and deal targeting try to steer most bond offerings away from retail. They have minimum denominations of €100,000, intended to ensure that only institutions or the very wealthy can buy them. Often this is to avoid the higher disclosure requirements a retail-eligible prospectus would require.

In a handful of asset classes, such as bank capital, the rules are stricter still, with the aim of ensuring that retail ownership of supposedly loss-absorbing debt cannot complicate future bank resolutions.

That leaves retail investors who want self-managed fixed income exposure with a strange barbell of choices. They can buy government bonds, mostly now yielding nothing or less in real terms, or rifle through a grab bag of virtually unregulated minibonds (technically loan notes, usually, to steer around securities regulation).

The UK’s Financial Conduct Authority moved last month to ban promotion of some minibonds to retail, but offers like that of Chilango will be unaffected — only minibonds whose proceeds are on-lent to other borrowers will be banned, such as notes that fund property development.

What most investors are not allowed to buy is bond exposure to the great mass of companies and banks that actually underpin the European economy. 

Some of these, true, are a little unexciting — many blue chip companies' debt trades at negative or almost invisible yields at the short end. But plenty of household names are not. The entire fixed income middle class — anything from roughly single-A to single-B ratings — is effectively off limits to European savers.

High pressure marketing ought to be banned, but there is clearly an appetite among investors to deploy cash into fixed income instruments a little spicier than Gilts and Bunds — though perhaps not as mouth-burning as Chilango’s hot salsa. 

Opening up the broader fixed income market to retail, so that savers don’t have to invest alongside their lunch order, would do issuers and investors alike a service, and might make them less likely to be tempted when someone offers them a deal that sounds too good to be true.

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