Schuldschein must evolve
A report by Scope Ratings last week on the German corporate Schuldschein market shone a bright and what must have been at times uncomfortable light on its subject.
Scope argued that Schuldschein is more heavily populated with high yield issues than was thought to be the case. For many market practitioners, this must have been surprising reading. The Schuldschein market has always given the impression of being an exclusive financial club for Germans, suitable only for governments and regions, Pfandbrief issuers, large cap credits and the more solid companies from the fabled Mittelstand.
But Scope has found that while 75% of rated issuers in the market are investment grade, rated issuers make up less than 25% of all corporate Schuldschein issuers. And that among the three-quarters that are unrated, Scope believes that if they were rated, 66% of them would be speculative grade.
The problem lies in the fact that, according to surveys by Finance Magazine, only a minority of investors (less than 25%) would be prepared to invest in non-investment grade issuers. This suggests a potential lack of transparency at best, or, at worst, investors deliberately ignoring the true quality of an issuer if thorough credit analysis were ever to be undertaken.
However, such is the pressure on investors to find yield that the supply-demand balance is so out of kilter that they will continue to move down the credit curve, wittingly or otherwise.
But as strange as it might sound, this is exactly what the Schuldschein market needs. Although it is a well established, diverse and growing market (2015 and 2016 are expected to be strong years, ahead of 2014’s €12bn total), it is facing competition from other private debt markets.
These include the EuroPP market, which although mostly used by French companies, is beginning to attract Belgian, Italian and German companies. It is also attracting more and more mid-caps, who are drawn to it by the simple documentation, the ability to issue unlisted placements (when required), competitive pricing and flexible deal sizes.
Having started in 2012 at €160m, the EuroPP market’s average deal size has fallen to €65m with 65% of the dealflow from smaller mid-caps of less than €1.5bn turnover. And it is also beginning to entertain racier structures such as subordinated bonds.
The European Commission has also recognised the importance of these private debt markets, slotting them in as a central plank of its Capital Markets Union project, as it looks to harmonise European capital markets. In addition, as Scope points out, trade associations such as Icma, the LMA, Afme and the Pan-European Private Placements Working Group have created guidance on best practice regarding documentation, market practices and principles for private debt issues.
For Schuldschein, its challenge is to move with the times, and present itself as a product for big and small companies alike, from across Europe and not just Germany. There are signs that it is beginning to do so — midcap companies are steadily increasing their share of issuance (they made up more than 20% of the total issued in 2014 and average deal sizes have decreased from around €220m in 2008 to around €110m in 2014). The market has also seen a small but important number of non-German issuers.
Meanwhile, the regulatory framework for Schuldschein has become more favourable under the amended investment regulations for insurers and pension funds. The directive, which became official in March, opens up more debt products for traditional fixed income investors and urges direct lending to corporates, something that could encourage debt funds to invest in Schuldschein.
The more Schuldschein can evolve and match the ambitions of the EuroPP market, for example, the more it has a role to play in Europe’s corporate financing future — a future where midcaps and unrated companies will be become as important and ubiquitous as blue chip borrowers.