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Corporate Bonds

ORB market buoyant amid fierce funding competition

The London Stock Exchange’s Order book for Retail Bonds — ORB — received lower issuance in 2015 than in 2014. The main reason was the strong return of banks to the lending field, supplemented by institutional direct lenders. But much made 2015 a year of advances and the mood was far from glum as seven ORB market participants came to the LSE to discuss a wide range of topics, including regulation, liquidity and defaults.

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Participants in the roundtable were:

John Barrass, deputy chief executive,

Wealth Management Association

Phil Caroe, director of social finance, Allia

Michael Dyson, head of fixed income, Numis Securities

Phil Holland, finance director, Primary Health Properties

Rory Renshaw, managing associate, Linklaters

Darren Ruane, head of fixed interest,

Investec Wealth & Investment

Gillian Walmsley, head of fixed income, London Stock Exchange

Ross Lancaster, corporate bonds editor, GlobalCapital (moderator)

Perhaps most pressing on the agenda was the issue of what will come out of the European Commission’s Prospectus Directive review. In particular, the issue of higher disclosure requirements for retail-eligible bonds, which many felt have put off potential issuers from entering the market. 

Also on the agenda were competition from private placements, liquidity on the ORB and the emergence of green and social bonds. 

The issue of defaults was perhaps more pertinent than in recent years but also seemed less alarming. Three ORB issuers, Bollywood film producer Eros International and oil companies EnQuest and Premier Oil, were trading at distressed prices during the conversation, but without disastrous effects on sentiment in the market.

Similarly, there had been no knock-on effect from the Secured Energy Bonds default on a mini-bond, an unlisted deal away from the ORB market.

Market participants are clearly confident that the retail bond market has grown to a point where it can weather such storms, including low issuance. When the cycle favours retail bonds again, the signs bode well.

Global Capital: Issuance on the ORB is on course to finish down on 2014, at £395m compared to £526m that year. Why is that, and what does it mean for 2016? Is the market struggling to attract new issues, or is there a lack of demand from investors? 

Michael Dyson, Numis Securities: The original premise of why investors want retail bonds is still a good one: fixed returns. 

From an issuance point of view, that enquiry has picked up a bit recently, and it still offers issuers more than just the coupon. It’s about profile and targeting different types of investors and diversifying funding. 

But at the end of the day, the competition in lending money is very intense at the moment, and there are a lot of places people can go to get quotes. Ultimately, it is down to pricing.

We went into 2015 expecting rates to rise, and it never happened. But that has put a bit of a brake on investors’ appetite for buying longer dated bonds, because of the duration risk.

In 2016, we might have that conversation again I’m sure, but I think the demand is there. What we might see is a lowering of investors’ coupon requirements. That’s quite important and will bring more mainstream issuers back into the market.

Gillian Walmsley, London Stock Exchange: Yes, I think it is entirely a feature of market conditions. There are many other funding sources out there, and it’s just where we are in terms of rates at the moment. 

I don’t think it’s a lack of investor demand at all. From what we hear in the market, there’s still very strong demand from retail investors for retail bonds. We shouldn’t forget that this is still very much a young market in its early stages of development.

For pretty much all the issues that have come to market, there’s been very strong demand. Throughout the history of the market, investor demand has always outstripped supply.

So, I don’t think there’s a lack of demand from retail investors. I think it’s just purely a feature of market conditions and the cost of funding.

Darren Ruane, Investec Wealth & Investment: Yes, when the market first started, which was in 2011-12, the banks essentially weren’t lending, and they certainly weren’t lending to small and medium sized companies. 

By that I mean even small and medium sized companies according to the FTSE, as opposed to SMEs, as most people would know them. 

Since that time, banks have very much come to the fore. Their capital has been raised and they are lending now. So as investors, we’re now competing not just with banks but also with other investors. We’re competing with products like private placements. On the private client side, that’s not something really you can get involved with.

But investor demand is certainly still there. We live in a low interest rate, low inflation environment, so the search for yield continues. 

As to what happens in 2016, I think those conditions will prevail. It could be that we have to go through a market cycle again. Although it’s hard to see it now, perhaps banks will become more reluctant to lend to companies, and perhaps there will be more of a place for the retail bond market in that environment. 

Right now, though, I think we as investors have essentially been priced out of the market by cheaper sources of funding.

Phil Holland, Primary Health Properties: I agree with a lot of what Darren and Gillian were saying there, and Michael as well: it’s about where we are in the cycle.

When we issued our retail bond in July 2012, we couldn’t get anything longer than three years from the banks. But we were not of the scale that we could go into the institutional bond market, so the retail bond offered a very good alternative.

We’re now at the point that the banks are lending and the terms on which they’re lending are attractive. Their pricing has come down, so there is competition on pricing. In the retail bond market there seems to be a floor below which the coupon that is acceptable to investors isn’t falling at the moment. So we are able to access cheaper sources of financing through private placements and bank funding. That gives us a blend that matches the sort of maturity we would otherwise get in the retail bond market. 

Dyson, Numis: I’d like to ask Darren a question. There’s still a belief that the floor for retail bond coupons is 5%. Do you feel that coupons are falling in the retail world? Obviously credit spreads are very tight, looking at a lot of the mainstream issues. For example, Hammerson recently issued an institutional bond at 3.5%. Do you think that the floor is flexible within the retail investor community?

Michael-Dyson

Ruane, Investec: My response has always been 

consistent on this: we will judge a bond on its merits,

and we’re agnostic about whether it’s issued in the retail bond market or the institutional corporate

bond market.

What we need is an acceptable or appropriate rate of return, and preferably we need to access it in small size. The problem is, most of the institutional bonds, like the Hammerson bond you mentioned, are issued in £100,000 minimum denominations. That rules out most private investors — they don’t have portfolios large enough to take that on.

To go back to coupons, we’ve been happy to look at coupons in the 3% to 3.5% area, if that’s the appropriate rate of interest. We have no problem buying bonds that don’t have a minimum coupon of 5% or even 4%.

It’s a really good point though, because there are definitely others that will say ‘how can I invest if I don’t have the minimum return of 5%?’

Dyson, Numis: I suspect that more people will start to take that view that you assess a bond on its own merits, without the floor. That would be helpful.

Ruane, Investec: Let’s look at it from a macro point of view. One of the things we’re repeatedly told by macro policymakers, particularly central bankers, is that the height of the interest rate cycle this time will not be anything like it’s been before. 

So if you go back a decade, there would have been trades in the UK at 4% to 6%. In this cycle, those trades might be between 0.5% and 2.5%. So if you’re

earning 3.5% on your corporate bond, you’re actually doing well.

You’re taking some credit risk. But with a company like Hammerson, it’s been well run and I’m happy to take that risk.

Walmsley, LSE: Much has been said about the interest rate floor. I think it’s entirely about the diversity of the investors. With the retail bond market, there’s sometimes a misconception that it’s purely a certain type of self-directed, small investor. But such is the diversity of the investor pool accessing retail bonds that there is quite a variety in what they are looking for.

That’s one of the strengths of the retail bond market: it’s quite a diverse retail pool.

Global Capital: The market is still dominated by financial institution issuers. Can it move beyond that?

Walmsley, LSE: Certainly, just to stress the point again, we’re still in the early stages of the market’s development in the UK. Yes, there have been a lot of financial institutions that have tapped this market. But a number of interesting corporates have also come to market. If we look at what Allia is doing on the retail charity bond as well, there’s huge potential for innovation.

Many companies are looking for investor diversification. We’ve seen a few examples of non-financials issuing retail bonds, and as the market develops, there’s no reason why we wouldn’t widen that issuer base out.

Ruane, Investec: For me, a more interesting question is, can we entice back some of the bigger issuers, which we had at the start? We’ve increasingly had smaller issuers come to the market, not just in terms of issue size, but also the market cap of the companies issuing.

Generally, you want to invest in bigger companies because they can withstand hits to the balance sheet better than smaller companies. We’ve seen that recently in both the retail market, where one or two issues have been hit, but also across markets, where there has been a lot of price volatility. 

Look at Volkswagen, they had some really poor news in 2015. Yet, if you’d been a senior investor in the bonds, you’ve dropped maybe 6% to 7% and that’s been the extent of it. Compare that to the price volatility in some of the smaller companies, which have smaller capital bases, and can withstand less some of the hits they might take through general trading. 

So the size of company is more interesting to us, we’d like to see some bigger issuers return.

Global Capital: What arguments can be put forward to bring the bigger issuers back in?

Ruane, Investec: We had bigger issuers when the market first opened up. There’s no reason why issuers like Severn Trent, which issued an inflation-linked bond, can’t come again. Severn were able to issue on commercial terms, and we don’t want to have a higher rate of interest than everyone else. We just want to receive an appropriate rate of interest for the risk we take. So providing they’re willing to issue the bonds, we will be willing to buy them.

Rory Renshaw, Linklaters: If Severn Trent came and issued that 1.3% inflation-linked bond now, would

you expect the book to be made up of institutional investors?

Darren-Ruane

Ruane, Investec: It depends on your definition of institutional investors. Even within the retail bond space, we have the self-directed personal and private investors and then private investors who access those bonds through institutions like ourselves, usually under the umbrella of the Wealth Management Association. We are institutional in the way we behave and, yes, we would buy in. I think there would be lots of demand.

Dyson, Numis: I agree, but I’ve always been a bit of a fan of inflation bonds anyway. It’s a misunderstood market and the headlines don’t help at the moment. We’ve got constant headline figures that say inflation is falling, which it is, or that it’s going negative. 

But inflation bonds are RPI [retail price index]-linked, which is why it’s a bit higher. Also, all Gilts are on

negative real yield, so a corporate bond is actually the only way to get a positive real yield on an inflation bond at the moment. 

With the pension changes coming up, people will want more control. There’s probably very good demand for an inflation-linked retail bond, but it would have to be planned very carefully: what are the messages? It is an institutional market, but in 2011 National Grid sold £260m of inflation-linked retail bonds very quickly. It was the right name at the right time, the right product.

John Barrass, Wealth Management Association: I’d like to go back to Darren’s earlier point. At the WMA, we find that the €100,000 limit is quite obstructive to the retail market. Issuers have problems about issuing at lower levels than that, because it’s so complex — you have to deal with the prospectus issue and so on.

There’s been a general sense in the market for the last few years that if you go to retail, it’s more expensive and takes longer to distribute and you may get caught with extra liability for keeping up with market changes and issuing amendments to the prospectus, which will add to the expense. 

We think these are actually myths and not borne out by events at all. The retail market is strong and healthy and you can issue well into it.

But the problem with this €100,000 limit has been to restrict a lot of issuers that otherwise might have come to the market. You cannot meet the suitability criteria of the regulator, or meet the appropriateness test, by advising someone to put €100,000 into a single bond, or even try to divide it up between 10 people. If someone sells up, where are you going to put it?

So there’s a real problem here, and that’s one of the things we want to tackle in the Prospectus Directive review, to change the way it’s done.

What we’d like is a much more fluid market, where you don’t have this threshold. Where issues into the retail end of the market in smaller denominations are much more normal and ordinary. Combined with a single prospectus arrangement, it would be much more sensible. Then you would get more issuers and the ORB numbers would go up substantially.

Gillian-Walmsley

Walmsley, LSE: Yes, there’s been much discussion about that €100,000 threshold and the impact it’s had on the market is clear. Just look at when the €50,000 threshold was first introduced, and its binary impact in terms of wholesale and retail issuance. Pretty much everything from then on went into wholesale, because the €50,000 denomination had been introduced as 

the distinguishing factor in terms of disclosure

requirements.

When it became €100,000, it was even more pronounced. It has resulted in a much smaller number of bonds being available to retail.

We wanted to open up bond markets to retail investors, because we saw such strong demand. But we also wanted to offer a new source of funding to issuers wanting to diversify and engage with retail investors.

So there is much discussion on what should be done with that €100,000 threshold. Is it actually protecting retail investors? Because there’s a school of thought that it is not. But then if you remove the €100,000 threshold, how do you continue to protect retail investors?

There’s an ongoing programme of investor education, and there are various suitability protections around the level of the broker that potentially could do that.

Ruane, Investec: For client protection, one option is for people who would otherwise have put their money into sensible investment grade companies and are no longer able to do so. They still have to have some monies in safer assets, such as bonds, so the money has gone into bond funds. 

That is professionally managed, so a tick in the box for being better protected. But the downside is that some of these bond funds now are €20bn to €30bn in size. Given that there’s very little market liquidity, what happens if we have a downward march on bond prices? What happens to those bond funds?

So, are investors actually in a better place than they would have been, had they bought a three or five year bond from a sensible company where they get their money back, providing the company doesn’t go bust? I have to say, it doesn’t sound like a great trade-off.

Renshaw, Linklaters: It’s quite ironic that for all of this regulation, an effect it seems to have had is that many issuers that regulators might want to see selling this kind of product have just said, ‘OK, we’ll do it in €100,000 minimum denominations then’. 

But some that, frankly, the regulators might rather not see selling to retail are the ones that are. This is an unintended consequence of the current regulation, I guess.

Barrass, WMA: The unintended consequences are quite severe, actually. They are pushing people not only into bond funds, but minibonds and areas where there’s no cover under the compensation arrangements if things go wrong. 

The prospectus arrangements in those products are very limited, and some say you can’t get the information. Bond funds are also rather opaque, and you don’t quite know what is in them. 

Our view is that these are not substitutes for retail bonds and it’s not right for the European Commission or anybody else in Europe to say that they are. 

Our view is also that the €100,000 limit is actually not great protection for investors. It’s pushed them into areas they would otherwise not go, which are dangerous, and we’ve spent a lot of time on this with the UK regulator, the Commission and the Treasury. 

We’ll see what comes out of this, because the debate is focused on changing the Prospectus Directive, which actually sets the law on this matter.

Now, to go back to the point I made earlier about getting a more liquid and free market. One that actually reduces the risk to investors by making the range of products they can invest in wider and by making sure the secondary arrangements for investor protection

are in place.

You need all the complex product arrangements for what you can advise investors to do and what sort of quality of bond they can get into. Something that actually sets limits to the free market, in particular financial instruments. 

It has to be implemented properly right across Europe, not just in the UK, and it has to be put in place by regulators with some authority. It’s not entirely clear that across Europe, this is all working very well. 

So the €100,000 limit is a kind of substitute for good regulation and we would like to see it be put out and for good regulation to come back in.

Renshaw, Linklaters: Because of this arbitrary €100,000 threshold (you call what’s below it retail and what’s above it wholesale) issuers in the retail bracket have to disclose more. The prospectus is much longer and much more costly to put together. It is all predicated on the assumption that investors benefit from and read the disclosure, and that it’s there for their protection.

But the evidence suggests that investors don’t read

or understand those 200 pages of disclosure. So the whole predication of the Prospectus Directive seems misguided. 

At the moment, there are various exemptions under the Prospectus Directive that allow issuers to get away without producing a prospectus, or producing a relatively light touch ‘wholesale’ disclosure prospectus. You can offer the bonds to less than 150 people, you can sell for a consideration of at least €100,000, and obviously the one we’re all most familiar with is the minimum denomination size being €100,000 (or its equivalent in other currencies). That’s the one that’s taken the most stick from stakeholders in the market. 

But from the European draft regulation that we’ve seen, it does seems like the Commission are considering getting rid of this €100,000 denomination threshold.

Dyson, Numis: There was a fear it was going higher, wasn’t there?

Renshaw, Linklaters: That was talked about, yes. But the most recent draft regulation we’ve seen doesn’t include any denomination threshold. But then you have to assume that if the regulators do get rid of 

this threshold then they are going to require some

sort of protection, which could come through the MiFID intermediary system, through trying to

encourage more intermediation to protect retail investors that way.

Barrass, WMA: Advice is going to be critical in this. At the moment, European legislation effectively says there are two categories of product which are not complex. One is straight equities, and one is straight bonds. 

There is an idea that to get a better supply of suitably denominated retail bonds coming to market, you change the way the regulation works.

One of the quid pro quos would be that the advisory arrangements the investor has are with a professional intermediary who is good, and that the investor gets good advice.

Phil Caroe, Allia: Can I just pick up on the earlier point about larger issuers coming to the market? We are at the other end of the spectrum. We want to see more small scale issuers being able to come to the market, which is the reason we created the Retail Charity Bonds platform. We’re bringing down the transaction costs and simplifying access to the market for issuers.

I think there has been a market failure in that respect. We’ve been talking about good investor demand, but the costs of issuing a retail bond mean only larger organisations can access that. So how can one enable smaller organisations to enter this space and create more diversity, more opportunity for investors to have different kinds of issuers in their portfolio?

What we’re also seeing is that investors aren’t simply interested in financial return. There is a real interest in who the issuers are and what they are doing, particularly in the case of the ones coming to the Retail Charity Bonds platform. Part of what we’re doing through Retail Charity Bonds is not only enabling charitable issuers to come to the market, but to also change investor culture.

Phil-Caroe

We are keen to see investors thinking more about social impact. Making social impact products into something investors can recognise and feel comfortable with is an important step, where a lot of social impact opportunities at the moment sit outside the mainstream. Our goal is to see more people thinking about the ways they can invest money for social impact, as well as for financial return.

Global Capital: Is green and social bond issuance likely to increase?

Walmsley, LSE: We are seeing a huge appetite for social impact and green bonds. Charity bonds, particularly, give an interesting story that investors want to engage with, and the retail bond market offers them that possibility.

There may be potential for retail green bonds in London. The London Stock Exchange recently launched a range of dedicated green bond segments, because we do see demand for this. 

But for retail there’s absolutely still a question of investor education and raising awareness.

As part of the admission requirements for the green bond segments, we require a copy of the second opinion document, so that a third party provider certifies that the bonds are green, and the proceeds are going to green causes. 

That is something that this market is working together to develop and define, and much progress has been made. Of course, there is still the question of how you standardise that across green bond markets.

But, for retail, green and charity bonds make a naturally engaging story that investors do want to buy into.

Holland, PHP: That is a key point: explaining to the market what the impact is, and how it’s measured, both from the impact it’s making and also from a corporate perspective, in terms of the benefit the company gets.

We’ve been involved in some of that with the Social Stock Exchange. One of the difficulties is getting that consistency of message, against a very wide range of activities of their member companies. 

Then you also have to be able to measure that for your shareholder, as to how much benefit that’s generating you.

It’s going to be a big, growing market and people are going to be much more conscious of where their money is going.

But until you get a methodology that can be comparable, then it’s very difficult to see how green bonds will suddenly take off in any retail bond scenario. 

It’s even more confusing for the retail investor, compared to a big investor that will have somebody engaged purely to monitor what’s being written and how it’s being described and put in place.

Dyson, Numis: There’s a public desire for green and social bond issuance to increase. But at the moment I think it’s just as confusing for people as CPI [consumer price index] versus RPI. It needs a lot more clarity around the messages carried out and the measurement and monitoring.

Whether people would actually want to give up any coupon for them is another matter. With charity bonds, as you say, it’s not just about the cash return. That may be the case for green bonds as well, if people really believe in the mission. But we’re a little way off that at the moment.

Ruane, Investec: As a large wealth manager, our demand is more limited. It’s not a big market for us. The problem is that when we have clients that want to do something on an SRI basis, often that’s done by negatively screening stocks, so taking out things you don’t like, such as tobacco or armaments or alcohol.

We do have some investors that want to invest in things that are socially or economically positive, but to do that you need to have a diversified basket in which you can invest. So we simply go down the funds route, because you can get someone who can invest across borders, in global markets, either in bonds or equity. But in terms of direct bonds, that’s more limited for us.

One big impediment to the market is that if you are Lloyds Bank, you can issue £1bn worth of debt, but if you’re a social bond issuer you can only issue a very small amount. 

Large wealth managers have to restrict themselves to how much of any issue they want to take. If it’s a

£10m issue, they might be able to take £1m or £2m. We have £5bn of fixed income assets, so if we spend lots of our time trying to work out whether a £1m or £2m investment is a good idea, that’s not an efficient use of our time.

Caroe, Allia: This is certainly a challenge at the moment, but the market is clearly growing and impact investing is becoming higher profile, particularly in 

the US. 

From when I started at Allia six years ago, things have changed dramatically in terms of the number of players involved, and the number of mainstream financial institutions which are setting up impact funds.

One of the reasons for that growth is that there is something of a generational trend. Most investors at the moment who are doing self-directed investments are probably at least in their forties. When you look at millennials and the way they view the world, it’s very different. It’s a generation that is much more interested in the impact of its investments.

Global Capital: Could you explain how you are trying to develop the market for charity bonds?

Caroe, Allia: The development of any new market is a slow process. With Retail Charity Bonds, it took about three years from concept to launching the platform last summer. It was extremely difficult, creating something that had never been done before.

But as I said before, the market is definitely moving forward. There are many more intermediaries than there were — advisers, fund managers, infrastructure developers. 

At the same time, within social organisations and charities, there is a growing view towards thinking about how taking on finance could support the

organisation. That’s a big change of culture for many charities.

They are thinking about taking on loan finance, whereas a number of years ago, the idea of getting into debt might have been anathema. Now there is a more entrepreneurial, business-like culture coming in. 

More organisations like Golden Lane Housing, which was the first to borrow through Retail Charity Bonds, are saying, how could we expand and grow, and do more for our beneficiaries, by taking on loan finance? We’re now talking to a growing number of charities which want to explore retail bonds.

So there’s definitely a move. Nothing happens dramatically in the charity sector, but there is movement.

Global Capital: Phil, does the idea that the retail bond market is growing deeper and more diverse ring true to you?

Holland, PHP: It’s difficult for us to say, as we are to date a one-time issuer. Would we like to issue again? Yes. Will we issue again at the moment? No, because of other alternatives that are around. It comes back to the cost of it.

We’re having people knocking on our door from all sources of debt finance — high street banks and even people that are not supposedly in the market are now coming back. Some of the Irish banks that have been out for a long time have now got themselves back on their feet. 

Phil-Holland

But we are also seeing institutions come to us direct, such as insurance companies that need to get return. They are looking at private placements and coming to us saying, we’ll start small and build a relationship that can become bigger.

So we’re not just looking at your standard corporate bond that needs to be £150m or more in our sector. These investors will start at £5m to £10m to get their foot in the door, get that return and build on it with future transactions.

Again, scale comes into it. We issued a convertible bond in 2014, which we couldn’t have done at the time that we issued our retail bond, so that has an attraction as we grow.

It opens the door to different avenues of raising capital, whether it be debt or equity or a combined product.

Global Capital: Where does that leave retail bonds, if there is so much competition from other products like private placements?

Ruane, Investec: The very fact that Phil is not coming and talking to the retail bond market, that he’s getting knocks on the door from direct lenders, means that we’re finding it very competitive, so we just have to accept that perhaps our provision of finance is not the cheapest in the market. 

At the same time, I don’t mind that being the case, because as I said earlier, we go through cycles in markets — economic cycles, market cycles. So it could be a case that some of that goes away. Maybe then we’ll swing back to being competitive again.

Walmsley, LSE: It’s not just about the cost of funding, it’s diversification and profile as well. If you look at the media coverage when some of the retail bonds have come to market, it’s about engaging with a retail audience and increasing brand awareness. It’s not just a pricing discussion.

Holland, PHP: That’s very attractive for us, and why we will keep the retail bond market very much under review, because it fits naturally with our shareholder register. 

In 20 years, we’ve grown as a company, so we’ve got a lot of private wealth managers that are representing clients, a lot of high net worth individuals, so we would like to be continuing in that, with some of the debt we do as well as the equity.

But then at the moment, Darren is right: at this point in the cycle, there are cheaper alternatives.

Dyson, Numis: Markets adapt, though, don’t they? It never happens overnight. Ultimately, it’s a great time to be a borrower. 

Like Phil said, you have charities that didn’t borrow in the past. At these rates, I can imagine it’s very attractive. Whether it would be attractive at much higher levels, I don’t know, but I think markets will adapt and competition eventually is healthy for all.

Barrass, WMA: The retail bond market is not going to go away, and I think there is something to be said about regulation here. I do think that if there are substantial changes to European regulation then we will get a material increase in the amount of retail bonds issued in the UK. 

If that happens, then from what we are picking up from our firms, the investor appetite is certainly there. And in market conditions which favour issuance and which favour retail investment, you’ll get an upsurge in retail investment. 

It will go up and down. That’s going to be the single biggest factor, but only once we get rid of some of these unnecessary barriers.

Rory-Ranshaw

Renshaw, Linklaters: It seems like the goal is that we all end up not using this word ‘retail’ at all, that bonds are just low denomination, and that issuers are not disincentivised from issuing in low denominations. That’s got to be in the end good for issuers and for investors as well.

Dyson, Numis: That’s true, but it’s also important to have a central marketplace. While it’s never going to be perfect, the ORB has brought a focal point to pricing and transparency, which would need to continue.

 Ruane, Investec: On a slightly different tack, one 

challenge we have had is that issuers at the moment have so much demand for their bonds. I see the institutional side of things as well as the retail, and particularly when a new investment grade issuer comes to market, the books will be covered between four and 10 times over. 

So the fact that retail is not in the market at the moment, issuers don’t really care. It doesn’t matter. One challenge for us is that big issuers don’t need us at the moment.

Global Capital: So what can be done to make the retail market more attractive?

Walmsley, LSE: I think we need to look at removing the barriers between the two separate markets, one for retail and one for wholesale. 

Transparency is also very important: the demand for having a central order book and on-exchange trading is only increasing.

A couple of years ago, we expanded our offering for on-exchange liquidity. We now have the order book for fixed income securities, which offers more flexibility for issuers, and a wider range of securities are possible on that platform. 

It offers continuous quoting from market makers, but end of day pricing as well. It’s a complement to the retail bond market and offers a broader range of options for issuers and investors.

Global Capital: How was liquidity in 2015 on the ORB?

Walmsley, LSE: Liquidity was good, and the fact that we’ve got committed market makers who are there on screen throughout the trading day is important, and always has been. Investors know, when they’re buying into a new transaction, that they can trade in and out in the secondary market and continuously see a price.

Holland, PHP: Do you see a great volume of secondary market liquidity in certain retail bonds? 

Because from our interaction with some of our holders, it still seems to be very much a buy and hold philosophy. We’re not a regular issuer and would pay more attention to liquidity if we were issuing a further retail bond, but we get a sense that liquidity actually isn’t that high, from the stats we see for our bond.

Walmsley, LSE: It varies. ORB issues that have been brought to the retail bond market specifically and distributed through that primary market process tend to be the most liquid. 

Before we launched the market, we did expect a certain amount of buy to hold, but secondary market liquidity has been stronger than we expected. We see good, strong turnover, particularly in new issues. The fact that you’ve got those dedicated market makers has been very important.

Some larger issues, like the London Stock Exchange Group’s own 2012 issue, have very good, strong liquidity.

Holland, PHP: But again, is that a function of scale and brand name, rather than being a function of the market?

Walmsley, LSE: I wouldn’t necessarily say so. We’ve looked at some of the £25m and £35m issues, and there continues to be strong liquidity in these. It depends on your definition of liquidity. Is it that it’s trading continuously in large volumes? Or is it that investors can buy and sell when they need to? 

We’ve found that investors are able to trade in the sizes they need to trade. And the fact that there’s a tradeable market maker price there all the time —

that’s liquidity.

Dyson, Numis: Darren might have different views on this, but I think the test of liquidity comes in a crisis. We’ve had three bonds which have had quite difficult times. We’d always hoped with the retail bond market that there would be other people, other investors in the market to provide liquidity in those situations, and we’ve seen it recently.

So, perhaps on the negative side, you see extreme price moves, but with those, you get a whole new type of investor coming in. So liquidity is there, but it might not always be at the prices people want to see. That must be quite difficult sometimes for investors.

But, in terms of absolute liquidity, I would say that does function. There’s a big debate around how it functions, but liquidity is there.

Global Capital: You’ve touched on some issuers getting into difficulties. Would a default on a retail bond have a disastrous effect on the market, or have sentiment and education now reached a point where investors could see past a default and can keep faith in the market?

Dyson, Numis: From a sentiment point of view, a default is always disappointing and at a personal level, obviously people will be distressed. A default doesn’t necessarily mean total loss, of course — there should be some recovery after a default — but it would be a bad PR exercise to have a default.

Having said that, it goes back to the denomination debate. It’s all about diversification and quality and good advice. If you can have enough issues with small denominations, you can spread your risk quite widely. I think there have been 38 fixed rate issues, and four index-linked as well. If you had put £2,000 into each one of them, even with three of them trading quite a long way below their issue prices, you would just about be holding your head above water. So it’s quite hard to generalise. There are all sorts of things that could trigger it, but it’s never going to be pleasant.

Holland, PHP: It will also depend on the publicity around the default. If you’ve got a big investor that’s lost money on a bond, as opposed to Mrs Smith on the corner who has suddenly lost a chunk of cash, then it’s just human nature that there will be a very different reaction to the latter.

Dyson, Numis: Yes, it’s about people’s expectations. There was a lot of comment around Phones 4U defaulting on its high yield bonds in 2014, but that was a high risk investment in the first place. In general, with retail bonds it has not been the intention to issue very high risk bonds, and investors have not expected high risk, so I think it really would depend on the circumstances that have caused the default event.

Holland, PHP: Does that also take you back to what information is given at the point of issuance? We were a well-known company when we were selling our retail bond and there was a lot of equity information already out there. 

But if you come into a market just with a retail bond, there are some slightly higher risk issues, even though the bonds are not sold as high risk. There isn’t a rating service aimed directly at retail bonds.

There isn’t necessarily a piece of research that is done for retail bond issuance that will highlight that these are the risks, compared to this and that and the other. Is that something that you see developing?

Dyson, Numis: As Rory was saying, there’s a lot of debate about just how much disclosure is actually read in a prospectus. But I do think that when the Financial Conduct Authority was formed, it instructed issuers to show the ‘you are here map’ within the risk section of the prospectus. I think that was a very positive thing, and I would encourage a lot more clear but effective measures, going forward. Maybe that will be something that comes up in MiFID.

Caroe, Allia: It’s worth remembering that we had the first mini-bond default in 2015, which does seem to have made some people more cautious about minibonds in general. A lot of the commentary on that default flagged the difference between the regulated markets and non-regulated, and questioned the adequacy of disclosure for that mini-bond when investors discovered that what they thought to be the case perhaps wasn’t quite the case.

So if we do see a retail bond default, I would hope that the effect of regulation would be to limit the potential for controversy and help to maintain trust in the retail bond market. But perhaps the danger, if there is a default, is that a natural reaction from the regulator could be to ask again whether there was enough disclosure. Does it all need to be beefed up further? And the risk is that that could make everything even more complex and therefore more costly. 

John-barrass.

Barrass, WMA: The word ‘rating’ has come up, and obviously rating is linked to risk of default in certain ways. There are in fact ratings — German firms do this for bonds in Germany. 

We had quite a debate on our retail bond committee, to which some of you belong, and we’ve had presentations from people who rate bonds from Germany and are looking to get into the British market. 

We’ve talked to the regulator and they have not made a decision. 

Now there are different arguments in favour and against rating bonds. But one is that it might happen if you ended the distinction between wholesale and retail markets, and had a single bond market, in the way that you would if you changed the Prospectus Directive and European legislation. 

As you got more diversity and a greater range of retail bonds, you might then get ratings coming in more.

If you got defaults, there might well be more focus on the risk elements in disclosure documents. You have the Key Investor Information Document (KIID) idea in funds now, and bonds were going to be included in that, but they were eliminated after discussion.

But, that could come back, and you might find yourself with KIIDs, which included a risk element and a rating. That could then lead to a perception of default risk by the investor. 

The markets are going in this more sophisticated direction and becoming more of a market where a default is on the horizon and more normally considered. It would then have less of an impact when it happened. But we’re not there yet.

Ruane, Investec: In some ways, we’ve actually already had a default in the UK market. We’ve got two or three bonds that are trading at distressed prices, but haven’t yet defaulted. 

One impact is that when new issuance comes to market, it’s going to be harder for companies that are higher risk. 

I don’t often disagree with Michael Dyson, but I think there have been issuers that have come to market over the past few years that I would put in the high risk category. They certainly wouldn’t meet an investment grade credit rating criteria. They would be somewhere in high yield, and some of them have been further down the rating spectrum of high yield.

The effect is that it will make investors a little bit more cautious. Certainly, investors will want issues to err towards the side of bigger, better capitalised companies. 

Over the past few years, we’ve met lots of companies that were keen to issue, that we pushed back on, because we felt they weren’t right for the market. So I think there has been some self-policing of this market that not everyone would have seen, because the deals may not have got to the public stage.

Dyson, Numis: I agree entirely. We rely on the filtering system such as yourself, which we’re always very grateful for: trying to weed out the issuers which are either unsaleable, or might be a good credit but are unsaleable for other reasons, or too high a risk. What I meant was, there have been some which have been sub-investment grade, but I don’t think anybody has intended to put something very risky into retail.

Global Capital: So what can we hope for in 2015 in the retail bond market?

Ruane, Investec: There is lots of pent-up demand for good quality companies to issue debt into the marketplace. The key thing that could change the market would be allowing big companies to issue bonds in £1,000 or £2,000 denominations.

Holland, PHP: I would echo that, from an issuer perspective. 

There’s also, obviously, a perceived floor in the market, below which coupons should drop. In the current environment, that would help stimulate some additional issuance. But I think being able to issue in lower denominations would get back to what the retail bond market was designed to be for.

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