Retail bonds — be careful what you wish for
The recent resurgence of retail investing in the US could serve as a cautionary tale
Despite a lack of progress on the regulatory front, European bond market participants and lawyers still hope that a viable retail bond market can be established. But have they fully considered the consequences?
Retail investors have been able to buy equities since the very invention of the joint stock company, and have historically played a large role in major markets, owning more than 90% of the stock of US corporations in 1950. And although they have long since been eclipsed by institutional investors, retail investors regained prominence recently, especially in the US, where in the past year they have taken on hedge funds, averted bankruptcies and gained direct access to initial public offerings.
Retail participation in the bond market, by contrast, has been severely limited. Governments have historically sold bonds to the public from time to time, notably to fund wars, but in the contemporary era the marketing of debt securities to retail investors has been hamstrung by regulation. The government of Italy maintains a functioning retail bond programme and a push by the London Stock Exchange (LSE) to create a retail bond market in the UK resulted in several listed bond issuances in the 2010s, but there is nothing like the participation of retail investors in the stock market.
To most observers, this state of affairs makes little sense, since stock is riskier for investors to hold, all else being equal, than debt.
“We still feel it is quite odd that a retail investor can own the shares of National Grid, but you can't own a senior bond in National Grid,” said Pete Mason, co-head of EMEA capital markets at Barclays, in a recent interview with GlobalCapital.
“My concern remains that without access to safe, straightforward public bonds, retail investors find themselves drawn to riskier, less regulated options such as mini bonds,” he added. “And we have seen a few disasters in that area in recent years.”
Despite their name, mini-bonds are usually structured more like individual unsecured loans from retail investors (who are often also retail customers) to the issuer. UK burrito chain vendor Chilango defaulted on its 8% mini bonds in 2020, shortly after the Financial Conduct Authority implemented a temporary ban on the sale of such investments. The FCA has since made the ban permanent.
But would the existence of a healthy retail corporate bond market have prevented the excesses of the speculative mini-bonds? Perhaps. The securities listed on the LSE’s Order Book for Retail Bonds pay coupons of up to 7.5% (on a note issued by Provident Financial in 2011) but there are not many bonds being offered today that could go toe to toe with Chilango’s 8%.
So it is possible, but far from certain, that retail investors would be better served by having access to a flourishing, properly regulated bond market.
But what about issuers?
Some organisations clearly see benefits in offering their debt to retail investors. It is, first and foremost, simply another way to diversify one’s sources of funding, and who doesn’t want that? It may also incur lower costs than an issuance of bonds to institutional investors, especially when raising relatively small amounts. Thirdly, it can be used as a way to cement loyalty among the existing customer base or employees, or gain the attention of a wider audience.
But are those advantages to a limited group of issuers worth the time and effort it would take to reshape the regulations and get a European or UK retail bond market off the ground?
And are there other risks — not to investors but to the issuers themselves — that may not have been considered?
Planet of the apes
The recent resurgence of retail investing in the US seems to show a change in the character of the typical retail investor, and could serve as a cautionary tale.
It is true that the interventions in the stock of companies such as video game retailer GameStop Corporation and car rental company Hertz by individuals schooled in the online forums of Reddit have generally been favourable to the companies involved — and unfavourable to the hedge funds that were shorting them — but it is not difficult to imagine the chaos that could be wrought by these self-styled “degenerates” and “apes” if they were ever to make the leap to bonds.
Adam Aron, the CEO of cinema chain AMC Entertainment, has adapted his investor relations strategy since the company became a meme stock, taking to YouTube and Twitter as part of his shareholder engagement drive. “I have started to follow Apes, about 500 so far, to get a first hand sense of what our community is thinking snd [sic] saying,” he tweeted on May 16.
Which is all well and good, but now imagine entering into restructuring talks with a group of noteholders who pay more attention to r/WallStreetBets than they do to the Wall Street Journal.
Or consider a simple consent solicitation. It has been difficult enough for borrowers to obtain consents from sophisticated financial institutions to shift pricing benchmarks from Libor to alternative risk-free rates. It would surely not be any easier, if a similar need were to arise in the future, to seek such consents from an army of apes.
A hedge fund manager may be a tough negotiator, but it is to be hoped that they are, at least, a rational actor.
When mobile app-based brokerage company Robinhood was forced to halt trading in GameStop shares due to a large clearing house deposit deficit caused by extreme volatility, conspiracy theories abounded. What if an influential Redditor wrote a post claiming that the Libor transition — or whatever other reason there might be to seek an amendment to the terms of a bond — was an Illuminati conspiracy?
This may seem far-fetched, but remember that most series of bonds have a total outstanding amount that is much lower than the market capitalisation of a company such as GameStop, Hertz or AMC. If the Redditors were to discover bonds — and it would only be a matter of time if retail were allowed into the market — they would have no trouble taking control of a particular maturity.