Europe’s corporate debt markets since the crisis have experienced feast and famine.
Large companies that can access bond markets have mainly been feasting. Since the crisis, investment grade firms have consistently been able to fund at tighter levels than the marginal cost of funds of banks that are supposed to lend to them.
Larger and larger bond deals with more and more ambitious structures have proved feasible. Meanwhile, banks have carried on clamouring to be included in loss-making corporate loan facilities.
Wobbles at the sharp end of leveraged markets have been quickly forgotten, and credit standards have carried on weakening. The European Central Bank’s Corporate Sector Purchase Programme kicked the bull run into higher gear, but even before it began, benchmark corporate bond markets were purring.
But for smaller firms, at least in policymakers' eyes, it has been closer to famine. Working out how much SMEs were starved of funds, and how much they didn't want to borrow is a thorny economic problem. However, there's a view that despite a hefty regulatory subsidy to do so, banks struggled to make the maths work on small business lending, and have maintained exacting standards on collateral and security.
Prolonged macroeconomic pain in Europe’s periphery has left many small business loans non-performing, with borrowers protected from their creditors only by inefficient courts. Public institutions have lined up to offer credit support for SME lending, but it still looks like bad business for some banks — and the Commission wants to fix it.
Their proposed solution is to connect the two — if more small firms can access the bounty of the capital markets, then perhaps the lack of bank finance will prove less painful. That’s the basic logic of Capital Markets Union, which has been rumbling forwards in Brussels since 2014.
The latest plank of it is a report, drafted for the European Commission, on how to make corporate bond markets work better. It is full of good ideas — smoother trading, more orderly new issues, a lighter burden for prospectuses, and a host of other changes.
Many of the recommendations are aimed at unwinding some of the more onerous parts of recently passed European regulations — several, in fact, relate to MiFID II, which has yet to come into effect. So it is hard to cheer too vigorously for the European Commission at this point.
Moreover, it will take years for anything to get done. The expert recommendations will form the basis for a consultation, which will, by autumn 2018, form the basis for Commission recommendations. Only then can the European legislative process, in which the Commission, Parliament and Council must agree, start in earnest. Then, of course, the European supervisory agencies, ESMA, the EBA, and EIOPA, must figure out the technical details.
But supposing any of the report actually sees the light of day, it will still be large companies, regular visitors to the capital markets, that see the greatest benefits.
There are three main recommendations that touch SMEs: an even easier version of the ‘Growth Prospectus’, a planned light form of a full prospectus, which is already in the works; a nudge to the Commission to get on with its work on private placements; and a suggestion that “National Promotional Banks should be given the necessary mandate to support SMEs to issue corporate bonds”.
The first two of these are essentially a thumbs up to existing EU initiatives, and the last is not too far off. The biggest public sector lenders in the EU, such as the European Investment Bank, EBRD and KfW, already have pretty extensive support packages aimed at funnelling finance to SMEs. In any case, there is little to stop countries tweaking their national promotional banks to spend more on supporting corporate bond markets.
Nearly everything else, however, will have most impact for the large companies, whose funding has never been a problem.
Three major recommendations — on market soundings, allocation policy in high yield, and cutting order inflation — will largely apply to deals big enough to be properly syndicated. Below this size, where debt issues tend to be semi-private or club deals, allocation is less of a bunfight, and soundings have always been more necessary.
The secondary market recommendations, too, will tend to ease conditions for larger issuers more than small. It would be nice if small issuers could enjoy more active trading of their debt — but a €100m deal placed with six accounts will never offer much liquidity, no matter what the regulatory treatment.
By contrast, regular issuers in sizes above €500m could get a big jump in liquidity if banks find it easier to make markets, if corporate bond exchange-traded funds expand, if there is a revival in corporate credit default swap and repo markets, and if more corporate bonds are traded electronically and are cleared.
More liquidity allows easier switches into new issues, makes yield curves more meaningful, pricing more accurate, and may promote more complex trading strategies. All that will tend to make corporate debt yet more attractive to investors — as long as it is issued by the big companies where this benefit is greatest.
Yet these are exactly the issuers that are already thriving, after years of cheap money, booming bond market demand, and a huge slug of central bank buying to boot.
Ways to boost the corporate bond market are welcome, and promise a corrective to many of the worst regulatory decisions of the last few years. But once again, it is the big players that will benefit most.