Schuldschein tries to keep old virtues but embrace the future
The Schuldschein market has broken into unknown territory, welcoming borrowers and lenders from far-flung lands, while establishing itself as a hotbed for technological advancement. Can the miracle last? Silas Brown reports.
the Schuldschein is shedding its old skin. Once an austere and staid German market, it has shown a remarkable ability to adapt to borrowers’ needs. It has grabbed the attention of European corporate finance and racked up over €27bn of issuance in 2017, from 150 borrowers.
Participants believe the enticing mix of tight margins, lean documentation and tenor variety the Schuldschein can offer has worldwide appeal.
Technology can help the instrument clean up inefficiencies of process, which will help it expand to issuers across Europe, Asia and North America.
Seeking tech breakthroughs
Almost all see technology as one of the keys to the growth of the Schuldschein market, but some believe it is the paramount factor.
“There are many efficiencies to work on in the Schuldschein market, which could drive down costs for arrangers, issuers and investors and open up the market much further,” says Paul Kuhn, head of debt capital markets origination at BayernLB in Munich.
In June last year the market hosted its first Schuldschein using blockchain technology, issued by Daimler for €100m via Landesbank Baden-Württemberg. Origination, distribution, allocation and execution were conducted electronically through software provided by Targens and TSS, LBBW and Daimler’s IT systems.
The deal was sold to German savings banks Kreissparkasse Esslingen-Nürtingen, Kreissparkasse Ludwigsburg and Kreissparkasse Ostalb. This was a surprise to some, who felt this sort of bank might be too traditional to be receptive to technological developments in the instrument. But the lender base has been receptive to new ideas, and arrangers are energised by this.
“Blockchain technology will change the role of banks as intermediaries in the economic process. We don’t want to merely observe this development; we want to proactively shape this field,” said Joachim Erdle, head of corporate finance at LBBW, in a statement.
Telefonica Deutschland followed in January, launching a €200m Schuldschein, which included a €50m one year tranche using blockchain technology, also led by LBBW.
“I compare the situation around blockchain with the internet when it started,” says Albert Graf, Telefonica Deutschland’s director of corporate finance.
“It [blockchain] will disrupt this world — and instead of reading about it, or thinking about it, we’re acting on it.”
Blockchain might cut costs for distribution, but there are more prominent inefficiencies that a distributed ledger could not solve. So some question whether introducing blockchain goes far enough.
“LBBW’s attempt was a pioneering effort, but it was very much the first step,” says one arranger from a rival bank. “There is still a long way to go — and actually, the real cost and time is in the process of the Schuldschein, not in merely the distribution.”
Although the marketing period for a Schuldschein is lengthy, between four and six weeks typically, there is some sense to this. As three quarters of the borrowers entering the market are unrated, serious credit work is required to determine whether the issuer is a worthwhile investment. So the market could not function effectively if it did not give investors adequate time.
Costs in the Schuldschein market are largely beyond what blockchain technology can undercut. There are legal costs and bank fees for issuers, and for investors and arrangers there is a lot of time spent negotiating pricing over phones and emails. This is where proper efficiency gains can be made, and there are other schemes attempting to provide answers to those.
Putting everyone together
Helaba and VC Trade launched a digital platform for Schuldschein issuance in mid-March, designed to cut costs for arrangers, issuers and investors alike, while making the market more transparent.
“This software will oversee the whole process between issuers and investors, and will make the Schuldschein market much more efficient and transparent,” says Andreas Petrie, head of primary markets at Helaba in Frankfurt.
The software is open to all Schuldschein participants. It is meant to carry a Schuldschein transaction from negotiation through pricing and allocation all the way to settlement.
This could reduce the labour and cost of issuance for participants by up to 40%, says one banker involved in the launch, and perhaps provide some compensation for arrangers’ falling fees.
This in turn could make the market more accessible to smaller issuers, which either cannot afford the fees, or struggle to find an arranger willing to put in the effort to bring them to market.
“No one wants to bring smaller issues of €10m-€20m to the market, as there’s not enough money in it,” says one Schuldschein banker in Frankfurt. “But if the software could dramatically cut the costs of issuance, and arranging that issuance, the market could open for smaller issuers.”
Helaba is in close contact with issuers and investors, which are set to begin using the platform shortly. “I had a quick look in my inbox [an hour after the launch] and there is already substantial interest from institutional investors looking for access,” says Stefan Fromme, co-founder of VC Trade.
Of course, the platform becomes more interesting the more widespread its use, but the participants seem highly confident of its success. “We expect the system might have 80%-90% of the market using it by the end of 2019,” says one banker involved in the platform. He believes progress towards a comprehensive software is useful for every market participant, and particularly if the Schuldschein market has ambitions to grow across the world.
Advances in technology could ease the understanding of the product in Asia, which is where the more ambitious Schuldschein arrangers are looking for new opportunities.
“Is it possible to truly take the instrument to Shanghai, or Tokyo?” asks Helaba’s Andreas Petrie.
“We are in the process of examining taking the product across Asia. We had roadshows in China, Japan and Taiwan for Lufthansa and Trelleborg and over 50 insurance companies and regional banks came.”
The interest in that region was sparked by the influx over the last few years of Asian commercial banks entering the market to diversify and increase their lending in Europe.
Forklift truck maker Kion Group sold nearly €1bn of Schuldschein notes at the beginning of 2017, benefitting from that increasing Asian interest. Commerzbank, HSBC and LBBW offered investors tenors of five, seven and 10 years, at fixed and floating rates, and Asian commercial banks’ European offices pushed the transaction to €958m. But the real growth lies in Asian lenders without such worldwide presences.
“What we are trying to do is not just sell to Asian offices in Paris or London, but selling in different non-European jurisdictions across the world,” says Petrie.
“This raises different questions around tax and legal documentation that have not been fully explored yet. That could be the next big growth for the market.”
If these investors are found to be good candidates to buy Schuldscheine, this could be the next long term milestone for the instrument, and draw it that much further from its German roots.
In the meantime, however, the German arranging banks are looking north for growth.
Can you see the Northern lights?
Nordic issuers are ahead in this respect. The region is proving fertile ground to find new borrowers for the Schuldschein market, as originators notice that local bank lenders are not providing tight margins to local borrowers, and Schuldschein investors are becoming more interested in diversifying their portfolios to that region.
“There is room for arbitrage in the Nordics, and we can compete with the local banks on price,” says Kuhn.
But the test will be whether arrangers can entice the broadest range of Schuldschein lenders to invest in Nordic borrowers.
“Nordic issuers are the next step after Benelux and the German-speaking region, and it seems that the wide range of investors in the market are interested,” says one investor at a German savings bank, although adding that some lenders are still watching from the sidelines.
Huhtamäki, the Finnish food packaging maker, offered five and seven year tranches in April last year, in either euros or dollars, and a 10 year euro tranche. It closed the transaction with €117m and $35m raised. Asian and European commercial banks, as well as some smaller regional German lenders, bought the loans.
“Once there are a few more flagship transactions you can expect more and more investors to become interested,” says the investor. “Sometimes German investors need to see a few transactions succeed before they have true confidence in a developing region.”
This is beginning to happen. Konecranes followed Huhtamäki’s deal in November.
It hired Commerzbank, Deutsche Bank and Helaba to arrange the facility, which was split into four and seven year fixed and floating rate notes.
Swedish agricultural group Lantmännen launched at €100m dual currency Schuldschein in early March, and Finnish packaging firm Wihuri debuted with a €75m transaction.
As the investor predicts: “Once you see one or two Northern lights, more and more will begin to appear.”