Retail Bond Expert

   By Philip Gilbert, Beaufort Securities

In February 2010, the London Stock Exchange launched its new electronic bond market for retail investors, the Order Book for Retail Bonds (“ORB”)

The background to the reason behind the launch was two-fold; increasing private investor focus on fixed income, and corporate funding needs. In reality, both were a consequence of the Global Financial Crisis; historical low interest rates led investors to chase yield, and the deterioration of bank balance sheets lead to them stopping lending, particularly to “smaller” companies.

One of the Key aims of ORB was to develop an efficient, transparent secondary market in bonds for UK investors and to establish a primary market for distribution of dedicated retail bonds, opening up new sources of capital for companies seeking to diversify their funding

In addition to offering more than 180 retail-size bonds on the platform, ORB is now established as an alternative source of funds for a wide range of corporates. There are now in excess of 50 ORB-dedicated new issues and 6 taps of existing ORB issues that have raised more than £4.75 billion for 28 different issuers.

ORB has successfully enabled:

• A diversified investor base - increasingly strong demand for retail bonds from retail brokers, wealth managers and private investors

• An alternative source of funding for issuers

• Flexibility - the size of a retail bond can be tailored to meet issuers’ particular needs; issues have ranged from £20 million to £300million

• “Simple” structures for retail investors to assess

However ORB issuance has diminished overtime:

The key columns here are the number of Issues and the number of new Issuers coming to market each year. 2012 was the halcyon year, since then there has been a steady decline, what explanations are there for this? 

•             Cost – the necessary documentation and legal costs required to support an issue are considerable, £200,000 would be a conservative estimate.

•             Regulation – ORB, quite correctly, is viewed as the “blue chip” listing, as such it can be difficult for an issue to match the criteria required.

•             Size – because of cost it can be

-              uneconomical for issues of less than £25m.

-              difficult to get the support of market-makers which is a prerequisite of listing on ORB

Whilst supply has fallen there has been no diminution in investor demand, in the fact quite the opposite:-

“Mini bonds are part of the so-called UK alternative finance market…..

• Issuance grew by 91% from £492 million in 2012 to £939 million in 2013, according to The Rise of Future Finance: The UK Alternative Finance Benchmarking Report by Nesta, the University of California and the University of Cambridge.

• The study discovered that more than 647,000 projects, individuals or business financing campaigns were fully funded through alternative finance intermediaries. When compared to 2011 and 2012, in which the figures were around 448,000 and 503,000, respectively

• Based on the average growth rates between 2011 and 2013, we can cautiously predict that the UK alternative finance market will grow to £1.6 billion next year and provide £840 million worth of business finance for start-ups and SMEs in 2014.

Source: Moneywise 2^nd September 2014

Whilst mini-bonds serve the needs of investors seeking greater income from their investments, and have successfully allowed “smaller” issuers to access a debt market, they do have shortcomings when compared to ORB issues, such as:

• Liquidity: There is, at best, a very limited secondary market, requiring them to held to maturity

• They do not have the same levels of transparency and disclosure required of ORB issues as they are not written under the full prospectus required by EU law

• Currently, they do not qualify for ISA investment

The net effect of all this has been to create a two-tier retail bond market that, possibly, doesn’t reflect what investors actually want. ORB has delivered considerable benefit to investors allowing them to:

• access to listed bond investments

• achieve higher yields

• full disclosure and transparency over the company they are lending to.

What is hasn’t achieved is sufficient supply to meet the obvious demand. Mini-bonds have achieved the opposite,

• plentiful supply

• without the disclosure and transparency expected of an ORB issue

What is the ideal solution? Is a different market to list onto where smaller issues, possibly £10m plus, can be listed with the disclosure standards required by ORB? Whatever the solution, it must find a way to serve some of the issuers that have used the mini-bond route whilst offering investors the protection afforded by the disclosure and transparency of a full prospectus. Only in this way, can we ensure that investors have the benefit of plentiful supply and sufficient visibility to fully assess the loan they are making.

Philip Gilbert

Philip Gilbert is Head of Fixed Income & Structured Products at Beaufort Securities www.beaufortsecurities.com.