Budget Could Lead to ‘A New Era For Retail Bonds’

Newly installed Chancellor of the Exchequer Rishi Sunak will have been in office for just four weeks when he delivers his first Budget on 11^th March, and it could lead to the creation of a new exchange for retail bonds.

Sunak started his career at Goldman Sachs, before moving into hedge fund management with The Children’s Investment Fund Management and then fintech investment; the ex-chief secretary to the Treasury has promised to go ahead with the government’s flagship economic policy speech as planned despite speculation that it would be pushed back.

Given the dearth of issuance on the London Stock Exchange’s Order Book for Retail Bonds (ORB), there will be many income investors watching the Chancellor carefully because in the past he has advocated the creation of a small- and medium-sized enterprise (SME) retail bond market, funded by savers and subsidised by the government.

In a 2017 report published by right-wing think-tank Centre for Policy Studies, Sunak laid out plans which may offer the most insight into his vision for the economy.

Entitled ‘A New Era for Retail Bonds’, the paper argues that UK SMEs are overly reliant on a few big banks for credit, while the SME debt capital markets are ‘underdeveloped.’

As a result, there was a potential £35bn funding gap between the capital that SMEs could potentially raise, and the capital that was made available to them.

‘a new exchange launched for retail bonds, modelled on the FTSE’s AIM exchange’

The Chancellor’s plan would see a new exchange launched for retail bonds, modelled on the FTSE’s AIM exchange; it would be ‘flexibly regulated’ by the Financial Conduct Authority and the London Stock Exchange and be open to all small businesses as a place where they could easily sell tradable bonds.

Investors could fund the exchange by buying and selling relatively low risk SME bonds, or by investing in index tracker funds; they would thereby earn higher returns than they could achieve from a savings account, without the volatility and risk associated with the regular stock market.

It is these characteristics that saw demand regularly outstrip supply on ORB, with many bonds trading at a premium in the secondary market; the bonds would also be eligible to be held in an ISA, offering investors tax relief.

Mr Sunak added that the government may also issue some of its own debt as tradable bonds so that ordinary savers can have easy access to long-term Treasury bond returns.

‘Although alternative sources of debt finance, such as P2P networks like Funding Circle, are growing, they still account for a tiny fraction of the overall SME credit market,’ he wrote.

‘Moreover, the bonds issued are generally not freely transferable or tradable, which inhibits the development of a proper market.’

Albeit that this paper was written in 2017, and since then there have been some seismic changes in the P2P and SME lending market, Mr Sunak’s comments have prompted some consternation in direct market lending circles.

It has prompted Ablrate and ASMX founder David Bradley-Ward to pen an open letter below offering some advice, ‘from one fintech veteran to another’ pointing out why the AIM structure may not deliver the benefits that Mr Sunak is seeking, and are already in place in the alternative lending sector.

The P2P industry contends that the Innovative Finance ISA allows retail investors to access tax-free returns, while the rise of the secondary market means that P2P loans are now more liquid and tradable than ever before.

New regulations in December 2019 added an extra layer of security to the P2P market, which believes that it already fulfils the role of an SME bond market.

Perhaps the challenge for the P2P industry is to ensure that levels of education and awareness around marketplace lending are high so that those seeking relatively low risk investments delivering predictable income are aware of the options that exist.

What seems certain is that if Mr Sunak were to facilitate the establishment of such an exchange there would be plenty of would-be ORB investors that would be attracted.

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