Is There an Alternative for Investors Starved of Retail Bonds?

Philip Gilbert

Head of Fixed Income

The low interest rate environment of recent years has made the hunt for yield more difficult and as I highlighted in the last edition of DIY Investor Magazine demand from investors for retail bonds has outstripped supply leaving investors frustrated by the shortage of issuance.

The London Stock Exchanges’ Order Book for Retail Bonds (“ORB”) is considered the blue chip listing because it represents the benchmark for transparency and disclosure that retail investors should expect and it has become the listing of choice for the buyers and distributors of retail bond issues.

This transparency and disclosure comes from the supporting documents to the issue, specifically the prospectus and information booklet required by the exchange. Regulation requires that the prospectus is the lead document, the information booklet “follows” and is intended to provide a summary  to help retail investors understand the relevant points, but it must not be viewed as a substitute for the prospectus.

“there is expectation that the “new norm” for rates will be lower than in years gone”

There are a number of reasons for the lack of issuance on ORB; one is the perception that the coupon needs to “start with a 6”, and another is the re-emergence of the banks in lending to firms that had turned to ORB as a source of funding. At the same time, the listing has become harder to attain for new issuers as it is intended for only the most vanilla bonds.

One of the prime tasks for managers of a bond issue is successfully distributing the paper. Many of the traditional investors of retail bonds prefer issue size to be at least £50m. Whilst this may be small compared to the institutional bond market, where benchmark size is at least £200m, it is well in excess of the funding requirements of many potential issuers, or it is more than they need from a single issue.

We are typical of a number of firms who meet potential issuers with successful businesses whose funding requirements are deemed “too small”.

These companies have been recognised by Standard & Poor’s who have created a Mid-Market Evaluation process that allows them to potentially rate these firms.

We have been exploring alternative listing venues, for example the LSE’s Order Book for Fixed Income Securities (“OFIS”), or the Main Market of ICAP Securities and Derivatives Exchange (“ISDX”). Both of these alternatives can enable us to better serve our clients in issuing public debt which, in turn, should lead to a greater supply of bonds for investors to consider.

A number of issuers do want larger amounts of funding, some in excess of £100m, but not all in one go. An example of this is an issue we are currently managing for Indian Solar Energy PLC, the Borrower and Guarantor is Nereus Capital Investments (Singapore) Private Limited. Their funding requirements over the next 2-3 years are up to £200m, to provide this they have established a Medium Term Note (“the Notes”) Programme

A Programme, unlike a single issue prospectus allows them to issue notes on an on-going basis without producing an individual prospectus for each issue. Instead, the programme is amended or supplemented on an on-going basis, including at the time of each issue. For an issuer such as Indian Solar Energy PLC the establishment of a programme becomes very cost effective, and shortens the time it takes to bring an issue to market.

It is not unusual to have a newly formed company as the Issuer, with a loan between them and a guarantor who actually uses the proceeds of the issue. The issuer has no assets other than the loan agreement and the collateral pledged to cover the loan.

In this instance, the collateral includes a pledge of all the outstanding shares of the Borrower and appropriate negative covenants ensuring 100% indirect ownership and control of the Lead Assets, which are the Dubbak Solar Projects Pvt. Ltd, and the Medack Solar Projects Pvt. Ltd

• Dubbak has leased approximately 27 acres of land from the firm contracted for doing the engineering, procurement and construction (EPC) works of the 9.20MWp project in Telangana State
• Medak will own 39 acres of land and has executed an EPC contract for the development and construction of a 8.24MWp solar power project.

All the documentation and the economic details of this issue can be found at http://bond-shop.com/index.php/current-issues

We will continue bringing such issues to market next year in an effort to achieve a broader retail bond market, with an increasing supply, whilst maintaining the standards of transparency and disclosure referred to at the beginning of this article.

“dividends cannot be relied upon to provide a fixed level of income”

Low interest rates in recent years have made the hunt for yield more difficult. Whilst 2016 does appear to be the year when  interest rates finally start to rise, there is expectation that the “new norm” for rates will be lower than in years gone ⁽¹⁾ by, reflecting the low inflation environment we are currently experiencing in-spite of all the global quantitative easing.

Dividends have, for many years, been a very good source of income for investors, however recent reductions by firms such as Tesco, Standard Chartered, and Rolls Royce endorse what should be known; dividends cannot be relied upon to provide a fixed level of income.

In conclusion, we hope that our efforts will allow investors to access a wider universe of bonds, which have a high level of disclosure and transparency, enabling investors to further diversify their portfolios.

Notes:

1. http://www.societegenerale.com/sites/default/files/documents/Econote/N29%20Econote%202015-09_MHD_Low%20interest%20rates.pdf