Remember Retail Bonds and ORB? You’re no Mr Bond Chancellor

 

Mr Bond has decided to take a trip down memory lane, this isn’t tales of sultry Russian spies and nights of Bollinger and caviar, it is something much rarer; he was thinking of retail bonds and ORB.

 

From those without such a good memory ORB, the Order Book for Retail Bonds, was launched by the London Stock Exchange to much acclaim in 2010, as it enabled retail investors to buy new issues of bonds directly, and then trade them on the exchange.

The first 2 to 3-yrs saw good flows of new issue onto ORB, however since then it has become increasingly moribund, and almost forgotten, much like my beloved ‘00’ status, licence to kill!

Then, like the presence of Pussy Galore, Mr Bond’s interest was aroused when, last week, people remembered the new Chancellor’s previous support for ORB, so much so that Retail Bond Expert wrote…

 

‘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.’

 

Read the article here

 

Before I continue, let’s consider what ORB was designed to achieve:

 

It was launched in the aftermath of the financial crisis; banks had shut up shop and smaller businesses were finding it                  hard to access capital. Issuing retail bonds on ORB gave                  them another option

Post the crisis central banks globally slashed rates to record lows, investors were chasing yield and ORB bonds provided            them with another option

It further democratised markets, allowing investors to buy bonds in the same way as they could equities

 

It all sounds great and, to be honest, it was. So, what changed?

Firstly, the banks came back into the market, bank debt carries no execution-risk (see below), can be cheaper than what retail investors ‘expect’, and has no costly prospectuses and lawyers.

‘since then it has become increasingly moribund, and almost forgotten’

Alongside this we had the rise of the ‘nanny state’, where regulators became so determined to ‘protect’ retail investors, that they required an even bigger, and therefore more expensive prospectus, further increasing the execution-risk for issuers.

Allied to this, distributors became increasingly aware of regulatory scrutiny and shunned anything that looked the least bit risky.

This was particularly successful, it spawned a whole new industry, known as ‘mini-bonds’, which flew beneath the radar and, in many cases, lost investors their money.

So, why does Mr Bond regard this supposed renewed enthusiasm for retail bonds as just noise?

As I am Mr Bond, I can answer a question with a question, in this case, two. What’s the point of another listing? What would it change?

‘why does Mr Bond regard this supposed renewed enthusiasm for retail bonds as just noise?’

In my opinion, the answers are no, and nothing. To fully explain my discontent, let us consider the process of issuing a bond.

The first step is the prospectus and, although we have technically left the EU, we still fall under their rules until year-end. Currently, any issue in excess of €8m falls within the European Union Prospectus Directive (‘the PD’) and require a full prospectus.

Once we leave it is expected that there will be some form of ‘equivalent’ regime, meaning that little will change. Should this not be the case, for the City it would be little short of a disaster.

 

Shhockingly Expensive

 

This prospectus requirement means that legal costs can easily be C.£300K. All parties to the transaction, the Arranger, the Issuer, and the Trustees require legal representation.

These can be sunk costs if, for any reason, the bond doesn’t get away, this includes the issue not receiving regulatory approval.

The next step is the regulatory approval itself; the overall regulator, the FCA, has a separate entity, the UK Listing Authority (‘the regulator’) which approves the prospectus for use. The listing is, to an extent, academic, it’s the regulatory approval that is crucial.

They are part of the FCA whose somewhat misguided attempts to protect retail investors have mis-fired somewhat.

Hence, my questioning why we need another listing, ORB does what is necessary.

‘Hence, my questioning why we need another listing, ORB does what is necessary’

The next step is the Arranger, which firms would act in this capacity? Very few have the relevant experience and knowledge to do this, and they are very ‘picky’ on the issues they bring to market. Primarily, because they have concerns about the issue being successful in raising the required amount.

The ‘real’ bond market, the institutional market, is dominated by the major investment banks They don’t play because they don’t need to, they only care about selling the bonds out-of-the-door with the lowest possible coupon.

Can pressure be bought on them? Unlikely, the only major player that is UK owned is Barclays Capital, and they have a history of doing what suits them. Strangely, they were involved in the early-days, although the desk behind broke up as members left the bank.

 

No Time to Die

 

This bring us to who will, and how will the bonds be distributed?

I cannot see any alternatives to the current ORB model, which is the domain of the Discretionary Fund Managers (‘DFMs’) and the Execution Only (‘X-O’) vendors, the latter being where retail investors can buy directly.

The harsh reality is that the DFMs have control, if the majors say no to a proposed issue it doesn’t happen.

‘we may not have the retail bond market that we want, but we have the retail bond market that they want us to have’

Whilst X-O vendors have, in total, raised up to £20m for some past issues, the lions share has always come from the DFMs.

X-O might work in small size, up to £10m, however, the cost of issuance can make this prohibitively expensive. Added to this is the fact that with X-O there is zero assurance of any money being raised, meaning there is 100% risk and considerable sunk costs

Is there an answer? No; perhaps the government would act as underwriter?

Another issue around distribution is that most of the DFMs and X-O vendors that matter are only connected to the LSE, meaning that any new listing needs to be under their umbrella, begging the question, why not stay with ORB?

Finally, if you get past all the above there is the small matter of market-makers. These are the people who enable investors to buy and sell bonds in the secondary market. General market perception is that any issue under £50m is too small, it will be illiquid, and therefore too risky for their book.

Mr Bond has previously suggested that the number of investors holding bonds not the size of the issue is the driver for liquidity.

Retail tend to buy ‘small size’, say £20,000, therefore a £10m issue might have 500 investors, isn’t that enough to make a market? Apparently, not

This might sound like a tale of doom and gloom, and it is. There are so many variables that need to come together to make it work that Mr Bond cannot see anything changing.

The new Chancellor might be well intentioned but that is all, that powers that be are entrenched; we may not have the retail bond market that we want, but we have the retail bond market that they want us to have

 

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