The Retail Bond Alternative

The UK and European retail bond markets are becoming an increasingly credible alternative to the traditional institutional bond and bank markets for borrowers.

While certain European markets have maintained active and liquid retail bond markets for years and are an established platform for companies to raise debt, more recently the UK has seen the launch of several bonds specifically targeting retail investors.

The Overseas Story

The European retail bond market has long provided a route to liquidity for borrowers by attracting the proverbial ‘Belgian dentist’- representing the typical middle-class, conservative investor – to invest in corporate names. Luxembourg, Germany, Belgium and Italy are among those to have established liquid retail bond markets. Several European stock exchanges operate dedicated retail bond platforms, including Germany’s Börse Stuttgart Bondm and Italy’s Borsa Italiana MOT, while others list retail bonds alongside wholesale bonds, as in the case of Luxembourg and Belgium.

European retail bonds are typically publicly listed instruments, with issuers comprising not only a range of domestic corporates but also multinationals with high brand recognition locally. For example, Shanks Group, Europe’s largest listed independent waste management company, listed on the London Stock Exchange (LSE) and operating in the UK, the Netherlands, Belgium and Canada, issued its debut €100m retail bond in October 2010 to investors in Luxembourg and Belgium.

Further afield, the US also has a long track record of retail bond issuance, while in Australia direct retail investment in corporate debt appears to be increasing, echoing recent developments in the UK market.

The UK Market

In the UK, interest in retail bonds is continually growing across both investors and borrowers. Demand from UK retail investors is increasing as they seek alternatives to traditional savings products and equities. In addition, long-term structural change to the funding markets is ongoing, impacting traditional financing routes and in response borrowers are seeking alternative funding options.

Two principal routes to market have come to the fore in the UK. The listed market has been assisted by the launch of the LSE’s retail bond trading platform, the Order Book for Retail Bonds (ORB) enabling trading in bonds with small denominations. UK issuers that have already accessed this market include Tesco Personal Finance, property manager Places for People, utilities National Grid and Severn Trent, Primary Health Properties and, most recently, ICAP.

The second route to market, used by borrowers including retailer John Lewis, hotels chain Mr & Mrs Smith, Leon restaurants and green energy company Ecotricity, is the unlisted ‘mini-bond’ route which offers non-transferable bonds with issues typically targeted at raising funds directly from customers. With more than £1.5bn raised in the UK retail bond markets since the beginning of 2011, the market could provide meaningful opportunities for borrowers to diversify debt funding.

Demystifying Retail Bonds

The relevance of retail bonds to individual borrowers is likely to vary, depending on objectives and circumstances. An important factor in the continued development of retail bond markets, both in the UK and overseas, will therefore be building borrowers’ understanding of the markets’ key features, and whether a retail bond is right for their business.

For example, retail bond pricing is driven by different factors to other funding options and reflects the alternative products available to retail investors, such as bank deposits or equities, as much as credit risks per se. Cost of funds can therefore vary compared to other sources of capital and across different debt maturities. This can result in retail bonds looking comparatively more expensive than other options, but in some cases pricing can be more attractive than that available in other markets.

In the UK issue size is smaller than the institutional bond market, typically from £25m to £150m in the listed market and £1m to £10m in the unlisted ‘mini-bond’ market. Funding is therefore possible for companies without the scale normally associated with public bonds. This may be important where bank funding lines are unattractive or unavailable. While National Grid’s September 2011 offering of a £282.5m bond indicates that issues of scale are possible, small issues can be more accurately matched to borrower requirements and may reduce the over-funding inefficiencies associated with ‘benchmark’ issues. With Provident Financial, Tesco Personal Finance and Places for People having completed repeat issues, the UK market continues to develop and is showing signs that it can absorb periodic multiple issues to allow substantial funding programmes over time.

Standard bond terms and structuring, with both fixed rate coupons and index-linked returns, have prevailed in recent UK listed issues enabling issuers to benefit from established market mechanics. In contrast, the unlisted UK market has seen bonds paying out exotic coupons such as store vouchers, products or customer discounts. This flexibility can enable a retail bond issue to be as much a marketing and profile-raising opportunity as it is a funding exercise, and allows for highly tailored, bespoke issues.

In contrast, the more established European retail bond markets typically see larger-scale issuance, around the €100m to €500m mark. And while fixed rate issuance dominates, more sophisticated structures are also seen in Europe, including a large volume of floating rate issuance, as well as inflation, equity and commodity-linked structures.

For listed issues in both the UK and Europe regulatory requirements for disclosure of information, which are largely driven by EU law, typically follow the standards for the institutional market although certain additional obligations can exist. Requirements are typically less onerous for unlisted issues.

Outlook

Access to the retail bond market was once considered to be restricted to borrowers with strong corporate recognition, material assets, robust operating performance or large customer bases. While name recognition and brand awareness still remain important factors, recent experience in the UK market suggests that the range of borrowers accessing retail funding will widen materially.

Retail bonds provide an opportunity to access funds, often on an unrated basis and without covenants, although the likely terms for any new issuer will be significantly driven by individual circumstances and may well change materially over time. Given the stress in the European bank markets and the access to a new investor base a retail bond offers, borrowers should consider whether a retail bond should feature in their basket when shopping for funding.

We have seen a large rise in the number of our corporate clients looking to explore retail bonds as a way of diversifying their borrowing. Severn Trent’s recent issue, on which KPMG advised, demonstrates the continuing development of the market and its emerging role as an important element of a diversified funding programme for borrowers, especially as the bank debt markets look likely to remain under stress in the future.

 

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