The London Stock Exchange (LSE) is celebrating the fifth anniversary of its Order Book for Retail Bonds (ORB) today. The trading platform enables retail investors to buy and sell corporate bond issues.
Corporate bonds should be an important asset class for retail investors. They generally offer higher interest rates than many bank and building society deposits. But sadly, the UK retail bond market has yet to fully seize the enormous opportunity that they offer.
The wholesale market – which is directed at institutional investors, such as pension funds and insurance companies – involves tens of billions of pounds of new sterling bonds each year. But new corporate listings on the ORB in 2014 totalled just £526m, according to the LSE’s own figures, with not a single one issued by an investment-grade-rated London-listed UK corporate. Unfortunately, household-name issuers have remained stubbornly shy of tapping the retail investor base via an ORB listing.
What the market really needs is consistent issuance from well-regarded, highly creditworthy borrowers with strong track records. This means investment grade, corporate “frequent issuers”, with a strong following among professional investors. The likes of British Gas, National Grid, British Telecom and Vodafone should all be very safe homes for investors’ money.
But current requirements on documentation are keeping the kinds of issuers the market needs away. To understand why, let’s consider what goes through the mind of a corporate treasurer who is weighing up whether to issue a retail or a wholesale bond.
The first consideration for any issuer is price. And there are three possibilities when it comes to the interest rate on the retail bond: it needs to be higher, lower or the same as it would be on an institutional bond. If it is higher, the treasurer won’t proceed, as it is a more costly route. If it is lower, there are understandable corporate and bookrunner sensitivities – it could be construed as implying mis-selling to retail investors, even though that is probably wrong. So many companies and bookrunners conclude that the only “safe” way to issue to retail investors is if the interest rate is the same as on an institutional bond.
The same thinking goes for the structure of a retail bond issue – and many firms come to the conclusion that it should be on an equal footing with other debt, not junior to it. The thinking then becomes, “it might as well be the same bond, bought by both sets of investors”.
Then there’s a question of admin and costs. Frequent borrowers – of the kind needed to get the retail market moving as it should – typically update their bond documentation only once a year. While they might be happy to set minimum denominations at a retail-friendly level (say, £1,000), current UK Listings Authority (UKLA) rules require a different prospectus format for low-denomination bonds, which adds to the time and cost of the annual update. Because their bonds are already oversubscribed by institutions, the treasurers simply don’t bother.
The UKLA’s current requirement for an alternative format is understandable – it seeks to protect non-professional investors’ interests. But selectively relaxing it could open up many billions of pounds’ worth of top-quality corporate bonds to retail investors.
Clearly, retail investors need protection, but it should be proportionate. The UKLA could announce that, for issuers with London-listed equity and an investment grade credit rating, the documentation appropriate to institutional investors is also appropriate to retail. For more complex issuers or deals, the rules should rightly demand full disclosure in straightforward language.
This would mean that retail investors could see how a deal performs early in its life, and then take the decision to buy in the secondary market. Primary distribution to institutional clients, with retail picking up paper via the Institute of Financial Accountants (IFA) and market makers in the secondary market, would also allay many large bookrunners’ fears that their compliance procedures are not currently set up to deal with retail.
If the UKLA made these changes, in five years’ time – or perhaps even next year – we could be celebrating a retail market many times the size of the one being lauded at the LSE this week.