The rise of the retail bond
“We have come to ORB three times and each time, we have seen really strong demand from investors."
Paul Fuller, Head of Market Execution, Tesco Bank
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London Stock Exchange Group’s retail bond platforms have been highly successful in the UK and Italy. But there is plenty of potential for growth, as Helen Power reports.
Retail bonds have taken the UK by storm since London Stock Exchange Group [LSEG] opened up the lucrative corporate debt market to private investors in 2010.
Initially, just ten corporate bonds were traded on the Order Book for Retail Bonds (ORB). Now there are more than a hundred, with household names including Tesco and National Grid, as well as LSEG itself, taking its lead from UK investors’ desire for a better yield than that which is on offer from standard savings accounts.
However, the retail bond market revolution actually began in Italy. More than 15 years before London’s move into retail bonds, Borsa Italiana was routinely providing sovereign and corporate bonds to domestic and European investors. Borsa’s retail bond market, MOT, which will celebrate its twentieth anniversary next year, is the biggest bond market in Europe by turnover, with trades worth a billion euros completed every day.
Pietro Poletto, LSEG’s Head of Fixed Income Markets, who oversees both ORB and the MOT, believes the trend began in Italy because successive cash-strapped Italian governments desperately needed capital.
"Investors in Italy are familiar with this type of financial instrument, probably because Italian government debt has been quite large historically, so retail investors were happy to invest in it and considered it secure," he says.
What started as a market for Italian sovereign bonds quickly became another fund-raising avenue for Italian businesses.
"There was already a strong community of brokers in place who worked in the Italian government debt market and they helped to drive a dramatic increase in interest in corporate debt," he adds.
Fast-forward to 2010, and the Italian prototype looked very compelling for UK companies struggling to borrow from a broken banking system and the banks themselves, anxious to rebuild their weakened balance sheets. At the same time, UK investors were getting a raw deal, as savings rates remained stuck at historic lows. The market was ripe for a new type of corporate fundraising that would allow corporate and financial borrowers to raise money directly from private investors.
So, with the backing of the UK Government, LSEG exported the fundamentals of Borsa Italiana’s MOT to London, launching ORB as a Financial Conduct Authority-regulated, MIFID-compliant, retail fund-raising and trading platform.
From the start however LSEG was mindful of key differences between the UK and Italian retail investment community
"It was clear that the needs of UK retail investors were quite different from those in the wider European markets.. Traditionally, UK investors have been equity driven and only recently has there been a change of attitude to bonds. Education is key to our strategy, not only in the UK, but everywhere – it’s important to educate investors and the wider community as to how to interact with a new market," says Poletto.
Top names come to market
Fortunately, an influx of new issues from household names catapulted retail bonds into the consciousness of small investors struggling to find decent returns on their capital. Tesco’s financial services arm, for example, accessed the market three times, including by way of an innovative, inflation-linked transaction.
"We have come to ORB three times, and each time we have seen really strong demand from investors. London Stock Exchange gives the market real credibility and from our perspective, ORB provides us with another funding source," says Paul Fuller, Head of Market Execution at Tesco Bank.
"ORB also allows you to do smaller deals than the institutional market," he adds.
Other issuers range from international utility, National Grid to specialist mortgage provider Paragon Group.
"We were used to the institutional bond market but ORB gave us access to a different group of investors. We also issued an eight-year bond, whereas a typical institutional deal would be three to five years," says Nigel Terrington, Chief Executive of Paragon Group.
Such was demand for Paragon’s £60 million transaction, the books were closed early.
"We had a very good experience. We were well advised by our PRs and our lead manager and we even got to open trading on London Stock Exchange. We would definitely like to come back to the market," he adds.
Oil & gas group Premier Oil accessed ORB late last year and also experienced robust demand.
"We do not have a credit rating, so when we looked at the sterling bond market, ORB was an obvious place for us. Initially, we were concerned that the issue sizes might be a bit small, given the documentation requirements. But over time, the market proved it was perfectly capable of absorbing larger transactions, so it became more attractive to us. We also structured our documentation as part of a broader MTN (medium-term note) programme so we can use it to issue bonds in other currencies and markets," says Tony Durrant, Chief Financial Officer at Premier Oil.
Broadening the scope
Looking to the future, Poletto believes macro-economic fundamentals will help to sustain British investors’ appetite for retail bonds.
"It seems that interest rates will remain at a low level for a while and many medium-sized companies are keen to secure non-bank debt. This is an area that we are just beginning to exploit but there is real potential for growth," he says.
"The UK Government has long been asking how is it might be possible to help companies in these difficult times to find alternative finance. ORB could provide these businesses with a solution to the credit crunch, particularly if they have a good story, but it will depend on their quality and on there being advisors and brokers with the expertise and knowledge to help them," he adds
Poletto points to Italy where LSEG recently acquired a majority stake in EuroTLX, another retail-focused fixed income platform, which has been used successfully by a number of medium-sized companies.
"The experience of EuroTLX shows there is appetite from issuers and investors, provided the circumstances are right and the knowledge is there," he says.
Medium-sized companies are just part of LSEG’s strategy however. In both the UK and Italy, the Group is keen to attract a range of corporate, banking and government issuers.
In London in particular, Poletto sees LSEG offering banks a platform for some mutual bond funds that they would have run in-house before the credit crisis.
"Some big banks that previously managed bond funds internally may now prefer to outsource some services because of the potential for conflicts of interest and reputational risk in the wake of recent scandals like LIBOR and interest rate swap mis-selling," he says.
Central to LSEG’s ambitions is the creation of a pan-European platform for retail bonds - and more broadly - all fixed income products.
"The idea is to maximise these assets, offering not just a market for Italian or UK investors, but a solution for all investors across Europe. The foundation is already in place, so we are in good shape to export our skills."