News

22nd Jul

All Bonds are not Born Equal…….Mr Bond Explains


In February 2010 the London Stock Exchange (LSE) launched the Order Book for Retail Bonds (ORB) with the objective of making a new generation of bonds accessible to the retail investor and providing liquidity in the secondary market for those that did not wish to hold the investment to maturity.

Retail bonds proved an instant hit with investors and as a result many offers were over-subscribed and most traded above par in the secondary market;

As a champion of the market RBE has become increasingly concerned by a number of recent issues and the risks they present to investors.In an article in June 2013 (Caveat Emptor – Mr Bond Urges Caution When Purchasing Retail Bonds) Mr Bond voiced concern over the number of different types of bonds that were being touted around and the protections or lack thereof they provided – ‘all bonds are not born equal’ was its sentiment.

Whereas many investors will be enjoying the certainty of guaranteed returns in excess of 6% from secured bonds, the 1,000 investors that backed Secured Energy Bonds from CBD Energy lost their shirts when the company tanked and those seeking the relative sanctuary of ORB will have shuddered when EnQuest bonds hit a nadir at £29.15.

So, here are some guidelines that investors should consider prior to making their investment – Remember, don’t solely focus on the coupon that you are likely not to get.‘don’t solely focus on the coupon that you are likely not to get’Firstly let us define our subject: A bond is a loan made to a government or company – this article concentrates on corporate bonds. The bonds are usually listed on a Recognised Investment Exchange, and some also trade on that exchange.

Let us start at the beginning….. In 2003 the European Union created the Prospectus Directive (‘PD’) which provided the basis regulatory template for issuing listed debt – bonds – in Europe.As you might imagine it is a monstrous document, however a few points will serve our purpose in this editorial:


  1. 1. Any issue in excess of €5,000,000 requires a full prospectus
  2. 2. There are several ways to avoid using a full prospectus, the most often used route is to use denominations of €100,000.Issues using the €100,000 denomination exemption are often referred to as ‘institutional’.

Therefore, to create an issue that is targeted at retail investors, issuers have to create a full prospectus, given the legal support required to do this, and the paying agents and trustees needed to support the issue, the likely cost is > £200,000.

In addition there are two very basic requirements: 

The Issuer must be a PLC, and

The issuer must have 2-years audited accounts; alternatively, if the Issuer is a newly established holding company then an operating company beneath it needs to have the required accounts and is designated ‘the guarantor’.

With the advent of historically low interest rates after the financial crisis, the London Stock Exchange seeing the success its wholly owned subsidiary, the Borsa Italiana, was having listing retail bonds decided to create its own platform, the Order Book for Retail Bonds (“ORB”), a segment of their main market.Since then ORB has raised close to £5bn for firms as diverse and National Grid and Alpha Plus Schools: 

ORB was designed to be an open and transparent market for trading in retail-size.

Dedicated market makers are committed to quoting two-way prices throughout the trading day and all other registered member participants are also able to enter orders onto the book.

Private investors are able to see prices on-screen and trade bonds in a similar way as they currently trade shares

To further support the market the LSE created a second segment, the Order Book for Fixed Income Securities (‘OFIS’) in 2014, this has the same features and benefits as ORB, but was aimed at issues that might be seen as more complex.

The following is simply a guide to what any investor might wish to look for when considering investing in a bond:

1. Listing

All stock exchanges aren’t born equal, not only is the LSE ‘the’ stock exchange in the UK it is one of the world most known and respected listing venues. From an investors perspective bonds listed there will have tight bid-offer spreads, and be well supported by marketmakers, meaning that should you wish to sell, in retail size, then you can and at the price shown by your broker. This is not always true of other listings

2. Prospectus

The PD is the ‘gold standard’, it requires the issuer to be provide both clear and exhaustive information about their business and audited accounts, often referred to as disclosure. This is vitally important, the more you know about a business the more you will be able to understand the risks

3. Covenants

A covenant is a promise that certain activities will or will not be carried out, for example stating the limits at which the borrower can further lend or other such stipulations. Covenants are put in place by lenders (you) to protect themselves from borrowers defaulting on their obligations due to financial actions detrimental to themselves or the business. 

Example of covenants include:

• Insurance on charged assets

• Regular valuations on any security (‘charged assets’) offered by the borrower

• The value of the charged assets compared to the issue size of the bond; how and when this is monitored, and actions required if it falls below the covented level

• Withdrawal and replacement of charged assets

• Negative pledge to ensure that charged assets are not then pledged to someone else• A leverage ratio to ensure the company doesn’t take on too much debt

• Financial Information – to ensure that audited accounts are delivered on time

• EBITDA to ensure there is always sufficient EBITDA cover to meet coupon payments  

REMEMBER: a bond without covenants is no better than lending money to someone you meet in the street. 


Summary:


There are numerous financial instruments marketed as bonds, not all are good, in fact as another famous Bond said in the opening scenes of Goldfinger (please read in Scottish accent) many are ‘shhhocking’.

RBE says look for the following: 

The prospectus: a full PD document, likely to be 120pages+

The listing; LSE is the “gold standard”

Covenants; there must be investor protection as shown in Point 3 (above) 

But there are not always LSE listed bonds available? 

This is very true. There has only been three issues year-to-date, however don’t then buy any old bond that might have an acceptable coupon.

Buying a bond is like buying a dog; ‘not just for Christmas’.We regularly speak with the players in the retail bond market, they would all like to have greater supply of LSE listed issuance; one we know is looking with their clients at listing Preference Shares (colloquially, ‘prefs’) on the main board of the LSE as an alternative

So, a quick few lines on the subject.

Preference shares offer a steady and predictable source of income, some with a higher yield than the corporate bonds quoted on ORB. In addition, preference share dividends are more secure than those on ordinary shares. Overall, they occupy a useful position on the risk–return spectrum. A thought for the future, perhaps?

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