Rory Renshaw, a partner at Simmons and Simmons LLP, was one of the speakers at the FinanceMalta annual conference. He shared some insights into capital markets through the lens of the local scenario.
Domestic capital markets tend to have very specific features, which can overcome the disadvantages that you might associate with a small jurisdiction, Rory Renshaw believes.
For example, in a domestic market, he explained, people tend to invest in names they're familiar with.
“It makes a difference to be able to point to the buildings or other assets or revenues backing a bond issue. Name recognition is important. In many ways that is a sensible basis for investment, more similar to the way that our grandparent’s generation invested in the stock market – assessing the utility of the product,” he said.
There are also opportunities for issuers who wish to raise fairly small amounts of finance – which would not be economically feasible to do on the international market.
“When you are dealing with small amounts of financing, say €20-50 million for a fixed 5-year term, domestic markets can be the most efficient way to raise capital,” he said, stressing that the whole point of going to market is often because it is a cost-effective way to raise finance.
Indeed, the aspects that are often raised as being a drawback of a small jurisdiction, from the lack of liquidity to the absence of credit ratings, have to be balanced against the costs and other implications associated with markets that have such features.
And these factors have an impact not only on the issuer that chooses where to list its bonds, but also where institutional investors look to buy them.
“Big institutional investors would be looking at much higher amounts, sometimes of around €350 million plus. There is not a ready supply of Maltese domestic issuers looking to raise that amount; and there is not the depth of investor base to regularly absorb that size either. You cannot compare what happens on the Malta Stock Exchange with the institutional corporate bond market, where all trading is over-the-counter (OTC), off-market so to speak.”
He explained that there were various reasons why, in the international markets, bonds trade OTC rather than on stock exchange. Firstly, there are significantly more bonds outstanding than there are shares, so the debt markets are less concentrated than equity markets. Bonds also typically trade in far higher sizes – often in €100 million trades – as compared to equities which may trade in amounts of less than €100,000; and bonds trade far less frequently.
“So, unlike equity markets, there is never a constant two-way market for buyers and sellers whereby minor changes in bid- or offer-prices result in a trade. Instead, liquidity needs to be provided by banks who intermediate trades,” he said.
He explained that in the domestic bond markets, issuers come to market because they get cheaper financing than they would from banks, and even though they might still have to give security, their covenants would not be as tight as what banks would demand.
Rory explained that pricing is important too: “Bonds issues by the larger investment grade issuers may only yield 1.5-2% a year.”
“Many retail investors can get that kind of return on their current accounts, so it's not terribly interesting to them,” he added.
The lack of credit ratings in the small retail bond space is a tough nut for jurisdictions to crack, due to the cost involved when balanced against the ability to get a meaningful rating.
“All of the retail bonds – and there have not been many in our market in the last 10 years – have been sub-investment grade. And if you are only trying to raise is €30 million, it is not worth the time and cost to get a credit rating,” he said.
He also admitted that it was not easy to resolve the lack of a market maker, an issue faced by all domestic stock exchanges.
“How do you force an institution to take the risk? They would need to hold capital against it on their balance sheet, which is expensive, as you're effectively underwriting someone else's debt. That's an expense that someone will need to pay – which means it would push up the cost and investors would not be able to get as much of a return.”
Mr Renshaw also discussed consumer protection, pointing out that sentiment across Europe was changing. By 2006, EU member states had absorbed the Prospectus Directive – now Regulation – into their own national legislation, laying out what information needed to be included when selling securities to retail investors.
However, this was based on the assumption that investors read it and based their investment decisions on it.
“Issuers produced a long document covering every single aspect of their finances and operations – but research showed that retail investors don’t generally read long disclosure!
“Of course, there are exceptions, especially if an issuer is coming to market that they are not familiar with, but mostly retail investors are looking at the yield,” he explained.
As a result, the focus is now not so much on regulation as it is on market intermediation and legislation such as MiFID, which means banks and the brokers are more focussed on assessing how appropriate a relevant investment is for the specific needs of the relevant investor. The logic is that they should be the gatekeepers, while investors should be given a little bit more autonomy in their investments.
“Policymakers have realised we're all living a bit longer and that none of us have saved enough for our pensions, so we need to be encouraged to invest more, not only in equity but also in debt.
“The current thinking is that once retail investors are given a chance to invest they become very sophisticated! And that applies also to bonds, which regulators have always looked at as being a bit of a ‘funny area’ that investors don't really understand. Equities are clearly understood to be investments and cash current accounts are clearly understood to be savings… but bonds sit somewhere in the middle.”
The aim is to get people to invest rather than leave their money in current accounts, which amounts to trillions in Europe.
“Imagine if just 5% of cash could be moved from peoples’ current accounts and put into the bond markets. That would be hundreds of billions of euro…”
This has a positive economic impact too, as apart from getting protection against inflation from some bonds, and setting something aside for their retirement, they are also putting more money into the economy by lending to local corporates.
So much for the carrot; what about the stick? All issuers trading securities are subject to the Market Abuse Regulation in Europe and should be disclosing price-sensitive information on a timely basis, for example, although the threshold differs between shares and bonds.
“With bonds, investors are usually interested in the ability of the issuer to pay their debt on a timely basis when it falls due. An issuer with an equity listing, on the other hand, may have a substantial amount of information – say if they are changing a director – which is not really relevant to debt investors.
What about the future? Mr Renshaw believes that there is untapped potential for Malta when it comes to attracting international corporates – and investors – who do not necessarily have economic links to the island.
Equity issuers tend to consider a jurisdiction’s investor base, but it is different with bonds, which could be listed in any market and not necessarily the issuer’s home jurisdiction.
“They will go where the costs and the ecosystem is better. Bear in mind that a listing is perceived as adding liquidity, and there are specific cases – such as UCITS and insurance funds – which need to invest in listed entities, which is usually through a recognised stock exchange,” Rory said.
“Many issuers, not only in Europe but also in Asia, the Middle East and Africa are targeting investors whose mandates require them to invest in listed securities.”
Another consideration is the country’s stance on withholding tax: the Malta Stock Exchange is one that offers an exemption, meaning that an issuer can avoid paying that tax if listed here. This is an area of potential for Malta, which other jurisdictions have already tapped into, with the advantage of still falling under the Market Abuse Regulation – which some non-EU jurisdictions do not comply with.
“The important thing is to understand what other stock exchanges are doing, what regulations you can offer within the parameters of the EU legislation, what fees they are charging, how easy it is to do business there and how user-friendly the stock exchange and local advisers are,” he said.
“The potential is there.”