Mini-bonds unpicked

di Patrizio Messina

Abstract: The article provides an analysis of the difficulties and risks but also the potential, needs and benefits for SMEs issuing Mini-bonds on the market. This tool represents an alternative to the bank financing, without aiming at replacing it. To give a wider European framework of the Mini-bonds’ market, the article offers a comparison of some of the major European Member States and a focus on the peculiarities of the markets for SMEs trading instruments on the African continent.

Summary: 1. Diversifying the sources of funding and reducing their dependency on bankers: SMEs can kill two birds with one stone. – 2. A functional alternative finance tool. – 3. Countries with widespread practice and availability of mini-bonds. – 4. Alternative economy in developing countries. – 5. Improving the African SME companies.

1. The European Commission launched in December a two month public consultation on the creation of a proportionate regulatory framework for listings carried out by small and medium enterprises (SMEs)[1].

In parallel, several initiatives such as Horizon 2020 and G20 2017[2] aim to create a dynamic environment for SMEs including from a financing perspective. Minibonds are considered a useful tool in each of these programmes due to their ability to boost SMEs’ trading activities and foster platforms dedicated to nonlarge companies[3].

Small and medium enterprises can find it challenging to raise financing. In that sense, so-called mini-bonds are considered a useful tool because of their ability to help attract funding for these non-large companies. These debt financial instruments are directly placed on the market, meaning investors can build a loan agreement directly with the issuer. A mini-bond’s value is typically no more than €50 million, and the product is subscribed by institutional investors (or even retail investors) and not the subject of a solicitation of public investment. Mini-bonds are set to grow in volume as recent market conditions in Europe and in developing countries create new channels for innovative financing for SMEs[4].

The phrase mini-bond is not a proper legal term but rather a journalistic expression to indicate debt financial instruments, principally corporate bonds. Setting aside their technicalities and peculiarities, these products are issued by companies and directly placed on the market, meaning investors can build a loan agreement directly with the issuer. A mini-bond’s value usually exceeds the limit of twice the value of net equity, is subscribed by institutional investors (or even retail investors) and is not the subject of a solicitation of public investment.

Mini-bonds are generally issued for no more than €50 million ($61.2 million approximately) on regulated markets, have an average duration of around three to five years and an annual interest rate of five to seven percent.

2. Recent market conditions in Europe, developing countries and Africa have shown the need to adopt new tools that can open innovative financing channels for SMEs, and help to partially detach them from bank financing[5]. Alternative tools offer a new option in addition to banking finance but don’t entirely replace it: regular loans, infrastructure, services and networking have a relevant role to play which is not worth abandoning[6]. SMEs have faced some difficulties over the year when it comes to accessing capital markets: lack of credit ratings, and costs of verifying SMEs’ creditworthiness and of performing a risk assessment without standardised information. From an SME perspective, it’s worth reminding of internal barriers related to organisational resources and strategies for internationalisation. In addition, the typical structural features of SMEs put them in an unfavorable position compared to their larger counterparts. High default rates in previous years have had an impact on choice of financing and don’t necessarily foster investor interest. Capital markets have typically been structured for medium and large companies, leaving micro and small enterprises out of potential funds. Of course, there are different kinds of alternative finance that could turn out to be useful for SMEs, but debt financing tools, together with well-structured and efficient platforms, are necessary to allow them to carry out funding activities efficiently and grow profitably. Mini-bonds are meant to provide a more fluid process, with fewer and more flexible requirements that allow a more economical issuance on ad hoc markets, and release resources for diversifying investors’ portfolios by granting SMEs’ further lending. Once the mechanism becomes efficient, the entire system becomes a virtuous circle, reduces the risk associated with this kind of investment, and widens the range of potential interested investors.

3. Since SMEs represent over 99% of EU businesses[7], a considerable number of member states have specialised retail bond markets. These have been organised in order to arrange a wider access to the market for these companies[8].

In 2005, an unregulated market was born, the Nordic ABM, dedicated to the listing and exchange of bonds and commercial papers up to 12 months. The list is divided into two segments: one open only to institutional investors and the other one for retail investors.

The London Stock Exchange’s order book for retail bonds (ORB) is a platform opened for mini-bond emissions in 2010[9]. The price list is open to retail investors. According to the same list managers, due to the current requirements, the market is not efficient for issuers who are willing to raise less than £ 20 million (around $ 28 million). The UK also allows mini-bonds to be issued on specialised crowdfunding platforms.

Italy is also a stimulating environment for mini-bonds. It approved a regulation for mini-bonds in 2012[10] and hosted 300 issues on the ExtraMOT Pro market for a total value of more than €14 billion[11]. It’s worth noting that emissions under €50 million in the last quarter of 2017 increased strongly, both in value and volume, establishing a record for the last three years. This means that mini-bonds are actually functioning as proper tool for SMEs and have so far had minor issues.

France has had three financial markets dedicated to SME bond issuances since 2012, all for institutional and retail investors: the B and C segments of the regulated Euronext market, and the multilateral trading system Alternext. The minimum amount of a mini-bond is €100 and the duration must be between five and 10 years.

Retail investors can subscribe to securities through banks and brokers, and are entitled to certain tax advantages. Notwithstanding the well-structured SME market, only 10% of French issuers had a market capitalisation below € 1 billion; in other words, bank loans are still considered the main financing source.

In Spain, the mini-bond experience is quite recent: in 2013 an unregulated debt securities market (Mercado Alternativo de Renta Fija or MARF) opened for SMEs[12]. It is managed by the Bolsa y Mercados Españoles, and both financial bills and bonds are listed. The latter are intended for professional investors only (the minimum denomination is €100,000). All companies listed on this market have a rating, as required under Spanish law. The boundaries set by the law are certainly intense; this can be considered the main cause for its reduced dimension. As of today, no defaults have taken place.

Every German financial centre has had its own list of SME debt securities (Mittlestand-Anleihen Bonds) since 2010. It is probably the only European country where the experience of mini-bonds cannot be considered successful so far with 128 transactions in 2016 and various insolvencies recorded in recent years following these issuances.

4.  In the past few years, developing countries have focused on increasing the level of employment, innovation and economic growth. SME capital markets play a fundamental role that can be fulfilled only if the relationship between banks and companies does not impact the efficiency of lending and investing mechanisms. Because of the economic recession of the last 10 years, SMEs have been looking for alternative funding tools that can allow them to resort to lending even in periods of financial distress[13]. Therefore, in light of the above, different growth segments and multilateral trading facilities within the regulated market, but dedicated only to SMEs, have emerged. Equity platforms for smaller issuers typically have less strict listing and disclosure requirements as well as more contained costs.

Moreover, the 2015 G20 Action Plan on SME Financing confirmed that the particular regulatory and jurisdictional setting of a country is a important prerequisite requirement: the goal, indeed, is to think of new regulations and dedicated measures to allow an easier access of SMEs to funding[14].

China, in these terms, can be considered an important standard: its Banking Regulatory Commission outlined that, at the end of 2016, the total balance of SME loans by Chinese banks reached RMB26.7 trillion ($4.2 trillion). The edge of transferring at least part of these sums is wide[15].

5. The current unique African continent requires a dedicated analysis.Indeed, the majority of platforms for alternative investments is located in South Africa[16]. The number of SMEs in the country is high but the number of micro-enterprises cannot be underestimated either. No specific regulation exists for alternative finance schemes so, on the basis of the one-size-fits-all principle, existing laws have to be applied to all kinds of enterprises operating on the market. Moreover, due to region wide governmental instability, smaller companies prefer remaining in the informal sector, thus diminishing their tax and regulatory constraints. Despite their reduced chances of accessing many different funding resources and of expanding, this approach has been the norm for so many years that companies operating in the agricultural, infrastructure, manufacturing and technological sectors would be encouraged to be placed and trade on the formal economy if there were important advantages.

Given the huge amount of micro-enterprises spread around the African states[17], numerous initiatives supporting them have been implemented, leaving the bigger SMEs more exposed to risks, a situation that economists and marlet players have called the missing middle[18]. In other words, a condition where SMEs are too big to benefit from schemes created for smaller enterprises, but at the same time not structured enough to compete with larger companies. Some individual countries have put a significant effort in developing local or inter-state programmes that could strengthen the network of local intermediaries who are well aware of the needs of their clients and of the local peculiarities.

ADVANTAGES AND CHALLENGES OF MINI-BOND ISSUANCES

Mini-bonds, as an alternative funding instrument, are quite generally spread on the markets that have an increasing appeal in countries that have realised the importance of exploiting the advantages of alternative finance at most. These countries have adopted regulatory reforms that often have provided for many (fiscal) advantages for SMEs.

Issuances of mini-bonds usually happen to support investments in research and development, possible acquisitions or the restructuring of a company’s liabilities. They are carried out to ensure a constant cashflow to SMEs which allows them to carry on a policy of growth and enhancement. This circumstance usually goes together with the risk related to liquidity and credit[19]; specifically, risks faced by SMEs are more critical to deal with primarily due to lack of adequate information. Thus, assessment of credit risk must be as accurate as possible and the real challenge is to provide data that can somehow complete the picture. In this context, the costs of placing a mini-bond are a crucial element in the assessment of feasibility. The principal costs, although tax deductible for the majority, concern the certification of the financial statements and the hiring of a financial advisor for an issuing and a possible listing on the stock exchange. This is the reason why at the very beginning of the opening of a new market, mini-bonds may face some challenges in spreading[20]. Indeed, these instruments can end up being more expensive than bank loans, due to higher rates and issuance costs. In the future, however, the appeal of an alternative financing process usually leads to a continuous decrease of interest rates.

Although it remains to be seen how strong and successful minibond issuances (and markets for trading SME tools) will be, setting up dedicated platforms has to be considered an important first step for a more affordable and flexible alternative financing for borrowers.

Patrizio Messina is Fellow of The Dickson Poon School of Law at King’s College, London.

[1] Public Consultation – Feedback Statement building a proportionate regulatory environment to support SME listing: https://ec.europa.eu/info/sites/info/files/2017-barriers-listing-smes-feedback-statement_en.pdf.  Public consultation on the review of the SME definition: https://ec.europa.eu/info/consultations/public-consultation-review-sme-definition_en#contributions.

[2] For more information please read https://ec.europa.eu/programmes/horizon2020/sites/horizon2020/files/H2020_IT_KI0213413ITN.pdf.

[3] Caratozzolo, R., 2015, Caratteri ed obiettivi dei recenti interventi regolatori sulle PMI: i mini bond tra disciplina civilistica e regole di mercato, Rivista Trimestrale di Diritto dell’Economia, 58. SMEs, Entrepreneurship, and Innovation. OECD 2010. https://www.oecd.org/mena/competitiveness/44936057.pdf. Carter, S. & Jones-Evans, D., 2006, Enterprise and Small Business: Principles, Practice and Policy. Pearson Education.

[4] OECD, 2006, The SME Financing Gap: Theory and Evidence vol. 1, s. 15, OECD.

[5] The excessive dependence of companies on bank financing satisfied, among other things, short- or medium-term needs, rather than at long-term objectives. It has been the subject of studies carried out by national and international institutions. Visco, I. 2012, Considerazioni finali, Assemblea Ordinaria dei Partecipanti; Gupta, J. & Gregoriou, A., Impact of Market-Based Finance on SMEs Failure, http://iranarze.ir/wp-content/uploads/2018/01/E5409-IranArze.pdf. Centro Studi Confindustria, 2012, Sulla ripresa la cappa dell’incertezza e della sfiducia: Nuova finanza alle imprese per superare la scarsità di credito, Scenari Economici, No. 16, 19. Beck T. & Demirgüç-Kunt, A., 2006, Small and Medium-Size Enterprises: Access to Finance as a Growth Constraint, in ‘Journal of Banking & Finance’, 30, pp. 2931, 2943.

[6] Forestieri, G., I nuovi canali di finanziamento delle imprese. Mini bond, cartolarizzazioni, capitale di rischio, Loan Securitization and Mini-Bonds, New Channels for Smes Financing, http://www.bancaria.it/assets/PDF/2014-06.pdf. European Commission, European SMEs Under Pressure: Annual Report on EU Small and Medium-Sized Enterprises, EU Publications, (2009).

[7] Analytical report supporting the main report from the Commission Expert Group on Corporate Bonds November 2017: https://ec.europa.eu/transparency/regexpert/index.cfm?do=groupDetail.groupDetailDoc&id=35768&no=1

[8] European Commission, Annual Report on European SMEs 2016-2017: Focus on self-employment, 5, EU Publications, (2017). Entrepreneurship at a Glance 2017. The publication is produced by the OECD-Eurostat Entrepreneurship Indicators Programme based on official statistics. The 2017 edition features a new trends chapter, which also introduces recent developments related to the emergence of the “gig economy” and the use of digital tools by micro-enterprises: https://www.oecd-ilibrary.org/docserver/4adb3322-en.pdf?expires=1575389751&id=id&accname=guest&checksum=1BAB9AAD00BFD0C69617DC0F7F445A8F

[9] Trading bonds on London Stock Exchange A guide for private investors: https://www.londonstockexchange.com/traders-and-brokers/security-types/retail-bonds/private-investor-guide.pdf.

[10] Regolamento del Mercato ExtraMOT del 13 marzo 2017: https://www.borsaitaliana.it/borsaitaliana/regolamenti/extramot/reg20170313conev.pdf.

[11] ExtraMOT PRO – il mercato per le corporate italiane: https://www.borsaitaliana.it/obbligazioni/segmento-professionale/extramot-pro/checosaeextramotpro/checosaeextramotpro.htm

[12] Circular 9/2013, of 18 December, on Alternative Fixed Income Market fees: http://www.bmerf.es/docs/ing/normativa/circulares/2013/Circular%209-2013.pdf.

[13] Carbó-Valverde S., Rodríguez-Fernández F. & Udell G. F., 2016, Trade Credit, the Financial Crisis, and SME Access to Finance, in ‘Journal of Money, Credit and Banking’, 48, pp. 113 and 143.

[14] G20 Action Plan on SME Financing IMPLEMENTATION FRAMEWORK: Credit Infrastructure Country Self-Assessment, 2016: https://www.gpfi.org/sites/gpfi/files/documents/G20%20Action%20Plan%20on%20SME%20Financing%20Implementation%20Framework.pdf.

[15] For more information please read: https://www.reuters.com/article/us-china-economy-loans/china-banks-extend-record-12-65-trillion-yuan-in-loans-in-2016-as-debt-worries-mount-idUSKBN14W161.

[16] SMEs, Entrepreneurship, and Innovation. OECD 2010: https://www.oecd.org/mena/competitiveness/44936057.pdf.

[17] Giuliana Licini, “Africa nuocva frontiera di business, l’Italia è il terzo investitore”, articolo de Il Sole 24 Ore: https://www.ilsole24ore.com/art/africa-nuova-frontiera-business-italia-e-terzo-investitore-AE3cJnjB

[18] For more information please read: https://www.uniafrica.org/nuovi-finanziamenti-e-progetti-per-le-pmi-africane/.

[19] De Haan, L. & van den End, J. W., 2013, Banks’ Responses to Funding Liquidity Shocks: Lending Adjustment, Liquidity Hoarding and Fire Sales, in ‘Journal of International Financial Markets, Institutions and Money’, 26, pp. 152, 174.

[20] Forestieri, G., I nuovi canali di finanziamento delle imprese. Mini bond, cartolarizzazioni, capitale di rischio, Loan Securitization and Mini-Bonds, New Channels for Smes Financing, http://www.bancaria.it/assets/PDF/2014-06.pdf. European Commission, European SMEs Under Pressure: Annual Report on EU Small and Medium-Sized Enterprises, EU Publications, (2009).