Last year, there was an increase in the number of UK companies launching retail bonds.
These are bonds that specifically target retail investors and are separate from the far larger corporate bond market dominated by institutional investors.
Retail bonds are becoming a popular way for companies to raise funds. This enthusiasm is matched by investors, who are seeking alternatives to traditional savings products and equities.
However, not all retail bonds are sold with the primary aim of raising capital.
Some are more of a marketing strategy aimed at cementing customer or employee loyalty and the sums raised can be fairly small.
Broadly speaking, two types of bond fall into the category of retail bonds – listed bonds that are traded in lower denominations than the traditional corporate bond market on the London Stock Exchange’s Order book for Retail Bonds and “passion brand” (or mini) retail bonds, which are not listed on the ORB and are not tradeable.
Retail bonds are essentially debt of the issuing company (similar to a loan note) and are generally unsecured.
Private investors are invited to lend to the issuer and their return is by way of a fixed annual return, typically paid once or twice a year.
Yields may be fixed, floating or index-linked and the returns vary according to the type of bond.
Listed retail bonds pay cash interest to bondholders while unlisted bonds may pay out in a range of “currencies” such as store vouchers, products or customer discounts.
Size of the market
The ORB was launched in February 2010 and the UK-listed retail bond market has since grown from £100m to more than £2bn as of November 2012. Some 170 bonds were listed on 30 November, including those issued by National Grid, Severn Trent and Tesco Bank Personal Finance.
The unlisted bond market is much smaller and includes brands such as John Lewis, King of Shaves, Ecotricity and Hotel Chocolat.
Advantages for companies
The first advantage is flexibility. Subject to certain legal requirements, companies have free rein in defining the key terms of their retail bonds, including repayment date, amount of interest paid and perhaps whether the interest is paid in cash or by way of other “currencies”.
Second, retail bonds open up new sources of capital and are an alternative funding option to bank loans and private equity financing, which may be unavailable or too expensive for small start-ups and some other businesses.
Third, the intention may be to target existing customers or employees of the business and the bond may be an opportunity to increase the company’s profile and interaction with them and to engender brand loyalty.
Last, bond issuers may
not incur all of the costs and delays associated with other capital-raising options, such as equity issues and traditional bank lending.
Listed retail bonds
These are essentially retail-size corporate bonds – that is, an instrument that promises to pay a given rate of interest or a coupon.
They are listed and can be bought and sold in the secondary market via trading on the ORB. By virtue of their small denominations – for example, £1,000 – listed retail bonds are targeted at individual rather than institutional investors.
In order for them to be traded on the ORB, they must comply with the LSE Admission and Disclosure Standards and must be admitted to the official list by the UK Listing Authority. They must also:
- Be supported by a committed market-maker willing to provide electronic two-way prices throughout the trading day
- Be tradeable in units of no larger than £10,000l Comply with minimum disclosure requirements for the retail regime under the Prospectus Directive, meaning that a prospectus will have to be drafted and approved before the bonds are offered or listed
- Be set up for settlement in Crest.
Unlisted retail bonds
These follow a fundamentally similar concept in that investors buy company debt in exchange for regular interest payments and the bonds must generally be issued by a public company.
However, there are differences. Most importantly, unlisted retail bonds cannot be traded on the capital markets and are not transferable. As there is no secondary market, the amount invested can only be redeemed at maturity (unlike with listed bonds, which can be sold in the secondary market). Companies have typically chosen maturity periods of three to five years.
The amounts raised by unlisted bonds tend to be smaller than those raised by listed bonds. With the excep-tion of the John Lewis bond, every UK unlisted bond issued has raised less than £25m.
In some instances, non-cash returns are paid in lieu of cash interest. For instance, Hotel Chocolat offers a return in chocolate boxes while fast-food restaurant chain Leon offers its bondholders restaurant vouchers.
These “mini-bonds” can represent as much of a profile-raising opportunity as a funding exercise and are typically targeted at raising funds directly from loyal customers or employees who may be particularly drawn to these exotic coupons.
Interest rates and risks
The rate of interest offered by companies issuing retail bonds is higher than rates commonly found at UK high-street banks (typically between 5 per cent and 7.5 per cent).
The attractiveness of this return may diminish over time and the rates reflect the higher risk represented by retail bonds over cash deposits.
In the case of listed retail bonds, which can be traded through the ORB and whose price will vary over time, the price is likely to decrease if, for example, deposit interest rates increase (because the interest rate on the retail bond will be less attractive by comparison). There is a risk that investors would not be able to sell the retail bonds for the same price at which they bought them.
For unlisted retail bonds, the investor may not transfer the bonds and must hold them until maturity. This means they will be unable to switch their investment to other products that may have a higher rate of interest in the meantime.
Retail bonds are not covered by the Financial Services Compensation Scheme, which means an investor’s return is dependent on the bond-issuing company remaining solvent. Therefore it is important that investors are able to make an informed assessment of the default risk of the relevant issuer.
In the case of listed retail bonds, prospectus and ongoing disclosure require-ments mean investors have a similar amount of information available to them as available to issuers of listed shares.
For unlisted retail bonds, although there is no approved prospectus, the documentation inviting investors to purchase the bonds will contain information on the company at the time of issue.
To comply with the financial promotion rules, this information should not be unfair, unclear or misleading.
Michael Cavers and Jason Harding are partners in the financial services group at CMS London