An underdeveloped bond market is a threat to business growth
November 18, 2009
In an opinion piece published on Newsmill on 18 November and in aninterview in Svenska Dagbladet the same day, Daniel Sachs, CEO of Proventus, and Erik Thedéen, President of NASDAQ OMX Stockholm, argue that in the years ahead, we can expect an enormous demand for capital to develop and change businesses.
Translation of the article published on Newsmill, 18 November 2009:
Companies in need of growth capital today basically have to choose between equity in the form of new share issues or bank financing. The performance of the stock market in recent years shows the problem with relying totally on equity. Bank financing, on the other hand, is complicated by the extensive (and continued) losses in the banking system. Historical problems, greater risk aversion and new regulations are likely to limit bank lending to businesses for some time. The crisis in the financial market is reason enough for the market’s players to work together to develop a third way: debt financing directly from investors – both institutions and individual investors – through corporate bonds.
Today the Swedish corporate bond market is small and undeveloped. Liquidity is limited and transparency is weak. If we exclude instruments issued by banks, mortgage institutions, municipalities and real estate companies, there are only around 100 “pure” corporate bonds listed on the Stockholm Stock Exchange with an aggregate market value of about SEK 46 billion, compared with about SEK 3,150 billion for the stock market. “Swedish” corporate bonds are also listed on other exchanges, but the picture is still the same: the market for corporate bonds for Swedish companies is too small.
The bond market is also illiquid. A clear example of this is that the spread (the difference between bid and sell rates) from time to time can be as high as one full percentage point. (On treasuries the spread is 2-3 hundredths of a per cent!) Historically, trading by banks with their own portfolios has served as a guarantee for the market’s liquidity, but after the Lehman Brothers collapse last fall and the widespread uncertainty that arose in the system in its wake the banks have at times stopped trading bonds. For small investors, it is difficult to invest in corporate bonds, which means that companies are missing out on an attractive investor group. Even large investors sometimes have difficulty today finding a counterparty when they want to trade.
Just as important a problem is that the market is far from transparent, which naturally is also one of the reasons for the poor liquidity. At present there is no way to determine the volume of corporate bonds traded or at what prices, since trading on the institutional market is mostly handled by phone.
Increased standardisation of bond terms and conditions(through self-regulation) would also increase transparency in and accessibility for these sometimes complex instruments. Another area for improvement is corporate governance. In coming years many bond investors are likely to find themselves in situations where they should have had greater influence in connection with restructurings, voluntary exchange offers, refinancings or insolvencies. Today knowledge is limited and the structures are not sophisticated enough to handle such situations. There is also a lack of active investors to protect the interests of bond investors when changes arise, which in many cases leaves bond investors stuck between banks and shareholders.
We feel that we must have a dialogue on what the secondhand market should do to strengthen transparency and liquidity. The positive effects of a more developed market for corporate bonds are obvious. For issuers, it would mean increased demand and that investors would require a lower risk premium, which would lead to less expensive funding. For investors, it would mean lower transaction costs. The market therefore has the potential for increased volumes, which in turn would further professionalise the market and create a stronger basis for analysis and advice.
We believe that a number of measures are required to create a broader market for corporate bonds with more issuers and more investors. Right now we are experiencing something of a Catch-22: poor liquidity leads to poor transparency, which in turn discourages new players from entering the market. The vicious cycle must be broken, but it requires an open dialogue between the various parties active on the market and the appropriate authorities.
An improved corporate bond market could be created at little cost, but requires coordinated efforts by those who today are – or would like to be – active on the market. As a result, we are now inviting representatives of issuers, investors, banks, other market players and the Financial Supervisory Authority to a discussion on how we can work together to improve a market that is vital to the economy.
Daniel Sachs, CEO of Proventus
Erik Thedéen, President of NASDAQ OMX Stockholm