The European Commission published the new Prospectus Regulation (PR), supplanting the Prospectus Directive, in the EU’s Official Journal on 30 June.
The regulation aims to modernise the directive by streamlining its implementation, ensuring that a prospectus is only required when needed, prescribing information that is useful rather than unnecessary, and opening the gates for cross-border funding.
This mostly relates to equity IPOs, but it also covers issuing listed bonds with the aim to ease retail investor access. This new approach seeks to reverse the direction of existing EU law, which had severely constrained the UK retail bond market.
Pimfa, and before it the WMA, has long argued for this reversal and invested considerable time and energy in explaining why to relevant UK and EU authorities, including Treasury, FCA, EC, European Parliamentary Representatives (MEPs), and governments. There was rejoicing when the case was won.
Essentially, Article 13 of the PR allows non-equity securities (principally bonds) to be issued for trading on a regulated market provided this trading is limited to qualified investors (QIs). This does not sound like much, but it allows the issue to be made under wholesale arrangements, a prospectus-lite format in which the issuer and lead manager can be exempt the expensive, lengthy and burdensome full retail prospectus requirements because wholesale investors and buyers know what they are doing and don’t require the full retail detail. This QI category includes discretionary investment managers (DIMs) acting under mandates for retail clients.
In addition, the Article also allows the bond denomination to be in any size. Under Article 13 QI provisions, this means that if issuers choose smaller amounts – denominations of say £1,000 or £2,000 – and offer, the bonds would be small enough to be flexible in trading and selling on at retail level. This will allow DIMs to invest in corporate bonds for their clients, while still meeting the regulatory suitability tests for the retail market.
Until now, the law permitted exempt bond issuance for denominations of €100,000 or more, too unwieldy for the private investor, with no permitted QI route to allow for variation in bond size. All bonds under €100,000, including those intended for institutional investors, required a retail prospectus – long, detailed, expensive, and unpopular with both issuers and lead managers – which meant that almost no small denomination bonds were produced. The high denomination exempt issues were always well subscribed, so there was no need to seek additional liquidity from retail.
The impact of the €100,000 limit was to skew the corporate bond market heavily in favour of the institutional investor, squeezing out any meaningful retail engagement. This exclusion of retail investors from high quality, vanilla, corporate bonds forced them into bond funds and mini-bonds not covered by compensation schemes.
So a perverse consequence of past prospectus regulation had been to force retail investors into asset classes that the regulators themselves would rather they avoided.
Further damage from the rigid €100,000 exemption threshold was to long term savings. At a time when personal pension provision was becoming ever more critical to individuals as the state’s ability to care for them in later life diminished, one of the key types of investment matching long-term product stability and regular payouts to the long-term needs of the elderly – the bond – was denied to them.
As it sought to protect investors, the threshold requirement in fact prevented retail investors from getting into bonds, effectively cutting off a potential solution to one of its key problems – saving and paying for old age. This situation had to be changed.
A significant advantage of the QI route is that it does not entail a retail investor free-for-all. The presence of the DIM now ensures that a qualified professional is mediating an investment decision for the retail investor, adding a layer of investor protection and ensuring that retail access to bonds, boasting diverse offering sizes, remains well managed.
It is the hope of PIMFA that, having at last achieved a situation in which the retail investor can once more participate appropriately in the corporate bond market, this will favour improved returns and sound hedging against equity volatility for retail investments.
John Barrass is deputy chief executive at Pimfa