£3.7 Trillion Unleashed! Exploring UK Bond Market Reforms and their European Ripple Effect.

“These proposals will allow issuers into the UK to use low denomination sizes in bond transactions without the additional disclosure requirements that many feel are currently required” says Michael Smith, Head of DCM for Winterflood Securities, the UK’s largest market maker².  “And in so doing, they will broaden their entire investor base on a bond issue, as the UK’s substantial retail investor market will become accessible as well as the current wholesale investor base, with positive implications for liquidity and pricing.

“The aim is to address the unintended consequence of the 2005 Prospectus Directive,” says Smith, “which was to exclude retail investors by requiring extra disclosure for bond issues using low denominations.  This caused issuers to use high denominations, only realistically accessible to wholesale investors.”  

“We know from our close ties to retail investors – which these days mostly comprise wealth managers and investment platforms – that there is enormous pent-up demand for investment grade bonds.  We’re seeing this in the Gilt market, where there’s been a massive increase in demand over the last 18 months.  Retail are also now participating in primary Gilt issuance on investment platforms proving that the infrastructure works.  There is no reason they can’t participate in a corporate bond issue.”.  

“To give you an idea of the scale of the retail market, just one of the investment platforms has said that they could fill a sterling benchmark issue of £250m+, for a top tier name.  In reality, you’d need to have the books open for longer than a few hours but even so, that sort of demand expressed in the primary and secondary market can’t keep being ignored.” 

Some History

The regulation known as the ‘Prospectus Directive’(PD), was rolled out in 2005 across the EU, which at that time, included the UK.  At a high-level, the PD required bond issuers using denominations less than €/£100k to adopt more onerous disclosures³, with the aim of protecting retail investors.  The majority of issuers decided to use the more efficient option of €/£100k denominations, thereby excluding retail investors and restricting their own investor base to wholesale institutions, such as insurance companies and pension funds.  

An attempt was made in 2011 to give UK retail investors access to the bond market via the London Stock Exchange’s “ORB” (Order Book for Retail Bonds) market. After a successful start, the additional challenges of documenting low denomination bonds, meant the market did not take-off and issuers reverted back – or stuck with – the ‘disclosure-lite’ wholesale market.

What is the UK situation now?

By 2023, with legacy low denomination bonds maturing and new ones rarely being issued, the stock of sterling regulated (investment grade) bonds with denominations under £2k had dwindled to just 3% of all such bonds in issue (from c70% prior to 2005)⁴.  

Thus, UK retail investors have been unintentionally excluded from the market.  This has been significant.  In being excluded, they have been channelled into alternative, riskier investments – such as equities (mainly), cryptocurrency, bond funds and unrated/unlisted mini-bonds.  At the same time, many issuers now find that the GBP bond market has become dominated by a few large, similar investors and requires a minimum issue size of £250m.   

In the years since 2005, the retail investor market has grown substantially (see intro).  Recently rising interest rates and inflation, combined with a government drive for individuals to provide for their own futures, have driven mounting discontent, leading to action groups such as “iARB” (Investor Access to Regulated Bonds) being set up to agitate for change.

The UK’s Financial Conduct Authority have recognised the poor outcome for consumers.  Following a period of legal stability post Brexit (which formally happened on 31 January 2020), the UK has been seeking to change laws adopted from the EU, where thought to be beneficial.  

“In my opinion”, says Smith, “there’s nothing to stop issuers from choosing low denominations right now.  The prospectus formatting is a bit different but nothing insurmountable.  However, in practice, many issuers are steered away from using low denominations by their legal and banking advisers.  So, reform is required.” 

What is going to change? 

As part of the most significant set of reforms in the UK capital markets in a generation, the FCA published a paper in September 2023⁵, which made two core proposals:

1. To replace the different reporting requirements for high and low denomination bonds with a single reporting standard based on the current higher denomination standard favoured by issuers; and
2. To allow even lighter reporting for regular investment grade issuers who retail-enable their bonds through a reduction in denomination size (to incentivise a move to lower denomination bonds).  

The FCA believes that retail investors will get better outcomes by being able to invest alongside sophisticated institutional bond investors in the same bonds.  Their view is that the presence of more knowledgeable institutional investors in a transaction is beneficial to retail because institutions are better able to apply scrutiny and exert pricing pressure. 

The FCA also notes that there have been a number of developments in retail investor protection, which offer better tools (than the issuer’s prospectus documents) to ensure good consumer outcomes. The FCA published a summary of the feedback to this consultation in December 2023⁶, which was strongly supportive.  Next steps are to construct detailed proposals in 2024, with implementation in early 2025.

From the issuer perspective, this should unlock a significant pool of capital creating an attractive additional source of demand for UK bonds.  

“This is NOT about making retail-only bonds” says Smith.  “This is about re-introducing retail back into the mainstream bond markets alongside wholesale investors.  Retail just want access to the same investment grade bonds that wholesale investors have access to – and there is no reason why they can’t co-exist.”

How should corporates adapt and take advantage?

“Many issuers have a perception of retail investors that is rooted in the past”, says Smith. 

In the years since 2005, technology has created on-line investment platforms, whilst wealth management businesses such as Rathbones, who now have assets under management of c£100bn, have grown.  “These days” says Smith, “retail investors comprise a large number of wealth managers of different sizes and execution only platforms.”  All of these intermediaries are regulated businesses, which protects investors and issuers.  

Wealth managers who manage retail money are like wholesale institutions.  They are sophisticated and can move at scale and speed.  The only reason these investors aren’t in the primary market is because 100k bonds are too large for their clients.  “A material amount can move within the same three-hour time window that an investment grade bond issue takes to complete” notes Smith, “whilst execution only platforms will also be able to act within this timescale, given practice”.

“If it was me”, says Smith, “I would start to ask questions of my advisors and banks because retail inclusion is coming down the line in one form or another.  Once it becomes real, later this year, we think there will be a competitive opportunity for one of the banks to drive this alongside us.”  Smith suggests issuers consider the following:

1. consulting their advisers and lowering denominations prior to the regulation change;
2. updating their EMTN base prospectus to allow for retail friendly denominations of £1k (or less);
3. engaging with the UK retail investor base (by speaking with them, you’ll hear firsthand that their demand is real); and
4. engaging with a retail lead manager that knows the retail investor base and can place, settle and actively make a market in your bonds to act alongside your wholesale lead.

“If you can introduce a huge amount of demand into the primary book and the secondary market by reducing the denomination to £1k or less, why wouldn’t you?  

“Lead Managers are always looking for the genuine additive demand to show their issuing clients.  It’s been there all the time staring us in the face.  Just look at the recent Gilt issues that we have made available on the Hargreaves Lansdown⁷, Interactive Investor and AJ Bell platforms – they received five times more demand than expected.”

A material amount of capital stands to be unlocked from the retail investor market by using low denominations.  Not only is improved liquidity and pricing attractive to issuers, but also a diversified investor base and the ability to issue in smaller and more frequent sizes to mitigate against the impacts that geo-political risks have on funding accessibility and pricing.

Wider implications

When it comes to capital markets, the world does not operate in isolation.  

Despite facing similar regulatory and disclosure barriers, the EU has embraced lower denominations more than the UK.  Perhaps that is why regulatory authorities there have not yet proposed reforms as the UK have done.  However, change is afoot, with bodies such as ‘European Issuers’ – perhaps inspired by the UK – advocating for amendments to the law to enable the inclusion of retail investors and the benefits they would bring⁸. 

In the US, things are different, denominations of $1k are normal and retail participation is more common.  It is not unusual for issuers to engage multiple book-running managers on an issue that specialise in different investors and geographical regions.  A bond issue by Amazon in 2020, involved no less than 20!