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Unlocking SME Finance Through Market-Based Debt: Securitisation, Private Placements and Bonds

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Unlocking SME Finance Through Market-Based Debt: Securitisation, Private Placements and Bonds OECD Journal: Financial Market Trends Volume 2014/2 © OECD 2015 Unlocking SME finance through market-based debt: Securitisation, private placements and bonds by Iota Kaousar Nassr and Gert Wehinger* Small and medium-sized enterprises (SMEs) are key contributors to economic growth and job creation. The current economic and financial crisis has reduced bank lending and has affected SMEs in particular. Capital markets will have to play a bigger role in financing SMEs in order to make them more resilient to financial shocks. This article reviews the spectrum of alternative market-based debt instruments for SME financing. It focuses on securitisation and covered bonds and also addresses issues regarding small/mid-cap bonds and private placements. It reviews the current state of the market for these instruments and identifies associated risks; analyses the barriers for issuers and investors alike; and provides best practices and high level recommendations to help alleviate barriers without hampering the overall stability of the system. JEL classification: G1, G2, G23, G28 Keywords: SME finance, SME securitisation, non-bank finance, (high-quality) securitisation, asset-backed securities (ABS), SME CLO (collateralised loan obligation), (covered) bonds, private placements, financial regulation, European DataWarehouse, Prime Collateralised Securities (PCS) initiative * Iota Kaousar Nassr is Economist and Gert Wehinger is Senior Economist in the OECD Directorate of Financial and Enterprise Affairs. This report was presented and discussed at the October 2014 meetings of the OECD Committee for Financial Markets (CMF) and the OECD Working Party on SMEs and Entrepreneurship (WPSMEE) and benefitted from comments by delegates and OECD Secretariat staff. It also profited from discussions held with private sector participants at an OECD Financial Roundtable hosted by the CMF in April 2014 (Nassr and Wehinger, 2014). This work contributes to the report on “New approaches to SME and entrepreneurship finance: broadening the range of instruments” which is part of the OECD-wide “New Approaches to Economic Challenges” (NAEC) project. The authors are grateful for comments received but are solely responsible for any remaining errors. The cut-off date for regulatory changes and information was end-December 2014. This work is published on the responsibility of the Secretary-General of the OECD. The opinions expressed and arguments employed herein do not necessarily reflect the official views of OECD member countries. This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area. 89 UNLOCKING SME FINANCE THROUGH MARKET-BASED DEBT: SECURITISATION, PRIVATE PLACEMENTS AND BONDS I. Background, overview and policy implications In the years since the crisis, the credit transmission channel in a number of jurisdictions has been impaired as regards quantity, price and distribution of credit. The effects of such malfunctioning are particularly felt by small and medium-sized enterprises (SMEs), especially in Europe. Being heavily reliant on traditional bank lending, SMEs are faced with important financing constraints in an environment characterised by widespread bank deleveraging. As credit sources tend to dry up more rapidly for small firms than for large companies during economic downturns, broadening the range of non-bank debt financing instruments for SMEs should help to make them more resilient to financial shocks. Given SMEs’ importance in all economies, this is also essential for economic recovery from the current economic and financial crisis. Non-bank market-based financing can improve the flow of credit to SMEs, while enhancing diversity and widening participation in the financial system. This study reviews the spectrum of alternative non-debt market-based instruments for SME financing, focusing in particular on securitisation (off-balance sheet) and covered bonds, but also addressing issues regarding small-/mid-cap bonds and private placements. These financing instruments could complement bank lending, help repair the credit channel and ease SMEs’ financing constraints, while also facilitating a better distribution of risk amongst market participants. The study builds on various sources spanning academic literature, market research and discussions with practitioners in private institutions active in SME debt markets. It reviews the current state of the market for these instruments and identifies associated risks; analyses the barriers for issuers and investors alike; and provides policy conclusions to help alleviate such barriers without hampering the overall stability of the system. Section II reviews securitisation as a financing instrument in general and identifies structures and techniques relevant for SMEs. It also provides an overview of SME covered bonds as an alternative to securitisation, illustrating its characteristics and similarities to securitisation and its relevance for SMEs. The double recourse offered by covered bonds and the consequent preferential treatment from a legal and regulatory standpoint is the main difference between securitised SME loans and SME covered bonds. Recourse to the originator bank improves liquidity for the instrument, but the regulatory treatment seems to be the main reason for the popularity of covered bonds. Despite its attractiveness as a financing instrument, covered bonds cannot be the sole form of capital market finance for SMEs, not least due to asset encumbrance considerations. Section III discusses the benefits of SME securitisation to all stakeholders, with a particular focus on its impact on SMEs themselves. The recent financial crisis has strongly impacted securitisation and covered bond markets as showcased in Section IV that gives an overview of the past and current developments, and an asymmetric rebound of the respective markets in the US compared to Europe and Japan can be observed. Section V illustrates the impact of ongoing regulatory reforms on the revival of the securitisation market. It presents different approaches to high-quality securitisation and 90 OECD JOURNAL: FINANCIAL MARKET TRENDS – VOLUME 2014/2 © OECD 2015 UNLOCKING SME FINANCE THROUGH MARKET-BASED DEBT: SECURITISATION, PRIVATE PLACEMENTS AND BONDS analyses the existence of an unlevel playing field for the instruments reviewed, making the case for a co-ordinated regulatory approach at all levels. The revival of a healthy, safe and high quality securitisation market could be a way to generate additional capital market funding for SMEs, while providing banks with capital relief that allows for the unlocking of resources and further on-lending to the real economy. Securitisation can act as a credit risk transfer mechanism potentially resulting in a deeper and sounder financial system. While regulatory reforms are required to improve financial stability and avoid pitfalls of the recent past, some of these reforms may also unduly dis-incentivise originators and investors and thus potentially inhibit the revival of a healthy securitisation market. Complex and sometimes conceptually contradictory regulation may have unintended consequences that should be considered when designing new rules. Clarity over ongoing regulatory work streams is also important for originators and investors, especially institutional investors, to fully engage in these markets that could benefit from their search for yield in the current low interest rate environment. A sensible calibration of ongoing regulatory workstreams (e.g. liquidity ratios of Basel III, capital charges in Solvency II, retention rate requirements) can be important for the revitalisation of the securitisation market. As illustrated in Section VI, post-crisis public intervention has played a significant role in the securitisation market, particularly in Europe, where the eligibility of asset-backed securities (ABS) as collateral for monetary operations has been driving a large part of the market, but has not led to a revival of private market-based SME securitisation. Although such intervention is undoubtedly considered as important for banks’ funding, it has not fostered further on-lending to the economy. Such effects and other potential unintended consequences of public intervention (particularly when such intervention does not foster further on-lending to the economy if it provides no capital relief to benefiting banks) should be taken into account in relevant policy making. Section VII discusses non-regulatory impediments to the revival of securitisation. Various challenges in disintermediation of SME finance exist, especially the lack of sufficient economic viability of SME securitised products (mismatch of yield required by investors and return on the underlying asset for the issuer). This, in part, reflects problems regarding transparency of information, data availability and standardisation. While capital markets can complement the role of bank lending, the challenges of SME financing (especially due to the heterogeneity of SMEs – which at the same time is an important source of attractiveness to private investors – and typically scant credit information) do not allow for a complete disintermediation of banks when it comes to the origination of SME loans, given the fixed-cost nature of sourcing and monitoring rather small and mostly local firms. The limited economic viability of SME CLOs (collateralised loan obligations)
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