SPACs and the power of the story

The much-debated question in the market at present is whether SPACs are being misused and overly inflating the potential value of companies that are not ready or even organised to realise such growth? And is this because they have failed to assemble an execution-minded management team and/or because they have not mapped out a robust and creative strategy that builds credibility and trust in the company?

A little more about SPACS

With a SPAC transaction, a private company becomes publicly traded by merging with a listed shell company; the SPAC. SPACs are an alternative to the traditional IPO route and push the business into the public listing space at a faster pace. As a listing route, it is also more cost effective.

Why has the popularity of SPACs increased in recent times? Because you negotiate the pricing with the SPAC before the transaction closes, as opposed to your IPO price depending on market conditions at the time of listing. If the market is volatile, a SPAC provides a lot more certainty surrounding price.

However, as mentioned above, in recent times SPACs have hit the press in a less than desirable way. This is due to investors ‘cashing in’ before a number of public listings, subpar management teams and SPAC founders or sponsors, who are typically given a 20% ‘promote’ of the shell’s company more or less for free – which is for their efforts in finding a target company, not being particularly motivated to find a company because they received the shares for free and will cash in regardless. On a more positive note however, there appears to be a new generation of SPAC vehicles emerging, that each are backed by a more accomplished group of sponsors who are better able to find attractive merger targets.

The positive outcomes

Listings using SPACs have led to many companies realising their growth ambitions and financially being deemed successful over the years. One example is sports betting site DraftKings, which originally merged with a SPAC called Diamond Eagle. Diamond Eagle had already raised USD 400m in its share sale, and then at the same time as announcing the merger with DraftKings, it announced that Fidelity Investments would lead a group of funds buying another USD 380m of new stock. After the merger, and despite spending USD 200m in cash to buy another company, it still had more than USD 500m on its balance sheet and a resulting value of USD 2.7bn.

The not so positive outcome

Media company Buzzfeed went public not so long ago by merging with a SPAC. Its share price immediately spiked by 35% but then closed down 11%. Buzzfeed expected to raise just USD 16 million from its offering, because days before, 94% of the USD 287.5 million raised by the SPAC was pulled by investors. This was reportedly due to investor distrust in the company’s plans.

Enhancing the investor reaction to a public listing before it happens

Should the process of going public using a SPAC, which has been likened to writing a blank cheque, be bolstered – pre-listing – with a strategy that builds credibility and trust in the company, as opposed to it simply being a numbers game? One tactic that SPACs could look to adopt is to develop a brand strategy, which will explore and decide on the brand story, its messaging, the company vision and go-to-market strategy from day 1 through to day 365. A brand strategy also has the ability to bind together the management team, who is then organised to go in one clear direction; the investors, who can buy into the vision, but also understand how it will be executed in the short- and long-term; and the general public, who has the power to make or indeed break a business that is about to be listed or newly listed with speculation on social media, and who is often forgotten during the listing process.

Some may wonder why you would opt to spend precious budget on a brand resource prior to a listing, but the difference it can make is nothing short of transformational. Imagine if someone paints you, as an investor, a vision that addresses societal or environmental issues, or taps into much needed diversity in a saturated market, or simply tells you a story with robust evidence to back it up and in a creative way that appeals to your senses. Then, you will engage much quicker and on a deeper level if you resonated with their story, than if you were given a standard investor deck presentation, and on the front, it featured the words ‘Invest in a company that will sell innovative HealthTech products and disrupt the technology sector around the world’, to give one example.

Not forgetting the hero and the villain; social media

Whilst we are on the topic of branding and all things marketing, it is worth considering the role that social media plays during the SPAC process leading up to a public listing. Social media has the power to not only build a brand and accelerate its growth, but also to hinder the growth of a business through social media speculation. If a message appears in clusters, investors are understandably inclined to start digging for the truth. Even if they cannot find what they need to confirm or disprove the message, it will plant a seed that will impact the share price through investor behaviour.

“Given the speed at which a bad rumour spreads on social media and the still evident bad press surrounding SPACs, any company looking to go public via a SPAC should be willing to ‘join the conversation’ on social media to clarify any concerns about the company and quash the fast-spreading nature of speculation leading up to the listing date.”

Lauren Marks, Brand Strategist, OMNIA Global

To conclude, the takeaway message for us as a business and the one that we want others to be mindful of is that companies going public using a SPAC need to inject strategic creativity to not only help elevate the entire process, but also help bind the management team, the investors and the general public. With a robust brand strategy as described above, there may actually be a reduced risk of social media speculation and people ‘filling the gaps’, but the management team should still be willing to communicate beyond their target investors and to think more long-term, when it comes to communicating the brand to the wider world.

Want to hear more? Please take a moment to listen to our CEO, Daniel Hansen, impart his view on SPACS as part of a succinct round-up of topical issues that entrepreneurs have to be mindful of when growing their businesses and ultimately taking them public. Click here to listen.

Time to be honest about the transition to green energy

Even before the election, Germany had taken huge steps towards the green transition; the so-called “Energiewende” in Germany had started. In 2011, former German Chancellor, Angela Merkel (CDU), announced a phasing out of Germany’s nuclear power plants. And Germany does not lack ambitions; by the end of 2022, the last three of Germany’s nuclear power plants will be shut down, the Germans will reduce their CO2 emissions by 60% before 2030, and they have decided to shut down the last coal-fired power plant by 2038 at the latest. Finally, the new government wants to have 80% renewable electricity by 2030 compared to the target of 65% from the previous government.

Driving through Germany on the Autobahn, one can easily see what is likely to replace nuclear power: wind turbines. As far as the eyes can see across the German landscape, they see wind turbine after wind turbine of a significant size. 

But in a country with a population of 80 million, can wind turbines realistically replace the power from coal and nuclear power plants? Even if we add solar panels to the equation, the data says no. The graph below shows the amount of energy produced by wind turbines and solar panels (blue and brown) in Germany in November 2021, together with the amount of energy consumption (purple). From this example, it is obvious that Germany is far from being able to cover their current energy consumption with wind turbines and solar panels.

How will they keep the lights on in Germany?

Providing the Germans with enough power from wind and solar sources to cover their current energy consumption would require at least a tripling of the current capacity from wind and solar. That might sound like a straightforward solution, but the main issue with wind and solar energy will always be the intermittency of these energy sources, as there will never be a guarantee of the amount of sun and wind that we receive each day. We simply need to be able to generate power from different sources of energy to cover our consumption every minute and to avoid an electricity gap.

And then, we have not even talked about “NIMBY” (Not In My Back Yard) yet. We want to be oh so green as long as it is not interfering with our daily lives – or the view from our backyards. In Germany, a greener government has been elected, but at the same time, the protests against the gigantic wind turbines that keep popping up around the German landscape just get louder and louder. This is due to the noise levels from turbines that disturb people’s sleep and the wings that disturb the views from people’s houses. Many Germans are simply against the Energiewende taking place in their backyards.

Also, let’s not forget that despite the constant focus on going greener, our net consumption of energy has continuously increased:

 

Wind turbines are part of the solution, but just as we need to solve the need for multiple sources of energy, including nuclear power, we also need to consider how and where wind turbines are manufactured, decommissioned and ultimately disposed of. Wind turbines are made, in part, from oil, and solar panels are made using coal. At present, China manufactures a large amount of the world’s supply of solar panels and wind turbines, but in real terms, this means that we have exported our CO2 emissions to a country with cheaper production. When the life of a wind turbine comes to an end, they are buried at so-called ‘wind turbine graveyards’, with no solution on how to get rid of them for good. In particular, the wings, which consist of fibreglass that does not burn, and so are difficult to dispose of.

So, are wind turbines providing a truly a green-to-green solution? No. One possible solution is to focus on reinvigorating and extending the life of existing wind turbines, rather than building them from scratch. This means less, if any, opposition from locals who are accustomed to the view and noise, zero carbon being expended because they are already in place, and additional time to invest in research that solves how to decommission the turbines in the greenest possible way.

Has the pandemic disrupted our working life?

The concept “remote work”, which we have all become so familiar with, is not new – the demand for flexibility in where and how people work has been building for decades. Before the crisis, surveys showed that 80% of employees wanted to work remotely at least some of the time. Over a third would take a pay cut in exchange for the option.

During the pandemic, we all got a taste of what life could be like with a more flexible job that includes days working remotely – and it seems safe to say that the pandemic has accelerated a trend, which much likely would have peeked way later than it will now. According to McKinsey’s report “The future of work after COVID-19” from February 2021, remote work and the use of virtual meetings are likely to increase – although not as intensely as during the pandemic as many people are forced to go back to the office.

“At OMNIA, we have a fully remote workforce – which we have had since we started in 2009. For us it was business as usual when the lockdowns hit. It just made everything easier for us, when everyone else were doing the same – virtual meetings became the norm. It was like an epiphany for people in 2020!”

Daniel Hansen, OMNIA Global Founder & CEO

Global Workplace Analytics (GWA) supports McKinsey’s report saying that those who were working remotely before the pandemic will increase their frequency when they are allowed to return to the office. For those who were new to working remotely when the pandemic hit, there will be a significant upswing in their adoption. GWA’s best estimate is that we will see 25-30% of the workforce working remote on a multiple-days-a-week basis by the end of 2021.

“The pandemic has shown that working remote is possible. We were forced to learn it and many people really liked it. For some, the way they work is now more important than who they work for. This is new!”

Daniel Hansen, OMNIA Global Founder & CEO

So, what could the future of work look like?

There’s no doubt that lockdowns have opened our eyes to how our working lives can be post-pandemic – particularly knowing that post-pandemic, our children will be in day care, kindergarten and school giving us much better working conditions than during lockdowns, where working remotely mainly was a stress test. Time said it bluntly “The pandemic revealed how much we hate our jobs. Now we have a chance to reinvent work.”

With people considering moving due to the ability of working remotely, it could prompt a large change in the geography of work, as individuals and companies shift out of large cities into suburbs and small cities. However, this subject is highly debatable as some argue that the big cities always will attract talent with their energy and amenities.

We will most likely see smaller workspaces as companies shift to flexible workspaces with employees coming to the office 2-3 times a week meaning fewer desks are needed. A survey of 278 executives by McKinsey in August 2020 found that on average, they planned to reduce office space by 30%. Although there are disadvantages of remote working and having virtual meetings rather than meetings face-to-face, the office savings may outweigh the costs from the disadvantages.

Finally, we will most likely experience a decline in business travel, now that we have all become familiar with the extensive use of videoconferencing and virtual meetings making jumping on a plane less necessary. McKinsey estimates that an approximate 20% of business travel will not return.

“What I have missed the most during the pandemic has been the creative part of my job: Travelling and meeting new people and through that getting new ideas. It has been a more effective year because I have had more time to do all the paperwork, but definitely also a more boring year. It’s the journey that should be fun, and honestly, the journey is a bit boring at the moment!”

Daniel Hansen, OMNIA Global Founder & CEO

Then, what about the downsides of remote work?

So, while many of us see the advantages of this transformation, we have to be aware of the disadvantages. According to McKinsey, there is some work that is best done in person – although it is possible to do it virtually. Negotiations, critical business decisions, brainstorming sessions, providing sensitive feedback and onboarding new employees are examples of activities that may lose some effectiveness when done remotely.

If a company chooses to offer their employees to work remotely, while still having people coming to the office every day, there is also a risk of creating a divide between these two groups of employees. Will it be the employees at the office who are more likely to receive promotions? And what about the company culture and social interactions?

“When you run a company with a remote workforce it requires that we meet occasionally to create and maintain a team spirit. There is only so much you can do on Zoom! Because of the pandemic, we have employees who have never met each other. And we have missed celebrating all the good things happening together. We definitely need to give it some extra on the other side”.

Daniel Hansen, OMNIA Global Founder & CEO

Will we seize the moment?

The pandemic has forced us to ask ourselves if our working lives still make sense to us on the other side of the pandemic. How many hours do I want to spend in a giant office from 9-5 – and how many hours do I want to be away from my children? Do I want to live somewhere else if working remotely is an option? And even – do I want to change career? According to Time: “(…) people are not just abandoning jobs but switching professions. This is a radical re-assessment of our careers, a great reset in how we think about work.”

This is an opportunity to bring some more balance into our lives with more flexible jobs whether that is through moving to the countryside to work fully remote or through commuting to the office two days a week.

This moment in time seems like a very good opportunity to re-evaluate how we spend our time and live our lives.

“Our society has gotten a wild and necessary wake-up call. We have realised that we do not have to sit at the same desk every single day. Knowledge-based and creative jobs can be performed anywhere! I really hope for more flexibility – whatever works for the employee should also work for the company. If you do your job well, it should be up to each individual how and where you do it.”

Daniel Hansen, OMNIA Global Founder & CEO

 

Why combining fine art and private equity clashed – our learnings from the OMNIA Bond 1.0

What was the state of the art market when OMNIA entered?

Following the financial crisis, it was obvious that the banks was forced to only finance against liquid assets, primarily stocks and bonds, and the only illiquid asset they took in was real estate. Previously, banks were able to offer their clients liquidity based on luxury assets such as art, classic cars, diamonds and other investment objects, but that service disappeared overnight. After a while, different funds with different legislation and more freedom to decide their own investment strategy and credit risk appeared, and they took over the market for banks within lending against different luxury assets with art being the no. 1 asset to lend against.

What was the market in need of?

Many of the asset owners who borrowed against their assets did it to follow an investment object or project, or simply to get liquidity. But the people I paid most attention to was those who had this valuable piece of art, which they would like to keep, but they would like to borrow against it to invest in a project for a return – in order to turn the intrinsic value of the artwork into a cashflow. Looking at the amount of loans issued, which was around USD 20bn, it was just a tiny percentage of the total value of art, which some believe to be worth 2,500bn, that was being lent against. What we found interesting was to combine the loan and liquidity, and with an investment with cashflow or upside – all in one offering. All in all, the dream was to make it easy for art owners, as we knew the interest for a simple setup for illiquid assets was very high.

Can you explain the setup?

There were three elements to the setup. The first one being the structure around the due diligence of the asset – getting it assessed, insured, authenticated and stored safely. The second element was approaching the market – the securitisation of the investment product meaning placing the asset in an instrument, which the capital market understood. That meant taking an illiquid asset, now with valuation, authentication and insurance, placing it in a bond or note, so that a family office, bank or insurance company could buy the securities, which were secured by the asset. The third element was the deployment of the investment – that is placing the liquidity in private equity investments, which provides a high return of approx. 15%, attractively more than the 6-7% that the capital market was pricing the notes. Thereby, the return matched the risk, which the art owner was taking, with enough cashflow from the investments to make it attractive.

Why did you call the OMNIA Bond 1.0 the perfect product for the capital markets?

Looking at mortgage bonds in Europe and particularly in Scandinavia, house owners are able to mortgage up to 80% of the property value despite real estate being an illiquid product with no cashflow, and the general increase in value is nowhere near that of the art market. Nevertheless, banks consider real estate as one of the safest investment products out there. With a higher annual appreciation in value for art than real estate, and a loan amount limited to 50% of the appraised value, I consider art a safer investment product than real estate. On top of that, we offered the capital market a product where the capital was invested in private equity with an average 15% annual return. To me that makes the perfect product offering for the capital market.

Why was it not what the capital market demanded?

What we learned was that there is a big difference between what the art market should buy and what they were looking to buy. And apparently, the motivation to buy a product is not always in the client’s best interest, but holds a great job risk for those taking the decisions. For example, as no one else offered art bonds, it was impossible to get credit rating on the art bonds, and without official credit rating, each individual asset manager had to decide on the risk and their internal credit rating of the bonds. If things do not turn out as planned, you as the asset manager who set the credit rating have to defend your rating, and then it might be easier to avoid the offering to begin with.

It was possible to get credit rating on the insurance of the bond, but only if the offering was more than USD 500m, which meant that the first offering had to consist of quite a lot of art! Finally, it turned out that it was very difficult for the capital market to understand the combination of art and private equity in our structure, as those involved in private equity and art are very different groups of people. We took two very different asset classes and combined them. The art owners thought it was a great offering, and we thought it was a great offering for the capital market with a high interest, but it did not work, because they simply did not understand it – was it an art product or a private equity product?

What were the main obstacles with the bond?

When you create a private equity fund, you spend two years raising the capital, five years investing the capital and building the companies, and then several years selling the companies – meaning it is a rather time-consuming process. We looked at companies with a high return and growth, which are typically SMEs. But that also meant we had to buy 15-20 companies to match the value of the bonds. Looking back, the entire setup was extremely time-consuming and required a much bigger team than we had for it to be an ongoing business.

What did you learn from the process?

We learned from the bond that issuing bonds or notes and using them as a loan in an investment company that acquires companies and sell them later was way too complicated. What we could do instead was take what we had learned and create a structure with fewer art owners. Now, we match few investments, for example our SPACs, with each client’s or investor’s need and leverage. We see version 2.0 as a cooperation with very few art owners with a common investment strategy in a fund structure, with OMNIA Global Management as general partner, based on the value of the art instead of a bond structure.

Thereby, each art owner gets his or her own mini fund either issuing notes or a credit facility combined with another form of acquisition finance with a planned exit strategy. This means bigger deals with fewer art owners and fewer investments that match the leverage from the art piece, and therefore, we are no longer only looking at SMEs. This is a structure that works way better for us, as the issues we had with the bond has been removed. SPACs and reverse take-overs are well-know, so is using art as collateral for a loan as well as creating a fund in Luxembourg – that makes it way easier to get everyone on board when you are not creating an entirely new product, but just twisting familiar products a bit.

Why are we ahead with version 2.0 today?

We are ahead because we have taken all the beating and the risk over the last five years and learned from that. We did not just talk about it – we went into the market and learned everything about the art market in relation to the capital market. Since we have also been in the investment market for almost 15 years, and are entrepreneurs to the bone, we have a great understanding of how to create partnerships and joint ventures. We have tremendous experience in what to do and what not to do! And that is what happens when you are not afraid of being innovative. The consequence of that, though, was that we had to take the bonds off the market, and invited bond holders to be part of version 2.0.

SPAC is the new black

To those unfamiliar with a SPAC – a Special Purpose Acquisition Company, also known as a blank check company, it is a shell company with no commercial operations, which raises capital from public markets with the aim of later merging with a private company that wants to go public. When the merger is announced, shareholders can either accept stocks in the new company or redeem their shares at the original price of the offering.

In the US, 46% of the USD 103 billion raised in IPOs so far in 2020 went to SPACs.

marker.medium.com

The attractiveness of SPACs

SPACs are appealing to private companies as the listing process is much faster than with a traditional IPO – there is no need for a roadshow with a SPAC, which is typically needed for IPOs; and therefore, companies spend USD 750,000 and 18 months on average preparing for an IPO.

A special purpose acquisition company may serve as a suitable alternative to traditional IPOs when time, capital, or market conditions are more constrained.

gilmartinir.com

Avoiding roadshows and generally speeding up the process is generally appealing for hyped businesses, but is probably particularly appealing during the current pandemic and might be part of the explanation of the noticeable increase in SPACs.

When major players choose SPACs

In the 80s, reverse mergers, of which SPACs are a type of, were very popular. However, in 2011, the SEC (the American Securities and Exchange Commission) issued a fraud warning, urging caution when investing in companies that went public through reverse mergers.

This reputation has obviously had an effect on SPACs as well, but recently we have seen major players explore the opportunities of SPACs, which is very likely to have removed some of the stigma related to SPACs.

Branson is making his first foray into an increasingly popular form of investment vehicle, and one he himself tapped in order to list Virgin Galactic.

Bloomberg.com

Some of the examples are Richard Branson’s VG Acquisition Corp., as the SPAC will be known, which plans to raise USD 400 million by selling 40 million units at USD 10 apiece, DraftKings, whose valuation has surged from about USD 3 billion to more than USD 13 billion after going public through a SPAC in April 2020, as well as Bill Ackman’s Pershing Square Tontine Holdings, which raised USD 4 billion to become the largest SPAC in history.

Time will tell if the entering of major corporations on the SPAC scene will make SPACs mainstream beyond the pandemic.

A golden opportunity for the private jet industry

As Covid started spreading across the globe in early Spring, both the commercial airlines and the private jet industry took a very hard hit. But then something happened with the private jet industry; clients came back in great numbers and noticeably, many first-time clients made bookings.

In May, commercial passenger demand was down 91.3 per cent compared with a year ago. By contrast, private flights dropped 70 per cent year on year in April but were down only 28 per cent in June, (…).

ft.com

PERSONAL TRAVEL BRINGING BACK THE PRIVATE JET INDUSTRY

While busines meeting after business meeting and conference after conference got cancelled, a majority of the private jet bookings were now for leisure travel due to the lack of commercial flights. Furthermore, people with the financial possibility chose private jets to avoid the health risks associated with the crowded commercial flights, as well as the many touch points going through the major airports, which are avoided with private jets as they depart from small, private terminals.

INVESTING IN FLEET AND TALENT

The current economic downturn has created a window of opportunity for the private jet industry. Private jet companies are currently taking advantage of this unprecedented downturn in the aviation industry and the economy in general to acquire new aircrafts at more favourable terms and prices.

“The day after the Fourth of July, when commercial airline travel was down 74 percent year-over-year, private jet flights were up five percent, (…).”

nytimes.com

But private jet companies have not only added aircrafts to their fleet – they have also added more pilots. For long, private aviation has experienced a shortage of pilots, but with major airlines furloughing thousands of pilots due to the pandemic, it has now become possible to attract talent. Thereby, the corona crisis has turned into a golden opportunity for private jet companies in terms of an extended talent pool and available aircrafts.

A TIME TO INVEST IN ELECTRIC ENGINES?

At this point in time, where everything is up in the air, another golden opportunity for the private jet industry is to start investing in electric jet engines to take steps towards carbon-neutral air travel. With electric engines, private jet companies would be able to issue green bonds, which can help finance this transition.

CHANGED HABITS

The question is now whether the aviation industry has changed for good? Both the commercial airlines and the private jet companies have experienced a tremendous fall in business trips due to worldwide travel restrictions, and as we all get more and more used to online business meetings it is easy to imagine that the amount of business trips never will go back to normal.

One company, one brand

Today, we launch an updated version of omniaglobal.com, while at the same time letting go of our subsidiary brands and websites. Instead, we have added the subsidiaries’ business areas to the OMNIA Global umbrella. You will find them all here.

Creative thinking in a conservative market combined with innovative entrepreneurship.

OMNIA is still the same though; an entrepreneurial family office specialising in alternatives, private to public investments with use of innovative finance and leverage within structured finance in order to consistently grow our balance sheet.

The changes are simply strategic in order to simplify our brand and how we communicate with our clients and network.

We still aim for the same goal: To do better – for our clients, our network and employees.

Green bonds

Green bonds have been around since 2007, when the European Investment Bank issued its Climate Awareness Bond, and the World Bank issued its green bond after a phone call from Swedish pension funds looking for climate investments in 2008. Since then, we have seen a noticeable increase in the issuing of green bonds – particularly over the last couple of years and particularly in Europe. In 2019, the wider European market accounted for 45% of global green bond issuance.

Global green bond and green loan issuance reached USD 257.7bn in 2019, marking a new global record.

Climatebonds.net

Green bonds are part of the strengthening of the global green transition, which especially aims to reduce carbon emissions, as well as being an answer to the increasing investor interest for sustainable options with a measurable effect. This investor interest in a social and environmental purpose of their investments reflects a fundamental shift in the bond market.

Using debt capital markets to fund sustainable solutions

A green bond, or climate bond, is a fixed-income instrument designed specifically to fund green, i.e. climate or environmental, projects or investments, such as renewable energy, energy optimisation and other green projects, which contribute to reducing CO2 emissions. The bonds can be issued by both public and private companies.

The majority of green bonds issued has green use of proceeds or are asset-linked bonds. Proceeds from these bonds are set aside for green projects, but they are backed by the issuer’s entire balance sheet. Also, the same credit rating applies to the green bonds as for the issuer’s other bonds.

As requirements for green bonds are different than regular bonds in terms of tracking, monitoring and reporting on use of proceeds, green bonds have some additional transaction costs. However, the Climate Bonds Initiative, a non-profit international organisation, states the following advantages of green bonds: They highlight the issuer’s green assets/business, create a positive marketing story and diversify issuer’s investor base (as the issuer can now attract ESG/RI specialist investors).

The lack of regulations for green bonds

When is a “green bond” truly green? Despite the definition of a green bond above, there is not an official set definition of a green bond or a sustainable investment. As of now, the green bond market is unregulated, however, certification schemes and guidelines, such as the Climate Bonds Standards, the Green Bonds Principles from International Market Capital Association and Bloomberg Barclays MSCI Green Bond Indices are available to issuers and investors, but on a voluntary basis and without explicit definitions.

Since March 2018, the European Commission has been committed to create standards and labels for green financial products. As part of the EU’s 2020 strategy for sustainable finance, the EU will launch a Green Bond Standard, which will set up minimum safeguards that activities have to comply with in order to qualify as environmentally sustainable, however, the Standard will most likely be voluntary and non-legislative.

Bonds that are issued in the green segment of big stock exchanges, such as the London Stock Exchange, need to have a green label, which must be certified by an agency. But again, there is a lack of legislation in terms of third-party rating agencies and green bonds together with the variable definitions of green bonds.

And one thing is the green bond itself – another factor is the issuer; how green is the company issuing the green bond? Currently, it is very difficult to assess and compare the sustainability level of a company. One way of doing it is through a company’s ESG rating (Environmental, Social and Governance) – but as with the bonds, there is an issue with varying approaches to the ESG ratings by the rating agencies. ESG ratings simply lack regulated methodologies.

With no legislation the green capital market is to a large degree based on self-regulation, market demand and investor research. Today, nothing prevents companies from pollution-intensive industries to issue seemingly “green” bonds.

Greenwashing green bonds

With the lack of regulation on the market of green bonds, there is a risk of greenwashing. The increased global focus on the environment and sustainability leads to a tremendous marketing potential in presenting your company as green.

Greenwashing is the process of conveying a false impression or providing misleading information about how a company’s products are more environmentally sound.

Investopedia.com

The temptation of a new green logo might be bigger than the reality of how green one company operates. The same goes for the green bonds due to the increased investor demand for green investments. The contradictory term “clean coal” is one that clearly shows how companies and industries urge to appear green – but it also makes the need for regulation on the market for green bonds stand out.

Purpose matters more than ever

With the noticeable change in investor interest, where the purpose of the investment has become significant, there seems to be endless possibilities for bonds of all the colours of the rainbow. A great place to go from could be the UN’s 17 Sustainable Development Goals, which each focuses on a global goal, such as poverty, inequality, climate change, environmental degradation, peace and justice – each goal with its own colour symbol.

We have already seen social bonds that raise funds for projects with positive social outcomes, as well as blue bonds that finance marine and ocean-based projects with positive environmental, economic and climate benefits.

What colour will be next?

Looking back at the securitisation market 2019

NEW FRAMEWORK FOR SECURITISATION

In 2015, the European Commission (EC) announced that it wanted to remove the “stigma” attached to securitisation and to revive the EU’s securitisation market by creating a framework for trusted securitisation. This resulted in legislation that laid down the framework for “simple, transparent and standardised” (STS) securitisation.

The EC thinks that if there was an increase in repackaging contractual loans and selling off the risk in a certified manner it would free up balance sheets, and the EC estimated that between EUR 100bn and EUR 150bn of additional credit would become available to the private sector – and that particularly SMEs would benefit.

The EC thinks that if there was an increase

The STS regulation has applied since 1 January 2019, but it was not until March that the European Securities and Markets Authority (ESMA) received its first notification of a securitisation product meeting the STS criteria. This is due to the fact that the market is waiting for some key implementing rules to be adopted by the EC.

Most people agree that the STS will become the standard in ABSs, and that the market will continue to grow steadily. We have started to see an upswing in deals issued as STS compliant, especially since some asset classes, such as residential mortgage-backed security (RMBS) and auto loans, were already familiar with the ECB purchase programme’s stringent requirements, so the impact has not been too much of a shock. However, there are other asset classes that will not be considered as STS, but will still have to meet more stringent reporting requirements under the new framework.

THE DIRECTION OF THE SECURITISATION MARKET

It is important to note that European ABSs offer a higher risk-adjusted yield than most other fixed income asset classes. As an example, a high investment grade rated ABS strategy currently yields 130 basis points above the Euribor (the Euro Interbank Offered Rate). ABSs offer exposure to direct consumer risk, which is complementary to sovereign and corporate exposure, both of which tend to be well-represented in most investors’ portfolios already. ABSs have a low, or even negative, correlation with traditional asset classes, and European Collateralised Loan Obligations (CLOs) have a very low default rate. All of the above qualities should make securitisation a more widely spread asset class among investors, unfortunately, this is not yet the case.

Whether STS securitisation will improve the market conditions remains to be seen, however, hope for European securitisation especially for SME financing could lie in the private debt market.

GROWTH IN THE PRIVATE MARKET

In recent years, we have seen substantial growth in the private debt market, which comes in many forms, but most commonly involves non-bank institutions making loans to private companies or buying those loans on the secondary market. A variety of investors, or private debt funds, are involved in the space. These include direct lending, distressed debt, mezzanine, real estate, infrastructure and special situations funds, among others.

The private debt market accounts for a substantial piece of the private markets; 10-15% of total assets under management with most private middle market companies having at least some debt.

Investor demand for debt funds is on the rise. Depending on factors like interest rates, regulations and business cycle, investors view private debt as a less risky way to dive into the market or diversify their assets. Because private debt investments are growing so rapidly, competition in the space is increasing, and therefore, these funds are facing overcrowding just like other asset classes.

THE IMPORTANCE OF INFORMATION ASYMMETRY

Another factor to note is called information asymmetry. This idea was formally introduced to economics by Nobel Prize winning research on the market for used cars. It was demonstrated how the existence of “lemons”, or bad cars, in a population of otherwise good cars could create the conditions under which no one is willing to pay a good used-car price, even for a used car in good condition. That is because it is costly for sellers of good cars to credibly communicate their private information – that their car is in good condition – because buyers know that the sellers of bad cars have an incentive to represent their cars as “good”, and because it is difficult for buyers to tell the difference.

Private debt funds invest considerable resources in due diligence and monitoring. To do so efficiently, they often focus on companies located nearby. The shorter distance facilitates the flow of both tacit and codified information, in other words, proximity reduces the costs associated with information asymmetry.

Overall, there are three central costs associated with asymmetric information in private debt investing. The first is general awareness of the deal. It is costly to learn about different deals, especially when ventures are prohibited from advertising private placements due to the general solicitation regulations. The second is transaction costs. The overhead associated with small, ad hoc debt transactions increases with added communication and delivery costs. Third, the due diligence necessary to address the information asymmetry problems discussed above requires face-to-face interactions between investors and founders; thus, the cost increases with distance between the investor and the venture.

Same is true in structured finance (capital) markets because private information about the credit quality of loans restricts the scale of securitisation in view of the way information asymmetries adversely impact on the market ability of such loans.

CREATING A STRONG EUROPEAN SECURITISATION MARKET

The key to a robust securitisation market in Europe is therefore reducing costs associated with information asymmetry and opening up the market to a broad base of non-traditional lenders and asset managers. This may be easier said than done, but the STS securitisation framework is a good start even though it may require some additional features to entice a broad base of investors into the market. The solution to his may lay in another trend gathering pace, which is marketplace lenders using securitisation techniques to fund their businesses with investors keen to profit from the lower loan origination at fin-techs.

Both marketplace lenders and crowdfunding platforms use the concept of syndicates to minimise costs associated with asymmetric information. These platforms operate as two-sided markets in which the platforms try to attract both investors and entrepreneurs. In order to succeed, there needs to be enough investors to make it worthwhile for investors. Although the various platforms are similar on some dimensions, they each have some unique market design features aimed at attracting certain types of investors or ventures.

Given the fixed-cost nature of sourcing and monitoring, particularly small and mostly local firms, capital market funding end lending by non-banks (direct or via funds) should have a complementary role alongside traditional bank lending channels.

Vladimir Petropoljac, Head of Structured Finance, OMNIA Global

 

Structured finance as a finance option for SMEs

VLADIMIR, TO THOSE WHO ARE NOT FAMILIAR WITH THE TERM “STRUCTURED FINANCE”, CAN YOU EXPLAIN WHAT IT IS?

“One of the best explanations for structured finance products especially in terms of securitisation is that securitisation is the issuance of marketable securities backed not by the expected capacity to repay of a private corporation or public sector entity, but by the expected cash flows from specific assets.”

“In a securitisation, the seller of assets is called the originator. It sells receivables – an asset or a flow of future receipts to a special purpose vehicle (SPV) established to isolate the receivables.”

HOW IS THE SPV STRUCTURED?

“It is usually structured as a bankruptcy-remote vehicle: it has legal protection against claims arising from the bankruptcy of the originator, limiting the credit risk faced by investors to the assets of the SPV. Although as a final result of the securitisation, the originator is collecting financing means, it is not borrowing, but selling a future of cash flows.”

“A crucial element is that the securitised asset is by all means effectively “separated” from the other assets of the originator, and in case the originiator goes bankrupt, this does not affect the rights of final investors on the securitised asset. This is a very important distinction from plain “vanilla” types of financial instruments widely available on the market. These are instruments such as a mortgages or overdrafts and look at the credit strength of the borrower.”

WHY DOES STRUCTURED FINANCE APPEAL TO SMEs?

“In the years following the last financial crisis, the credit channels in a number of jurisdictions have been impaired in regard to quantity, price and distribution of credit with the effects particularly felt by small and medium-sized enterprises (SMEs) – especially in Europe. This is due to the fact that these companies were reliant on traditional bank lending, and they are now faced with important financing constraints in an environment characterised by widespread bank deleveraging.”

“Investors need internal analytical capabilities and in-house expertise for the assessment of the pools of loans subject to securitisation and in order to assess the credit quality of the resulting securities. This can partially explain the fact that SME securitisation as an asset class is considered by some to be a niche market.”

HOW DO OMNIA APPROACH THIS MARKET?

“At OMNIA, we are working with banks, institutions and other non-traditional lenders who have the ability and information required to perform detailed fundamental analysis of the securitised assets and broadening the existing investor base for SME securitisations. Pension funds and insurance companies – as well as their asset managers – have been building in-house expertise in order to invest in this asset class, but the market is still in “larval stage” and has a lot of growth potential with some public sector support.”

“We believe that loans to SMEs are a key driver for the functioning of the economy and, properly applied, the securitisation technique is a replicable tool that can enhance access to finance for SMEs. Using this instrument in developed capital markets, public sector support for SMEs (e.g. guaranteeing mezzanine tranches) can create multiplier effects – and hence it is an efficient use of public ressources, which is especially important against the background of a high public debt burden in many key countries.”

SME issuance is still suffering from the crisis, however, the overall issued volume is growing to about EUR 19 billion in 2019, still a long way from EUR 27 billion five years ago.

“Since a well-functioning securitisation market can be essential in helping financial intermediaries broaden their funding base, achieve capital relief and ultimately, increase their SME financing, the recovery of the (SME-) securitisation market is also one of the focus areas of the Capital Markets Union (CMU). Furthermore, the European Commision intends to revive securitisation with the objective “to ensure that it can act as an effective funding channel to the wider economy and mechanism to diversify risk.”

DO SMEs EVEN KNOW OF THE POSSIBILITES WITH STRUCTURED FINANCE?

“Based on personal experience, SME owners and directors are not aware of the possibilities in structured finance (securitisation) markets, as SME securitisation traditionally has been done by financial intermediaries, such as banks which would extend loans to SMEs and then re-package these loans to be passed on to off balance-sheet vehicles.”

THEN, WHAT SHOULD BE DONE TO MAKE ENTERPRENEURS AWARE OF THE WORLD OF STRUCTURED FINANCE?

“In order to make the owners aware of the possibilities of structured finance, the public sector could and should provide support for raising awareness – among SME entrepreneurs as well as smaller local financial institutions traditionally serving SMEs – about the availability and attractiveness of such financing alternatives for SMEs and financial intermediaries.”

“The public sector could co-operate with private sector institutions in improving the visibility of successful transactions and platforms for such instruments.”

HOW DO WE EMPOWER SMEs IN TERMS OF FINANCING OPTIONS?

“All SMEs tend to reach out to their local bank when seeking financing. While such a relationship has its benefits, it often leads to, or perpetuates, SMEs’ lack of awareness of other financing options potentially available to them, such as those provided by the “shadow banking” industry, including crowd funding platforms or hedge funds that directly finance small businesses.”

“It is a well-known fact that SMEs generally are ill-equipped to deal with investor due diligence requirements, and that lack of information and understanding leads to a weaker position for SMEs in financing negotiations.”

I argue that when it comes to financing options, SME managers or owners need to be supported by independent advice, no matter if it is coming from the regulator or an independent market participant.

“Independent advice and financial education, more generally, could empower SMEs to reach out for the best financing option – be it a bank loan or something more sophisticated – and more importantly it would enhance competition between finance providers.”

“I believe that creating a central “meeting point” between investors and SMEs would encourage communication and increase awareness of alternative funding opportunities for SMEs. An experienced mediator like OMNIA ensures that SMEs are aware of different funding opportunities whilst delivering all the necessary information to investors in a manner that is both efficient and standardised allowing for a better functioning market.”