.jpg)
For the past three-and-a-half years new prospectus laws have been in force in Germany, as in the whole of the European Union. Prior to this time, since 2003, it was possible to issue bonds with a minimum denomination per unit of EUR 50,000 without a prospectus, but in 2012 this threshold was increased to EUR 100,000. The legislature provided for the exemption from the requirement to publish a prospectus on the basis that retail investors do not generally subscribe for or trade bonds in such large denominations; it is usually only institutional investors who do so. The latter do not rely to the same extent on the particularly high level of transparency offered by a prospectus and the liability imposed on issuers for misstatements in prospectuses.
The EU Commission is now looking into the matter again. The reason is that, like many regulatory actions, the changed prospectus requirement also did not sufficiently take into account the long-term economic impact. It underestimated the natural reaction of the issuers, who are under great pressure with regard to liability and costs. They responded to the incentive to issue their bonds in larger denominations, so avoiding the requirement for a prospectus. The consequences are obvious: for instance, since the EU Directive came into force five years ago, the number of newly issued corporate bonds in the eurozone with denominations per unit larger than EUR 100,000 has quadrupled, while two-thirds fewer bonds have been issued in smaller denominations.
The aim of the European Parliament, the European Council and the European Commission was laudable, but the result could be the reverse of what was intended. Instead of protecting retail investors better, as it aimed to do, the changed prospectus law actually resulted in the exclusion of these investors from many bond issues. It is generally not feasible for them to invest a minimum of EUR 100,000 – and impossible to achieve adequate diversification in their portfolios. Retail investors find access to lower-risk, investment-grade bonds especially difficult. Many of the issuers of these bonds are taking advantage of the opportunity to avoid the requirement to produce a prospectus by issuing their bonds in large denominations per unit – yet most of them do not seem to have any trouble placing their bonds on the market.
The current legal situation positively forces retail investors to opt for higher-risk securities, as these are often issued in smaller denominations. Investors who do not wish to take the risks connected with these bonds, and plan to diversify their portfolios with investment-grade bonds as usual, have to rely on costly financial derivative products. In the current low-interest rate environment, the higher cost of these products is having an even greater impact on retail investors.
The increased threshold for the requirement to publish a prospectus has also done a disservice to the highly regulated and publicly visible part of the bond market – exchange trading. Trading on the exchange-based secondary market has become less transparent and there has been a decline in liquidity – prices are calculated less frequently and at longer intervals. The proportion of price determinations for bonds in denominations under EUR 100,000 is falling steadily across all marketplaces. This intensifies further the general problem of the decline in the overall amount of liquidity in the bond market. Current prospectus law tends to benefit the less regulated and less transparent OTC market for bonds.
The EU Commission has now learned the right lessons from these undesirable developments. It proposes to do away with any exemptions to the requirement to publish a prospectus. In principle, this would increase protection for retail investors, as they benefit from the information contained in securities prospectuses. Above all, there would no longer be any incentive for bond issuers to choose a large minimum denomination. Smaller denominations should in turn result in greater transparency owing to the increased number of price determinations at shorter intervals on the exchanges. The bond markets could be provided with urgently needed liquidity if a wider group of investors took part in trading again. A larger number of different types of investors in the market should also reduce volatility. Retail investors would be pleased in any case, even to have direct access to higher-quality bonds again. However, it is important to note that the proposed widening of the prospectus requirement will be accompanied by a simplification of the prospectuses themselves. This is because such a reform of the prospectus rules would reduce issuers’ costs in terms of both time and money, stimulating an increase in the range of products on the bond market.
In the next few months the EU institutions must reach a consensus on the reform of the prospectus laws. It is to be hoped that their decision will be in the interests of retail investors and of a generally better-functioning market for all participants.
