During the past decade, the Schuldschein loan (SSD) market has undergone a remarkable transformation, reaching all-time highs for annual issuance in 2016 and 2017, based on available data (such transactions are often private placements rather than public, making them difficult to track). Volumes in those years reached close to €30 billion according to research by Erste Group, more than double 2012 issuance.
Although issuance dipped slightly in 2018 to €25 billion, the past three years have been among the most active on record. And with H1 2019 issuance estimated at around €14 billion, it would not be surprising to see another record year for SSDs.
The SSD’s global growth
Why would this particular funding instrument, governed by German law in a market dominated by German issuers, expand beyond its own borders? In part, because of a slowing economy. Erste Group research shows German issuers’ share of the SSD market declined by a third in the past four years. At the same time, SSDs caught the attention of borrowers and investors outside Germany, who were hungry for simpler, more flexible debt options.
The SSD’s growth outside Germany has been consistent and steady. Following its early expansion into the neighboring CEE region, as well as Scandinavia and France, Brazilian energy company Petrobras tapped the market in 2014.
By 2016, Etihad Airways had issued the first SSD for a company in the Middle East. In 2019, India’s largest private sector company, Reliance Industries, successfully placed a €405 million SSD, the first ever by an Asian issuer.
Chinese banks, meanwhile, including the China Construction Bank and the Bank of China, are actively expanding their SSD portfolios. There has also been issuance split across more than one currency as well as examples of SSDs issued exclusively in a foreign currency.
A flexible, ‘friendly’ option
Overseas investors and borrowers now recognize that the SSD structure provides unique flexibility, incorporating some of the most appealing aspects of loans and bonds by sitting between the two. It also helps investors and borrowers to diversify their respective credit and lender portfolios.
SSDs are privately placed, so they are not securities as defined by European Securities Law. An SSD is simply a promissory note between a borrower and a lender, and it can be transferred to other investors by way of assignment or by consumption of contract.
As a result, SSD distribution and documentation is simple and efficient. There are no prospectuses or ongoing statutory reporting requirements, so borrowers seeking smaller sums can tap the market without incurring prohibitive costs. Although SSDs can digest loans of up to €1 billion, they can be issued for as little as €15 million. (A bond issue of less than €100 million, by contrast, is rather rare.)
SSDs also offer investors a more consistent maturity profile, as they are typically issued in three-, five- and seven-year tranches, rather than the bullet payments typical of bonds and loans. There is further flexibility around fixed and floating interest rates and, as no public announcements of SSD issuance are required, borrowers and investors can enjoy a degree of discretion.
The introduction of standardized documentation in English and German at the end of 2018, an initiative by various banks, lawyers and trade associations, has been another factor supporting growing international interest and general SSD issuance. Borrowers and lenders only have to negotiate the substantial provisions relating to the needs of the borrower, which saves cost and time.
Finally, apart from one or two high-profile cases, there have been few instances of heavy restructuring. The arranging banks look carefully at credit quality and the bar is high.
SSDs have effectively become a European private placement regime with a German feel and format. An SSD cannot be seen as an alternative to a US private placement because the investor groups are completely different. However, due to its unique costs, timing and investor diversification profile, the SSD is now a well-accepted and mature piece of the funding structure of many medium and large companies, including several global players.
What lies ahead for SSDs?
The prospects for the SSD market remain positive. The product is usually at its most popular during volatile and uncertain times, so if we are indeed near the top of the cycle, we could see increased issuance.
One risk is the default of a major SSD borrower. Steinhoff and Carillion are two examples of high-profile defaults, and banks selling products that compete with SSDs have used those examples to raise questions about the SSD offer.
Another recent and ongoing development is the digitalization of distribution. SSDs arranged exclusively through digital platforms have already emerged, most notably Lufthansa’s €800 million SSD in April 2019. Although this will help to lower costs and support higher issuance, it could mean regulators start viewing SSDs as securities, because of the ease with which they can be distributed.
If that does happen, and an SSD is no longer categorized as a loan instrument but as a security, then MiFID, market abuse regulations and prospectus regulations all come into play. That would make the SSD more cost- and time-intensive. However, the arguments that SSDs should not be categorized as securities under European Securities Law are clear and strong.
Finally, SSDs are increasingly being used for green and social finance. For example, in 2018 Verbund AG was the first company in the world to issue a green SSD through a digital platform. The €100 million placement combined two major trends: green capital market products and digitalization. Additionally, in August 2019, Porsche placed a green SDS of €1 billion. As investors increasingly prioritize environmental, social and governance (ESG) issues, interest in green SSDs is likely to grow – especially if banks keep promoting the product in international markets.
