The recent growth of the schuldscheine market is not a reflection of anything inherent to the market itself but a reflection of the extraordinary things that are going on in the markets that are adjacent to it. Several articles recently have questioned the future direction of the market – has it stopped being German in anything but name? Is it in credit-denial? Are participants undergoing behavioural changes (no more Mr Nice Guy)?
To understand the changes, and the controversy, it is useful to ask the fundamental question: what are schuldscheine an alternative to?
The loan market?
Schuldscheine are loans. That may be correct technically and legally – the importance of which is not to be underestimated – but it isn’t correct behaviourally.
As a bond man I am of course deeply sceptical about the loan market. Its all about subsidised pricing, cross selling, poor credit analysis, cosy rearrangement agreements when the credit analysis goes wrong and heavy use of expensive balance sheet (that would be better used by the bond trading desk).
Needless to say, all of this makes me quite fond of schuldscheine as an alternative. An ex colleague told me that the sculdscheine market had even started pricing credit sensibly!
But to that technical and legal interpretation. The important thing about the legal categorisation of schuldscheine as loans is that they are not bonds. And, although it hurts me to have to say this, I think that explains a lot of their appeal.
The bond market?
I must declare a vested interest here. Having worked for eight years in bond origination for a German bank that was very good at schuldscheine, my perception of the product was that it was a domestic German alternative to the product that I was paid to originate. Having spent eight years explaining why bonds were a better alternative I can now safely do the exact opposite.
The biggest relative strength of the bond market is its liquidity, in both primary and secondary. Lots of investors, lots of diversity (the importance of which in an investor base is always underestimated), liquid prices. In contrast, the schuldscheine market is a small, homogenous group of investors and if you wanted to get a secondary market price you usually had to make an appointment a week next Tuesday with an investor.
Neither of these still apply. Just as the schuldscheine investor base has got more heterogeneous (therefore more accepting of longer maturities, lower credits and, best of all, different opinions), so the bond market has become more technical, less liquid and more herd-like in its behaviour. Don’t get me wrong, bonds are still better in this regard. It is just that the relative advantage has diminished.
Assuming that you prefer profits to losses (safe assumption, ignoring tax) the lack of mark to market in the schuldscheine market was presumably a problem when rates were falling – as they have been, more or less since the 1980s. Now that rates can only go one way, the mark-to-market on bonds is going to hurt.
I used to quite enjoy the public bond market syndication process, much more fun that the slow development of a deal in the schuldscheine market. But now that syndicate desks are enfeebled by regulation the fact that schuldscheine are not subject to Mifid and are allowed to operate under their own – shall we say idiosyncratic – ‘bookbuilding’ process is a blessed relief.
These are the opinions of a non-German who has spent some time on the edge of the market looking in. But I’m looking forward to hearing more informed voices discussing these topics – and their implications for the future of the market - at the Euromoney International Schuldschein Forum 2018.