The case for using debt-based securities

  • To learn what is driving debt-based security investing.
  • To understand how debt-based securities can work in a portfolio.
  • To be able to list the regulations around debt-based securities and the IFISA.
The case for using debt-based securities

There is a strong investment case for debt based securities (DBS).

They can offer cash-beating, potentially asset-backed yields from tangible and engaging assets, lower volatility than equities, a fixed term with a defined exit, easy accessibility, and diversification from mainstream equity.

Guy Tolhurst, managing director of Intelligent Partnership, says: “The higher regulations of equity with the lower risk profile of P2P make crowdfunded debt based securities a compelling option.”

The report explores these very attractive traits. It also identifies the powerful drivers working to grow the UK market for unlisted bonds and debentures which forms part of the investment-based crowdfunding market.

This in turn is part of the alternative finance industry, predicted to be worth over £12bn by 2020. By then, the initial agreement for the formal separation of the UK and the EU should have substantially clarified the new landscape for British business.

The potential loss of EU funding for UK companies is a point made in HM Treasury’s Consultation on Financing Growth in Innovative Firms, and access to capital for UK SMEs (whether patient or not) has never been more critical.

At the same time, the rolling introduction of Basel III builds on the capital requirements now applied to banks as security against potential financial shocks and to cushion against any failures of higher risk assets.

The stricter rules on calculating the capital to be held for each type of asset, additional requirements for capital buffers and imposition of liquidity ratios will amount to higher costs for lending, particularly for higher risk transactions, such as loans to SMEs.

Consequently, the prospect of banks tightening their lending criteria again is a very real one.

The OECD acknowledged the issue in 2015 when it stated: “While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become ‘the new normal’ for SMEs and entrepreneurs.

"It is therefore necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation and employment.”

Property Crowd’s Rohin Modasia recently commented: “The market for traditional banking is failing, and debt based securities are part of the solution to bridge the gap.”

Set against this backdrop, crowdfunded DBS, with a cheaper cost of capital than more traditional corporate bonds, are giving smaller, dynamic companies an important route to raising funds.

This is not new, but the Innovative Finance ISA (IFISA) is and it’s likely to be a major factor in bringing DBS into the scope of mainstream investors.