The European financial system is failing SMEs as the bank lending market continues  to retrench. Fortunately, there are other options that open this market to investors  and with the right structuring, securitisation and other instruments that can fill the gap, writes Andreas Wölfl.

In the years since the financial crisis, credit transmission channels in a number of jurisdictions have been impaired as regards quantity, price and distribution of credit. The effects of these malfunctions are particularly felt by small and medium-sized enterprises (SMEs), especially in Europe. Having relied heavily on traditional bank lending, European SMEs are faced with difficult financing constraints in an environment characterised by widespread bank deleveraging.

As credit sources tend to dry up more rapidly for small firms than for large companies during economic downturns, broadening the range of non-bank debt financing instruments for SMEs should help to make them more resilient to financial shocks. Given SMEs’ importance in all economies, this is also essential for economic recovery from the current economic and financial crisis.
Debt financing beyond bank lending will therefore play a major role in the coming years, led by securitisation, marketplace lending and a private placement mini-bond market.
And with securitisation and marketplace lending platforms increasing their importance as a source of capital, new types of investment products will evolve too. Examples include exchange traded instruments (ETI) that repackage portfolios of SME loans and SME mini-bonds and/or loans generated by marketplace lending platforms. These instruments will evolve to compete with lending funds. Taking into account that securitisations offer access to investors in a different regulatory framework than alternative investment funds, asset managers will focus more and more on the
launch of ETIs linked to and backed by companies originating loans or managing a portfolio of SME debt instruments.

One of Argentarius’ clients wanted to launch an investment product based on assets originated by marketplace lending platforms. The Alternative Investment Fund Management Directive (AIFMD) deterred the client because of high compliance costs and issues around the requirement to appoint a single depositor in the jurisdiction of the fund. They were searching for an alternative way to structure the product.
After analysing the marketplace lending platform, domiciled in the UK, Argentarius suggested the client structure the deal as an asset-backed security. An Argentarius securitisation cell company issued an asset-backed ETI linked to and backed by a performance-linked bond issued by a wholly owned subsidiary structured as a special investment vehicle (SIV). The sole purpose of the SIV is to invest via the marketplace lending platform. The asset-backed security indirectly delivers the yield of the portfolio of investments originated by the marketplace lending platform.

Such structures are set to attract more attention from both managers and investors in the near future. Added to that, they will help SMEs to diversify their funding sources.
Non-bank financing channeled through the capital markets can improve the flow of loans to SMEs, while enhancing diversity and widening participation in the financial system. Financing instruments like off-balance sheet securitisation or covered bonds, marketplace lending platforms as well as mini-bonds/private placements could complement bank lending, help repair the credit channel and ease SMEs’ financing constraints, while also facilitating a better distribution of risk amongst market participants.
Capital market solutions like securitisation and covered bonds can even support an investor base with a higher risk appetite than banks are willing or able to accommodate in the post-financial crisis regulatory environment.

Argentarius also structured an asset-backed ETI based on an underlying portfolio of mezzanine loans to European SMEs. The securitisation collateral comprises of debt and hybrid instruments issued within private placements by SMEs. Each asset was well under €5 million in size. These SMEs wouldn’t be eligible to access the capital markets directly given the small individual loans and banks wouldn’t finance them as they needed mezzanine capital with quasi-equity features.
By packaging those private placement instruments into an ETI investors with a higher risk appetite get access to high yielding investments while the SMEs were able to source funding for riskier projects ineligible for bank loans.

The regulatory reforms focused on reviving the securitisation market in Europe reflect the need for diversification of funding sources for the economy and SMEs especially. It presents different approaches to high-quality securitisation and exposes the existence of an uneven playing field for the instruments reviewed, making the case for a co-ordinated regulatory approach at all levels.
The revival of a healthy, safe and high quality securitisation market could be one way to generate the additional capital needed by SMEs, while providing banks with capital relief to unlock resources and further on-lending to the real economy. Securitisation can act as a credit risk transfer mechanism potentially resulting in a deeper and sounder financial system.
Disintermediation is particularly challenging for the SME segment. While successful disintermediation of the SME lending space is hard to achieve, there may also be limits to the desirability of disintermediation.
Nevertheless, the post-crisis environment still warrants further development of a healthy non-bank debt market for SMEs. To achieve this, a joint effort may be needed, involving all constituents concerned: investors, issuers, intermediaries, regulators and public policymakers. Such financing, when used properly, can play a significant role in the recovery of the real economy by unlocking resources and capacity for further lending, broadening the SME investor base and diversifying their portfolios, as well as assisting in the creation of a sounder financial system through better risk sharing within the economy.

In five years from now the landscape will have changed and disintermediation will be an established fact. SMEs will benefit from the diversification of funding sources. Debt managers will benefit from a wider range of assets and credit investors will see a wider range of investment products ranging from ETIs based on mini-bond portfolios, ETIs linked to marketplace lending platform-originated loans, marketplace lending direct investments through to CLOs securitising bank-originated loans or AIFMD-compliant loan funds.
Argentarius is ready to lead the transformation process as a service provider and arranger for ETIs securitising any kind of SME assets. The firm is increasing its presence as a platform provider for securitised marketplace lending-originated loans as well as providing SMEs with access to finance using its securitisation platforms.

This article first appeared in the Private Debt Investor magazine in December 2015.