Italian capital markets have long been underpinned by healthy support from retail accounts.
Just as mom and pop investors have been an important feature of the equity markets in countries like the US, households in Italy have shown a strong preference towards investing in bonds — bolstered by favourable tax treatments.
“This familiarity with bonds dates back to a time of high interest on Italian government bonds and continued in recent years, following the large volume of retail bonds issued by the Italian financial system,” explains Nicola Francia, head of private investors products Italy at UniCredit in Milan.
But there has been a shake-up in the way that retail accounts have been investing their money in Italy.
In particular, investment in bank bonds has been drying up over the last few years.
Consob, Italy’s securities market regulator, estimates that the amount of bank debt in Italian retail portfolios shrank by about 28% between 2015 and 2016, for example, accelerating a shift into other forms of investment.
Bank debt securities had become a very popular source of income for many Italians following the global financial crisis, but recent problems in the Italian banking system have eroded people’s confidence in the asset class.
The failure of Banca Marche, Banca Popolare dell’Etruria, CariChieti and CariFerrara in 2015 was perhaps the most important episode to demonstrate how easy it could be to lose money when investing in certain parts of a bank’s capital structure.
More than 15,000 subordinated bondholders suffered losses as part of a €3.6bn rescue of the four banks, and one investor, a pensioner, committed suicide following the collapse of the banks.
These ordinary Italians found themselves caught up in a new world of European banking regulation, in which the Bank Recovery and Resolution Directive (BRRD) and the minimum requirement for own funds and eligible liabilities (MREL) had spelt out how bail-ins should start replacing bail-outs — or in other words, how investors should bear the brunt of bank failures in the place of taxpayers.
“The impact of European legislation on bail-ins, together with the banking crisis affecting some Italian banks, may have had a negative impact on retail appetite for banks by increasing the perception of the riskiness of the sector,” says Maurizio Gozzi, managing director in debt capital markets Italy at Crédit Agricole in Milan.
But the banks themselves have also been losing their appetites for placing unsecured bonds with retail investors.
Issuers are being careful to make sure that liabilities can comply with MREL, which may require that senior bonds can be bailed-in nearly as easily by resolution authorities as subordinated debt instruments.
Though the Single Resolution Board — Europe’s centralised resolution authority — has said explicitly that it will not exclude retail exposures from a bank’s MREL calculation, the supervisor has also expressed doubts about whether or not these holdings would constitute “an impediment to resolvability”.
Indeed, much of the work that has been done on reforming bank creditor hierarchies in Europe in recent years has had the specific aim of making resolutions easier.
In 2018, for example, Italy will join other EU countries in issuing non-preferred senior bonds — a new asset class that has been designed with a bank’s failure in mind.
Because of the way in which Italian legislators have decided to implement the provisions of the Bank Recovery and Resolution Directive into Italian law, these non-preferred senior debt instruments will have high minimum denominations that will exclude retail investors from the market.
“There is a strong view that these transactions should only be placed with institutional accounts,” says Denis Beltramini, private banks and distributors sales at BNP Paribas in London. “This is not the case with preferred senior bonds, which investors might reconsider buying when interest rates are more compelling.
“But we have seen that banks have already begun replacing much of this funding in the wholesale market.”
All change
In the meantime, the Italian market for retail investments has been adapting to the new operating environment.
“It’s been quite a dramatic shift out of bonds,” observes Beltramini. “Most of the retail money has moved into asset management products, like funds, and some of it has also gone into current accounts.
“Italians are quite risk-averse in general. They are not willing to invest in the equity markets and they have become less willing to invest in bonds, given that yields are so low. Many have preferred to keep their money in current accounts, even if they are not being paid anything.”
Another alternative to bank bonds that has been gaining traction in recent years is a form of structured note or derivative known as an “investment certificate”.
The term investment certificate covers a broad range of securities that allow retail accounts to add exposure to any market by reference to an underlying asset — including commodities, currencies, indices, interest rates and shares.
The certificates are traded on the securitized derivatives market of the Italian stock exchange (SeDeX), as well as the EuroTLX market, and tend to be issued by banks.
“They represent a hybrid investment — combining the protection of bonds with the yield of the equity market,” says UniCredit’s Nicola Francia. “The most popular certificates in the last few years have been those with full or partial capital protection, while more recently there has been a growing interest towards conditionally protected certificates.”
Sales of investment certificates have boomed in the last few years, according to UniCredit.
The Italian bank expects issuers to have placed €8.5bn of the securities by the end of 2017, with total turnover on the SeDeX and EuroTLX passing the €13bn mark. The market was half as large in the previous year.
“In the current low-yield bond environment, investment certificates offer investors a defined return, in the form of redemption value or a periodical coupon, while allowing them to choose their own risk profile,” says Francia.
Old wine in new bottles?
But issuers of all types financial instruments — including bonds, investment certificates and asset management products — will likely find it more difficult to place their securities in the hands of retail investors with the arrival of the second Markets in Financial Instruments Directive (MiFID II) which came into effect on January 3.
One key part of the new regulations is the rules covering product governance, which aim to ensure that firms are acting in the best interests of their clients when selling new financial instruments.
The product governance framework stipulates that distributors should identify and assess the circumstances and needs of the clients they intend to focus on when designing a product, as well as when placing the securities in the market.
As MiFID II comes into effect at the start of 2018, so too do the Packaged Retail and Insurance-based Investment Products (PRIIPS) regulations, which require manufacturers — including issuers and underwriters — to disclose information about investments within short and consumer-friendly Key Information Documents (KIDs).
A combination of the two sets of rules is likely to pile pressure on the retail bond market in Europe, raising the cost of issuance.
Responses to a public consultation on the Capital Markets Union in June 2017 suggested that “PRIIPs and MiFID II product governance regimes will reduce the availability” of bonds to retail investors and even “constitute a barrier to selling products” to these types of buyers.
But the new regulations will not kill off the retail market in Italy, according to Emiliano La Sala, counsel at Allen & Overy in Milan.
Consob has played a key role in preparing the market for these sorts of changes.
“Consob has introduced a number of guidelines in recent years, aimed at filling the knowledge gap between issuers/intermediaries and retail investors as well as preventing conflicts of interest in securities markets and strengthening the position of retail investors under MIFID I,” says La Sala.
“The overall aim is for intermediaries to always act in the best interest of their clients.”
In some cases, says La Sala, the guidelines have anticipated the impact of the incoming European legal framework of MiFID II and PRIIPS.
For example, Consob made a series of recommendations in late 2014 aimed at issuers and financial intermediaries engaged in selling “complex financial products”.
Echoing a number of MiFID II provisions, the Italian regulator suggested that intermediaries place certain restrictions on the sale of financial instruments deemed too complex for retail investors, like perpetual bonds, convertible securities and over-the-counter derivatives.
Consob’s guidelines are not compulsory, but they can exercise a strong influence on market practice.
“In light of this, the introduction of the new rules, even though it must not be underestimated, might not be as disruptive in Italy,” says La Sala. “Intermediaries already comply with some of the new provisions when looking to place securities with retail clients.”
There is no doubting, however, that MiFID II will have a big impact the shape and size of retail bond markets — even in Italy.
Once the rules have been introduced, everyone will have access to far more detailed disclosures around the sales of financial instruments.
“We will have to see how the clients react to this,” says Beltramini. “They may well decide that the costs for some products are too high and switch into other products.”
Italian savers are largely adopting a “wait and see strategy” for now, according to Beltramini, as interest rates hover around historic lows and recent bank bond losses remain fresh in the memory.
Deloitte, the accounting and consultancy firm, estimated in May that one-third of Italian investors’ money was parked in deposits and cash.
Putting this money to work will be crucial for establishing new investment traditions for Italian savers.