3.6 Policies
Regulatory framework
162. Policies to promote asset-based finance relate primarily to the regulatory framework, which is
key to enable the use of a broad set of assets to secure loans in the case for asset-based lending, or to
sell/assign specific assets to financiers, such as accounts receivables in the case of factoring and purchase
order finance. Commercial laws that clearly define protection of a collateral lien are required. Also, the
efficiency of the judicial and bankruptcy systems, including the length of time for bankruptcy, is critical
for using assets to access credit. The power of collateral ex-ante ultimately depends on whether the priority
rights of secured lenders are upheld in bankruptcy ex-post (Berger and Udell, 2006). In empirical work
about institutions and bank behaviour in 20 transition economies, Haselmann and Wachtel (2010) find that
collateral is the main trigger for creditors to lend to informationally opaque firms, and that the willingness
to accept collateral depends on both the actual legal system and the perception by financiers of the legal
environment.
Hence, confidence in the operation of the legal system is as relevant as the laws enacted.
Also, the broader the range of assets accepted as collateral, the more the banks appear to be willing to
engage in lending that involves considerable asymmetric information.
163. According to Udell (2004) and Berger and Udell (2006), well-defined and strongly enforced laws
on security interest partly explain the significant development of asset-based lending in countries such as
Australia, Canada, the United Kingdom and the United States. For instance, in the United States, under
bankruptcy law, the judge is required to preserve the collateral claim of secured creditors and to give them
“adequate protection” if the collateral or its proceeds are denied to the secured lender. Also, in the United
States, an important role for the growth of the asset-based finance can be ascribed to the norms on
“Secured Transactions” included in the US Uniform Commercial Code (UCC) and to a well-developed
electronic registration system, which temporally defines lien filings.
164. These regulatory aspects have proven to be especially challenging for policies intended to
develop asset-based lending, which demands a sophisticated and efficient legal system, in transition
economies and emerging markets, as these generally present deficiencies in areas such as the scope of
assets that can be secured, registration and filing, priority and enforcement (EBRD, 2003). In the 1990s, in
most of the countries whose process of transition was supported by the EBRD, no rule on secured
transactions existed, or rules were deemed outdated or inadequate, making it highly difficult for a lender to
increase the chances of debt repayment by taking security over the borrower’s assets. A key element in
EBRD’s support to economic reform, thus,
has consisted in a “Model Law on Secured Transactions”,
intended to: illustrate the principal components of a secured transactions law and the way in which they
can be included in legislation; act as a reference point and checklist for the law reformer; provide guidance
as to expectations of international investors and lenders; and harmonise the approach to secured
transactions legislation14.
165. According to IFC (2010), the efforts made in overcoming the weaknesses in creditor rights
during the period of transition, as well as the large market share of multinational banking groups that may
have used leasing as a more secure way to provide financing to firms in riskier environments, may
contribute to explain why the leasing sector developed more in Central and Eastern Europe than in other
emerging regions.
166. In some countries, the development of asset-based instruments has been promoted through an
explicit and coherent set of rules, to overcome the overall weak legal environment for secured transactions.
This is the recent case of emerging countries, whose reforms aim at easing access to finance for SMEs and boosting trade. In India, a Factoring Regulation Bill was passed by the Parliament in 2011, which regulates
the assignment of receivables in favour of a factor, and was expected to address, among other issues, the
problem of delayed payments to micro and small firms by large companies.
Policy programmes
167. Across OECD countries, active policies to support asset-based finance have received increasing
attention, as governments seek to broaden the financing instruments available to businesses. Asset-based
programmes are largely intended for businesses that are unable to meet credit standards associated with
long-term credit. This is the case of the credit lines offered in the United States by the the Small Business
Administration (SBA), under the CAPLines programme, an umbrella programme that helps SMEs meet
short-term and cyclical working capital needs. Two types of asset-based lending are offered: i) Standard
Asset-Based Line, an asset-based revolving line of credit, which provides financing for cyclical growth,
recurring and/or short-term needs. Repayment comes from converting short-term assets into cash, which is
remitted to the lender. Businesses continually draw from this line of credit, based on existing assets, and
repay as their cash cycle dictates. However, because these loans require continual servicing and monitoring
of collateral, additional fees may be charged by the lender; ii) Small Asset-Based Line, an asset-based
revolving line of credit of up to USD 200 000, which operates like a standard asset-based line but with less
strict servicing requirements, providing the business can consistently show repayment ability from cash
flow for the full amount15.
168. New initiatives have been also launched more recently, as access to traditional bank lending
became restricted in the aftermath of the global financial crisis and following regulatory reforms. This is
the case of Japan, where the Bank of Japan (BOJ) in 2010 created a new line of credit to support assetbased lending, with the explicit aim to allow smaller firms, which do not have access to traditional lending
under strict banking norms, better access to financing. Initially, the programme intended to provide up to
Yen 3 trillion (USD 36.8 billion) in loans to private banks for up to four years, at a 0.1% interest rate, to
lend to 18 high-growth sectors, including renewable energy and medicine. The BOJ later decided to lend
up to Yen 500 billion specifically for equity investments and loans without real-estate collateral or
guarantees, that is, asset-based lending. However, while loans to growth-sector firms neared the Yen 3
trillion ceiling in 2012, lending to equities and ABL only totaled about Yen 89 billion, well below the
target limit16.
169. Policies have been aimed at strengthening longer-established instruments, such as leasing and
factoring. For instance, in Europe, guarantees on lease have been included among the financing tools of the
European Commission’s Competitiveness and Innovation Framework Programme (CIP). Under the SME
Guarantee Facility of the CIP, which provides loan guarantees to encourage banks to make more debt
finance available to SMEs, the European Investment Fund (EIF) offers financial institutions with
guarantees that cover part of the expected loss of a portfolio of new SME leases/loans. The instrument has
proved useful in incentivising leasing providers to offer financing solutions to risk categories which were
hitherto not approved, and thus cover new leasing volumes to SMEs and micro-enterprises (Kraemer-Eis
and Lang, 2012).
170. In 2013, the Nordic Investment Bank (NIB), an international financial institution owned by eight
countries17, signed a EUR 80 million loan agreement with private financial institutions for financing
equipment leasing to the Norwegian SME sector
4. Alternative debt
175. Alternative forms of debt differ from traditional lending, in that investors in the capital market,
rather than banks, provide the financing for SMEs. These include “direct” tools for raising funds from
investors in the capital market, such as corporate bonds, and “indirect” tools, such as securitised debt and
covered bonds. With alternative debt, the SME does not access capital markets directly, but rather receives
bank loans, whose extension is supported by activities by the banking institutions in the capital market.
176. These instruments have existed for some time, but they can be viewed as “innovative” financing
mechanisms for SMEs and entrepreneurs, to the extent that they have had until now been applied in a
limited fashion to the SME sector.
4.1 Corporate bonds
Modalities
177. Corporate bonds are debt obligations issued by private and public corporations. By issuing bonds,
the company makes a legal commitment to pay interest on the principal, independent of the company’s
performance,
and to return the principal when the bond matures. The terms of the contract can however
provide the company with the right to “call”, i.e. buy back, the bond before the maturity date. If it calls the
bond, the company will pay back the principal and possibly an additional premium, which depends on
when the call occurs in relation to the actual maturity date (SEC, 2013).
178. Bonds can be classified in relation to several characteristics, such as maturity, type of interest,
credit quality, priority claim, and collateralisation (Table 2). The terms and conditions of the bond contract
can combine these dimensions differently, giving rise to a large variety of cases.
179. With regard to maturity, bonds can be classified as short-term (less than three years), mediumterm (four to 10 years), or long term (more than 10 years). The longer the term, the higher the risk for the
bond-holders, hence the higher the interest rate. Interest payments are called coupon payments and can be
at a fixed rate throughout the term of the bond, or at a floating rate, based on a bond index or another
benchmark, such as government bonds. There also exist bonds that do not pay interest, so-called zerocoupon bonds, which rather make a single payment at maturity that includes a premium with respect to the
purchase price.
180. The price of a bond is negatively correlated with the market interest rates, as these determine the
relative convenience to investors of the coupon rate attached to the bond. Hence, for a given coupon rate, if
market rates increase, i.e. the bond pays relatively less, the bond’s price decreases. On the other hand, a
reduction in the market interest rates will imply a relatively greater value of the coupon, thus an increase in
the price of the bond.
181. The credit quality of the bond is determined by credit rating agencies, which assign and
periodically review bond ratings. In accordance with these, bonds can be distinguished in investment grade
(e.g. BBB- or higher by Standard & Poor's or Baa3 or higher by Moody's) or non-investment grade. These
latter are also defined as high-yield or speculative bonds, which pay investors a higher interest rate in
exchange for the higher default risk.
182. A corporate bond can be either secured over specific assets, whereby the company pledges
specific collateral as security for the bond, or be unsecured (so-called debenture). In this latter case, if the
issuer defaults on its bonds, the investor has only a general claim on the company’s asset and cash flow.
Also, the bond can rank ahead of all other obligations of the borrowers (senior debt), hence have priority
claim in case of default, or be subordinated. In any case, in the event of bankruptcy, the bond investors
have priority over shareholders in the claim of the firm’s assets.
183. The bond-holder is exposed to specific risks, which generally reflect into the bond price and
coupon rate (SEC, 2013):
• Credit or default risk. The risk that a company will not be able to make timely payment of
interest or principal, that is, that may default. The credit ratings by specialised agencies are
intended to estimate this risk. To limit credit risk, the bond contract may include covenants, that
is, conditions for the debtor, for instance in terms of financial ratios or limitations to the amount
of debt the firm can take;
• Interest rate risk. The risk that market interest rates may become relatively more favourable than
the coupon rate. The longer the maturity of the bond, the greater is the risk that rates will change,
hence the higher is generally the coupon rate;
• Inflation risk. The risk that inflation will reduce the real value of the investment and coupon
payments;
• Liquidity risk. The risk that the bond may not be easily traded, or that the investor may not
receive a fair price when selling the bonds in secondary markets;
• Call risk. The risk that the bond may be called back by the issuing company before the maturity
date, for instance following a decrease in interest rates that make the coupon rate relatively more
onerous for the company (but more convenient for the investor);
184. Reporting requirements on bond issuers are intended to increase transparency and reduce
investors’ risks. For instance, in the United States, a company that intends to issue bonds for sale to the
public must file a prospectus with the Securities and Exchange Commission (SEC). The prospectus
describes the financial conditions of the company, the terms of the bond, the risks of investing in the
offering, and how the company plans to use the proceeds from the bond sale. Also, companies that have
issued bonds in a public offering are required to file quarterly and annual reports (SEC, 2013).
185. Another mechanism to protect investors is the trustee, a financial institution that is given
fiduciary power by a bond issuer to enforce the contract terms. In practice, the trustee is responsible for the registration and transfer of the bond, and for the timely payment of the coupons and principal. Importantly,
the trustee acts on behalf of the investors if the borrower violates certain conditions and protects their
interest in case of default.
186. Bonds are primarily traded in a non-centralised dealer market, where investors shop between
dealers for the best quotes (Hotchkiss and Jostova, 2007). In other terms, contrarily to publicly traded
stocks, there is no central place or exchange for bond trading. Rather, the majority of corporate bonds are
traded “over-the-counter”, i.e. via a dealer network. By creating a “market” for bonds, i.e. quoting a price
to buy and sell, bond dealers provide “liquidity” for bond investors, that is, they made it easier for demand
and supply to coordinate. Beside dealers, the market is comprised of institutional bond investors, such as
financial institutions, pension funds, mutual funds and governments.
187. Institutional investors are the main player in this market. In 2010, in the US, institutional
investors held about three quarters of the USD 7.5 billion outstanding corporate bonds issued by U.S. firms
(Cai et al., 2012).
188. Typically retail investors buy corporate bonds from funds, which hedge risk across a large
number of issuers. However, corporate bonds can be also issued “publicly”, that is, directly to retail
investors. “Direct bonds” allow saving on the fees of the dealer network, but can include additional costs,
such as those related to marketing and the possible fees of other brokers.
189. In some countries, the regulatory framework allows Private Placements (PP) of corporate bonds,
i.e. the offer of bonds to a few, select investors by unlisted companies. These are subject to less stringent
reporting requirements and do not need a formal credit rating, although some credit rating agencies have
been providing specialised services for investors to better navigate this opaque market. In fact, lack of
information on issuers, lack of standardised documentation, illiquid secondary markets and differences in
insolvency laws currently limit the development of these markets (OECD, 2014a).