Imagine you go into a grocery shop and you’re standing in front of the milk shelf: what do you look out for? Price and origin? Or perhaps the brand too? At the end of the day, what you want is to buy a product that best meets your needs, as well as a brand you can get behind. When it comes to buying securities like shares or bonds, it can be worthwhile bearing these factors in mind too. But who is actually responsible for distributing securities? The answer: the “issuer”. But just what is an issuer, and why are they so important? Let us explain.
Issuers are defined as distributors of securities in the form of shares or bonds, their aim being to raise additional capital on the capital market or, as in the case of funds and ETFs (exchange traded funds), to generate revenue. In other words, issuers are debtors, whereas investors, who actually receive the securities issued, are the creditors. The distribution of securities is therefore known as an “issue”.
Issuers are legal entities that can be companies or state institutions. The type of security issued essentially depends on the legal entity:
In a nutshell, if someone is an issuer, this means that they have entered into an obligation towards the buyer, the “creditor”, in order to get money in return for their investment, or to generate revenue.
But not all issues place the same obligations on the issuer. There are differences between shares and bonds in particular. One way these two types of issue differ is in the type of capital that is issued, and the resulting rights for investors The difference between the key types of capital, the associated debtor obligations and creditor rights can be broken down as follows:
When issuing shares, the issuer generates equity for the company. Company owners sell shares and, in return, shareholders become co-owners of a company by buying the share. The private limited company therefore receives equity that can be used in the long term. In the event of bankruptcy, however, shareholders are subordinate to creditors that lent the company debt capital (e.g. in the form of bonds). There are many types of shares that are associated with various voting right and profit-sharing obligations for the issuer. Find out more in our article “The link will open in a new window The various types of shares”
Debt capital arises when issuing bonds, funds, ETFs or structured financial products, for instance. Bond buyers provide the issuing company with capital that has to be repaid. Repayment is generally made at the end of a pre-defined term, and is the interest-bearing nominal value of the bond plus any interest. How much the interest is and consequently how expensive debt capital is for an issuer depends, among other things, on their creditworthiness and the market situation (interest rate). Or, to put it another way, what the estimated risk on the market is of the issuer defaulting. When it comes to bonds/debt capital, the issuer does not assign any voting rights, but in the event of bankruptcy, the receivers gives the creditor priority over creditors with equity.
There is also something known as “mezzanine capital”, which is a blend of equity and debt capital. Here, the issuers retain their full voting right, but can give security owners a share in the profit. Mezzanine capital usually has to be repaid with a higher interest rate than debt capital and, in the event of insolvency, is in fact subordinate to debt capital. In order to raise mezzanine capital, convertible bonds or warrant bonds, for instance, are issued.
As an investor, the issuer can be crucial to the choice of security. Ultimately, it’s the behaviour and the decisions of companies or state institutions that impact the value or risk associated with securities. But what should you look out for when choosing an issuer and your securities as a result too?
One possible indicator of how a legal entity might behave in the future is past experience. Investors should therefore take a close look at a company’s business figures, success stories, past distribution policy and management. Outlooks a company publishes for its next financial year are also important indicators.
You should be sure to ask yourself: How certain can you be of the issuer fulfilling their obligations now and in the future? In other words, is the issuer creditworthy or not? Creditworthiness refers to the issuer’s ability to fulfil their financial obligations. This describes the issuer’s creditworthiness. At the same time, the issuer’s creditworthiness can also be used to estimate what the risk of an issuer defaulting is. In order to estimate the issuer’s creditworthiness, you can use ratings given by rating agencies.
The risk of default is directly linked to issuer creditworthiness. This defines the probability (i.e. risk) of the issuer becoming insolvent before the maturity date is reached. If this happens, you as an investor would either lose some of or all the money you have invested seeing as the issuer is no longer able to repay you the nominal value of and interest on a bond. This type of default risk is most common with bonds, and is known as issuer risk. When it comes to shares, the risk of default involves anything from major market value losses to a total loss as well as defaulting on dividend payments. The better an issuer’s creditworthiness is, the lower the risk of default on an investment often is. This is why you should bear in mind the risk of default when purchasing a security.
Volatility mainly comes into play with listed securities, and is a measure of the variation of the market value. It is essentially an expected value based on the average historical price gains and losses the security has undergone on the stock exchange. The greater the volatility, the greater the price fluctuations and potential returns and losses tend to be as well.
If, for instance, shares or bonds are purchased that are not in the investor’s currency (e.g. Swiss francs), but rather in a foreign currency such as euros, there is a currency risk. Specifically, if currencies are correlated to one other, there is a risk of this correlation fluctuating. If the Swiss franc now increases in value in contrast to the foreign currency that the shares are in, the shares will decline in value for an investor in Swiss francs.
Liquidity in this context refers to the speed with which securities can be bought and sold on the secondary market , as well as the quantity of securities available on the market. This means enough securities must be available on the secondary market for buying and selling. Liquid investments can be sold quickly and without any broad spreads. Liquidity risk is therefore the risk that investors are unable to find a market for their securities and cannot buy and sell them at their preferred time or for reasonable prices.
Investors have various needs as far as their investments are concerned. Some investors are more interested in risk and return, whereas others prefer less risky securities with lower return prospects. Depending what your own needs are, you may form a different idea of issuers and your risk indicators. Find out what strategy best suits you and your needs in our article “The link will open in a new window Define and implement your investment strategy properly”.
Once you have some awareness of your personal investment strategy and risk appetite, you should find out about the issuer risk of your investments. You can do this by drawing on credit ratings, for instance. You should note the following points:
Many companies and states are rated by rating agencies based on their creditworthiness. These ratings depend on the assessments of rating agencies as to whether an issuer is capable of repaying their debt and fulfilling the obligations they have entered into. These ratings usually have an impact on the total amount of interest the issuer has to pay on debt capital. The lower the rating, the higher the risk of default and the interest tend to be.
Rating agencies assess issuers according to two different timescales: short term and long term. The short-term rating suggests the probability of an issuer defaulting in the space of a year. The long-term rating, on the other hand, looks at the risk of an issuer defaulting over the course of a year or longer. Depending on what your investment horizon is, you should consider either the short-term or long-term rating.
Ratings are never static, but rather they change over time. This is why, as an investor, you should watch out for any changes to the ratings of issuers that issue your securities. After all, it’s not only the rating score itself that matters, but also how long a company or state has held onto a high rating for.
Ratings are always based on historical data, and so are not a guarantee of future performance. With this in mind, be sure not to place blind faith in these sorts of ratings, but rather try to see the bigger picture by taking into account other sources. In addition to media reports, you could, for instance, also factor macro-economic developments in countries and the annual reports of companies into your considerations.
