Dollar-based issuers are champing at the bit to capture the attention of the euro market. After years of being prohibitively expensive, the euro/dollar basis swap spread has moved enough to make euro benchmarks feasible for issuers that want to swap proceeds back to dollars. The opening up of the euro, and other markets, will give issuers a golden opportunity to diversify away from their dollar investor base.
“The euro is suddenly back on the table for supranationals,” says Hassatou N’Sele, manager of capital markets and financial operations at the African Development Bank in Tunis.
“It is a market that we will closely monitor for funding opportunities. We’ve sold benchmarks in French francs and Deutschmarks but never in euros. More than 40% of our funding needs are in euros, however it has been much more cost-effective for the AfDB to issue in dollars and swap into euros. This may change, and we will be ready.”
Although the spread has improved in dollar-based issuers’ favour, it is still volatile. These borrowers will hope the trend will continue, but the path may not be smooth.
“It makes sense to efficiently diversify the investor base with euro buyers,” says Ulrik Ross, global head of public sector at HSBC in London. “But we do not believe that the arbitrage in euros will stay consistent for a long time. If issuers want long-dated money and diversification — and the pricing is the same — then there will be more euro issuance.”
The ability to seize upon the investor diversification that euro deals offer has come at a useful time for issuers, as the next round of budget talks in the US looms in the first quarter of 2014.
One borrower that has taken advantage of the widening spread to reach new pools of liquidity is the Swedish Export Credit Corporation (SEK), which sold its first euro benchmark in four years in November, placing a €1bn November 2018 bond.
“What’s interesting for issuers like SEK is that with a euro deal they were able to reach investors they don’t normally sell to and it provides another outlet for the first quarter, when there is uncertainty over the US debt ceiling,” says Benjamin Moulle, head of SSA syndicate at Crédit Agricole in London.
“US politicians will probably avoid another shutdown, but there is a risk it could happen and if it does it will close the dollar market.”
The World Bank re-opened the euro market for dollar-based supranationals and agencies in November 2013, when it sold its first euro benchmark after a more than four year hiatus with a €1bn December 2016 deal.
Dollar funding issuers had been all but barred from euro benchmarks as a euro/dollar basis swap moved deeply negative in the wake of the financial crisis of 2008 and eurozone debt that followed.
In the three year part of the curve, the rate fell as low as three month dollar Libor flat being worth the same as three month Euribor minus 80bp in 2011, meaning supranationals would have to stomach a huge swell in the re-offer spread — and therefore their costs of funding — of any euro deal to have any chance of selling it.
The swap spread has moved towards positive territory since 2011, hovering around minus 20bp in September last year, before rising throughout October to reach minus 11bp on November 1 — its most attractive position for dollar funders in years — a few days before the World Bank deal.
Finding a niche
Wherever that spread moves next, sovereign, supranational and agency borrowers have plenty of options if the worst does happen and the dollar market closes. One of those is the Australian dollar market.
“Issuers looked at Australian dollars to circumvent the dollar market during the last US negotiations,” says Paul White, global head of debt syndicate at ANZ in Sydney.
“But Australian dollars are always considered as an alternative to deeper, more liquid markets. It can be the second or third most attractive in terms of volume, diversification, funding levels and more recently, duration. SSAs always monitor this market but it becomes more compelling when other markets are more challenging.”
But such markets have not proved as popular with investors as some hoped.
“The trend towards opportunistic currencies hasn’t been as dynamic as issuers were expecting,” says Crédit Agricole’s Moulle. “Many have roadshowed across the world to target new investors, but the interest from non-European asset managers/insurers is quite muted. As an example, there has been Australian dollar flow, although most of it went to central banks, large Japanese accounts and European accounts, with just a bit of interest from Australia.”
But another hindrance to niche currency market access is, say bankers, a refusal by some issuers to sign two-way credit support annexes (CSAs) with swap providers. So any cost saved via a favourable basis swap is more than offset by the costs of finding the collateral for the new issue swap that crystallises the arbitrage.
Under existing one-way CSA arrangements, or where no CSA exists between borrower and counterparty, incoming regulation has meant dealers must pass on the cost of having to find their own collateral when an issuer provides none for the new issue swap in question.
The charges involved make it difficult for issuers to gain market access at cost-competitive levels.
But as challenges develop in some traditional local currency markets, other new opportunities are appearing.
“Local currency markets are expanding and issuers are taking them more seriously,” says HSBC’s Ross. “It’s a one way street on renminbi. We expect it to be the third largest trade currency by 2015. More and more banks, corporations, central banks and sovereign wealth funds are setting up accounts in renminbi so they can warehouse to support investments and trade flow. That will create more issuance and a more liquid swap market.”
But for the time being, the small size of the swap market means that renminbi deals are out of reach for issuers without a funding need in the currency.
“Everybody’s talking about it,” says Tom Meuwissen, general manager, treasury, at Nederlandse Waterschapsbank in The Hague. “But we swap all foreign currencies and at the moment the swap market isn’t very mature. But it will develop and we will closely monitor this.”
But it is not just a matter of picking a currency when exploring alternative markets. There are new formats too. One of the biggest success stories for SSAs in 2013 was the development of the green bond market. HSCB’s Ross believes the market will “explode” in 2014.
“Volumes were $8bn-$10bn in 2013 and I expect that to more than double in 2014,” he says. “Fund managers can attract new cash from green funds, while pension and insurance funds are under pressure to demonstrate a clear socially responsible profile. Even central banks are looking. Investors are mobilising themselves and issuers can see the benefit of being green as part of their public policy role. It’s moved from a niche arbitrage market to the mainstream, with prices clearing at the same level as conventional bonds. That will give us the volume to kickstart the market, although European investors have been a bit slower to react than those in the US and Scandinavia.”
While some SSAs plan to enter the green bond market for the first time in 2014, established issuers are looking to diversify. For instance, the European Investment Bank — which sold its first Climate Awareness Bond in 2007 — plans to extend the product into new currencies this year.
But some bankers suggest in private that growth will be less rapid, particularly as syndicated green bonds require a lot of preparation and do not offer issuers a cost saving compared to conventional issuance.
There can also be a struggle to avoid traditional SSA investors buying up swathes of the paper — rather than allocating bonds to the new pools of liquidity that issuers seek.
Some see a chance to take advantage of demand for socially responsible investments without having to sacrifice allocations to non-specialist investors, however.
Rentenbank — which made its SRI debut with a privately placed €50m seven year renewable energy bond in August 2013 — believes tailor-made private deals are the best way to meet demand.
“With syndicated deals, you never know who is going to buy and you lose a little control over allocation,” says Stefan Goebel, head of treasury at Rentenbank in Frankfurt.
“If general investors receive a large allocation it could disappoint genuine SRI investors. That’s why we think it best to build up a new investor base through private placements and have a direct dialogue with them.” |