AT EUROWEEK’S bonds dinner in 2012, comedian Al Murray coerced London’s finest capital markets bankers into performing the motions to Itsy Bitsy Spider, in the hope that it might remind London’s financial sector of its powers of resilience and determination.
Had he been entertaining solely emerging market bankers, a group performance of Eric Carle’s The Very Hungry Caterpillar might have been more fitting. For after chomping through a variety of debut bonds in 2013 and suffering more than a little nausea in the summer, EM finds itself at a crucial phase in its development. 2014 could see the sector either turn into a beautiful bond butterfly or it could remain an immature grub of a market.
There were many times last year when EM looked as if it was finally ready to spread its wings. As well as the more traditional issuers, investors were last year offered debut paper from African sovereigns, a plethora of new Russian and corporate names, and a broadened range of currencies and structures.
For the first four months of the year these new types of EM deals traded ever tighter. But the market was turned on its head on May 22 when US Federal Reserve Chairman Ben Bernanke sent investors into panic by warning that quantitative easing could soon start to slow.
Some EM bonds sold off as much as 200bp in yield on his announcement.
Many market participants fear that EM will be subject to the same panic attacks when tapering measures are finally put in place this year.
Risk to stability
Economies with large fiscal and current account deficits will be the most at risk from these bouts of stress because of their vulnerability to reduced liquidity. If these economies are unable to borrow as much money on the international markets, consumption, investment or government spending must fall.
If the necessary adjustment is large, there is a risk to financial stability.
Despite those heightened fears though, the final quarter of 2013 was strong in the bond market as fears of rising rates were put to one side. Spreads for many credits returned to inside first quarter levels.
By late November, CEEMEA bond volumes were at $170bn, LatAm at $113bn and total EM at $451bn. All three surpassed the equivalent volumes in 2012, itself a record year.
“Given the volatility over the summer, the volumes in 2013 were good,” says John Wright, a CEEMEA syndicate official at Barclays in London. “After the summer sell-off many investors did exhibit a more measured appetite for risk. That said, the range of EM products executed in the second half of 2013 was impressive, including bank capital, corporate hybrids as well as high yield type names alongside the usual sovereign supply.”
Whether 2014 can carry on the trend of record volumes depends to a large degree on just how disruptive Fed tapering will be. Ignat Dirks, Gazprombank’s head of debt management, says that his bank’s base-case expectation is a moderate pace of QE reduction with the negative effect mitigated by the Fed’s continued low interest rates policy. He sees diversification of funding sources as being key for EM issuers over the coming years.
“In the longer run dollar liquidity could shrink and therefore we are diversifying the currency and regional mix of our wholesale funding,” he says. “For example, last year we placed an inaugural offshore renminbi issue, re-entered in the euro market since our last transaction in 2002 and printed the first deal in the Swiss domestic bond market via our local subsidiary.”
Fast end, slow start?
However, the start of this year could be quieter than usual. As well as potential investor jitters over base rates, countries such as Croatia, Serbia, Turkey and Hungary were unusually savvy in pre-funding 2014 in the last quarter of 2013.
But bankers say there is still plenty of paper left to print in Q1 and that issuers will still want to take advantage of the extra liquidity in the market after the Christmas break.
“There was a lot of pre-funding done in Q4 but it wasn’t excessive,” says Nick Darrant, head of CEEMEA syndicate at BNP Paribas in London. “Poland, for example, only did two deals in 2013 — so we’ll see people being active in Q1 even though QE tapering is looming on the horizon.”
As for the whole year, many are bullish. EM sovereigns have $29bn of net interest and principal redemptions due in 2014, with Barclays’ research team expecting them to issue around $94bn in new hard currency bonds in 2014, an increase of more than 20% from likely 2013 supply.
Ray Zucaro, a portfolio manager at SW Asset Management in California is among the optimists. “The EM primary issuance volumes are going to grow in 2014, it’s just the degree of that growth that’s under question,” he says.
Beyond the volumes, the list of banks aggressively chasing the business is evolving fast. Local banks such as Russia’s Sberbank CIB and VTB Capital, National Bank of Abu Dhabi and Brazil’s BTG Pactual have been taking larger slices of the EM bond pie in the last few years. Japanese banks, such as Mitsubishi and Nomura, have also been pushing harder both in lending and bond arranging. Meanwhile, competition has also come from unexpected corners such as Italy’s Banca IMI.
But there have been some casualties too. At the end of 2013, Credit Suisse took an axe to its EM trading team, a move that many observers believed signalled a further retreat by the Swiss bank from the emerging markets business.
The net result has been that those at the top of the league tables saw their market share grow in 2012 as some big competitors fell away. In CEEMEA, Citi’s share of the bond business rose to 10.49% from 9.31%, Deutsche to 11.19% from 8.03% and JP Morgan to 15.39% from 9.15%.
“EM is a profitable business if you are in the thick end of the wedge,” says Darrant. “If you are in the thinner end where you are either trying to enter the business or only taking on niche trades, it’s much harder, and some of those banks are dropping fees to try to gain market share. For those that aren’t in the flow of being one of the top five or six banks, it’s often an unsustainable business model on a standalone basis.”
CEEMEA sovereign deals are typically done for very low, sometimes zero, fees. Debut corporates or highly structured trades pay more, but those mandates are easier to win for banks that have done enough flow business to be near the top of the league table.
“You have to take a portfolio approach,” said Darrant. “If you try to be purely opportunistic it just doesn’t work as the business is just too competitive.”
Investing in EM bonds has always been a matter of finding diamonds in the rough. But the sifting process became even more laborious as yields came crashing down at the start of last year.
Though yields rose in the summer volatility, they are still low by historical standards, and with growth slowing in emerging markets, the EM world’s familiar mantra that it is the only asset class where investors are paid properly for holding risk started to look shaky.
But investors and bankers say that there are still opportunities and generalising about slow growth across the whole asset class is unfair. In Russia last year, for example, growth was at a sluggish 1.5%-1.6%, but in Nigeria it was around 6.8%.
“With interest rates moving towards a long term equilibrium, the higher yielding emerging market names are more attractive,” says Zucaro. “We are underweight the high rated long duration names, but we think the short-dated, high yielding paper is poised to do better, as it’s less sensitive to US Treasury risk.”
Others point out that while EM has rallied, so too have other fixed income asset classes, leaving EM still looking relatively alluring.
“We’ve seen the rally more in other asset classes,” says Richard Segal, an EM credit analyst at Jefferies in London. “For the ratings, EM yields still look good versus other bonds. And geographically they still offer diversity to investors who haven’t previously looked at these regions.”
That desire for diversity has prompted investors and bankers to suggest that some new geographies may open — and some dormant ones re-open — in 2014. Ukraine’s sovereign and its corporates and banks will be expected to return if the country can resurrect its free trade deal with the European Union. Ukraine had been due to sign the trade agreement at the end of an EU summit in Vilnius, Latvia, on November 29. But just days before the signing, Ukraine’s President Viktor Yanukovych said the deal’s terms would need to be improved before his country put pen to paper. The European Union was quick to accuse Russia of pressuring Ukraine to walk away from the deal.
The Kazakhstan sovereign is also expected, and some think a return of its banks in bonds may be imminent after Kaspi Bank tapped the market for $200m in October, although for many investors Kazakh bank paper might still be too much of a stretch.
More welcome will be Turkish debut corporate issuers — rumoured to be looking to tap the market — and deals from sub-Saharan African borrowers who are expected to step up their activity in the international capital markets in 2014.
The types of instrument will also continue to develop and expand. As well as a more sophisticated use of the private placement market (see box), banks across the region will press on with introducing new structures to investors in the form of Basel III compliant subordinated paper.
Meanwhile, 2013 also saw corporate hybrid trades — a first for the market — from MAF and GEMS in the Middle East, a trend that will strengthen in 2014.
“Many EM issuers face identical pressures to those investment grade names in Europe or the US,” says Wright. “Bolstering capital levels and protecting IG ratings drove new-style bank capital and corporate hybrid trades in EM last year — their successful execution is testament to the development of the space.”
In some instances further clarity may provide the trigger for more structured debt, for example the involvement of Russia’s Deposit Insurance Agency in the writedown of subordinated bank debt.
“The questions over the deposit insurance agency trigger are critical for the Russian sub debt space, but ironing out these details happens everywhere,” says one syndicate official in London.
“In Europe there was pushback from investors who had never really had to consider a writedown scenario before. It’s unsurprising we’re seeing the same thing in Russia.”
Local currency markets remain unattractive for the foreseeable future because of exchange rate volatility.
But the euro market was flourishing at the end of 2013 as the Fed tapering expectation was played off against the still dovish European Central Bank stance. Many believe the common currency could hold exciting opportunities for issuers in 2014, having already enticed issuers such as Russia, VEB, Mexico, Gazprombank and Turkey in 2013.
“The proportion of euro trades is increasing as European investors increasingly engage with EM,” says Wright. “The broadening investor base and improved basis swap enabled issuers to achieve genuine diversification with competitive pricing and size to that offered in dollars last year.”
The differential between euro and dollar deals had narrowed to an average of 10bp-25bp by the end of November for CEEMEA issuers, but in some cases, for example Gazprombank’s deal in October, borrowers were able to price inside their dollar curve.
With sovereigns having set new benchmarks in euros, their corporates and banks could also branch out into the currency.
Dirks at Gazprombank says that in Russia about 20% of all international debt issuance in 2013 was denominated in euros compared to only 4% in 2012.
“Generally, we expect this proportion to be maintained in 2014,” says Dirks. “At the same time, some portion of supply is sensitive to basis swap movements and as a result is less predictable.” |