ESM ready for crucial test in 2013

Europe’s new and improved bail-out vehicle, the European Stability Mechanism, is set to take over from the European Financial Stability Facility to deal with any new sovereign bail-outs this year. But although the ESM has a simpler structure than the often confusing EFSF, its task will not be easy. It has to contend with an enormous borrowing requirement and a tough economic outlook for the Eurozone. Tessa Wilkie reports.

  • 21 Dec 2012
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The European Stability Mechanism is the new, hotly anticipated, supranational borrower on the block this year. Its wait for someone to lend to ended in December, when Spain officially asked it for a €39.5bn bail-out for the recapitalisation of its banking sector.

The ESM will not need to raise cash for this: instead it priced €39.468bn of bills and floating rate notes on December 5, which it will pass on to Spain’s Fund for Orderly Bank Restructuring (FROB). The notes were not funded in the market.

But the issuer is now ready to enter the market. Spain is expected to apply for aid in the first quarter of 2013. The most the ESM is likely to need to borrow for Spain this year would be €60bn — half of the sovereign’s funding need for the year.

When the ESM does look to borrow in the capital markets, bankers advise it will be best starting with a five or 10 year euro trade, depending on market conditions at the time, to capture the widest range of investor demand but still offer some yield.

If the issuer manages to get enough investors on board by the time it launches its borrowing programme, it should price between the European Financial Stability Facility (EFSF) and the European Investment Bank (EIB). Towards the end of 2012 the EIB was trading at about swaps less 13bp in five year and the EFSF was at about 15bp over.

For one thing, the ESM has a simpler structure than the EFSF. The ESM will have €80bn of paid-in capital by 2014 as well as €620bn of committed callable capital, rather than being backed by a complex system of guarantees which the EFSF has. Its total subscribed capital should exceed its maximum lending capacity of €500bn by 40%.

"We understand that the ESM would have access to a wider range of investors as the structure is more straightforward and is simpler to understand," says Christophe Frankel, chief financial officer and deputy managing director of the ESM and the EFSF. "It will be easier for many investors to buy the paper."

OMT support

For another, its actions will be supported by the European Central Bank’s Outright Monetary Transactions scheme. The ESM has the capacity to make loans to a struggling sovereign, but the most likely method of support for Spain will be the ESM buying its bonds in the secondary market to help Spain maintain its own access.

"Investors were concerned about the size of the EFSF and ESM funds in 2012, but the game changer was the announcement of the OMT in September," says Julien Seetharamdoo, senior macro and investment strategist at HSBC Global Asset Management in London. "The ECB carries a big stick and the fact that it will support ESM operations has allayed fears about the effectiveness of the ESM."

But the issuer’s success will not depend on capital markets nous and a structure that is easy to explain to investors, or the ECB buying alongside it. The key factor will be the wider economic backdrop in Europe.

While GDP growth for Germany and France will be positive, at 1.1% and 0.5% respectively, according to UniCredit analysts, it will be -0.7% in Italy and -1.4% in Spain.

"There will be break points in the market this year — for example they could be set off by a poor fundraising effort from Spain or a strong showing by the anti-bail-out party in German regional elections," says Georg Grodzki, head of credit research at Legal & General Investment Management in London.

"There should also be more economic and fiscal disappointments and European sovereign ratings will suffer. That will force the market to review the true qualities of the EFSF and the ESM. There isn’t much difference between the credit quality of the two. They are equally doomed to suffer a slow decline in ratings."

A foretaste of what might happen came late in November when Moody’s downgraded both the EFSF and ESM to Aa1, following its downgrade of France to the same level earlier in the month — although the downgrade had little immediate impact on the sovereign’s secondary levels.

And given its nature as a bail-out borrower, it is likely to launch its debut when times are difficult.

"If a sovereign does request assistance, then you would assume that would be in a difficult and volatile market," according to PJ Bye, global head of SSA syndicate at HSBC in London. "Then the big question is, once one sovereign asks, does that make other sovereigns more vulnerable? If the market feels it does, that could be quite destabilising."

Tough love

But Maria Fekter, Austria’s minister of finance, is confident that the bail-out vehicles’ combined firepower of €700bn, plus the support of the European Central Bank’s OMT scheme, will be sufficient to support Europe’s struggling economies — but only as long as political and regulatory measures are enforced alongside them.

"The bail-out funds can be powerful at the margins, but money and credit alone will not solve the underlying problems," she tells EuroWeek. "So, first we need strict observance of the European Union framework."

She would like to see measures such as integrated macro-economic surveillance, for example the reformed Stability and Growth Pact — which imposes penalties on EU member states if they break rules on maximum deficits or debt to GDP — to support this. And she would like to see legislation designed to prevent and correct macroeconomic imbalances — such as the Macroeconomic Imbalance Procedure — implemented promptly when needed.

"The Single Supervisory Mechanism (SSM) and the related financial sector regulation, including the introduction of a broad-based financial transaction tax, should also help to contain risks and to develop a new source of financing the costs," she says.

Fekter also wants the ESM to be strict on conditionality when it comes to sovereign bail-outs.

"I tend to believe that ‘brutal’ but short adjustment periods (for example in Estonia and Latvia) serve a country better than protracted periods of shrinkage and stagnation, which discourages the labour force and capital alike," she says. "Moreover, there is a tendency to underestimate the structural problems of the countries concerned and thus the ‘medicine’ tends to be too weak."

Flexible qualities

The European Financial Stability Facility’s fundraising risked turning into a farce late last year when the borrower was forced to pull a three year benchmark because France was downgraded immediately after the EFSF mandated. The issuer’s long term rating was plunged into uncertainty and left it unable to issue until its own long term rating was resolved.

But unlike late 2011, when a dog of a deal from the borrower closed down markets for the rest of the year, the EFSF was nimble enough to change tack and look to its unchanged short term rating.

It launched a 364 day deal a week later and was rewarded with €9bn of orders, enabling it to get a €7bn trade away that not only finished its funding requirement for the year but ate into some of its 2013 target too.

"The success of the deal and the demand that we saw for the potential three year shows that the impact of sovereign ratings actions on demand for the EFSF is really minimal," says Frankel.

This year should be easier for the EFSF, as it shouldn’t have to take on more lending. According to Frankel, the issuer has around €40bn to raise in 2013, and it has the capability to borrow up to 25 years in maturity. It also plans to work on establishing liquid benchmark points across the curve from three to 25 years.

He is confident that he and his team will be able to manage two hefty borrowing requirements, as the same team manages both the ESM and the EFSF.

"We have the same team managing both issuers," he says. "We will manage the calendar very carefully."

EU to shine

The European Union, however, is set to steal the limelight from the EFSF and ESM when it ventures to print. It will combine a long established borrowing programme with scarcity value — it only has around €5bn to fund this year — and top credit quality. Its only potential hiccup would be if its borrowing costs drop too low.

"The only concern you might have for the EU is whether there is enough demand given where yield levels were," says PJ Bye at HSBC. "That was totally disproved by its 15 year late last year. That paid a coupon of just 2.5% and yet the EU managed to get €3bn away and a heavily oversubscribed book to boot."
  • 21 Dec 2012

Bookrunners of International Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
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1 Citi 38,857.97 184 9.39%
2 HSBC 38,447.58 227 9.29%
3 JPMorgan 34,744.34 142 8.40%
4 Bank of America Merrill Lynch 28,556.15 119 6.90%
5 Deutsche Bank 18,270.77 72 4.42%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 13,268.07 33 6.30%
2 Bank of America Merrill Lynch 11,627.56 29 5.52%
3 Citi 11,610.06 30 5.52%
4 HSBC 10,091.34 29 4.79%
5 Santander 9,533.17 25 4.53%

Bookrunners of CEEMEA International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 Citi 13,617.40 57 11.05%
2 JPMorgan 12,607.77 55 10.23%
3 HSBC 9,327.72 50 7.57%
4 Barclays 8,643.78 30 7.02%
5 Bank of America Merrill Lynch 6,561.15 18 5.32%

EMEA M&A Revenue

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 02 May 2016
1 JPMorgan 195.08 50 10.55%
2 Goldman Sachs 162.26 37 8.77%
3 Morgan Stanley 141.22 46 7.64%
4 Bank of America Merrill Lynch 114.20 33 6.18%
5 Citi 95.36 35 5.16%

Bookrunners of Central and Eastern Europe: Loans

Rank Lead Manager Amount $m No of issues Share %
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1 UniCredit 3,966.12 27 13.01%
2 SG Corporate & Investment Banking 2,805.90 16 9.20%
3 ING 2,549.27 20 8.36%
4 Citi 2,526.98 15 8.29%
5 HSBC 1,663.71 16 5.46%

Bookrunners of India DCM

Rank Lead Manager Amount $m No of issues Share %
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  • 19 Oct 2016
1 AXIS Bank 5,944.45 123 18.53%
2 HDFC Bank 3,792.05 100 11.82%
3 Trust Investment Advisors 3,390.86 145 10.57%
4 Standard Chartered Bank 2,299.63 31 7.17%
5 ICICI Bank 1,894.86 51 5.91%