The escalation of the Eurozone crisis has heightened European sovereigns focus on diversification, especially for issuers with the largest funding programmes. Most market participants expected these borrowers to target currency heterogeneity, but countries like Germany or France have deemed investor base diversification i.e. attracting more overseas buyers safer than venturing into markets not as deep as the euro sector. Instead, it has been the smaller and arguably more nimble borrowers that have been able to take advantage of non-core markets.
The quest for more foreign investors is the continuation of a trend that started in the pre-crisis era. According to the Banque de France, for example, foreign investors holding French government debt has more than doubled since the implementation of the euro. This proportion increased from around 30% in 2000 to 67.7% in 2011 year to date.
Those sovereigns that have maintained a niche currency presence in 2011 have been non-core European countries or those with smaller, more flexible funding programmes, such as Austria and Poland. "One-off trades in non-core sectors often work best for sovereigns with smaller funding programmes," says Bill Northfield, head of SSA origination at Deutsche Bank. "If you have 200 billion to raise, your teams are far more focused on the domestic funding programme."
Some of the most appealing niche sectors for this borrower category have been Swiss francs, Norwegian kroner and Japanese yen.
Swiss franc sovereign issuance, although no longer reaching annual levels above Sfr2bn like it did in the early 2000s, has remained consistent. Larger European sovereigns no longer tap this market due to an unfavourable basis swap, but the Swiss investor base and the currencys connection to the euro still make this market appealing for countries like Poland.
Poland has tapped this sector regularly since 2007. The CEE sovereigns overall Sfr6bn issuance volume is second only to Italys in the segment since 2000. Italy has priced Sfr12bn since 2000.
Italy and Austria tapped the Swiss franc sector regularly until 2002 and 2006, respectively, when they still kept Swiss franc proceeds unhedged. The two countries became less active after implementing new policies to reduce currency risk.
Since 2008, an expensive cross-currency swap has deterred some of the larger European sovereigns from tapping this sector. Volatility in the euro/franc exchange rate has discouraged borrowers which do not swap proceeds back into their home currency. The soaring franc exacerbated the problem, especially when it reached its appreciation peak this year at Sfr0.97/ on August 10.
Minnows head for Switzerland
But the francs connection to the euro, reinforced by the Swiss National Bank having set a minimum exchange rate of Sfr1.20 per euro this year, remains an attraction to smaller EU sovereigns. "The advantage of the Swiss franc market used to be the currencys correlation to the euro," says Anna Suszynska, deputy director in the public debt department at the Ministry of Finance in Poland. "Although the franc has diverged significantly from the latter, rates are still lower and more attractive than in the euro market."
A drought of European sovereigns tapping the Swiss franc market has not worried domestic investors, who, like many others, are shying away from this jurisdiction and opening up to more exotic borrowers. "EM issuers such as Asian and Latin American sovereigns would be very interesting for Swiss investors," says Thomas Gessner, senior Swiss franc syndicate trader at Deutsche Bank in Frankfurt. "Buyers would prefer them to EU names right now."
The nature of the investor base access also dictated Polands choice to tap the yen sector. "We have targeted these markets to look for something which all borrowers want rich, buy-and-hold investors," says Suszynska.
Polands yen presence is also part of a larger, long-term project to increase the countrys visibility in Japan. "Our yen presence serves more a general marketing purpose for Poland," says Suszynska.
Foreign direct investment (FDI) by Japanese names in this country is on the rise with companies such as Toyota having already established a Polish presence. "In a co-ordinated action with the [ministry of finance] FDI bureau, we hope that by promoting our country in this market we can strengthen the Japanese corporate presence in Poland," says Suszynska.
Austria is one EU sovereign that has remained active in the niche segment this year. Its relatively modest 16bn-19bn funding target for 2011 gave it the flexibility to explore new strategies.
Austria picked the Norwegian market to issue its first MTN since 2002 this year a Nkr1.75bn five year private placement priced in October.
The Norwegian krone sector has recently become one of the strongest niche markets, especially in the sovereign, supranational and agency segment. With annual krone issuance having increased from Nkr31.85bn in 2009 to Nkr42.03bn in 2010 to Nkr60.37bn year to date, the sector has proven itself as a reliable alternative to core funding.
Safe haven status, consistent retail and institutional demand, funding costs 10bp inside core markets and limited government supply have attracted a flood of SSA names into the currency this year. Domestic as well as a growing number of foreign investors have turned to Norwegian kroner as one of the safest investments as the European story turned sour.
"Central banks have started looking at the Norwegian krone as a proxy currency for the euro which does not entail the same risk," says Nigel Owen on the syndicate desk at RBC CM. "It has become the next safest haven alongside the Swiss franc but this years appreciation problems with the latter further increased the appeal of the Nordic krone."
Investors ravenous bid for the currency could even open doors to lower rated sovereigns. "We do not believe this space is reserved for only triple-A rated sovereigns as we have seen so far," says Kamal Grossard-Amin, head of frequent borrowers origination at Nordea. "The market can clearly attract other borrowers going forward."
Sovereign issuance has remained limited in other prominent non-core sectors this year. In the case of the Australian dollar market, investors find more value in agency names and sovereigns find funding costs unattractive. "Many investors are more yield sensitive in these low rate environments and some are cautious on the prospects of the euro," says Northfield. "If they can buy a World Bank or an EIB at a cheaper spread than European sovereigns on an asset swap basis, theyll do it."Austria is the only borrower with outstanding bonds in the currency.
For the larger issuers, the plan has been to broaden the number of investors buying the domestic currency, however. The US is set to broaden its investor base away from the typical domestic buyers and Asian central banks. "The US Treasury has been looking at new products such as callables and FRNs," says a head of sovereign capital markets at a bank. "It will potentially announce them in three to six months time."
Limiting diversification to their investor bases rather than currencies has allowed the largest European sovereigns to focus on domestic, deep markets providing sufficient liquidity a feature ever more necessary amid unpredictable markets when borrowers are trying to minimise funding targets. "We are in an austerity-dominated world," says Ulrik Ross, global head of public sector, debt capital markets at HSBC. "Sovereigns are trying to contract their borrowing programmes, not to increase their funding buckets."
Sovereigns have also focused on domestic issuance to satisfy investor demand for safe debt instruments. "In such a stressed market, investors will pick the domestic, more liquid product even if that means not gaining exposure to a foreign currency offering a more suitable match to their portfolio," says Jamie Stirling, co-head of the frequent borrower group at the Royal Bank of Scotland. "Liquidity is the key concern. If investors had to choose between a European sovereign in either euros or Norwegian kroner, theyd likely buy the more liquid instrument euro notes."
Moreover, issuing in non-core sectors limits sovereigns to small deal volumes a funding strategy not considered worthwhile by issuers with large programmes in such strained markets. "People are not experimenting nowadays," says Ross. "They dont have room for it."
Larger niche markets like the Australian dollar sector still have restricted scope for volume. "The Kangaroo market is not one in which you can issue transactions over A$1bn all the time," says Enrico Massi, head of DCM at RBC CM in Sydney. "On average, one can expect issues between A$300m and A$750m."
Issuing in niche currencies can also be time-consuming and costly. "There has to be a rationale and justification for costs, visits and efforts when we choose to issue in a niche market," says Suszynska at the Ministry of Finance in Poland. "We do not opt for one-off trades."Sovereigns that face large funding programmes could also consider investor participation in niche markets too unreliable compared to benchmark sectors. Momentum in the Australian dollar market this year, for example, has deteriorated sharply as the Eurozone crisis intensified. While SSA Kangaroo issuance reached a record breaking A$6.45bn in January alone, the market has slumped to a deal a week at the lower end of the size spectrum in recent months. "If anything, we have learned that you cannot rely on a single market," says Ross. "If one wants to invest in the major minors, it has to be a combination of them."
EM goes international with domestic issues
But this new trend has also benefited international buyers, providing them with new means of diversification. "Investors have the chance to get exposure to the currency they believe in, in a government bond format," says Ross.In the EM world, syndicated domestic issuance has increased from $9.8bn in 2010 to $12.5bn year to date among the minor niche markets. Russia, Mexico, Philippines, Thailand and Hong Kong have been the top issuers in 2011. The latter two issued debut inflation-linked notes this year.