Corporate issuers, well funded and mostly steering clear of ambitious M&A projects, have had limited need for debt capital markets financing in the last year. But when they have tapped the market, niche currencies have played a more important role than before. The low rate environment in core currencies is driving investors, especially retail, to look more closely at smaller markets.
"European rates are at historical lows and investors require yield," says Andrew Nicola, head of the EMTN desk at Commerzbank. "They also see the play on rates as an opportunity to make carry."
Volatility in core markets has also sharpened niche currencies rarity value. Corporate issuers are looking to tap different investor bases and also welcome the ability to issue smaller deal sizes.
Investors too have developed a heightened perception of risk. One result has been a greater differentiation within the niche currency universe than previously.
"There are two sectors in the niche currency market: the first involves Swiss francs, Australian dollars and the Nordic currencies, which offer a slightly higher yield compared to euros and US dollars and a currency bid to investors," says Quentin Renaud, head of niche currency Eurobonds and MTNs at BNP Paribas.
"The second is comprised of currencies offering almost double digit yields, such as the Brazilian real and the South African rand, as well as much higher volatility."
Institutional investors, the part of the buyside that is most sensitive to risk, are ever more selective in their choice of asset class and currencies. says Renaud. "If they play the currency risk, they will look at triple-A names."
Although the eurozone crisis has benefited corporate supply flows in niche currencies, it has also made investors increasingly aware of the danger of appreciating currencies. "Given the eurozone tension and the domestic inflation pressures, currencies that have rallied significantly, such as the Brazilian real and South African rand, are encountering additional risk-aversion from international investors," says Renaud.
The Brazilian real has appreciated sharply over the last two years, for example, strengthening about 20% to reach a level of R$1.5965 to the US dollar. The speed and strength of this performance is proving too much for some. There was only one foreign corporate issue in reais in 2010 (Anheuser-Busch) and there have been none in 2011 so far.
"The real has massively performed over the last two years and many investors are waiting for a cheaper entry level," says Renaud.
Domestic demand cannot be relied upon either, as Brazilian investors will only buy offshore paper that offers a pick-up over the government spread.
"Local investors do not typically participate because the relative value versus domestic issuers is not compelling," adds Renaud. On top of that, the real is not deliverable, leading to difficulties in swapping it back.
In 2010, the Australian dollar market was the go-to currency for corporates because of a favourable cross-currency swap and strong economic fundamentals. But the Australian currency has rallied sharply this year, breaking through parity with the US dollar and now trading at about $0.94. Twelve months ago it was at about $1.15.
"The currencys strengthening gives little scope for currency appreciation, limiting investor benefits on the foreign exchange play," says Nicola.
Oversupply in 2010 has thinned corporate issuance in 2011 and public sector names have taken centre stage instead. "There has been excess supply of deals and market indigestion," says Renaud. Consequently even the basic economics have started becoming unfavourable for corporate issuers. "Heavy supply has put the basis swap market under pressure," says Nicola.
The Swiss franc has also experienced a strong rally, hitting a record high of Sfr1.227 against the euro in late May. But the perception of the market as the closest proxy to the euro in terms of dynamics has helped to drive foreign corporate issuance, despite currency appreciation. It also makes it
the first to benefit from eurozone worries.
"The shake-ups in the eurozone could push corporates away from the euro market towards alternative currencies, such as the Swiss franc market," says Slaven Maligec, head of Swiss franc syndicate at BNP Paribas.
There was a surge of domestic corporate issuance in May, with some Sfr1bn raised in 10 days. But foreign borrowers, although not frequent, have been important in this years corporate issuance. Energias de Portugal issued its debut Swiss franc bond in February a Sfr200m three year note and Italys Enel returned to the market in June after a 25 year absence with a dual tranche deal a Sfr150m 4.5 year and a Sfr100m nine year.
Domestic demand for corporate paper is also very strong, as other asset classes typically dominate the market. "The Swiss franc market suffers from an undersupply of foreign corporate paper as most deals are covered bonds, SSAs or financials," says Andreas Tocchio, a syndicate manager at UBS.
And given that the market has been mostly made up of well established investors buying regular domestic borrowers, the investor base is able to digest new issuers, according to Nicola. Russian and Indian triple-B financial paper has been snapped up, for example.
But although demand for corporate paper is high, Swiss franc supply has decreased since last year because of unfavourable market conditions. The cross-currency swap, low absolute yields and tight spreads have all combined to create an environment in which it is tough to achieve big deals.
But a shift in the cross-currency swap is all it would take for the situation to change. "The current cross-currency basis is not in favour of the Swiss franc, but corporates will come to market as soon as there is a positive shift in the swap," says Maligec. "There is a deep pool of retail demand readily available."
Autos turn north
The theme in the Norwegian and Swedish currency markets this year has been the flow of auto trades from Daimler, BMW and Volkswagen.
Daimler issued its debut Swedish krona deal in early June a Skr750m three year note following trades from the other two German companies.
"There is competition between them. They are all in Germany and similarly rated they dont want to be the one to miss out," says Nigel Owen, vice president on the Syndicate desk at Royal Bank of Canada, which led a Swedish krona trade for BMW in June, a Skr1bn three year note.
Although the Nordic markets offer less attractive yield levels compared to other niche currencies, their healthy economic image has sustained demand. "The Nordic currencies offer lower yields compared to the Australian dollar market, for example," says Renaud. "But international investors are still relatively bullish on the Swedish and Norwegian currencies."
In addition to investor diversification and the opportunity to fund locally any business in Norway or Sweden that an issuer might have, strong foreign corporates save around 10bp in funding costs compared to the euro market.The Nordic currencies also offer the chance to tap an unusual investor base as it is domestic buyers that dominate the market. "[Issuers] can do it because they are blue-chip, high street, retail names, which always appeal to investors." Nordic markets also offer foreign corporates more flexibility in terms of deal size and tenors, with structures that would not be feasible in core markets.
RMB niche, but for how long?
"The offshore renminbi market will be one of the main stories over the next few years," says Andrew Nicola, head of the EMTN desk at Commerzbank.
With Hong Kong depositors having to put up with miserly returns, the potential for demand for offshore renminbi paper is enormous. "Hong Kong investors will snap up any foreign corporate bond to escape their less than 1% returns on domestic bank deposits," says Anthony Bryson, head of corporate DCM at BNP Paribas.
Proof of this demand was the reception to Unilevers Rmb300m bond in late March, which saw Rmb3bn of orders in less than three hours.
Interest is growing among foreign corporates in the offshore renminbi market as a means of financing operations in mainland China. "If you have corporates investing long term in China, then there will be a natural demand for issuance in the form of bonds, in addition to bank financing," says Bryson.
This year alone, there have been deals from McDonalds, Caterpillar, Unilever and Volkswagen, among others. Caterpillar is set to continue its strategy despite regulatory obstacles.
"Caterpillar Financial has a strategy of match funding its local asset portfolio with local currency funding," says Jim Duensing, executive vice president and chief financial officer at Caterpillar Financial Services.
"We can achieve this objective through funding in the new dim sum bond market in Hong Kong, subject to China regulatory approval in advance of issuance."
Indeed, the only matter holding back the flood of issuance in the market is the intricate regulatory framework set up by the Chinese government that complicates the transfer of funds raised in the renminbi offshore market to mainland China.
"The main challenges for corporates in the offshore renminbi market is how to get the money onshore," says Bryson. "The Chinese authorities are still imposing an array of regulations." He sees the market as typical of one in its early growth stages, with liquidity challenges and a lack of