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LBBW SSA Roundtable: Can SSA market get any better for issuers after a stellar 2017?

After a superlative funding year for eurozone public sector borrowers, thanks partly to the European Central Bank’s asset purchase programme, some of the region’s top issuers and investors discussed with GlobalCapital the outlook for 2018 — when the ECB will start halving its monthly purchases to €30bn.

While there seems to be less political risk lying in wait than there seemed at the start of last year, there are still some potential disruptors ahead, such as Italian elections.

The pricing of SRI bonds, as well as new regulations and technologies, such as blockchain and processes to automate bond issuance, also inspired vigorous debate among the roundtable participants.

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Participants:

Tim Armbruster, head of group treasury,  FMS Wertmanagement

Carlos Ferreira da Silva, head of euro funding, European Investment Bank

Philip Hertlein, head of SSA syndication and origination, LBBW

Tom Meuwissen, general manager, treasury, Nederlandse Waterschapsbank

Jozef Prokes, portfolio manager, BlackRock

Siegfried Ruhl, head of funding, European Stability Mechanism 

Petra Wehlert, head of capital markets, KfW

Craig McGlashan, moderator, GlobalCapital 

globcap
: How was 2017 for issuers?

Siegfried Ruhl, ESM: It was a very special year for us with a lot of funding needs — €60.5bn in total for both [the European Financial Stability Facility and the ESM]issuers. Especially under the EFSF, we had a lot of long-term funding needs to execute the short-term debt relief measures for Greece. 

We had strong demand in 10 years and longer, up to 40 years, where we did nearly €30bn. Spreads are performing. You issue and spreads continue to perform. It shows there’s plenty of liquidity and investment needs, and on the other hand it shows that even while everybody knows that at one point tapering has to come and the ECB policy has to change, the ECB was able to build a lot of trust in the way it executed this programme so far and investors trust the ECB will find a smooth way to unwind it. 

The ECB announced in October that it would continue QE until September 2018. If you take into account the planned €30bn a month of new money plus the reinvestment of the upcoming redemptions, we will continue with this spread environment for a while. 

In general, the market looks much better than 12 months ago, especially in euros. There was a lot of political uncertainty 12 months ago, with upcoming elections in France and the Netherlands, which all ended up going fine. Also, the macroeconomic data for all euro area member states show growth. So I’m quite optimistic for 2018. 

Petra Wehlert, KfW: Overall we funded nearly €77bn and the euro share was very high, about €40bn. But this is in the context of the overall market. Euros is our home market, it’s the currency we raise for our loan business and is where we have the broadest investor base.

Five out of six of our euro benchmarks in 2017 were €5bn, at the top end of our €3bn-€5bn range. That shows demand was very good. Our euro funding was longer than usual, at over eight years, while our dollar funding was much shorter at 3.5 years. 

We’ve moved from issuing across the whole curve up to 10 years in both euros and dollars to being short dollars and long euros because we take the market as it is. I have mixed feelings about that long term, because for the overall strategy it makes sense to deliver full curves. We’ll see how it looks in 2018.

Tim Armbruster, FMS-W: In the face of investor interest and a favourable market environment we did a lot of prefunding in 2017, especially in euros. In total we funded over €19bn. The focus was on euros, on around 48%, with the rest split between dollars (33%) and sterling (19%). The euro funding with durations between two and three years was prefunding because by 2019 we’ll have the opportunity to get euro liquidity directly from the German sovereign debt agency. This was possible due to a change of the Financial Markets Stabilisation Act in 2016. 

The market environment is of course in favour of us. The ECB will take a little bit longer to end QE than the market is expecting. You can see that, especially with the PSPP, the ECB is very cautious to take steps because it does not have experience with these actions.

If the ECB had known that there would have been zero market reaction to announcing the halving of the €60bn a month buying, it would probably have cut by even more. But it’s very much a learning process on how the market reacts.

globcap
: Is it fair to say the ECB has the advantage of looking at how the Fed tapered QE and can use that as a lesson?

Philip Hertlein, LBBW: There’s a strong view that the ECB has had the benefit of looking at the steps the Fed implemented in the US. It’s seen the market reactions from the process of the Fed’s tapering, with the Fed roughly four years ahead of the ECB in terms of implementing monetary policy tools in this cycle.

People do extrapolate views from that as to when the ECB would take actions. Assuming the economy grows at the speed it’s doing now, then yes, the Fed is a good case to look at.

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Jozef Prokes, BlackRock: The ECB has had a number of press conferences where people were left scratching their heads, thinking, ‘I’m not quite sure what they were trying to tell us’. But the broad steps are quite clear and it’s becoming clear that the inflation target is going to be approached benevolently as long as we are in strong economic growth. 

So it is not a huge surprise that it is decreasing the amount of purchases. But when the next QE deadline comes in September 2018 we will again have a similar inflation picture to where we are today. There is a bit of hope for a little more optimistic outlook, but I don’t think it will change greatly. So we will again be debating how strong the economy is and what the correct steps for the ECB are.

Both the ECB and Fed have tried untested policies, but there is a huge difference. Unlike the Fed, the ECB has had negative interest rates, which for me are the real unconventional policy, as opposed to the asset buying. We will see some form of QE as normal monetary policy in the future, versus the real nuclear option of negative interest rates.

That’s by far the bigger question. How will the ECB get out of that policy? It has been criticised for it and there’s been a lot of back and forth between the ECB members, also publicly, in terms of how capable or incapable individual governing members are able to sell the policies in their individual countries. 

What came to me as a surprise was that the ECB started unwinding the balance sheet measures by decreasing its purchases, but my feeling was that the real consensus — also on the ECB staff side — is that the negative interest rates need to be taken care of at some stage as it’s causing unwanted issues in the market. 

The ECB has made sure that any discussion about day-to-day interest rates going back to more normal levels is out of the question before it fully finishes the net asset purchases. That’s been communicated by the higher up members in the governing council and it’s been reiterated by Draghi that interest rates will stay at present levels for an extended period. 

But if you look at the PSPP composition or the impact on the asset classes, supranationals are getting by far the best deal from the decreases of net asset purchases compared to the other asset classes under the programme.

The lowered issuance expectations from EFSF and ESM combined in 2018 is helping to a degree there, but we are seeing the least impact on net issuance in that sector compared to core or non-core government bonds and so on.

Liquidity is the biggest surprise for me. We went through this exuberant phase after the PSPP was announced. I still keep a SWIFT confirmation on my desk when we sold EFSF bonds at a level inside Germany. But then we went into a near liquidity black hole. You couldn’t transact. You couldn’t buy or sell €5m for a protracted period of time. That has, for some reason I can’t specify, completely reversed. Supranationals have become a really liquid market. You can trade €150m tickets in and out without big problems. I don’t understand where we have found this liquidity. 

If I’m concerned, it’s not necessarily about the impact from a decrease in PSPP purchases or an unclear outlook for issuance. SSAs are less prone to taking advantage of market conditions by upscaling their issuance programmes because they have specific limits, unlike corporates or even sovereigns that can react quite quickly in terms of increasing their debt plans. 

But I still don’t understand where we find this abundance of liquidity given that we have not really rebounded to pre-CBPP levels in the covered bond sector. We are enjoying OK liquidity in the corporate world, but SSA liquidity has improved a lot — more than even sovereign liquidity — so the worry for me is that it all suddenly goes away because it’s almost unexplainable why there is so much balance sheet being put into use.

One explanation in the long end may be that many investors misread the strategy from EFSF and ESM. They had been positioning for steep curves way too late and then for way too long and were caught on the wrong side of the trade. They were too short when they were supposed to start covering. It explains the moves of the spreads, why you can transact in the long end better, and why you can issue bonds all the while at a very attractive level, but it doesn’t really tell me why I’m able to trade supranationals at literally multiples of the amounts of the other markets. 

It can’t be that efficient for the banks to provide a balance sheet for supranationals and not for the other markets, but I don’t have an answer why that should go away. It’s just something that we keep at the back of our minds — that it was unusually bad, now it’s unusually good, so it should revert to something that is normal. 

Ruhl, ESM: I agree we have good secondary market liquidity. But that it used to be poor is not in line with our figures. We have 40 banks in our market group reporting on secondary trades and they exclude the PSPP trading. The real trading has been at €30bn-€35bn per quarter throughout the lifetime of PSPP. There is some seasonality of course, but the volumes are quite stable. 

Carlos Ferreira da Silva, EIB: There was an initial shock effect from PSPP. This coincided with a 10 year trade we brought where the Bund spread was 5bp, which historically was very low. But afterwards our syndications and secondary bonds traded normally.

But there’s an interesting point here to do with our ECoop programme, which is based on reverse enquiry and is separate to our benchmark euro programme. Normally ECoops are priced fairly tight and we try to size the issues to the demand. What’s funny is that their performance has not worsened — on the contrary, it has improved to levels that we’d consider extremely tight historically.

This has also helped our dealer community because they know that if there is a need for more bonds, then EIB will be able to provide them.

Wehlert, KfW: We have had an additional investor in the form of the ECB for two years. In 2015 KfW bonds traded through Bunds when there was nearly no liquidity in the market. Overall liquidity went down until 2015 and then it stabilised more or less. The first three quarters of secondary turnover in 2017 had already reached the total volume of the previous year, so there’s very good secondary market support. 

That’s not so astonishing because not only is there an additional buyer, but the whole banking community is willing to have bonds. We will see what happens when the Eurosystem reduces its buying programme. I would expect that to have an impact on liquidity.

globcap
: What’s the investor outlook for the 2018 SSA market?

Prokes, BlackRock: A lot of investors say there is no value from these high quality, low volatility assets. But I have to be contrarian in this. We had a really good year in SSAs and covered bonds, so there is a lot of value there. Curves have been moving around a lot more than anyone expected at the start of the year in 2017. 

There are probably fewer reasons to be as over expectant about the market moves in 2018. The funding needs are a bit more defined. We saw a couple of issuers changing their plans quite significantly throughout 2017, which obviously had an impact on curves but it was down to investors to make their own judgements and position for that. 

So our view is probably more benign in terms of the opportunities to make money in the SSA market in 2018 compared to 2017, but we still expect enough vis-à-vis the other low beta asset classes for it to stay interesting. We are not leaving the market — we are as committed as we were before and will keep investing. 

There will be opportunities. We’re always discussing the relocation of issuance from dollars to euros and so on, so there will be enough on the table. The ECB is potentially changing its parameters on PSPP, so our hope is that its share of supranationals goes up. 

I can’t say I’m bullish on spreads, but there will be enough activity around.

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Tom Meuwissen, NWB: The spread development has been quite unexpected in 2017. You thought that with tapering around the corner the tightening of spreads in 2017 would come to an end, but the spread performance in 2017 was amazing. If we’d issued a euro 10 year in January it would have been at around mid-swaps minus 2bp, by the end of the year we could issue at almost minus 20bp. 

After the ECB October meeting this trend continued. You can argue over whether tapering was announced in October or whether it was actually an extension of QE, but in any case spreads performed very well afterwards. We have never funded ourselves better in euros than at this particular moment. 

Especially in the long term euro there is huge interest from investors and the spreads keep on tightening. We’re printing now in 20 years at the minus swaps level. I would have expected widening already and, of course, the ECB policy will come to an end one way or the other and when it does, it will definitely have an impact. 

For the year to come I don’t see much change and actually there even may be some potential for spread performance. On the other hand, the room for spread performance is smaller than the room for a widening of spreads, which eventually will have to happen.

Prokes, BlackRock: Will you be pushing your funding a little bit further out in 2018 in terms of timing? Not coming straight away but waiting for tighter levels from the spread performance?

Meuwissen, NWB: The experience over the last couple of years has been that January maybe looks like the best month to issue, but there is always tightening during the year. In 2017, you would not have expected that to happen, but it still did — and by quite a lot. For the next year we will try to spread our issuance over the year, although I can imagine that the focus will be more on the first half. 

Our business is long term lending and we have been very active in the 20-30 year bonds, in taps of our 2041s — that bond is €2bn now —and our 2036s, and also a new 30 year line. Each time we tapped them, the level kept on improving. In 2018 we will continue to monitor the long end of the euro market.

Hertlein, LBBW: It’s been a very successful year for everyone here. SSA spread performance has again been very strong throughout 2017, and I am bullish on the market with a view to the start of 2018. I expect stability at around current levels as we go into the new year. However, with the ECB as a very sizeable and significant buyer reducing their purchases next year, I see limitations with regards to further spread tightening. Also, if you look at the patterns from before the buying programme versus now, the question is of when non-eurozone investors that have not participated at the PSPP levels will come back and at what level will prices be then. We may see gradual adjustments to current levels in the process. That might be one of the questions for the latter part of 2018.

da Silva, EIB: A trader told me he expects a violent repricing in the high yield and corporate markets first because there is a complete dislocation there, with a slight impact later in the year. That seems to be the opinion of most of the trading community. 

globcap
: Are investors outside the eurozone buying into the recovery story or is it more about the expectation of ECB support?

Wehlert, KfW: My wish would be to come out of this negative interest rate territory because some investors shy away from it, which I completely understand. It does attract investors who do not have such a long-term view and buy into this market because they know there’s a good dynamic, there’s good support and medium-term the market will be stable. 

But at the turning point on QE it will not be as attractive because it doesn’t thrill you to see the overall numbers. So I expect some international investors to come back when we come out of negative territory, which will take at least a year or more than we expected. Some of the others, like asset managers and so on, I’m not sure about. We have huge order books because we have larger shares of asset managers and international hedge funds. But they could shy away and that will have a big effect on the size of order books, less so on the allocation overall

But I would not expect the ECB to take any risk of instability, because this is the ECB’s whole policy. My expectation is this will not change next year, or even as long as the policy is under Draghi’s management. 

Meuwissen, NWB: The ECB does eventually have to end the programme one way or the other though, whether it’s Draghi or his successor.

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Armbruster, FMS-W: In terms of overall sentiment, the political risks have really fallen compared to what we had in 2017. We had investor meetings in Asia in November and there were a lot of discussions regarding the German political situation. But growth was seen as very positive in Europe.

The Brexit situation is also of high interest to investors. We’ve had discussions and phone calls on what Brexit means for the overall environment and whether there could be any large negative impact on overall growth. 

On the ECB, most of our feedback was that investors expect the ECB to go very slowly in terms of unwinding QE.

Ruhl, ESM: I was roadshowing a lot outside Europe in 2017, partly to prepare investors for our debut dollar bond. Those investors see that the euro area has improved significantly over the past few years and especially over the last 12-18 months. They realised that Europe is a good investment opportunity and that the reforms are paying out. We see that especially in the former ESM/EFSF programme countries, which are the reform and growth champions in the euro area. Europe is growing faster than the US for the second year in a row. 

But under this growth perspective, the Cataluña independence movement, Brexit and the other discussions don’t worry me. It’s good for a country to be part of the EU or the eurozone. In the long run this will prevail. More than 70% of the people in the euro area are in favour of the single currency, and that’s a very strong stamp of approval.

It’s about explaining what is working well, instead of focusing on what can be done better. There is room for going ahead with the European integration process. There are discussions on finalising the banking union and developing the ESM into a European monetary fund. 

Hertlein, LBBW: The outlook is very strong for Europe as a whole and for the economy. It’s been firing on all cylinders and so are the forecasts. Business is set to be good for all issuers in 2018. I don’t know many people in the market right now who see Brexit or Cataluña as a risk. We’re a good year into the Brexit story and, in terms of market reaction, nothing has been derailed and the UK economy has been stronger than expected after the vote. 

Politics-wise, the main risk event in the 2018 calendar is the Italian elections. Aside from potential short-term volatility peaks, we don’t foresee adverse impacts on the market at this point. Overall, it’s hard to see any clouds on the horizon for 2018 as far as the economy is concerned.

Meuwissen, NWB: The only problem is where inflation will come from. It’s nowhere to be seen and the ECB needs inflation to end QE. It is stuck in the corner because nobody knows where inflation should come from, not from a rise in wages the way it looks now. In the Netherlands, people are urging the corporates to pay higher wages. It’s key and it’s just not there. 

Hertlein, LBBW: But we haven’t seen it in the US either where the economic cycle is a little bit ahead of us, also in terms of between the Fed and the ECB. It’s not kicked in there — particularly as to wage rises — and there’s reasons for that. 

Meuwissen, NWB: The problem with the ECB is that its policy is based on an inflation target and the policy of the Fed is not. 

Wehlert, KfW: You could also question the 2% inflation target. As long as this is the general guideline, there are good reasons to go on with the current policy. But at some point, if it goes on too long, it’s probably appropriate to question whether this inflation target is still appropriate. There are more and more people questioning that 2% mark, which comes from the old days.

Hertlein, LBBW: Inflation, expected inflation, would be the big swing factor for the market. If there were a few surprisingly strong inflation prints that led market participants to start pricing in higher inflation, it would be the major changing point. That would push interest rates up, and significantly impact our market as well.

globcap
: With the ECB cutting QE and the Fed on a rate rising path, will the whole curve of each currency become viable in 2018? 

Wehlert, KfW: It’s really hard to predict. In the first quarter of 2017 I had a completely different view to what I do now, especially on short dollars. Two years ago, short dollar funding was very expensive and then it developed to be much more attractive. As long as yields are negative at the short end I would not expect the euro to beat the dollar market, at least in terms of the funding levels you can achieve. 

At the long end, a 10 year in euros is not comparable to 10 year dollars. We used to do $3bn plus in dollar 10s. Now the market is for $1bn-$2bn. Printing $2bn would be fine. In general you can’t compare the number of investors behind a 10 year dollar and a 10 year euro. A 10 year euro has more than 100 investors behind it — a dollar trade has a fraction of that. A 10 year dollar trade depends on a few investors — and their view on long end dollars — driving the trade, which you can then offer to the broader investor base.

We will probably have a better balance towards the end of the year, but I wouldn’t expect it at the start. We monitor 10 year dollars and we issued our last 10 year two years ago, so it’s an interesting segment. But it’s costly compared to the euro market, and therefore this is the best funding choice at the moment and it is our home market.

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da Silva, EIB: Over the last few years we’ve issued dollars up to five years and everything longer is done via the euro.

In 2017 we had the longest average maturity I’ve seen in euros. In dollars the dynamics are a bit different because books are not as granular as in euros and a few key investors can determine whether a higher amount is feasible or not, depending on the tickets they are prepared to write. 

There will definitely be demand for long term dollars, meaning 10 years, but the prices are not as attractive and the investor depth is not sufficient to justify a global benchmark.

Meuwissen, NWB: We will not issue dollars if it is more expensive than euros, which is down to the basis swap. In 2017 we’ve printed more euros. In 2016, we issued 10 year dollars but it was cheaper after swapping than 10 year euros. We are not as strategic as KfW or EIB, which want to be present all the time in the markets. Normally up until five years maturity issuance is done in dollars and beyond that in euros. Our commitment is that we will issue at least one benchmark in dollars and one in euros each year. 

da Silva, EIB: It also depends on the target volume. One can just look at the basis swap if targeting $1bn or so, but it’s different if you’re looking for a minimum $3bn global. Of course you look at the after-swap price comparison, but sometimes it’s about the ability to raise critical mass to support a benchmark. That is simply not there.

Armbruster, FMS-W: For us it is different. Over 50%, let’s say, of our funding need will be in foreign currencies, so we need to drive orders in our dollar and sterling books to match our assets in those currency. That’s what we need to be careful about. We of course look at the arbitrage, but that’s not our first focus. Our first focus is to receive the liquidity in the currency to finance the currency asset directly. 

Wehlert, KfW: The ECB has said there will be €100bn of reinvestment from its redemptions under the PSPP within the first 10 months in 2018. The programme is being reduced by half in terms of new money, but taking into account the reinvestment, I calculate that it will be equal to two-thirds of the volume of cash put into the German agency sector in 2017. Given that the ECB’s quota for each existing bond is pretty much full, the demand for new issues will be pretty high, which will drive the euro market to still be very well supported.

That makes it even harder for the dollar market to compete, so it will probably take a bit longer until we have normalisation. But we are a bit closer than in 2016, which is why we’ve seen some 10 year dollar issuance. 

Meuwissen, NWB: I’m less optimistic for non-core currencies. In euros we have the ECB buying programme, in euros and dollars we have level one HQLA status. Over the last few years our non-core currency funding has been less than 10% of the total, which would normally not be the case as we’d have done more sterling, Swiss francs and so on — we like all the diversification we can get. But when you look at arbitrage now, it’s impossible to beat the current euro levels. This will only change when the PSPP is ended.

globcap
: Are any new or upcoming regulations giving issuers headaches? Or are some of these welcome developments?

Wehlert, KfW: The MiFID II regulations are not targeted at the SSA market, but the banks are affected and have to cope with the new rules, so we as issuers using the banks as underwriters and distributers will see the effects, too. The aim of the regulation is to put more transparency into OTC primary and secondary markets, therefore the SSA market will be affected, too. 

Allocation in primary markets have to be justified and recorded officially and secondary flows have to be reported, too. These rules could have the potential to shape markets and change investor behaviour when the rules kick in in 2018 and could have a long term effect. The banks have to cope with it and everybody is working to be well prepared.

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Ruhl, ESM: I expect the direct impact on primary markets to be limited at first. But there will be more granular data available in secondaries, which can change the market at a later stage. There will be tools developed to analyse this data and to take conclusions. In the primary market, we will know more about the flows and investor behaviour in the secondary market. This could have an impact on how we make our decisions in primary and how we react to investor demand. It will improve decision-making as it will be based more on concrete data than sentiment.

Meuwissen, NWB: Investor sounding has become a bit more difficult, because of the new parameters brought in under the Market Abuse Regulation. 

Ruhl, ESM: It depends how you do the sounding. We announce our trades publicly, so it’s public knowledge that we are coming to the market and sounding investors. There’s no private information involved. This gives us good feedback on market needs. 

Meuwissen, NWB: But on a lot of deals you see that IPTs can be more difficult to decide on, so you start at a more conservative level. That means there is more tightening during the bookbuild than before, when it was maybe easier to set the price.

globcap
: Speaking of new technology, KfW ran a blockchain test in September. What was the outcome?

Wehlert, KfW: Our intention was to learn about the new technology. We therefore used commercial paper, which is a very short term and standardised funding instrument. We worked with Commerzbank to prepare a CP transaction on blockchain that mirrored the real booking in our system. 

This was just one piece of the whole concept of digitalisation. People are working on how to make the business more efficient, while still serving investors and issuers. There are still a lot of issues to solve, including legal ones. We will work on those points. We also hear banks are doing the same. 

Ruhl, ESM: We are monitoring these developments quite closely. It’s very important that there are some test trades, like the one Petra mentioned or the one LBBW did a few months ago, to get experience and learn. Nevertheless, there is still some way to go taking the legal, regulatory and compliance aspects into account. But also the technological aspects.

There are still challenges on confidentiality and performance when dealing with a number of trades, which is needed to make it eligible for mass trading. There is still some way to go. Technology will impact our business over the next coming years in several phases. 

We looked at how we run our primary market business. There is room to increase efficiency with existing technology as a first step. For instance, automating more of the process of issuing a bond, especially via syndication. With auctions, some systems are quite efficient already. In parallel with that first step, there will be technical development on the distributed ledger technology — call it blockchain or whatever. This is the second step. 

Another element to be monitored is on the investor side. Some banks are using artificial intelligence to run a secondary market book. Investors are starting to manage a portfolio purely with artificial intelligence. If the investment decision is no longer made by a human being, this will impact how the intermediates — the banks — have to deal with investors. Issuers may also have to change the way they distribute bonds. This is at the very early stage, but there will be changes in the future driven by technology, for sure.

Wehlert, KfW: The end game for artificial intelligence is having no humans involved, I am somewhat sceptical about this. Everybody assumes investors would like to come into the office in the morning and type their orders on to platforms that directly access the books. But I’m not sure that generation is here yet. This is an international business. More and more I see that many people prefer to act like a human being — to call somebody. But the question is whether they’ll be forced away from this behaviour because of efficiency measures from the distribution side. I’m not sure about that yet.

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Hertlein, LBBW: There’s a tool called Investor Access that allows investors to submit orders directly, among other things. It’s work in progress as well. 

On blockchain and the larger shifts in technology, some of the work that needs to be done is having regulators accept the changes. Regulators will have to approve transactions carried out on technologies, rather than through humans interacting via banks. 

The bigger question is what the role of central banks will be in this new world. They are the source of trust in the financial markets system. With blockchain, “trust” is created through technology — that can be a great facilitator in areas or markets where trust is a scarce resource. It’s a little more complicated if you look into it. At LBBW, we learned a lot through a Schuldschein transaction for Daimler that we executed via blockchain. All of this is a lot more focused on the back office functions and simplifying or speeding up these processes. For it to become a key part of our markets and for central banks to become obsolete as a source of trust is a big step.

Institutions are clearly putting a lot of thought and work into the process and on which way we are going. One element is that a certain part of the investor universe will be closer and more directly linked to the syndicate desks of the lead banks on a given transaction. 

Armbruster, FMS-W: What sometimes gets forgotten when we talk about trading platforms is that blockchain must be implemented all the way from the front to the back. You have to implement this into your existing organisation, your existing process and so on. It is easier to do if you build up a bank from scratch. 

But in today’s world, especially for large institutions, there are existing platforms and different systems, so it will take a long time to implement. It’s absolutely right to learn from test trades, but if this is a running model then from the investor side and the large institutions there is still a long way to go.

globcap
: SRI bonds are another innovative area. What’s BlackRock’s take? Do you have, say, dedicated green bond portfolios or do you build an SRI focus into the existing portfolios? 

Prokes, BlackRock: We are active on a number of fronts. We have dedicated green bond portfolios with dedicated mandates looking at ESG ratings and considerations. But we are also putting ESG considerations into the whole credit research process. That for me is probably the bigger step. 

To get something out of this for your whole platform, you need to integrate this into your research process as opposed to saying, ‘OK, I have a fund that is taking out these industries or taking out companies with a rating below a certain level from an ESG rating agency’. We do that as well, but we’re also doing a lot of work to integrate this into the real decision making when it comes to looking at individual companies and trades. 

That means that we could end up turning down the chance to buy a green bond from a particular issuer that in our view might not be that green when taking into account the wider organisation.

da Silva, EIB: Do you find it acceptable to give up yield to justify buying a green bond?

Prokes, BlackRock: That really depends on the mandate of the fund. If it’s focused on a particular subset of the market — like a green bond mandate or a mandate requiring certain ESG ratings —then it is by nature of the end investors’ wish that they are happy to go into something that has a tighter spread or lower yield environment.

When it’s a consideration for the wider platform, the answer is on the issuer level. The reason to go or not to go buy a green bond with a lower yield from an issuer that we think is OK according to the other metrics will have to be justified by the fund manager. That could be on whether the green bonds are deemed to be more stable, whether there is a specific type of demand behind the investors that are going to predominantly buy the bond so it can go even tighter in secondary than where it was issued, and so on. 

But as a general remark there is no rule saying, ‘I’m happy to buy it at a tighter level because it’s green’. It has to be a consideration coming from the wider picture. My own view is whether it has value from a spread performance component.

globcap
: Are issuers finding that approach common among investors? 

da Silva, EIB: Our ECoop programme again helps us in this context. We try to price our Climate Awareness Bonds as normal ECoops, basically. What is more interesting for me is how the investors treat it — or in other words, how will it be traded? Is it deviating from the ECoop curve or not and is it becoming more expensive? That is the pattern we’ve been witnessing.

Meuwissen, NWB: We are very active in SRI — we issued more than €3bn equivalent in 2017. More than a quarter of our funding in 2017 was via green or social bonds. 

Our experience is that it’s a question of supply and demand. There is definitely more SRI demand than supply. Also, with SRI bonds you don’t normally raise the size of the issue because you have limited places for the proceeds, so therefore you see some price tightening during bookbuilding. Even with that tightening, the weeks after the book closing you see more performance because the investors may not have gotten the allocation that they wanted. 

I was on a panel in November where I heard an interesting idea — to split green bonds into ‘A’ and ‘B’ bonds. The ‘A’ bonds would be attached to the issuer and the ‘B’ bonds to the assets in their portfolio.

All our assets are either green or social in the end. So we could be considered an ‘A’ issuer and so all our bonds would be labelled sustainable. If you’re not such a green or social issuer, or a limited part of your activities is green or social, then you can issue ‘B’ bonds. The nice thing about that is that there’s then an incentive for issuers to really change what they are doing. At the moment, you can label your activities but you’d do that lending business anyway.

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Wehlert, KfW: It doesn’t make sense to force prices into markets. We just see how demand is. The observation for 2017 is that those bonds trade tighter. But it’s just an observation — I wouldn’t draw any conclusion from that yet. But our green bonds are trading tighter — our green Australian dollar bond is 10bp through our other Australian dollar bonds. This is a specific example, so I wouldn’t draw conclusions for euros and dollars, but it’s remarkable. 

But this market is about putting ESG ratings into the whole of the capital markets and accelerating green finance. Not necessarily through green bonds as an instrument, but also for other instruments. This is something which is indeed happening. The topic is widely spread and everybody’s talking about it. If green bonds can deliver their own contribution in the form of a few basis points saved for the issuer then that’s an added bonus.

But overall it’s a broad range of aspects and is something where markets have really done very well. I haven’t met any investor who has not heard about green bonds and green finance. Before, that was not the case. We used our distribution channels and our investor base to deliver this story to the world and this is something which is still happening. Focusing on the potential cheapness of a green bond is a little bit too narrow.

da Silva, EIB: There is a natural limit to the issuance, because you need to have the assets on the other side. It needs to be balanced between that and what you issue. You’d need astronomical values on the asset side to justify the same issuance on the other side. Therefore the supply and demand will not be balanced, which can also create pressure on the prices.

Meuwissen, NWB: What you see then is that all the bonds are way oversubscribed — much more than the conventional bonds. So therefore you also see a good performance after the book closing. So for investors it’s also quite interesting.

Prokes, BlackRock: There are definitely a lot of good reasons for developing this market further. But there also needs to be some level of cynicism and investors need to be very thoughtful about this. Think about the three words represented by ESG. The ‘G’ was always part of credit research. Getting the ‘E’ and ‘S’ into your trade research process is a huge step and it’s not easy. We are working on that. It’s not a simple approach and you need to say, ‘We’re going to look at this and we’re going to make sure that somehow it impacts our financial models of the companies’.

So there is a tremendous amount of work to be done on the investor side if they want to really have a proper impact as opposed to just saying: ‘We are SRI because we buy green bonds.’ It’s less of a case for SSAs because in some cases they have 100% ESG-compliant lending. But we do see corporates coming with green bonds that are genuinely not green. And then there is huge demand for those bonds, and the issuer gets the benefit — but the proceeds are used for new energy efficient windows for the company’s headquarters or something. Investors should not necessarily then say they participate in green bonds because they bought that particular bond.

I would look at that bond the same way I look at all of the other bonds from the issuer. Does it meet the platform wide ESG criteria? Is the issuer a no-go or does it meet a certain credit profile, including environmental and social? But governance should still be the dominant factor when it comes to the credit analysis. If it has a weak profile then the green bond will be looked upon as a weak bond. It needs to tick all the boxes.

It’s different when you look at any of the agency issuers. You can say that there is a certain benefit to the funding and you can be a lot more lenient with how you look at the bond.

But I’m amazed that firms in some industries can get as high an ESG rating as they do when in fact they are doing real harm to the environment. I’m sure some of them will bring green bonds over time. Then we have to look at whether they can go into our green benchmark fund — the overall business may be pretty bad, but have they managed to slice out a very small part of their business that is not so bad.

And just because something has a green label, it doesn’t mean it cannot default. We have had cases where issuers went into default with green bonds outstanding. There needs to be a bit of a toughness on the investor side. A bond being green is not a substitute for doing the work.

Wehlert, KfW: Green bonds give investors the ability to get transparency on the issuers too. It can have a negative impact for an issuer that comes out with a green bond and investors come to the conclusion that, after seeing what the company does, they don’t want to buy the conventional bonds anymore. This is also a good thing.

Prokes, BlackRock: Would I look at an issuer as a new entity just because it is doing a green bond as opposed to a conventional bond? It probably wouldn’t make a difference whether I do the credit work or not. Do I get a lot more insight into the business of a big issuer because they are doing a green bond? I would be very surprised if I did. If I did, then I was probably doing something wrong with my credit analysis to start with. They should really surprise me too much with what they are doing — unless it’s on how misused the green label is. 

As with every good development, there is a certain number of people trying to misuse that for their own benefit. There are a lot of negative things you can say about ESG ratings, because they are all relative inside particular industries. That’s why it’s important to get these topics into your credit research and come to a view on the issuer — irrespective of whether it is going to issue a green or just a conventional bond.

Wehlert, KfW: This is the long-term goal, that investors care more about ESG. In France they have even implemented legal requirements for asset managers to make their ESG strategy transparent. We don’t have this in Germany but potentially there will be more efforts in other countries. 

There is no real green bond label available—the investor has to take the final investment decision and the issuer has to deliver the transparency.  

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