Swiss Franc Bond Market: Swiss spot windows for foreign borrowers in francs
The Swiss franc bond market’s twin maladies of low interest rates and unattractive basis swap levels, which have hobbled foreign issuance since 2015, are showing signs of regression. Arbitrage windows will open this year as the market’s health improves, and financial institutions are best placed to exploit them. By Silas Brown
Last year ended better than it began for the Swiss franc bond market.
“2016 was a challenging year, with a clear sense of market deterioration and significant volatility in the first half of the year — among other things, subordinated debt got hit badly,” says Manuel Gadient, head of Swiss debt capital markets and syndicate for UBS.
Foreign issuers were kept away by cross-currency basis swap levels and attractive funding conditions in core currencies. Swiss investors, plagued by low interest rates, relied on a steady domestic bond flow — roughly Sfr35bn of issuance — or turned to the equity markets instead.
In 2017, by contrast, the shocks the Swiss market was braced for — notably the Dutch, French and German elections — proved inconsequential.
Cross-currency swaps became more attractive for foreign issuers, helped by the Swiss National Bank stifling further currency appreciation, and yields rose from their 2016 lows.
Swiss franc to euro and Swiss franc to dollar cross-currency swaps improved last year, and Swiss investors are optimistic the conditions are conducive, going into 2018.
Financial institutions, with frequent borrowing needs and quick reactions, are particularly well positioned. Higher yielding emerging market credits, too, will find opportunities to raise funds.
“There will be an increase in international volumes as the yield curve shifts upward,” says Dominique Kunz, head of Swiss DCM at Credit Suisse.
A flurry of short-dated deals from the likes of Acrotec, MSC Cruises and Russian Railways illustrated a change of mood among Swiss investors, toward credit risk, away from duration.
The Canton of Geneva set the high water mark for maturities in October 2016 when it sold Sfr200m of 40 year bonds — the longest Swiss public sector, non-government bond ever. But investors got scared when, in the three days after Trump’s election, the bond lost 7.7% of its value.
“Our view is that Swiss investors take huge duration risk,” says Kunz. “Is a three year bond from Acrotec with a 3.75% coupon really riskier than a 40 year one from a canton with a 0.5% coupon?”
Issuance between 11 and 15 years fell from a 25% market share in 2016 to roughly 17% last year, according to Credit Suisse, while tenors beyond that fell from a fifth to a tenth.
As the levels of emerging market borrowers rise, some believe the market needs to decide whether it is a source of diversification for them, or a source of arbitrage.
Well-rated emerging market borrowers can expect to place up to Sfr400m when approaching the market to diversify, whereas arbitrage issuers are looking at about Sfr100m but can expect tighter pricing.
However, when a new issuer attempts to access the market for both, some Swiss buyers become frustrated with the pricing differentials.
“A few investors are prepared to pay through the curve [when a borrower wants to use the market for arbitrage],” says one Swiss franc bond investor. “This disrupts the borrower’s lines, and made the rest of us very angry.”
“There are some Chilean issuers that have shut themselves out of the market,” says Kunz. “We put forward the diversification argument when we initially approached Latin American credits, but we didn’t show the tightest pricing, as we were positioning Swiss francs for a long term, sustainable funding strategy.”
Whether the ire of Swiss investors will last, or whether they are merely adapting to the market’s new position, is unclear. But emerging market issuance, alongside financial institutions, is tipped to rise this year, so the answer will soon emerge.
FIG’s quick feet
“Financial issuers are the best candidates for opportunistic, arbitrage-driven deals – as they have liquid curves, frequent needs and the shortest reaction times,” says Andreas Tocchio, desk head of UBS’s Swiss franc syndicate in Zurich.
Financial institutions increased their share of international issuance last year, from 35% to just under 50%, according to Credit Suisse. Additional arbitrage windows have opened, driven by a rise in interest rates and improving cross-currency swaps. Australian and New Zealand banks were key beneficiaries last year. Commonwealth Bank of Australian raised Sfr450m, in the largest single tranche Swissie bond by an Australian financial since 2009.
If Swiss rates continue to rise and basis swaps continue to improve, more financial institutions will use their quick feet and exploit those additional windows.