Annual LBBW Euro SSA Roundtable: SSAs face up to a funding world without QE
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Annual LBBW Euro SSA Roundtable: SSAs face up to a funding world without QE

Public sector borrowers are confident going into the euro bond market next year, with reinvestments from maturing bonds held by the European Central Bank likely to cap any spread widening from the end of quantitative easing. But political threats — from populists polling well ahead of European Parliament elections in May, Brexit probably in March and the Italian government’s stand-off with the European Commission over its budget plans — are likely to bring volatility, meaning timing will perhaps be more important than in 2018. GlobalCapital brought together European SSAs, investors and investment bankers to discuss what 2019 holds for the euro market — as well as the SRI sector and new technology.

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Participants in the roundtable were:

Axel Bendiek, head of treasury, Federal State of North Rhine-Westphalia

Nathalie de Weert, senior capital markets officer, euro division, European Investment Bank

Sophia Ferguson, senior portfolio manager, active fixed income and currency, State Street Global Advisors

Philip Hertlein, head of SSA syndicate and origination, LBBW

Siegfried Ruhl, head of funding, European Stability Mechanism

Otto Weyhausen-Brinkmann, head of new issues, capital markets, KfW

Craig McGlashan, moderator, GlobalCapital


GlobalCapital: How do your funding volume outlooks for 2019 compare to 2018?

Nathalie de Weert, EIB: We expect around the same volume as we’ve had in the last few years, this will be fine-tuned and finalised at the board meeting in December. We have more redemptions in 2019 than 2018. In 2018 we had only €47bn of redemptions. We have around €60bn next year, we expect a net issuance that will be slightly negative.

Siegfried Ruhl, ESM: It’s a bit of a new situation for us since August, after Greece successfully exited its support programme. For the first time, we don’t need fresh money for loan disbursements. Yet it doesn’t mean we disappear. We have to roll over our debt, as the debt is much shorter than our lending.

For the EFSF, the expected funding volume for next year is €22.5bn versus €28bn in 2018. For the ESM, we expect €10bn of funding for 2019 compared to €18bn in this year. So overall €32.5bn. And this is also in the area of €30bn-€32bn that we expect for the upcoming years — as long as we don’t get a new mandate or a new programme — to be our market presence based on the rollover needs.

Otto Weyhausen-Brinkmann, KfW: We will announce our funding needs for 2019 around mid-December, as with every year.

Axel Bendiek, NRW: Our funding programme for 2019 will be €14bn-€16bn. We always have a target range as opposed to a precise figure. It is a bit lower than for 2018, because we’ve increased the duration of our outstandings, there’s a debt brake in place for all German states and we have a balanced budget, so it’s about refinancing maturing debt. And the increased duration means there’s less debt to be refinanced.

The 2018 programme was a bit smaller than we expected it to be and that was due to good budgetary performance, courtesy of good economic development. Tax revenues were healthy and expenditures were lower than expected.

Philip Hertlein, LBBW: That all tallies with the overall picture for SSAs next year, barring any external shocks to the system as we saw in the crisis times. The expectation is for stable to slightly lower.

GlobalCapital: In 2018 euro issuance was far higher than dollars, largely due to the euro/dollar basis swap. Do you expect a similar story for 2019 or is it all about the basis swap?

de Weert, EIB: We usually issue around 30%-35% in dollars and 40%-45% in euros. That’s been pretty stable over the last three years, even though the basis was less favourable for dollars in 2018. We expect to use both benchmark programmes in roughly the same way. We try not to be too dependent on the basis swap because we want these programmes to remain important.

Weyhausen-Brinkmann, KfW: We have a slightly more flexible and demand-driven approach. We also want to maintain a regular presence in both markets. But a couple of years back when we had the QE programme in the US, we were doing more dollar funding than euro funding. This has changed, and year to date we’ve done roughly 60% of our funding in euros and nearly 30% in dollars.

The PSPP programme will obviously come to an end. However, the ECB is very likely to reinvest all the redemptions, so there will be ongoing support for the euro market overall, therefore the euro funding share in 2019 is likely to be higher than dollars again.

Obviously the cross-currency swap basis has continued to normalise in 2018 and hence funding results for European issuers have been less attractive. However, I haven’t met anyone who is really good at predicting the cross-currency basis and we remain mindful of further developments.

Bendiek, NRW: If you do, tell me their name. I need to talk to them.

The dollar share of our funding was at the low end this year. We don’t have a precise target range, but like most issuers we like to keep a regular presence in that market, and we have the same limitations as to the cross-currency basis — we need to hedge everything. It needs to match our euro funding grid on the euro leg of the swap.

What might help is next year, presumably euro spreads will have widened a bit across the SSA community. Everything else being equal, that could help dollar funding look at bit more attractive, but everything else will not be equal, so we’ll keep monitoring the market and see what we can do.

GlobalCapital: Sophia, from an investor’s perspective, how did you see 2018? Was it a good or bad year?

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Sophia Ferguson, SSGA: The basis has so much to do with dollar supply. That will be an ongoing story. It’s something we try to take advantage of, when it works in our favour to move out of US assets and into other areas. There’s a sizeable pick-up. It’s only increased over the past couple of months. We’re on the lookout for anything that can add return to a portfolio over and above the benchmark level. And we’re able to find that by switching in and out of different countries where we can exploit some of the factors that give us a favourable pick-up.

It’s been a challenging year, but the second half has really opened up some opportunities with the way spreads have widened. For a lot of investors, it’s time to start considering how to reallocate and redeploy cash and other sources of positioning in funds. We’re hoping the growth outlook will stabilise around where it is. Even if it falls from above potential levels, it should be able to provide support to the market.

The biggest factor at play in Europe has been the ECB and its telegraphing of guidance at the end of the QE programme.

Our biggest tail risk scenario is that QE doesn’t end. Is the economy stable enough for it to end? But even if it doesn’t, there will always be the ECB discount on the eligible securities. We’re very aware there may be a ceiling on how wide spreads can go.

GlobalCapital: Has it been a year of two halves? Very oversubscribed books and tighter spreads in the first half of the year, then less oversubscription and wider pricing in the second?

Hertlein, LBBW: I would echo that picture. Certainly in the weeks and months after the summer break there’s been less oversubscription — with exceptions as well. A recent KfW transaction had a book of over €12bn, for instance. So demand has been and is still there but at slightly different spread levels to the first half of the year or a year ago for all the issuers on the table. That in general gives a pretty good reflection of how the year went.

We’re now close to the start of the new year where most of the issuers here with sizeable funding programmes will look at the market again. That bolts into that scenario as well. We’ll have to see how new issue premia and pricing levels pan out for the beginning of the year. And again in light of the ECB policy and what to expect, its December meeting will give us further forward guidance. There’s a number of factors going to play into that and I expect an interesting start to the next year.

GlobalCapital: Is one of the reasons there hasn’t been so much oversubscription of late because investors are waiting for clarity from the ECB on its reinvestment policy?

Ferguson, SSGA: That’s definitely part of it. The other factor that can’t be ignored is over the past few years on every deal that comes, everybody is trying to participate because there’s nothing else out there that can get equivalent yield.

Even if you’re buying a two year bond at minus 0.3% yield, you’re still making a spread above where the Bund is trading. This year there was a rotation where you don’t necessarily want to buy something just because it’s offering an attractive premium. You want to buy something because it’s good value. As the ECB removes its backstop, there’s more to be done in terms of credit work on the analysis side to ensure the money you’re deploying and lending out will be paid back once that backstop has disappeared. That’s very important for us to really establish what we think an optimal basket or an optimal issue looks like in terms of not just what the ratings agency says, but what our internal analysts are saying about the issuer.

Not everything is money good anymore. That’s a very important lesson for the investor side to acknowledge.

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Bendiek, NRW: When comparing the first half of 2018 and the second half, I would look at 10 year benchmarks. In the spring we did a 10 year sustainability bond — so a bit of a different format — and a plain vanilla 10 year in the autumn. Both went very well and were significantly oversubscribed. But the one in spring was swaps minus 14bp and the most recent one was minus 7bp. I would attribute about 2bp to the sustainability format, so that would translate to minus 12bp. So you have 5bp of widening. That is significant, but not earth shattering.

On a general note, the second half for us was in some sense even better than the first half. We carried out our most ambitious projects in the second half of the year, new euro benchmarks at 50 years and 60 years. The first was €1.25bn which is quite large for us, and the 50 year was €900m. We also had a 20 year benchmark in the first half that went extremely well, so it’s been good all through the year.

Ruhl, ESM: I agree with Sophia. The end of the ECB balance sheet extension means we are looking more at the credit and here in the SSA segment, we all have a very good credit and can offer a very attractive investment opportunity for the investors. During the course of the year we see stronger periods and weaker periods. This is quite normal.

Philip mentioned KfW’s five year. We had a strong three year deal just a few weeks ago. Spreads are widening but it’s no reason to panic. We are at year-end, and in January there is new supply and new investment needs, and the picture could be completely different. I don’t consider the second half of the year as extraordinarily weak, nor the first half extraordinarily strong. We had volatility. This is what makes our markets interesting.

de Weert, EIB: Swap spreads and relative value versus Bunds were very positive in the first half of the year, so we had these oversubscribed books with everyone wanting to participate in our EARNs. When we did our last EARN in September, I had the impression investors who wanted to get the yield pick-up versus government bonds had already played, so there was no strong incentive to come again in the SSA sector for this relative value play at the end of the year.

That’s where I would feel we missed out a bit despite paying spreads above Germany and France. We had no French investors in our last Earn despite having a pick-up to OATs, which never happens normally. It was because these investors had already done it in the first half.

Ferguson, SSGA: That’s a trend you’re always going to see, because when spreads are so thin, the goal is not to profit from price movement.

Weyhausen-Brinkmann, KfW: At the beginning of the year there were a couple of deals with books of more than €10bn at very tight spreads and at ultra-low yields. It’s a little surprising there was so much demand on these low levels, so instead of value consideration we had the impression large parts of the market were rather trying to read the ECB. It’s nice from an issuers’ perspective to have that huge demand, but it’s not really sustainable. It’s very short term.

We now go into a period where relative value becomes a more important play and timing becomes more significant. We saw that already in the autumn. Actually, there were not really bad deals, most went OK. And there were a couple of pretty good deals in between as well. The redemption reinvestment from the ECB again played a role for our last five year euro benchmark, which had a heavily oversubscribed book. This will fade out slowly over the next few years and we will go back to more normal markets.

GlobalCapital: KfW’s five year a few weeks ago was one of those strong deals. Did it benefit from the high spread over Bunds?

Weyhausen-Brinkmann, KfW: It did. KfW’s spread over Bunds is quite high these days and has widened over the year, which probably has less to do with KfW and more with the Bund. I also have the feeling that the ultimate benchmark for Europe is shifting from Bunds to OATs, particularly for international investors. There’s therefore more relative value considerations versus OATs, and less to the Bund. The Bund seems to be an animal by itself.

Maybe with the fading out of QE, relative value plays become more interesting. We’ve seen since summer an uptake of asset managers in KfW taking advantage of the attractive spread over Bunds.

GlobalCapital: Are funding windows likely to be shorter next year?

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de Weert, EIB: It’s more a question of headline risk and volatility. Over the last weeks any news on Brexit or Italy would generate quite strong movements in spreads, making issuance windows close and open. This is less influenced by QE being operational or not. We expect a normalisation of curves from the end of QE. We had quite a variety of levels in our curves, with some distortions, which should normalise. But again, as Otto mentioned, QE reinvestments will still be done. This is a supportive element.

Ruhl, ESM: That’s especially for us on the supra side, where the reinvestment needs are close to 50% of the maturities. The ongoing demand from the reinvestment needs of the euro area central banks should be spread-supportive and make our bonds interesting especially for relative value players who will come back to the market likely next year. The supranationals should be an interesting alternative.

Hertlein, LBBW: We’ll have a combination of the factors mentioned, certainly in the first half of the year. For one, the ECB and its reinvestments should give further support to the SSAs. There will be a little more timing issues as mentioned, looking for appropriate windows, in that maturities differ week by week and month by month. There will be redemption peaks. Then it will be a question of how the ECB reinvests them, and people will try to read as best as possible again as to when that may or may not come due.

The other factor is with the outright purchases being gone, I expect the global political themes — as Nathalie mentioned — to drive markets and make it important to time your trades appropriately. At least for the first half of the year, Brexit looks to be strongly on the agenda – which is likely to make it a driver of volatility.

Italy I expect to be a topic at least until the European election in May, until there is an agreement on the budget between the government and the Commission. It’s certainly more of a question of timing against that backdrop for the first half of the year.

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Ferguson, SSGA: For us, the biggest factor is the transition from a liquidity source in the ECB that’s very stable to one that’s less predictable. Participants are governed by different needs. That can create more volatility and pockets of volatility. We’ve seen that transition start already.

Even though I don’t expect the ECB to use reinvestment as an active policy tool, how they choose to transact is critical to how this plays out. We expect to see slightly higher rates and a curve looking a little bit steeper. I don’t expect that to happen overnight. This is still a very slow and steady transition.

GlobalCapital: The ECB has said that rates will remain where they are at least through next summer. If rates do rise then, will opportunities open at the short end of the euro curve? Or is that already happening?

Ruhl, ESM: We’ve already seen it. Our three year issue a few weeks ago was our first three year benchmark since 2015. The short end is becoming more interesting for investors and it’s also good for the market, not only for existing investors but others who stayed sidelined for the last two or three years. We see them slowly coming back. That makes me confident for next year.

de Weert, EIB: We have had negative yields up to nine years at one point. Now it’s around four years and positive yields bring back investors. We, as the ESM and EFSF, have seen lots of demand for three and four year tenors in recent weeks.

Bendiek, NRW: I agree, but we should be cautious. Even if the ECB hikes in 2019, which is our expectation, it might not even be a full quarter of a percentage point, so we might not even leave negative yield territory.

It’s not really a game changer for next year but looking ahead we’ll have a different yield environment. We’ve heard a lot from investors, like Siegfried said, that they are sidelined in euros because yields are just too low.

Ferguson, SSGA: We’ve also seen transitions in investor preferences. For much of the past five years a lot of traditional short duration or money market investors — who aren’t so balance sheet constrained — have moved out the maturity spectrum and down the ratings curve. They’ve said they need to at least make it back to zero on their returns overall. For those types of investors, higher rates are really positive because they can go back to their actual profile of what they’re trying to achieve from that liquidity sleeve and have better cashflow matching. There’s a tonne of demand there.

Our biggest concern, though, with the rising rate environment is whether the economy can weather it, especially in the absence of QE, as reinvestments taper off. That’s our huge tail risk.

GlobalCapital: Has the ECB left it too late to tighten?

Ferguson, SSGA: There’s been a massive divergence between business cycles in the US and the rest of the world. The big question is, can the Fed pass the baton on to the ECB, the Bank of England and the Reserve Bank of Australia in a way that doesn’t damage potential growth? Growth rates are moderating from higher potential levels. Inflation is still not there. It’s not materialising in the ways our economic models would have predicted, especially given the labour supplies coming down.

We expect potential growth to be lower in the long run, so that means the differential in the terminal rates between the eurozone and the Fed could potentially narrow even further. But what we’ll be watching is where the market thinks that terminal rate will be — where the ECB can get to at the end of the cycle. That will impact the basis swap.

GlobalCapital: Higher rates will let shorter dated euro trades back in, but on the flipside, does that make the ultra-long deals NRW has been doing less palatable?

Bendiek, NRW: We are not scared if yields cross a 2% threshold. We would still be active at the long end. It is a strategic decision to increase the duration of the debt outstanding. We fund the public sector, and it is very much driven by yield considerations. We still consider yields to be exceptionally low, so we would like to lock that in for as long as possible really — 50, 60 years. At one point we’ll ask whether the yield level is still attractive to us, but 2% is certainly not a threshold in that regard.

GlobalCapital: Are there any concerns over liquidity, given the post-crisis regulations that have led to smaller bank balance sheets? Is that even more of a worry as QE is withdrawn?

Ruhl, ESM: I can’t see anything wrong with secondary market liquidity. In 2014 and 2015 EFSF and ESM had €30bn quarterly turnover. In 2018 and 2017 we had €50bn of quarterly turnover, excluding the PSPP trades. There is decent secondary market liquidity available, and we as issuers can steer that. The impact we have with our primary market activities on the turnover in the secondary market has increased as due to regulations, other trading reasons for the secondary market were reduced.

We do this actively by not issuing a €5bn bond in one shot but starting with €3bn and tapping it. Each time you tap a bond you bring additional liquidity to it and in surrounding bonds. This gives trading opportunities for investors. We will continue with this.

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Weyhausen-Brinkmann, KfW: I’m also quite positive about liquidity. We have witnessed similar figures to Siegfried — liquidity has actually gone up in the last year. We have also increased our outstanding bonds up to sizes of €6bn to ensure there can be more liquidity, instead of issuing smaller bonds into the market. I’m very confident for next year that liquidity will remain high. All the feedback from investors is that they are also welcoming liquidity and find it quite easily to trade SSA paper in larger size and at tight bid/offer spreads.

Ferguson, SSGA: Has the advent of centralised trading platforms like Tradeweb helped investor pools in the secondary market, in terms of increases in crossing pools?

Weyhausen-Brinkmann, KfW: MiFID II has accelerated the shift from voice trading to platforms, because of the documentation requirements. I suspect, and I have had discussions about this, that banks are pushing investors more towards platforms because that is an easier process. But it has not changed the liquidity of our bonds overall.

de Weert, EIB: The 2018 third quarter was our highest third quarter for turnover in our euro benchmarks and mini benchmarks since QE started. So these are pretty good conditions.

Bendiek, NRW: I have no concerns with liquidity, but liquidity is not our core strength to begin with. I believe German state paper is sufficiently liquid but most investors signal to us that they look at it more as a spread product. If the market is stable, traders will be more confident holding paper, maybe at times even going short because they know there will be sufficient liquidity to cover their needs. As a group of issuers, German states are a bit insulated from shifts in liquidity due to the nature of the product.

Ferguson, SSGA: The challenge we had at the beginning of the year was just sourcing paper at decent levels, especially covered bonds. So you had to get it in the primary market, otherwise you’re paying too much.

GlobalCapital: With trade wars, Brexit, Italy’s budget fallout and a chance of populists doing well at next year’s European Parliamentary elections, are politics the biggest risk factor for next year?

Hertlein, LBBW: At least for the first half of the year it is likely to have an influence on market windows, sentiment and volatility, so it’s a yes. Italy, Brexit, the trade war, the European elections and populism — which has gained strength across most European countries — will be a topic for the first few months of the year.

de Weert, EIB: Since 2008 we’ve have had a lot of volatility and have had to find the right windows. We didn’t create our mini-benchmark ECoop programme for this purpose, but it has helped us be present in the market when there was no window for benchmark issuance but was for a smaller issue. It adds some flexibility to our programme.

Politics as a risk is a situation we’ve known for several years. Every year in December we end up talking to our bankers, and they tell us timing will be key. We know timing is key, but finding the right timing is a different matter.

Ruhl, ESM: You’re absolutely right Nathalie. I’ve been with EFSF and ESM since the first day in 2011. The current political risks are quite low compared to what we had to manage in 2011, 2012, 2013 and the first half of 2015. Yes there’s some political volatility and this may impact the markets, yet relative to what we saw in the past it’s not a major thing.

Populism is a risk, and there is the risk that some politicians play with the fears of the people and put a much bigger project, the European project, at risk. This concerns me because it gave us more than 70 years of peace in Europe and is the reason for 70 years of growth. This is a big achievement, and should not be put at risk by trying to get votes and into power with a short term view.

On this, I would wish to see more global responsibility from the politicians. If we look geopolitically, Europe can only play a strong role globally if we stick together. This should be the objective of political decisions.

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Ferguson, SSGA: Populism is something that will be impactful over the long term, but not necessarily the short term. Over a 10 year horizon the policies governments enact will have huge ramifications for how corporations interact with the government and how trade takes place, cross-border relations, how people move and so on. That is a bigger ramification.

In the shorter term, the risks are around money supply and growth. As you both mentioned, the sentiment might shift and it might cause certain imbalances, but it’s really the long term transit and growth we’re focused on.

GlobalCapital: Are there any other big risks for 2019?

Weyhausen-Brinkmann, KfW: There are many challenges in 2019, again. I think the biggest risk for the markets are a combination of several risks occurring at the same time. And on the other hand, complacency. For many challenges over the last couple of years solutions were found and we moved on, but we should not underestimate the enormous effort needed for dealing with regulatory changes, unorthodox central bank policy, Brexit, and so on, and therefore we remain mindful of the market, see what is happening around us and be receptive to that.

Ruhl, ESM: We shouldn’t only talk about risks in 2019. There are also opportunities and positive developments, especially around the capital markets in Europe.

We will have the EU summit in December 2018 where leaders want to make decisions on how to further harmonise and strengthen the monetary union. One measure is that the ESM will become the backstop of the Single Resolution Board. And there are more steps to develop the role of ESM, which will strengthen the euro and the capital market in Europe.

Hertlein, LBBW: We are extremely optimistic as to the funding year ahead thanks to the credit nature of these issuers, with the caveat that timings will be key. That said, there will always be market access for issuers with this credit quality.

I’m very optimistic that will hold. That sets these issuers apart from certain other segments of the capital markets, for example financial institution or the corporate sector that — particularly in the second half of the year and for various reasons — have had to postpone certain transactions. We’ll have to see how some of those FIG issuers position themselves next year as a very large TLTRO tender comes due and that funding runs out.

For the SSA segment it’s a very positive outlook on funding plans for the coming year.

GlobalCapital: How is the introduction of the new risk-free rate for the eurozone — the Euro Short-term Rate or Ester — progressing? Is Europe lagging the UK and US on this front?

de Weert, EIB: Banks and all the industry associations are working together and there are several working groups preparing for the new benchmark. We’re part of one of those working groups.

Everyone is waiting for the ECB to publish the benchmark, which will be the official reform. The official publication will start in October 2019.

Ferguson, SSGA: The timeline of getting everything ready by January 2020 is quite ambitious, especially given the second consultation is not even finished yet. It will be interesting to see how they’re able to get a fully functioning derivatives market in place by that time.

Weyhausen-Brinkmann, KfW: The discussion in the eurozone is twofold; first Euribor is amended to a hybrid methodology to fulfil requirements of the BMR. Second, the successor of Eonia as the new RFR will be Ester. Given that Ester will not be published before October 2019, the timeline looks ambitious. There are several reasons why the UK and the US are more advanced, for example that the Sonia rate was always there and hence already familiar to market participants.

The impact of the new RFR is in my view much higher for the derivatives market, ALM and valuations. In the bond markets we have seen a couple of issuances of Sofr and Sonia FRNs but the vast majority is still fixed income.

The clearing houses are probably the catalysts. First, are they able to clear derivatives with the new risk-free rates? The second point — which is not that obvious but is probably even more important — is the discounting with the new risk-free rate. This is quite a big change, moving from Eonia for discounting to Ester.

de Weert, EIB: There was also more of a sense of urgency in dollars and sterling because of the imminent threat of Libor discontinuation, whereas in the short term Euribor is expected to continue.

Ferguson, SSGA: It does make us more selective on tenors for floating rate instruments. We are being quite cautious in how we approach anything that’s still outstanding beyond 2022. It’s unclear what the outcome will be so we need more certainty around how these fall-back provisions are going to look and how things are going to be calculated in the transition, or if there will be ways we can hedge for portfolios concerned with capital preservation.

Hertlein, LBBW: We are at different stages. There is no disagreement that the US with Sofr and the UK with Sonia are at a different stage of the transition from the interbank rates to transaction-based quoting on the variable rates.

GlobalCapital: How useful was the MTN market as a funding source in 2018? Were there any changes to last year? How do you see it developing next year?

Weyhausen-Brinkmann, KfW: We have seen only small changes to the overall market. We have been less active in certain currencies, for instance Turkish lira and Brazilian real, because of the political situations and volatility in those currencies. A couple of Asian investors are still looking at the MTN market and also some German institutional investors looking for longer dated placements.

Bendiek, NRW: It’s the same for us. We haven’t seen many niche currencies but that was also because the economics often didn’t work out on our side. We saw stronger demand in callable instruments, but not much stronger — only a bit more than the year before. We did a couple of the typical structures like CMS or range accruals, but not on a very large scale.

de Weert, EIB: We issued in 18 different currencies so there was still strong diversification, but in terms of structures the activity in euros was not significant.

Hertlein, LBBW: I agree that there was little change to what we saw in 2017. There was no major shift in structures or currencies like you sometimes see — for various reasons — where the market shifts from one product to another.

There were certain parts of the year when, at the very high end of the yield range, there was more activity. In the long end, we saw a shift where strong credits like the issuers present and the other SSAs were more sought after via reverse enquiry when the volatility rose. Investors asked for those names over corporates and financial issuers.

Specifically in the US market, at times we saw accounts looking to play the yield curve, with steepeners sought after for certain periods.

GlobalCapital: What was everyone’s SRI bond activity in 2018 and what’s the outlook for 2019?

Bendiek, NRW: We sold another benchmark transaction in the sustainability bond format this year, our fourth in total. We’ve raised more than €6bn between them, so they’ve been quite large issues. We only do one public deal per year and always towards the end of the first quarter. We try to provide some reliability so investors know when we will probably approach the market.

Initially they were based on the Green Bond Principles, but we extended the use of proceeds to take account of the full portfolio of the state’s mandate in terms of social and environmental projects. It has worked out nicely. We feel the approach has been vindicated by the guidance we’ve got from ICMA with the Social Bond Principles and Sustainability Bond Guidelines.

We can achieve a certain pricing advantage in the primary market, but not so much in secondary. New issue concessions tend to be a bit lower in the SRI format.

What we particularly see is that SRI products are very resilient, even at times of high volatility. We’ve talked about political risks. The SRI investor base is very reliable. Even if there’s a bit of uncertainty and volatility you can usually count on them being present when you approach the market.

We have gone through the budget with a very fine comb and I assume we have found most of the eligible projects. A new topic is digitalisation, which was not necessarily considered to be eligible a couple of years ago. We had debates on that — is it green enough, is it social? I would say it is maybe something in between. It has green connotations about enhancing efficiency and using less resources. It has social connotations in the sense that having an enhanced broadband network supports rural areas in particular.

Digitalisation is also a huge political issue, not really controversial but high on the agenda of the state government, which decided to speed up the development of digital infrastructure across the state. Therefore, we are happy to be able to address the topic in the context of sustainability bonds. We’ve got the projects in the budget and it obviously resonates well with investors based on the feedback we have received.

Weyhausen-Brinkmann, KfW: We once again had a very successful year in the SRI market. There were two particular highlights. First, at the beginning of the year we issued the largest ever green bond in Swedish kronor.

Second, we issued a large euro green bond a couple of weeks ago. In the secondary market our green bonds tended to trade tighter than the regular benchmarks so this time, together with LBBW as a lead manager, we tried to derive fair value from the green bond curve, which was inside the traditional curve. And it worked.

We priced a couple of basis points inside the traditional curve, which was new for us. We were not able to do that last year or the year before. The reason we could this time is that the green bond market is still growing, particularly on the investor front where so many are focusing on the theme.

I should admit that we only issued one large green bond in euros this year, our last one was more than 1-1/2 years ago and the size this year was limited to €1bn, which were clearly supporting factors. But still, we don’t normally price inside the traditional curve on smaller trades.

We are very enthusiastic about the green bond market and will continue issuing next year

GlobalCapital: Do you expect to use your green curve to derive fair value again next year?

Weyhausen-Brinkmann, KfW: We have to see. One has to be very careful and I’m not saying we will always price inside the traditional curve. It was just an observation. Ultimately it is a function about demand and supply of green bonds.

There are green bond investors in the books with multiple times higher orders than we usually see in traditional bonds. The green angle is getting more important for certain investors.

Bendiek, NRW: Our approach is a bit different as we do not want to set those products apart from the plain vanilla instruments. We don’t want to build a sustainable or green curve by itself. Rather we want those products to be an integral part of our overall curve.

Successful issuances presumably have a positive spill-over for the rest of the funding, which needs to be done in plain vanilla format. SRI funding makes up 15%- 20% of our annual needs so the other 80%-85% is what really counts, in a financial sense anyway. If the sustainability bonds were an asset class of their own and had their own curve inside the vanilla curve, that would make all the other issues look a bit weak in comparison.

So we want the SRI products to be an integral part of the curve. Concessions might be a little lower as I said, but secondary pricing is in line with the other issues.

de Weert, EIB: This is exactly the approach we had taken when we redeveloped our Climate Awareness Bond issuance in euros in 2013, after having brought the first Climate Awareness Bond in 2007. We priced these bonds from our curve and do not consider green bonds as a niche product, but a mainstream product together with our other bonds.

However, we have a Climate Awareness Bond curve that counts six points and these trade inside our conventional curve. So when we bring a new issue we price it from what we are now able to call the green curve, and it is inside the conventional one. If pricing occurs inside when you bring a primary trade, it’s because investor demand is there at that price — otherwise we wouldn’t price inside.

It’s really a matter of interest in the product and we have observed this year, as last year, that most of the green trades are oversubscribed and that allows for some tension in the price. But it’s more a consequence of the demand than issuers wanting to make a point and say, ‘my green curve is tighter than the rest’. We take what the market gives us.

In 2018, we launched our first sustainable bond that was structured from the Climate Awareness Bond template and was called a Sustainability Awareness Bond. All the features reflect the processes of the Climate Awareness Bonds that have already been proven and are well known by the market in terms of definition of eligibility, use of proceeds and reporting.

This first Sustainability Awareness Bond covered the water sector because it combines an environmental aspect and a social aspect. It was a perfect fit for a sustainable bond. Hopefully we will be able to enlarge the scope of this product to other sectors, such as health or education.

In the future, we expect to continue issuing both types of bonds, the Climate Awareness Bonds and the Sustainability Awareness Bonds.

Ruhl, ESM: We sold €46bn of socially responsible bonds this year and €60bn last year because as our mission is to safeguard financial stability by providing loans to member states, all our issuances are socially responsible.

For example, Greece, our biggest client, saves 6.7% of its GDP every year because we provide them with cheaper funding than what they would have to pay in the market. Spain, Ireland and Portugal went through a programme with us, went through the conditionality and are now among the growth champions in the eurozone, which is to the benefit of the people there. Our mandate means we cannot issue green or climate awareness bonds, but all our bonds can be considered as a socially responsible investment.

GlobalCapital: How does State Street approach the SRI market?

Ferguson, SSGA: It’s been a big challenge in the passive industry to attract a sticky client base and inflows on a regular basis in this area. But there are clients that have a more separately managed approach that are more receptive to engaging in these types of activities. But what makes it tricky is that everybody comes to the table with a very different definition of what social responsibility means.

The environmental piece is a little bit easier to quantify. There are standards and a green bond index that has criteria you need to meet.

Clients are saying yes, social responsibility is important. Depending on what angle you’re coming at it from, there’s very different demand and very different ways you can execute, particularly in a comingled or exchange traded fund structure.

de Weert, EIB: It is very challenging as an issuer too. That’s why for the sustainability bond we chose the water sector to start with, because it was the most obvious. We had all the indicators in place to be able to report on the impact of the investments. Adding social sectors would probably take time because you have to find indicators that are sufficiently transparent or that provide sufficient information to give comfort to the investor about the social benefit of the investment and how it really helps the population. How do you measure that? That’s challenging from the issuer’s point of view as well.

Weyhausen-Brinkmann, KfW: I have the impression that the ESG ratings from MSCI, Sustainalytics and so on are gaining more importance when I am speaking to investors. Is that the case for you?

Ferguson, SSGA: It is very important. They come in and ask, ‘can you screen, based on these factors? What does this index look like if you’ve screened on X, Y and Z?’ So yes, it’s important for investors now. They’re asking about it more. It’s a part of many RFPs — do you have these offerings? Are you able to do it?

GlobalCapital: Sustainable and social bonds have been gaining traction as we’ve discussed. Philip, do you expect more issuers to enter these markets in 2019? And are there still some SSAs that could issue green that have not yet done so?

Hertlein, LBBW: Possibly. Take as an example EIB, which played a pivotal role in establishing the green bond market back in 2007 and have been very frequent issuers in recent years — certainly after the financial crisis — and have now established another product with its Sustainability Awareness Bond.

That’s something we’ve seen from other issuers over the last year and something we expect to continue in 2019. But that holds for both the pure green bond market as well as for the social or sustainability orientated assets, where obviously there’s a broader range available to issuers, and with that, a larger market to be catered to.

As we’ve seen this year and as Otto mentioned about KfW’s euro green bond issuance this year, in the past people have tried to find a way to establish whether green or sustainability bonds come at a premium to investors or have cost benefits to issuers. Statistical evidence had been ambiguous, to say the least.

But this year — and it holds for all the issuers present here, with the ESM’s exception where the entire programme serves a social benefit to Europe — we’ve seen the green or sustainability curves establish themselves through the conventional curves for all issuers. The smaller sizes of the SRI trades and other aspects play into that, but it’s a fact that you now see we can price new transactions — as we’ve done with KfW — at a negative premium to the conventional curve, and dedicated accounts and funds pay that premium.

Ferguson, SSGA: The argument is that in the long run, investors are going to benefit from the resources. That’s the alpha you can’t quantify at the moment. But maybe down the line, we’ll be able to.

de Weert, EIB: In the short term there’s the price performance, because these trades tend to perform.

Bendiek, NRW: The good thing about ESG ratings is they draw focus to the issuer as a whole, as opposed to just the deal in question. That’s really key when the goal is for sustainability to become more of a mainstream concept.

We all use the use of proceeds format for SRI issues, with good cause, but with full recourse to the issuer, the focus should really be on the issuer in general and its sustainable qualities, as opposed to very narrowly focusing on the projects at hand. That’s what ESG ratings do. In that sense, they are an important supplement to the credit rating, providing an evaluation about the sustainability quality of the overall approach.

GlobalCapital: Will blockchain change the capital markets or is it just the latest buzzword?

Ferguson, SSGA: Faster transactions and more centralised record-keeping would be huge positives for the industry. Is blockchain what gets us there? That’s the big question mark.

Weyhausen-Brinkmann, KfW: We started a little experiment with Euro Commercial Paper on the blockchain last year. It was a very interesting use case. Among a lot of experiences we found two things that suggest this will probably not go into the mainstream capital market in the immediate future, say 2019 or 2020.

First, we were required by law to still have a physical document — a wertpapier urkunde — that we cannot replace with the blockchain. Second, we don’t have a viable currency available on the distributed ledger.

However, there is huge potential for the blockchain technology. In particular if it provides shorter settlement periods — for instance, in collateral management or just the possibility to track funds. So we will continue to monitor the developments closely.

Ruhl, ESM: I agree on the viable currency aspect. Especially for our market, for issuers as well as for investors, safety and security on the payment is extremely important. This is here still a hurdle. In addition, we all are issuers of big liquid benchmark bonds, targeting a wide audience. We already have very efficient systems with Target2 and Target2S from the ECB.

I have doubts whether blockchain is a big game changer for the SSA market. Nevertheless, new technology per se is one of the advantages I mentioned for the future because there is room to make our issuance processes more efficient and more transparent. Also for investors, to give them better access to the primary market — especially for investors outside the eurozone.

I just spoke to a head of a bank’s trading desk. They have to perform more than 400 auctions a year in euros — all the governments issuing bills and bonds. Each issuer has its own technology, process and deviations. For an investor outside the eurozone this market is very opaque. Here we can use technology to make the market more transparent and easier to access. That’s another tool to support the integration and harmonisation of the eurozone capital market.

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