EDDI fits the mandate of SSAs – if it can reduce costs
The European Stability Mechanism’s initiative to create the first public sector-backed bond platform could seriously disrupt the current model for issuing euro bonds. But the plan only makes sense if it brings down costs.
Public sector borrowers have a duty to their shareholders — ultimately, taxpayers — to achieve the lowest possible cost for issuing debt. So any ideas or initiatives to bring down this cost should be commended, including, most recently the European Distribution of Debt Instruments (EDDI).
As GlobalCapital reported, one of the key ways in which EDDI could reduce costs for borrowers is by cutting out the involvement of investments banks in the bond issuance process, and allowing investors direct access to investors.
The idea of using technology to bring issuers and investors closer is not a new one. Ipreo's Investor Access tool allows investors to put in orders directly to a book, once they have been approved by banks, though it has achieved patchy take-up among the top bond underwriting banks.
Taking out the banks completely, however, is altogether more ambitious. While this will remove the fees borrowers pay to banks, that doesn’t necessarily mean the overall cost of issuing a bond will be lower.
For example, will issuers be able to achieve the same level of investor demand and subsequently, tighter spreads, without the support of banks? Even if they are able to, the role of a syndicate isn’t just restricted to bringing investors to the table.
Banks are also responsible for various other functions in the process, including setting the price of the securities, and making markets afterwards, with the aim of best serving the interest of issuers and investors.
Without an intermediary, the issuance process will have to be some version of an automated auction, where the price of bonds will be subject to whatever investors want to pay.
If that’s the case, then this brings up the question of why issuers don’t just use auctions for their entire funding programme — accessing the various auction systems already used by sovereign borrowers. Syndication clearly serves some value, with some of the most sophisticated sovereign borrowers actually boosting the use of this approach over recent years, and surely it will retain a role, whatever new technology platform is produced.
But a likely landing point is somewhere in between, with bookrunners probably accepting a reduced role and fees in new issuance for SSAs — but keeping some level of control over a process that can still be complex.
EDDI is a great technological initiative and another example of the development of fintech in the primary bond markets, which have so far been slow to take up technological solutions. But it can only prove successful in the long term for SSA issuers if it can show that it really does reduce costs.