Swaps, spreads and green bonds on the agenda for 2014
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Swaps, spreads and green bonds on the agenda for 2014

Despite the improving economic environment in the US and Europe reducing the momentum of the flight to quality supranationals enjoyed during the eurozone sovereign debt crisis, the issuers are still meeting strong demand this year. The recovery brings a fresh set of opportunities — and some challenges — for this sector.

The dying down of the eurozone crisis has helped the euro/dollar basis swap approach parity, opening up opportunities for dollar funding supranationals to issue benchmarks in euros — which the World Bank did in November after a four year absence. 

The green bond market, in which several supranational issuers have been pioneers, took off last year — International Finance Corporation sold the first green bond to reach $1bn in February 2013 and repeated the feat in November. World Bank was able to sell its first green benchmark in euros in March, while the African Development Bank used the format to print its first ever bond in Swedish kronor in February and the European Investment Bank priced its first Climate Awareness Bond in Swiss francs.

Ever-tightening dollar swap spreads have raised concerns that the supranationals — some of the most expensive names in the sovereign, supranational and agency asset class — would find it harder to fund in dollars without compromising on their levels versus Libor. The increased cost of derivatives has prompted some issuers to explore reducing the cost of swaps in their funding activities — including for some the possibility of revising their credit support annex documentation. GlobalCapital invited key issuers and bankers in the supranational bond market to New York to discuss the issues and developments in this evolving market. 

Participants in the roundtable were:

Marcin Bill, head of MTNs, International Finance Corporation

Søren Elbech, treasurer, Inter-American Development Bank

Jeanmarie Genirs, head of global high grade syndicate, Deutsche Bank

Jens Hellerup, head of funding and investor relations, Nordic Investment Bank

Eila Kreivi, head of capital markets, European Investment Bank

Peter Munro, head of investor relations and marketing, European Investment Bank

Hassatou N’Sele, manager, capital markets and financial operations division, African Development Bank.

George Richardson, head of capital markets, treasury, World Bank

Jigme Shingsar, managing director, debt capital markets, RBC Capital Markets

Sean Taor, head of debt capital markets and syndicate, Europe, RBC Capital Markets

Olivier Vion, head of supranational and agency DCM, Société Générale

Katrin Wehle, director, SSA origination, Deutsche Bank

Tessa Wilkie, SSA Markets editor, GlobalCapital

GlobalCapital: The euro/dollar basis swap has moved sharply since last year, and allowed the World Bank to bring its first euro benchmark since 2009. George is that something you’re looking to do more of this year?

George Richardson, World Bank: We’d love to. We’ve always said that euros is an important market for us. It’s just unfortunate that in many cases over the last few years it just hasn’t been possible, financially. Last November a short window opened and we issued, and it was something we’d love to repeat whenever possible. We look forward to the basis swap continuing to develop to allow that.  

GlobalCapital:Is a euro benchmark an aim for other funding officials around the table?

Søren Elbech, Inter-American Development Bank: We would like to see that as well. The challenge for us is that we have no lending in euros. For us it would make sense only on a swap basis. There’s a window, and that window can close very rapidly. We haven’t been active in the public euro market since 2000. There’s certainly a diversification opportunity to get, but it has to make sense from a cost perspective. If that can be sustainable, then certainly we would like to take advantage of it as well.

Jens Hellerup, Nordic Investment Bank: A large part of our disbursements are in euros so it is a possibility for us. But we are quite a small issuer and we’ve been active in dollars for the last 10 years, and we are committed to the dollar market. 

We would still look at dollars ahead of euros, but if there’s room enough we can do euros. We issued euros in 2009 and that bond matures this year, so of course it would be nice to follow that with another euro benchmark. But dollars takes priority for us.

Hassatou N’Sele, African Development Bank: The euro is an attractive proposition especially from a diversification and a duration perspective. More than 40% of our needs are in euros and although we have never issued in that currency, we have been able to access it via swaps. We are planning to meet with euro investors this year, and a benchmark is definitely on our table as long as the basis continues to move in the right direction and we can obtain euros at a cost that is similar to what we can source through our dollar global programme.

Marcin Bill, International Finance Corporation: We are definitely looking at that market and see great flows and good liquidity there. If the basis continues to move in the right direction we can perhaps enter. So far the market looks promising up to three years.

GlobalCapital: Eila, are you concerned about increased competition from dollar funding issuers if euros becomes attractive for them to issue in? 

Eila Kreivi, European Investment Bank: The euro new issues market has been robust throughout the introduction of Société de Financement de l’Economie Française, the European Financial Stability Facility, the European Stability Mechanism and government guaranteed bank issues, so we are not overly concerned. And the market remains very strong. Furthermore, in euros we have been focusing more on longer dated deals, and in that area there is less competing supply, though one should say that demand is strong across the curve. This year we have experienced very solid demand for our euro benchmarks in seven, 10 and 20 years.  And there is plenty of unsated demand at the short end, where we have had less of a requirement.

GlobalCapital: What about sterling? That seems to have been quite a popular currency this year, certainly for euro issuers that are swapping back. Marcin, you’ve been active in sterling this year. 

Bill, IFC: We returned to sterling this year after roughly a three year break. We keep observing the sterling market but the basis has moved away from us a little bit at the moment. It’s a market we would like to be a regular issuer in, but again for us the key is the cost-efficiency so we will only move if we can get the right level.

N’Sele, AfDB: We returned to the market this year after a 23 year break with a well received £250m issue. We are planning to increase that line subject to market conditions. 

Given that most of our currency needs are in dollars, euros and South African rand, the cross-currency swap needs to work for the AfDB to issue in sterling.

Hellerup, NIB: We are a regular sterling issuer and we monitor it for opportunities but it is working better in the short end and we want slightly longer funding. 

Elbech, IADB: That’s one of our reasons too. The maturities that we have been able to get in recent years have been short. We also came back to the market this year after a hiatus of seven years, but we would also like long dated funding. Sterling 15 to 20 years ago was known for providing very long dated maturities, but not any longer.

GlobalCapital: Now you’re getting that in dollars.

Elbech, IADB: And Australian dollars.

Richardson, World Bank: Sterling is one of the strategic currencies in which we try to issue at least once a year, and, fortunately the cross-currency swap from sterling to dollars has allowed for many more issuance windows than the swap from euros to dollars. 

But we don’t have any lending in sterling, so the proceeds do have to be swapped and the cross-currency basis swap is particularly important. 

On top of that the maturities on offer in sterling are short. We issued one five year but we can’t go much longer at the cost levels we would like. That said, sterling is a good market for diversification of investors because you see orders from some investors who buy only sterling.

Peter Munro, European Investment Bank: Sterling volumes have been high for us this year, and EIB remains the largest non-Gilt issuer. This year, we have issued a lot of floating rate notes, reflecting the fact that investors have been cautious about the rates outlook in the UK. The basis swap into euros is less of a concern for us, given that we also have extensive lending in sterling, and so maintain a sizeable sterling treasury.

GlobalCapital: Do any of the bankers here think that there’s still potential for the Federal Reserve’s tapering of its quantitative easing programme to destabilise markets?

Sean Taor, RBC Capital Markets: Looking back at last summer, there was a sharp increase in underlying yields because of the fear of what tapering might bring. Since then Treasury yields have gone back down again — from over 3% to below 2.75% and have remained in a very stable range.  

The first effects of tapering have been very well absorbed by the market. As long as tapering is well flagged and the message is very clear, then the market will not be overly concerned by it. The shock of the unknown is clearly more concerning to the investor base than tapering itself.

Jeanmarie Genirs, Deutsche Bank: We’re not concerned about volatility coming from tapering, or further tapering. Where we could get some volatility is related to the economic data that’s going to come out and re-price the market. We’re beginning to get larger rate moves associated with payroll numbers, and as the market starts to digest those numbers it will have a much bigger implication in the near term for rates. That’s not to suggest that it necessarily has to be destabilising, but it definitely could bring us to a new rate environment. 

Olivier Vion, Société Générale: Asset buying is meant to stabilise the market, so when you take it away there will always be some destabilising side-effects. What is interesting is that at the moment things seem to be under control. But for the future, this is a new tool in the central banks’ toolkit, and the question is when will they use it again after they finish this round? 

Katrin Wehle, Deutsche Bank: Recent Federal Reserve Committee testimonies have continued the theme of a measured and accommodative approach that is necessary to keep the market calm and to keep confidence up. They appear to be very much aware of preventing a nascent recovery. In our view, there are other themes that have a bigger potential to destabilise the markets at the moment. The dampening of the China growth story is raising much more question marks right now than tapering.

Kreivi, EIB: Last year the prospect of tapering caused some volatility, but this year the smooth implementation of tapering seems to have been comfortably digested by the market. We have printed three years, five years, sevens and 10s in dollars, and they’ve all met very strong demand. It has been a few years since we printed in all those maturities in one year let alone in the first quarter. This speaks to the view that the dollar market is in robust shape. Also, it does not harm that at the longer end of the dollar curve our spreads still look attractive versus Washington supranationals. Investors in European dollar issuers are further reassured by the fact that the situation in Europe is improving. This has helped our spreads in dollars tighten in and normalise somewhat over the past year. 

GlobalCapital: The dollar market has been extremely good for much of this year. Are you concerned that we could return to a market where there are patches where it is difficult for issuers to bring deals because of economic data? 

Genirs, Deutsche Bank: It’s not a major concern because we have a very healthy capital markets environment. And that’s not just true for the SSA sector, it’s across all of high grade. We’ve had an incredibly robust new issue calendar. We had record volumes last year and we’re already running ahead of that pace this year, so we have a very healthy funding environment. That’s not to say that every day will be a good day to fund. We could hit tough periods but right now we have an incredibly healthy environment. I expect that could lead to some pre-funding, although that’s probably a better question for issuers here, but it’s a very healthy environment, even at what are narrow spreads to Treasuries.

GlobalCapital: That was another thing I wanted to touch on for the issuers. Spreads are very tight but that doesn’t appear to have affected demand. Do you feel that any investors have been baulking at the tight levels versus Treasuries because of tight swap spreads?

Hellerup, NIB: The Libor valuation of our bonds is on the wide side looking at where it has averaged over the last 10 years, but that’s a function of the swap spread. We don’t feel we have any issues selling our bonds, it’s all about price. 

Elbech, IADB: We have a borrowing programme that we need to complete and we price at market levels. So when swap spreads get tight it influences our ability to price where we would like to versus Libor.

Of course we would like swap spreads to go wider again, but we don’t control that. 

We’ve not had a problem distributing our bonds, but we’ve certainly seen that there’s a pressure on pricing.

N’Sele, AfDB: We issued a successful dollar benchmark in early March, which attracted very good demand — 200% oversubscription — despite tight swap spreads. Not all our investors target spreads versus Treasuries. There has been at least one instance where we tapped a global bond through Treasuries. Widening swap spreads would be welcome in terms of attracting more investors, but we have been able to launch successful transactions in tighter environments.

Jigme Shingsar, RBC Capital Markets: It depends on the valuation metrics of the particular investor base. For example, bank treasuries look at asset swap levels and as Jens pointed out those are historically attractive, so bank treasuries have been able to pick up the slack when other investors that are focused on the spread versus Treasuries are maybe faltering. That is why it has been a strong market: some significant investors have been able to step in when others have reduced their participation.

We are also in a more benign credit environment, there’s less concern about Europe, and that has contributed to a big spread compression between European issuers and the washington supranationals, for example.

Genirs, Deutsche Bank: Given the environment that we’re in and the spread compression that we’ve seen, to have the supranationals trade as tight to Treasuries as they are trading, is an amazing feat and a testament to the credits. Some volatility, some higher rates and some wider swap spreads might be a good combination for everybody here at this table.

Kreivi, EIB: Overall, all investors would like to see higher interest rates and spreads versus Treasuries. However, this has yet to materialise, and we’ve not really seen an impact on investor demand. To reiterate, we have seen demand remaining exceptionally robust across the dollar curve. Also, we have seen very good demand from the US over the past six months, despite our spreads tightening to Treasuries. That increase in demand is in part due to the improved macro situation in Europe. Investors still need to invest.

Vion, SocGen: I have a question for the issuers around the table. It doesn’t seem like tougher levels versus swaps is actually so unfavourable for you, judging by the size of your programmes. Your programmes are not going down.

Richardson, World Bank: No, but there are different reasons for funding programme sizes going up. It could be that a particular year is a heavy refinancing year, or it could be that lending is developing well because of reasons not related to swap spreads. But you’re right, we’re able to support larger funding programmes than we ever have, successfully, and the cost to that is a few basis points versus Libor. 

And if your measurement or benchmark is Libor, then that means something. But if your institution, like most of the supranationals are, is a cost pass-through institution, then that additional cost gets passed to the end borrower, so the real benchmark is how much value are we providing to our borrowers.  

In most of our cases, borrowers are seeing much wider levels than a few basis points. So the relative value that we provide our borrowers is still at a nearly all-time high. 

I believe we can successfully print at tight swap spreads, because there are not as many alternatives for investors to buy. If you look at where Treasury yields are, every few basis points is a more significant percentage increase in yield than it would be if Treasuries were at 5%. We’d be in a different situation if five year Treasuries were 5% and swap spreads were 10bp. Then, I believe, we’d be trading at much wider levels versus mid-swaps.

Taor, RBC CM: To Jigme’s point, there are different types of investors — while many central banks look at relative value versus mid-swaps they are actually cash buyers. Bank treasuries look at asset swap valuations. Real money asset managers look at Treasury spreads. We have to consider the combination of all of those. As George said, yields are low. They’ve gone down since the start of this year. That has created demand as investors have become less concerned around rising yields. Central banks globally have been very clear that they’re in no hurry to move interest rates up in the near term, so for the investor every basis point counts. If an investor can get a decent pick-up over Treasuries for a safe asset then that’s better than buying Treasuries in many instances.

Bill, IFC: Every basis point that we save on funding can transfer into an increased capital base and we are raising funds for a certain function — to reduce poverty worldwide. So we try to squeeze every single basis point out of the programme. Liquidity needs and loan disbursements are the two driving forces of the funding programme, not just the spreads in the market, but we do observe them closely, of course. 

The way we have managed the programme this year has been to frontload it in a favourable environment so that we can then focus on arbitrage funding, which is what we’re doing at the moment. While conscious of costs we obviously need to get out and raise a relatively large amount of funding, so we have to price according to where the market is.

GlobalCapital: Are you looking at doing any pre-funding?

Bill, IFC: We most likely will pre-fund for the upcoming financial year. We are close to completing funding for this fiscal year, ending in June — we are only $1bn short. We have a mandate to pre-fund up to $2bn for the upcoming year. That gives us the flexibility to pick the most effective funding strategy.  

Kreivi, EIB: EIB has been using pre-funding to smooth the scale of its funding, and this year we will retain the option to do likewise. This also enables EIB to respond selectively to demand, after the main programme has been completed. 

: The issuers around this table have been very active at exploring new investor bases and markets but are there any in particular which the bankers here think are looking particularly attractive at the moment?

Shingsar, RBC CM: This issuer base is very active in seeking out liquidity. They are usually at the forefront of developing new markets. There’s nothing obvious that they’re missing, or if they’re not involved it’s generally a function of what we have talked about with regard to whether those new markets are sufficiently cost-effective.

Taor, RBC CM: The investor base is more global as well — they are looking at many different currencies. We’re seeing a lot of sterling demand, and the Aussie dollar market has had a very good start to the year as well. A lot of the local currency markets in Europe, Asia and South America have had a very good start to the year also. That will continue.

Wehle, Deutsche Bank: We are also seeing more demand out of Japan. Renewed optimism emerging from the  Bank of Japan’s new policy is creating activity, even in plain vanilla structures.  

GlobalCapital: New Zealand dollars seems to have been doing quite well as well.

Taor, RBC CM: The New Zealand dollar market has also seen strong demand.

Hellerup, NIB: That’s an interesting market because if you look some years back, then it was basically a domestic one. Before last year deal sizes were around NZ$150m to maybe NZ$200m. And last year they started to come at NZ$500m and they’ve stayed at that level. That’s because the international investor base has come into that market. 

Richardson, World Bank: The US market provides a lot of potential in different areas. One is upcoming changes in regulations — the Federal Reserve Board’s proposed minimum liquidity requirement for banks could change how US banks will view supranational paper from a risk weighting standpoint. Whereas before we were handicapped versus US agencies, the regulatory change  may mean that we are at an advantage. Even smaller, regional banks could potentially hold our paper with zero cost to capital or zero risk weighting. And if the US agencies are left at a little bit higher, that’s going to create an arbitrage opportunity. That could be really big for supranationals, because banks tend buy and hold for their liquidity portfolios. 

But the one issue here is that most of them don’t even know who we are. That’s a different story. As long as the technicals allow it, then it’s really just up to us to get out there and see and educate investors on our sector.

Genirs, Deutsche Bank: That translates into the banks from a secondary market making capacity as well. We have banks from an investment standpoint, for our liquidity portfolios, but then we also have the investment banks which are market makers. Clarity on how supranationals are versus government sponsored enterprises [GSEs] versus senior unsecured debt —that will most likely affect bid/offer spreads on those securities and dealers’ willingness to hold the paper in the secondary market. 

We don’t have a tremendous amount of secondary market flows because the combination of an incredibly healthy capital market backdrop, oversubscribed books and low volatility is not a good recipe for heavy secondary market trading. But at some point this year we will see more secondary trading and that is where we may see an even more transparent advantage in terms of pricing or bid/offer spreads coming through for some of the supranationals. 

Vion, SocGen: Bank treasuries have been very active investors in supranational paper and there is more to come. Some smaller players may not have completely adjusted their liquidity coverage ratio yet. Something that we are already seeing is that these smaller bank treasuries are not going to be a new source of liquidity per se, but some of them will outsource the management of their buffers into more professional asset managers. 

They will be able to follow regulatory developments very closely. This will create a new type of investor that will have to be marketed to by the supranationals. SocGen’s Lyxor Asset Management is already an example of this business. 

GlobalCapital: Do you expect to see a lot more of these kinds of investors setting up?

Vion, SocGen: Yes, it makes sense for a small bank, because regulatory compliance can be a very heavy workload, to either completely outsource the management of buffers, or even for larger banks to benchmark that management — to have a reference and do it with professional asset managers. 

Shingsar, RBC CM: George touched on the US market, which is something that this issuer base has marketed to continually, though distribution to the US has waxed and waned. There is a good backstop of liquidity in the US, but US investors have historically been crowded out by central banks. If that normalises, then with this additional backdrop of GSEs being in flux, there’s an opportunity there.

Elbech, IADB: The supranationals have been doing a lot of work to get into the state funds and we’ve only just seen traction in one of the states where they actually passed legislation meaning that they can buy the Washington supras. That is a major change because it takes a lot of time — you need domestic or state-wide legislation. But once it is approved then it opens up the doors. There is potential for a really big backstop of liquidity there, but we haven’t really focused a lot of attention on it until now, because we have been much more globally oriented.

Richardson, World Bank: I agree. That backstop exists. We certainly can do more to improve that backstop and we should, because the liquidity available is enough to cover all of our funding requirements together. And all it needs to have is six, seven, maybe 10 of the top fund managers know who we are and they only would provide that backstop if our spread level is attractive enough. 

If we did more, and it takes enormous amount of time and effort, to get deeper into the US, we can improve that level at which the backstop exists by expanding the number of fund managers prepared to invest in our sector.

Shingsar, RBC CM: But it’s not really in the consciousness of the purely domestic investor base.

Richardson, World Bank: It’s not yet. We all need to get out in front of them, and give them product.

Shingsar, RBC CM: Giving them product is the challenge because you have targeted deals where you hoped to gather more domestic US participation, but inevitably the traditional investor comes in too.

Richardson, World Bank: That’s true.

Bill, IFC: A good way to raise investor awareness in the US on top of the work with the states or the institutional investors, is to bring a retail product as well. IFC has just launched a retail programme. The volumes are projected to be relatively thin at the beginning, but the idea is to grow it organically and reach out through a network of the brokers to a wide spectrum of the investors and, as a result, make a wide range of investors aware of who IFC is. We hope that it will also contribute to the legislative process of opening lines up to us.

N’Sele, AfDB: We’ve had discussions with banks that put forward the possibility of doing themed bonds in the US in the same way that we have done themed bonds in Japan. 

In terms of this huge US investor base that we have not yet been able to access, how can we go about that? If there has to be legislation, it’s out of our hands. But what else can we do to be able to have that access?

Richardson, World Bank: The things that we’ve done include engaging with banks we’ve never engaged with before, such as regional dealers and so-called minority firms. We’ve added them to our discount programme. We also are working on the same programme that the IFC has just launched. 

That’s going to be very helpful in raising awareness among retail investors. 

Getting more traction with US investors is about getting on their calendars and knocking on their doors. We are just chipping away at this. We have been at it since 2009 and only just now have we got one of the larger states to potentially change their state investment code to allow buying some supranationals. It takes a long time. 

But in the background we have GSEs shrinking. The banks are doing a better job now of getting research out to investors and talking about the need for alternatives to the GSEs. And if you’re looking at triple-A rated alternatives, there’s nothing else but the supranationals.

Elbech, IADB: Congress is actually debating what’s going to happen to GSEs, so maybe there will be a whole new mortgage model for the country. That will change how GSEs access markets in the future. So maybe investors won’t be able to replace them today but will be able to later on. That will impact us as well. 

GlobalCapital: Marcin, it’s very early days but I’m interested to hear how the reaction to IFC’s US retail programme has been. 

Bill, IFC: We’ve received some first orders. The idea is to go out bi-weekly with new prints. The products will be a range of fixed, floating, step-up coupons and some callable notes as well. We based the product selection on feedback from investors. We aim to raise $200m through the programme this year. We’re hoping that the programme can grow considerably, because I think everybody here agrees that the US market has big potential and that it’s a matter of getting through to the small retail investor with denominations of $1,000 and presenting an alternative to GSEs. This is in its beginning phase, but we consider the launch of the retail programme an important move in the right direction as far as strengthening the franchise in the US, which will contribute to the diversification of IFC’s funding sources.

N’Sele, AfDB: We’re just wondering how attractive is it in terms of cost compared to the arbitrage funding we get out of Asia. Marcin, is it much different? 

Bill, IFC: It’s less attractive than the levels achieved in Japan, for example. There are costs and overheads associated with US retail issuance, which is normal when you enter the market. But you could also argue that there is value even if you pay up versus what is achievable via other retail programmes in that there’s a value to the brand recognition among the investors and that’s something worth paying money for.

Elbech, IADB: Did you debate reputation risk before you accessed the market?

Bill, IFC: Yes, we manage that with our arranger, InCapital. 

Elbech, IADB: So you were limited on what type of structures you could do.

Bill, IFC: Yes, the only structures that we work with are step-ups and callables — three and five year maturities are the most sought-after.

Richardson, World Bank: InCapital has been doing this a long time and is very experienced. We highly recommend looking at US retail to those around the table if it makes sense from other aspects such as legal and documentation. As far as structure goes, at the World Bank a few years ago we changed our minimum non-call period down to three months, knowing full well that we could not use that money for our lending programme. But, we carved out a part of our programme to do these only because it’s more likely that the investor in the US would buy those kinds of deals, because that’s what agencies issue. We started doing that, and shortly after we began receiving calls from brokers we’d never dealt with. It’s like our approach to any market, we try to diversify the ways we can get product out there. 

GlobalCapital: Hassatou, was the themed programme you were discussing to be targeted at US retail?

N’Sele, AfDB: It would be US, yes, but not retail. It would go to smaller institutions and funds.  

Bill, IFC: Another thing that could be added to the retail programme for us at some stage is to issue green bonds off it and raise awareness in that respect as well.

Taor, RBC CM: It would be interesting to see how it goes. In Europe a decade ago there was a big push into retail bonds — smart notes, COINS etcetera, however it didn’t work particularly well — partly on cost and partly because the retail investors in Europe were just not as familiar with the bond market as they were with the equity market. We’re arguably at the low point of interest rates and with potentially higher rates going forward I think it will be challenging. But there’s certainly a deep investor base out there.

GlobalCapital: On the SRI perspective is it a marketing tool as well?

Bill, IFC: Yes, we view it as a marketing tool if you have the US retail issues on top of the other green issues, but the increase in the general public’s awareness of green related matters is very important.

GlobalCapital: One of the things we’ve been discussing quite a bit with issuers and bankers in the SRI sector is some of the green bonds are now starting to trade inside issuers’ curves.  Could issuers begin to print inside their regular curve with their green bonds?

Richardson, World Bank: Realistically speaking, even for the World Bank, which has a larger amount of bonds outstanding, technicalities in particular bonds happen all the time, and it is hard to predict what causes those technicalities. It usually is just because an investor bought a decent size and took a dealer or two short. 

It’s too early to conclude that one product can beat the other product. We all hope it can — the market is moving definitely in that direction. But the amount of investors that is required to do that may not yet exist, at least from what we’ve seen. At the moment it’s just simply the size of a transaction that can cause that particular deal to trade more tightly. 

Bill, IFC: It all depends on the supply and demand in play, versus what you can see on the traditional benchmarks. But if you do allocation towards the SRI orientated investors, it crowds out traditional investors to some extent and potentially you have the spread tighten on that basis. Some of the recent corporate issues show the overwhelming demand in the green space with the books three times plus oversubscribed. Our latest green bond was 1.5 times oversubscribed, and at the same time the spread was driven quite tight.

Genirs, Deutsche Bank: It might be too early to tell. It’s a very young market, we’ve been in an incredibly low volatility environment. It has not been tested. It will be really interesting to see what happens if we have higher volatility and we actually do have heavy secondary flow and selling of bonds — will an investor choose to hold on to his green bond and sell a different World Bank bond? Then that could translate into perhaps those issues trading through the curve, over time that could lead to a new issue level if investors are learning that those bonds are really not going to come out, even in a volatile or widening spread environment. 

Richardson, World Bank: So far the green bond market has been a primary market phenomenon. And the subject of secondary market green bonds is a fascinating one because there are good arguments to say that the secondary market buyer of the green bond receives less ”green” benefits to its investment than the primary market buyer, because their dollar doesn’t actually go to the project, it goes to the previous owner of the bonds. Money gets traded around and it’s all fungible, so secondary market buying provides a less direct support of the green project we lend to. In most cases thus far, investors are very interested in being there in the primary phase, because that’s when they can truly say their dollar went to that green project. The secondary market is different. 

Elbech, IADB: I would like to add to, and this comes as no surprise to anyone in this room, that I am slightly sceptical about green bonds issued by supranationals. As long as there is no actual true segregation of funds, and supras just don’t have that, then it will not be possible to price differentially.

As investors cannot say with 100% certainty that their investment in a green bond goes to specific green projects, why would there ever be a price differentiation? For issuers which have fungible balance sheets, like us, we will never be able to actually get the price differentiation that would be necessary to recoup the admin costs associated with green bonds. So, in my perception, unless investors are willing to substitute financial yield for a properly facilitated “green” return, green bonds make it actually more expensive for a supra to lend the same money to the same projects, so I can’t justify this activity. 

Richardson, World Bank: That’s why we went through the effort, a lot of us, to segregate the use of proceeds. It’s true that the money investors get back is fully backed by the whole balance sheet and is not project specific. But the cash coming in can be accounted for step by step the whole way through. There’s a difference between these earmarked proceed bonds and most themed bonds issued in Japan. The latter are mostly best-efforts bonds which do not ring-fence the investor’s money to specific types of projects. 

Elbech, IADB: My criticism is that if a green bond-funded loan doesn’t repay to the supra, it would still repay the bond. Meaning there is just no segregation in the balance sheet. You might see the money flow in one direction, at issuance, but you’re not seeing the money going in the other direction. 

Richardson, World Bank: That’s true. The repayment of that loan is backed by the full credit of the institution. It needs to be this way in order to preserve the triple-A rating of the bond. 

Otherwise, the investor is beginning to take project risk, or at least the risk of a sub-component of our total lending.

N’Sele, AfDB: Yes indeed, but through the transparency and traceability of our green bond framework, investors have the assurance that their money is going to fund the portfolio of green projects identified. Going back to the performance of green bonds, a few months back I would have told you, yes, we have heard that our bond is trading through our curve, but as George indicated there might be some technicalities involved, and maybe the market is still too young to make statements about secondary performance.

Taor, RBC CM: There may be investors who have to buy a green bond because they have to invest their money in green assets, so they might have to pay what they think is too tight a spread because they have no option. So on the margin you may see some outperformance of green bonds, whether in primary or secondary, for that reason. But I agree with the earlier comments that it’s very early days to look at the market as a whole and say that pricing is or could be through benchmarks, or that the secondary performance is stronger. 

N’Sele, AfDB: Our green bond platform has opened a new market to the AfDB this year, allowing us to issue for the first time in Sweden. We issued two bonds in Swedish kronor placed with investors interested in sustainable investments. The pricing of the transactions set an excellent and tight reference point for AfDB among its peers for any forthcoming transactions in the Swedish market.

Hellerup, NIB: Last year we entered the Swedish market. First we did a normal bond and that went to a very narrow investor base. Then a month later we brought a green bond with the same pricing and the distribution was much wider. 

Wehle, Deutsche Bank: We had a similar experience with the green bond format being a positive investment trigger for a European corporate bond recently: the issuer brought a very similar non-green security just six months ago, the order book finished at around €1.2bn. In February, the issuer went for a green bond with the same maturity. The order book was €2.5bn, there were new investors to the company and the pricing was tighter. I agree, it is too early to derive clear conclusions, but the SRI investor base is clearly growing. The momentum is with us, but with a small ”m”. 

Kreivi, EIB: EIB has issued green bonds, specifically Climate Awareness Bonds, in eight currencies, and the range of currencies and volumes has been growing quite significantly in the past 12-24 months. This seems to signal a healthier market emerging. In terms of pricing, we don’t pay up to do Climate Awareness Bonds but we don’t expect investors to pay up either. There may be exceptions, but most investors have a fiduciary duty to observe.

Shingsar, RBC CM: A key question is, is this product just targeting SRI investors, or is the idea that you are encouraging everyone to become more socially responsible?

Kreivi, EIB: This is a fair point. Leading investors are starting to explore overlays that span large parts of their portfolios, so as to sensibly mix SRI considerations with traditional financial criteria.

Elbech, IADB: I want to be clear that I am not arguing against green. IADB does several billions of “green” loans every year. We fund them with the bank’s regular bond issuance. It is the instrument, a supranational green bond, that I am speaking out against because it just doesn’t deliver what it is supposed to. 

If we were to do a green bond, it would increase our cost base — not the cost of funding but it increases our admin costs, and admin costs are covered through our loan spreads. That means that if we have to do green bonds, we would have to recover the high admin costs through making our loans more expensive. That is wasteful and why should I put that on our shareholders?

Hellerup, NIB: Then you have the argument that it provides diversification. It maybe is a little bit more costly, due to admin costs but it can also cost to get other kinds of diversification. That’s been our motivation for doing the green bonds.

Elbech, IADB: I certainly don’t want to seem arrogant but if there was a problem raising our annual issuance volume, we would of course also look at green bonds. But we don’t have such a problem. 

Bill, IFC: If you consider that one of your statutory missions is raising the awareness of the green issue, then that’s also something that you could argue to justify the cost. Plus to address your concern on investors’ clarity on where the flows are going, the Green Bonds Principles initiative will help investors understand the process.

Elbech, IADB: But isn’t there a problem with the timing between when you do a bond issue and when you do a disbursement through the project? There can be months in between. In the meantime you have your money sitting there in the liquidity portfolio. 

Bill, IFC: At the same time, if you weren’t taking the action then that would never happen because it’s obviously physically impossible to align the disbursements with the issuance of the bond. 

N’Sele, AfDB: The way we would do it is to have a debt allocation process where you match the debt with the specific assets to be funded. That exercise is done after the fact, be it for regular bonds or green bonds, because you need to match the disbursements made on your loans with the bond proceeds available during the same period.

Elbech, IADB: In my perception that would be running green bond refinancing risk in your balance sheet because if you do a three year green bond you are not funding a three year loan with that, you are probably funding a 10-15 year weighted average life loan.

N’Sele, AfDB: And we are all completely transparent about it. There is full disclosure on all our green bond framework, and investors are fine with partially funding a green project. This is is the reason why they are participating in green issues.

Elbech, IADB: I want to go back to awareness creation.  Green bonds is primarily a marketing tool. 

Bill, IFC: That you could say serves a bigger purpose. 

Elbech, IADB: Yes, and if we could just all agree that it is what it is. 

Richardson, World Bank: I don’t agree. 

GlobalCapital: I’m interested in the issue mentioned there about the investor base. I wonder how many investors at the moment actually need to have their proceeds in green bonds.  Would a lot of SRI investors buy normal World Bank bonds anyway? 

Richardson, World Bank: In our experience there are many different shades of green. Some investors will not buy anything other than a green bond, even if it’s World Bank. There are others that will buy both. And there are others which buy both and have a preference for mainly green. Then there are others which will say as long as the price is the same, they don’t care. The list of investors is huge, depending on where you cut it on the green scale. The deep green part is comprised originally of small investors, such as religious institutions, investors which have been focused on SRI specifically and have been green for a long time. Then there are the lighter green investors, and that’s the part that’s growing really fast. Some of these large US money managers, fund managers which have dedicated green portfolios now, are coming online fast. That’s what has provided the impetus of the growth in green issuance over the last 18 months or so.

Genirs, Deutsche Bank: We’ve seen a preference from some investors for a green bond. They’re not blind to the price of the bond, which still needs to make sense. It is a preference that is expressed through size. Maybe an investor’s order is $50m for a standard bond, but if it’s a green bond then maybe their order is $100m.  

Shingsar, RBC CM: Where investors might otherwise see supra pricing as being too rich, the green aspect of a bond has sometimes been able to convince them to bring their pricing preferences in line with the new issue level — which is not through the regular funding but at least in line. That same investor might just find the regular bond too expensive at the same price.

Richardson, World Bank: We’ve also seen institutional investors in the last year which absolutely demand, let’s say, a $1bn allocation for regular bonds and always have had. Yet for green bonds they’re OK with $350m or $400m if it has to be. They themselves give in to get the deal done because they’re very interested in the growth of the market and they need the product. Maybe they won’t give up on price, but there are other things that they can do to  show some flexibility and demonstrate their commitment to this market.

Genirs, Deutsche Bank: It also has an implication for what their intentions are around holding the bond. So liquidity is not their purpose for buying this bond. Liquidity is at the top of many buyers’ lists and often we’re very focused on that. With green bond syndications investors often have a different priority. 

Munro, EIB: It’s interesting to note the example of investors in the euro market, where they have been encouraged by the introduction of a traditional mini-benchmark product in green format. That has enabled EIB to strike a certain balance between liquidity and flexibility, which has meanwhile proven its worth for traditional and green investors alike. 

N’Sele, AfDB: When we did the green bond, some investors that usually buy regular AfDB bonds placed orders that were a multiple of what they usually invest in our issues.

Elbech, IADB: Which could have been an excellent opportunity to tighten the price? 

N’Sele, AfDB: I gave an example of one investor but that’s not the case for all of them. As George indicated, you do have those different shades of green. There are the deep green or SRI investors for whom the social return takes precedence over financial return. And you have the other socially responsible investors that have to equally weight the financial and social return of their investment.

Bill, IFC: I understand the EIB’s Climate Awareness Bond in Swiss francs was larger than they intended it to be.  One could argue that you can achieve a larger volume or potentially tighten your price. 

Vion, SocGen: You could also argue that if you issue two bonds at similar prices and one is smaller than the other, then on the less liquid one the investor is already paying a premium.

Richardson, World Bank: It depends on the investor. If it’s not a buy-and-hold investor, then yes, they’ll be paying. They make sacrifices in different ways — sometimes on maturity, sometimes on size. They do give into this process just like we the issuers are giving into this process.

Hellerup, NIB: Investors on our normal roadshows say they would like to look at green bonds but they need the same price and the same size. So they want green, if they can get it, but they don’t really want to sacrifice anything. 

Elbech, IADB: We would all like that. But when you go to the supermarket you can buy ecological milk or you can buy regular milk, and if you say, “I want to buy ecological,” you pay a premium over the regular stuff. So why can’t investors do the same?

Taor, RBC CM: It’s too early to know whether the deal size or order book on a specific deal is larger because that deal was green, because we do not have enough data points to qualify that statement. If you look at the corporate market, and let’s applaud the SSA sector for leading the way, there have been several new issue corporate green bonds. Arguably, they’ve been issued at a wider new issue premium to make sure that those deals worked, because the issuers and the banks wanted the positive headlines to help promote the wider green cause. Because the new issue premia were wider they ended up with a larger order book. It’s self-fulfilling. But again, highlighting the green aspect of the transaction, surely, is a good thing long term. But if you just look at one deal for one issuer then it’s very hard to say for certain what the long term outcome will be.

I do disagree with George on one thing though and that’s around secondary trading. To have a position in a bond on the secondary book, one of the clients which originally bought the deal in primary would have had to have already sold their position. They bought, for example, into a five year green bond, effectively committing to a project, then sold the bonds in secondary soon afterwards. You then need an investor to come in and buy in secondary to take up the mantle of investing in that bond for the rest of the life of the bond. To me that’s no less green than the investor that bought it in primary.

Promoting the secondary market of green bonds is important. It drives the secondary curve, which will in turn drive primary pricing as well.

Richardson, World Bank: I agree the secondary market is critical, otherwise we would be issuing loans instead of bonds. But my point was that the primary market investor has two things that he or she can add to the sense of being green. With a secondary market investment, the investor cannot really say his or her dollar goes to that project. The secondary market investment supports the green project indirectly, because it’s definitely the case that the better the secondary market in any product goes, the better the primary market will be. But it is one, maybe a half step, removed versus knowing your dollar went to the project by buying in primary market. And that is enough to make it a point of discussion with investors sometimes. 

GlobalCapital: Another issue, which we’ve been talking a lot about over the past two or three years is regulation and the impact on banks and profitability of the SSA business. Is that something that issuers here are concerned about, that banks are really struggling with the profitability of this business?

Elbech, IADB: Absolutely, it is a development we all need to look at. Banks have left or cut back in the business — what does that mean for the swap market? We’re all very much looking at that. As George said before, we are pass-through borrowers, so the cost of the business we’re doing will have to be passed through via our loan spreads. If a fundamental strategic change comes to the swaps market, we definitely need to think about what it does to the products we offer to our own borrowers.

Hellerup, NIB: But isn’t it also to some extent that some banks are leaving but there are new banks are coming in? They may not be as experienced when they come into a new market, but new banks can also do a good job.

Elbech, IADB: One of the problems could be that you have minimum ratings requirements for your counterparties. If you’ve already exhausted those which are there and available with primary dealerships in the currencies that you need and which supply secondary liquidity to your swaps, and if you don’t have new counterparties coming into the market, you will have a smaller market. 

Shingsar, RBC CM: Healthy markets always have new entrants and some players falling by the wayside. But what’s different in this case is that if you look at the league table positions of a bank like UBS — we are not talking about a fringe player which decided to shut down. They held meaningful market positions.

Hellerup, NIB: We have seen banks which have come up in the dollar market from a low level in the league tables, and have done quite well. 

Taor, RBC CM: Looking at the industry as a whole, the resources deployed within the SSA sector are noticably smaller than they used to be, and that’s only heading one way. FIC revenue for the global banks last year, was down 40%-45%. It’s not going to be easy this year either. Banks’ cost of capital is going up, and financial institutions have to look at all their businesses on a stand-alone basis and be selective around where they put their scarce capital. 

It’s not going to get any easier going forward. There are some new entrant banks, however many others are less active, and some have withdrawn completly. The industry as a whole has fewer resources allocated to the sector. We should all be very concerned.

Elbech, IADB: George and I were sitting in the same meeting room in London in January when JP Morgan announced its results and a $1bn CVA charge appeared in its statement. This discussion is only going one way.

GlobalCapital: Are any borrowers looking at two-way CSAs? 

Taor, RBC CM: The capital deployed, and resultant charges from banks’ derivative books are a real concern. It’s very clear that many banks have been lobbying issuers to move to two-way CSAs for some time, in order to help them compete and to therefore continue to invest in the business for the long term. There has been some progress in some areas but less progress in other areas.

GlobalCapital: Have those costs been getting passed on to the borrowers or are they being absorbed by the banks? 

Taor, RBC CM: Banks’ revenues have gone down — so in answer to your question banks have been trying to pass on some of the costs and some have been successful in some areas, and some haven’t. The overall profitability of the business has gone down, which is why there is less capital investment in the business. 

Genirs, Deutsche Bank: The inability to pass on those charges is temporary at best. It’s just not sustainable for a long period of time, especially when revenues are under pressure and capital is under pressure. Banks are looking very forensically at individual business lines and not necessarily just cutting resources but perhaps reallocating resources to different areas. That is going to be a theme that’s going to stick with us for some time.

GlobalCapital: Where will that hit borrowers? Are cross-currency swaps, coverage and secondary trading the main areas where they could see an impact?

Genirs, Deutsche Bank: You have several very large global banks at this table, so this business in and of itself is a very important one for us and to our clients. It’s an important one that we continue to invest in and we think it is still worthwhile to invest in. Having said that, it is important to right-size the resources for the revenue and business opportunity. We should do that all the time, but, especially when revenues are under pressure, dealers are going to do that maybe more quickly than they’ve done in the past.

Kreivi, EIB: It is fair to say that swap charges have gone up. The longer you go the more costly the swap is. However, there can be alternatives to complement traditional swaps. We are looking at various ways to reduce our overall needs for swaps. 

GlobalCapital: Are any of the borrowers around the table looking at reassessing their CSA documentation? 

Bill, IFC: We are considering it at this stage. The way that we try to mitigate the cross-currency cost in the meantime is via inter-desk swap transactions. We work with our portfolio managers and where there are assets that we can invest the money in without entering into the cross-currency swap, we try to do that internally. But there are limitations on the amount of assets where we can do that. 

Hellerup, NIB: We are also looking at it. We have still not taken the decision to go to a two-way CSA. We are analysing the extra cost of having a two-way CSA such as the cost of the extra liquidity you need. And we still think the extra costs of doing swaps, with the one-way CSA is lower than the cost of having a two-way.

N’Sele, AfDB: The African Development Bank is in the same position. 

Elbech, IADB: We have updated our internal analytics for this and have prepared a lot of the groundwork to do two-way CSAs. We have not yet made a decision on that, and that decision will be made later this year. It’s very transparent to us what the costs are to the business, and that we could lower the swap costs if we were to go to two-way CSAs. I have a different viewpoint than NIB. From a cost perspective two-way makes a lot of sense.

GlobalCapital: Is that a ”no comment” from the World Bank?

Richardson, World Bank: We are very strong supporters of the green bond market.  

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