Exploring opportunities in a recovering eurozone
Agency issuers have this year emerged blinking from under the shadow that the eurozone sovereign debt crisis has cast across European capital markets since it erupted in 2010. Borrowing conditions in the first few months of 2014 have even been better than anyone dared hope at the end of last year.
Agencies have been able to price a run of oversubscribed deals at low new issue premia, despite turmoil in emerging markets currencies and the Federal Reserve tapering its quantitative easing programme.
But it’s not all rosy. As the economic situation in Europe has recovered the euro/dollar basis swap began to swing towards flat from the deeply negative levels which have provided euro funding issuers with attractive levels in dollars for several years. That has taken away some of the allure of dollar issuance for European agencies — and may lead to a more crowded euro new issues market. As yields grind lower and lower across the core and peripheral sectors, investors may begin to look elsewhere to meet their returns. On top of this, regulation is making it more expensive for banks to provide derivatives and use balance sheet to support secondary trading.
Leading European agency borrowers and bankers joined GlobalCapital to discuss the impact these developments will have on public sector bond markets.
Participants in the roundtable were:
Carl-Henrik Arosenius, head of investor relations, Kommuninvest
Alex Caridia, managing director, debt capital markets, RBC Capital Markets
Holger Dohra, head of investor relations, Erste Abwicklungsanstalt
Bart van Dooren, head of capital markets and investor relations, Bank Nederlandse Gemeenten
Kerr Finlayson, SSA syndicate, RBC Capital Markets
Stefan Goebel, head of treasury, Rentenbank
Eske Hansen, head of funding and treasury, Kommunekredit
Joakim Holmström, head of funding, Municipality Finance
Steven Jallport, director, sovereign, supranational and agency group, Deutsche Bank
Tom Meuwissen, general manager, treasury, Nederlandse Waterschapsbank
Clinton Orr, director, sovereign, supranational and agency group, Deutsche Bank
Rodrigo Robledo, head of capital markets, Instituto de Crédito Oficial
Olivier Vion, head of supranational and agency debt capital markets, Société Générale
Petra Wehlert, head of public market new issues, KfW
Tessa Wilkie, SSA Markets editor, GlobalCapital
Craig McGlashan, deputy SSA Markets editor and MTNs & CP editor, GlobalCapital
GlobalCapital: Looking at the debt markets this year, it is tempting to say we have reached a turning point in the peripheral eurozone recovery. I wanted to start by asking some of the bankers here if that is indeed the case.
Kerr Finlayson, RBC Capital Markets: It’s still fresh in all of our minds, but in terms of the supply and demand dynamic it feels like we are returning to a more positive backdrop. Spain did a 10 year deal that smashed the record in terms of order book size, attracting nearly €40bn of orders with over 60% being placed outside Spain. There is clearly going to be European Financial Stability Facility and European Stability Mechanism support for a long time and investors have taken comfort from that.
Clinton Orr, Deutsche Bank: Portugal will aim to exit its programme in May, that’s one of the milestones coming up. Whether they do that without a backstop, as Ireland did, or with the backstop remains to be seen. They did a bond buyback in February so they clearly have ongoing market access.
As Kerr mentioned the official entities will be funding these sovereigns for a while so the crisis will still be with us. But it’s interesting that this year the market has taken any news or shocks in its stride and investors have differentiated between countries, not just in the eurozone but in EM as well.
One question is whether yields are actually getting a little low in some of these countries.
GlobalCapital: Rodrigo, would you agree with that?
Rodrigo Robledo, Instituto de Crédito Oficial: The situation has changed a lot. Moody’s, which was the most negative rating agency on Spain, has just upgraded it. If someone had told me one year ago that the first rating agency to do that would be Moody’s, I would have been very surprised. They were close to downgrading Spain barely 18 months ago. But their analysis behind the upgrade is finally based on fundamentals in the economy, the reforms of the labour market, the deficit and the financial system.
Like Spain, Ico is in a very different situation too. We have been experiencing demand this year from a non-domestic investor base which we had not seen in two years. Two years ago we were mainly a domestic player, and since last year we are placing more and more bonds with international investors and this is because confidence is coming back around countries in Europe’s periphery, and especially to Spain.
Stefan Goebel, Rentenbank: There’s been a fundamental change. Just a year ago, investors were wondering whether they would get their money back at all from some of the peripheral eurozone countries, and if they did then they weren’t sure which currency it would be denominated in. Now it’s a completely different game as investors are really looking again at value and asking how far spread tightening can go. The concern about a potential break-up of the eurozone has completely disappeared. It’s really only a year ago that we were discussing that as a serious prospect.
Olivier Vion, Société Générale: Throughout this year there has been strong appetite from investors for risk and that has led to a collapse in peripheral yields.
Coming back to the rating agencies: it seems that they are using this market evidence to change their course of action in the same way as they started to downgrade countries because they didn’t have access to the market.
Petra Wehlert, KfW: It was a good strategy of the Federal Reserve to begin tapering its quantitative easing programme in December because the market is quiet at that time of year and nobody wants to create any positions. Consequently, in January the decision was out of the way by the time issuance kicked off.
After the €40bn book for Spain, which represented a peak in market sentiment, there was some trouble in emerging markets and I was concerned about how that would impact our asset class. But the whole sector of eurozone bonds was unaffected. Countries affected by the debt crisis have made progress over the past year and it seems to be a pretty stable environment. But also the safer credits such as KfW have tightened.
There is high liquidity in the markets leading to very tight spreads everywhere — European assets are really in demand.
GlobalCapital: That tight spread environment — has that affected the behavior of certain investors? Have you seen any not participating in deals because spreads are just too tight?
Bart van Dooren, Bank Nederlandse Gemeenten: We haven’t seen a lot of change in investor behaviour, although every issuer around the table is seeing more and more bank treasuries getting involved in their deals. In the coming years we will see what permanent impact the Liquidity Coverage Ratio has on the investing pattern of the bank treasuries, but that’s something for years to come.
Carl-Henrik Arosenius, Kommuninvest: There seems to be some irrational behaviour in the market, because when Ireland came back to issuance, they had a five and a 10 year issue, and the five year issue actually came out at a yield lower than the Kingdom of Sweden. That is strange because Sweden is rated Aaa/AAA/AAA with a stable outlook and Ireland is BBB.
Wehlert, KfW: There’s just a lot of money around to be invested. On the dollar side swap spreads to Treasuries are very tight. Nevertheless we have just done a three year issue and the take-up in the market was really good. We were able to achieve a $7.5bn book — despite the very tight spread to [US] agencies. In this environment every basis point counts. Spreads don’t reflect risks properly anymore because investors cannot be on the sidelines just to wait for higher yields.
Finlayson, RBC Capital Markets: You’ve got a combination of central banks with large flows of cash and bank treasuries that are buying product for their Liquidity Coverage Ratios. That combination of demand means investors have to buy the product regardless of spread. Based on where yields are, there has been some evidence of treasuries pushing out the maturity spectrum.
Vion, SocGen: We haven’t seen any pushback on spreads per se, but we’ve seen a number of investors not very happy with the level of yields and not necessarily participating in full size in the deals on offer. So while there is no problem with credit risk right now there’s a question of whether investors are hitting their targets.
GlobalCapital: Is Federal Reserve tapering an issue at all? Last year investors didn’t participate at times in the market because they weren’t quite sure of when the Fed was going to taper and how fast. As the Fed announced in December, are investors happy with the direction and pace of tapering or are some still a bit nervous about the way yields could go?
Orr, Deutsche Bank: The surface tension has broken. Last year when investors were expecting the taper and the Federal Reserve didn’t taper that caused a bump or two. But since the Fed did it as we were going into January, investors could more or less work out the schedule. The Federal Reserve has made it clear that it will not alter course to accommodate the problems in the emerging markets. That makes a pretty predictable path for investors. We have to remember these are extraordinary measures for very difficult times, so it’s not that unusual that there should be some volatility caused when the measures are withdrawn. But the more EM has problems, the more there’s a bid to suppress yields in SSA paper.
GlobalCapital: We have the European Central Bank in more of an accommodative stance at the same time as the Federal Reserve is tapering its quantitative easing programme. That’s quite an unprecedented situation where there are major central banks on divergent courses.
Finlayson, RBC Capital Markets: The key is that both of them have adapted in different ways but both of them are making it quite clear what their route is, which takes away uncertainty. That’s a comfort to the investor base.
Van Dooren, BNG: As long as the Federal Reserve is transparent, its communications to the market contain no surprises, and Yellen follows the same policy as Bernanke, then tapering will go smoothly. But the Fed has to be very careful in its communications to the market.
Wehlert, KfW: We had discussions with banks in New York in December and banks’ forecasts for 10 year Treasury yields this year differed tremendously. Only one house actually predicted that yields would be lower this year and that was indeed what happened against the general market opinion of rising rates in 10 year Treasuries.
For the US market it’s a good outcome. They could keep tapering, step by step, and still yields will be low. They should be finished with tapering in October or December and maybe without Treasury yields spiking, which would be a great result for them.
Europe, however, depends on the ECB. And the German Constitutional Court’s decision on the Outright Monetary Transactions scheme is not priced in at the moment. That is something that nobody wants to think about.
The whole market was caught by surprise by the problems in emerging markets, but now those seem to have been digested.
GlobalCapital: Is the German Constitutional Court’s decision a big issue which the market is just ignoring?
Wehlert, KfW: The German Constitutional Court has expressed its concerns about the constitutionality of the Outright Monetary Transactions scheme and moved it to a European-wide judgment. My understanding is that The European Court of Justice has 16 months or so to take the decision. If the court supports the German court’s decision, it’s a serious situation for the markets, but if they don’t they might have to face a debate with Germany. It’s not an easy decision which they have to take.
Orr, Deutsche Bank: The immediate market reaction was that it was a good thing for peripherals, wasn’t it?
Wehlert, KfW: Yes. Passing it on to a European level was a good way to put it on a higher level and find an agreement which is acceptable for everybody.
Robledo, Ico: This year we have seen very nice flows, not only because of OMT effect but because confidence is coming back.
GlobalCapital: At the time the OMT was announced, the saying was that it was a very clever instrument because it instils confidence without ever having to be used. So if the European Court does overturn it, and if it’s not judged constitutional, will that have an impact or not?
Vion, SocGen: Rating agencies have diverging views on that. But it’s not important at the moment anyway because the OMT is not needed. There are enough lines of defence to avoid any big problems, so it’s not really top of the agenda. It means we have time for the courts to do their work and come back with an answer.
GlobalCapital: I want to move on to another big change compared with this time last year, which is the euro/dollar basis swap. The five year was around minus 60bp last March and it’s now getting close to being flat. We have a lot of borrowers here that fund in euros but also print dollars. I’d like to ask the issuers here if this basis swap move is going to impact their strategy in dollars.
Tom Meuwissen, Nederlandse Waterschapsbank: For most of us it will have a big impact. For the past several years you could say that out to five years borrowing in dollars was cheaper than euros, but that has changed because of the development of the basis swap. I expect that there will be less dollar issuance because of that.
GlobalCapital: Does that mean that euros is going to be even more crowded?
Meuwissen, NWB: Yes definitely, because not many other currencies are picking up in attractiveness and for size you need dollars or euros.
Van Dooren, BNG: A lot depends also on the size of your funding programme. We have made the commitment to issue benchmarks in euros and dollars so we will continue to issue in dollars. Maybe not in such large sizes as we issued before but we definitely will be there.
Wehlert, KfW: Given the size of our programme we need the dollar market because it’s the largest market in the world. We don’t aim to fund the whole programme in euros. Last year about 39% of our funding was in dollars.
There’s a balance between having funding in many currencies for strategic reasons and looking at effective funding costs. You have to weigh up how much you need to do in each market to ensure the strategy works and at the same time to be cost efficient to ensure competitiveness for the loan business.
We have a strong following with the central bank investment base and those investors want to buy dollars and we would like to deliver. But the move in the basis swap has changed the landscape and forces everybody to look closely.
That said I don’t expect costs to stay as they are now. The basis is one thing but the spread environment is another. We’ve been able to get funding done at very attractive levels versus Treasuries this year.
Joakim Holmström, Municipality Finance: We have the luxury to choose as we have a much smaller funding programme. We expect to borrow around €7bn this year. We’re also quite a newcomer to the benchmark markets, so we want to continue to develop our relationships with investors.
We decided to focus on dollars for our benchmark funding programme because that’s the number one reserve currency in the world. We are also committed to servicing our dollar curve.
We will do one or two benchmarks this year. The first one will be a dollar trade. But after that euros might be a viable option. All-in pricing for us in dollars is more or less flat to euros in the five year part of the curve. It would be nice to do euros to diversify our funding and to expand our investor base even further.
Arosenius, Kommuninvest: We are in the same situation but the important point for us is that we have made a commitment. If you have a benchmark curve, then it’s important to maintain it.
Building up a benchmark curve in dollars has proved a very successful strategy for us, and you can’t jump in and out of the market. One good result of euro and dollar costs levelling out is that then we would have the luxury of choice. The investor base available to buy our bonds would become bigger.
We are coming back to a historical pattern — pre-crisis the swap was fairly level. I expect it will be anchored close to this level for some time. It will be hard to shift it over into positive territory, unless the Federal Reserve and the ECB diverge too much. We hadn’t been able to do euros for several years because it was too expensive. But in January we did the first small euro trade for a long time and we have started to look at building up our relationship with the investor base again.
Steven Jallport, Deutsche Bank: I would have expected there to have been a lot more euro issuance from those agencies that have focused predominantly on dollars. But then there’s another obstacle that has been put in the way. That is, with the recovery of the markets, the sheer volume of issuance coming out in euros on the covered bonds side. This is direct competition. A number of agencies have looked into the possibilities of euro issuance, and the valuations that you should theoretically be able to get sometimes are not actually there because of the fact that you’ve got other products out there which are offering an incremental spread over agency paper, and are part of a more traditional buying pattern for investors.
Eske Hansen, KommuneKredit: We try to be flexible and accommodate the needs of different groups of investors with our funding programme.
Back in 2007 when we did our first benchmark it was a euro trade, and at that time we were very much determined that it was going to be a euro programme. But it turned out to be very different, so we have issued a lot of dollars in past years. We did a very successful dollar trade in the first week of January this year. The way we look at it is to keep our minds open and also, being a Danish krone house, we want to service our clients in Danish kroner. Ultimately, we are concerned about the all-in costs of doing the funding transactions and looking at the proceeds in Danish krone.
Robledo, Ico: We’ve been out of the dollar market for a few years, for obvious reasons, but now we are having very promising conversations with dollar investors. We are not monitoring the basis swap very closely as dollar investors are asking us to pay the same in dollars as we are paying in euros. It is just a matter of lines re-opening, from investors that haven’t been buying Spain for some years.
GlobalCapital: Are you seeing increased demand then from US investors?
Robledo, Ico: Yes, we are having very productive conversations and we expect to come back to the dollar market if possible before the summer break.
Goebel, Rentenbank: It may be the case that we issue less in dollars this year than in recent years. But that doesn’t mean that the share of euros will go up. The last couple of years we have focused on euros in maturities longer than five years, and also issued fairly long term in Australian dollars. In the dollar market we’ve looked to print in maturities up to five years. If dollars turns out to be less economical, I would expect our company to gravitate towards other currencies like sterling or the Scandinavian currencies. We must not forget that the cost benefit that we have lost from dollars compared to euros in five years is a double-digit number of basis points in the past year. So other currencies, which were less economical than the dollar, may still be more cost effective than euros in the front end.
Wehlert, KfW: For KfW, you have to differentiate between the strategic dollar programme, which we have run for 12 years now, and where we aim to deliver the full curve every year in transactions of $3bn-$5bn, and the arbitrage deals where we target more cost efficient funding.
There is reduced US agency supply, and we see more and more US investors getting interested in KfW paper. But for the arbitrage transactions we will probably move to other currencies given the costs development.
Alex Caridia, RBC Capital Markets: The widening out of the euro/dollar basis swap won’t necessarily result in as a significant shift from dollars to euros because there still is demand for dollar based spread product from central banks and bank treasuries. If one looks at where the basis traded historically, a lot of dollar issuance was still done when the basis swap was close to flat, so I don’t expect to see that big a shift.
GlobalCapital: With reduced US agency supply allowing borrowers like KfW to tap new investors in dollars, and then the fact that we also have issuers like the World Bank doing euro benchmarks for the first time in four or five years, could dollars be actually quite an attractive market for issuers that need to maintain a presence there?
Meuwissen, NWB: One question is how strategic should you be. I can understand the perspective of a large issuer like KfW but for a smaller issuer like us which needs to raise €10bn each year, and as a euro denominated issuer, should we really pay up to keep a continuous presence in the dollar market? I don’t think so. I don’t think that investors value that strategy so much. But maybe that’s a question more for the bankers. In the end you look for the best source of funding with the best price.
Jallport, Deutsche Bank: A question for our friends on the funding side: do you see any changes on your loans provisions? Increasingly, your clients are looking to lock in long term funding, is that actually helping to drive any of your strategic plans on the funding side?
Meuwissen, NWB: For us not so much. Our clients are public sector in the Netherlands and they don’t tend to take a view on the development of interest rates. They always require long term funding and they borrow when they need it.
Holmström, MuniFin: We do not do back-to-back lending with our funding. We just manage the funding gap. Our customers are very conservative, they tend to finance long term investments with long term funding — the average duration of our lending portfolio is around nine years. The majority of our lending is in floating rate format so the underlying level of interest rates is not a key issue for our clients.
Arosenius, Kommuninvest: Our owners and customers, the municipalities, are doing exactly the opposite from the Finnish ones. They are borrowing as short as possible.
Jallport, Deutsche Bank: Maybe some arbitrage is possible?
Arosenius, Kommuninvest: Where there is so much liquidity, the competition has increased and we compete with the banks and other lenders. Competition is much more fierce now than in the good times. We have scaled down our growth forecast from 17% per year to 6% per year in line with the local government sector’s investment plans.
GlobalCapital: Eske, what are you finding?
Hansen, KommuneKredit: The Danish situation hasn’t really changed.
Holmström, MuniFin: The competition is more fierce because of the borrowing behaviour of your clients. The shorter the tenor, the more competition there is. Banks are more aggressive in, say, the two/three year part of the curve. If we go out to 10 years, there’s not really any competition. Our largest competitor is a supranational from Europe, not the traditional commercial banks which were active pre-crisis.
Wehlert, KfW: It’s the same in Germany. The strength of a development bank is to provide long dated loans, especially to small and medium enterprises.
Robledo, Ico: Ico’s business is lending to SMEs and we have made a great effort during the crisis to increase our activity in volume. Peripheral countries have the challenge to channel liquidity to SMEs and there Ico is a major player. We would love to print long tenors because there is a clear demand, but our lending activity is concentrated on short maturities and we have to introduce an ALM perspective to our funding strategy — plus short maturities provide the most cost effective funding to on-lend to SMEs.
GlobalCapital: Holger, you’ve got a slightly different model.
Holger Dohra, Erste Abwicklungsanstalt: Yes. We have to look at funding from a totally different perspective, because our business is static, we don’t do any new loans, we don’t invest money, we don’t have a going concern — but we have a mandate to unwind a given portfolio. Here the major principle is risk minimisation. We will always be involved in dollar funding because a lot of our assets are in dollars. And recently we’ve had even a much better response in dollars than we have had in euros.
GlobalCapital: I wonder if that gives you maybe an opportunity in dollars as well, if the euro funding issuers are reducing a little.
Dohra, EAA: We are trying to do that. This year we haven’t even raised €400m in euros but close to $2.3bn in dollars. Also given that the issuers State of NRW and NRW.Bank are backed by the same credit as us, they would love to have us do more dollar funding so that we are out of their way in euros.
GlobalCapital: I wanted to address derivatives and cross-currency swaps, and get a feel for whether those are becoming more expensive for issuers to do now because of regulation.
Wehlert, KfW: That is probably one thing we have to live with. It is a big change and every bank has to cope with it. We have two-way CSAs which are asymmetric. That is still a pricing issue and it is something which we are addressing in bilateral discussions again. On the other hand competition is quite high in the banking business and therefore in some currencies we see quite good prices. That’s not necessarily in cross-currency swaps but in interest rate swaps definitely.
Holmström, MuniFin: We have always had two-way CSAs, but they have been asymmetric. We have a multicurrency funding programme and we do a lot of structured funding as well, and given some of the charges that banks are putting on the swaps we decided early last year that we would start to move into offering symmetrical terms to banks. We have actually now signed quite a few CSAs already with zero thresholds, and we’re clearly seeing the benefits already.
Hansen, KommuneKredit: We see the same. We’ve been, in a friendly way, forced or maybe encouraged to renegotiate the existing agreements we had in place. It makes a lot of sense, because it will also be to the benefit of our clients that we are even more cost-efficient. We can reach out to investors that are keen to do structured trades or trades that need to be hedged.
Goebel, Rentenbank: It’s extremely important to come to arrangements with the counterparties that create a reasonably level playing field. You will always find two or three banks quoting swaps at quite attractive levels, but that means that you incur concentration risk in your portfolio and you don’t encourage the broadest possible coverage from market participants. When banks figure that time and again they see the opportunity to place bonds, but never have cost-effective swaps because of distorted swap pricing, then they will at some point throw in the towel and stop covering you as a borrower. This would not be in our best interest.
Arosenius, Kommuninvest: Two years ago we saw these new regulatory changes coming up — and our funding programme had been growing quite a lot as well — and the board took the decision to start up a domestic bond programme attached to the Swedish market.
The bank situation doesn’t change because some banks disappear and then others become more aggressive over time. As long as there are many banks around, it’s not a big problem for borrowers.
When we have universal clearing, that will alleviate a lot of these problems around the cost of derivatives. That will reduce the necessity to negotiate and renegotiate swap agreements and it takes the pressure off the capital bases of the banks.
I remember two years ago we asked five banks for a swap level and there was a difference in price of 27bp between the quotes — pre-crisis that would have been half a basis point. But we are coming into a better situation, although not as good as it used to be.
Van Dooren, BNG: We have symmetric two-way CSAs arranged with the banks, but one issue we had was that under Dodd Frank, we were going to be treated like a bank. We were not willing to report under Dodd Frank and our US counterparties had to set up separate entities in the UK to do business with us, and we had to renegotiate CSAs with them. But a central clearing system will help a lot.
Meuwissen, NWB: Mandatory centralised clearing is now scheduled for 2015 but the problem is that the main costs come from cross-currency swaps and those are not clearable and won’t be for quite some time. The derivatives issue is a really major topic. We swap all our funding, we swap all our assets, and have symmetric CSAs with zero thresholds with our banks, but still the pricing you get is not at all transparent because your position with a particular bank makes such a big difference. The biggest influence on the pricing nowadays is from your swap position and your CSA agreement with a particular bank. This will remain an issue for many years to come.
Robledo, Ico: We have had the possibility of moving to a two-way CSA on the table for the last three or four years. In recent years we were mainly euro players and we weren’t very affected by CSAs cost. We are considering the pros and cons of moving to two-way CSAs as market normalisation enables us to print again in other currencies.
Caridia, RBC Capital Markets: For several years the main problem has been that there are regulatory differences between different jurisdictions. The Canadian regulators are looking at it differently to the US and they are looking at it differently to Europe, and this created an unlevel playing field. We’re at a point now where most agency issuers have two-way CSA agreements in place with a couple of exceptions. We’re almost over the hill on that as well.
Jallport, Deutsche Bank: CSAs are a more common discussion and problem in the supranational sector, because in the agency sector it’s been addressed quite well.
Orr, Deutsche Bank: Agencies have been at the forefront, from two-ways to zero thresholds. They are to be commended for that.
Jallport, Deutsche Bank: And the agencies have been able to benefit because it’s not only the vanilla markets coming back but the yen structured markets too. Having addressed CSAs helps issuers that want to access that market.
Wehlert, KfW: If you don’t have two-way symmetric agreements in place, it’s even more expensive.
GlobalCapital: Joakim, you were mentioning that demand for structured deals is coming back a bit.
Holmström, MuniFin: Last year we did 30% of our funding through some form of structured issuance. We’re seeing more demand for structured notes in euros this year.
Jallport, Deutsche Bank: The investors are still scared post-Lehman Brothers. The euro structured market used to be quite a developed market, but it hasn’t really taken off again because investors are still concerned about the liquidity of these instruments. The investor base in Japan has gone through a major shift. During the course of the last couple of years we have increasingly seen a number of banks issuing in their own names as well, using their pricing power with derivatives.
Arosenius, Kommuninvest: I agree with what you are saying, Steven. Our investor base is typically central banks or official institutions and for those investors liquidity is more important than some extra basis points. They can’t get out of a structured instrument as easily as they could a benchmark bond. If we see an increase in demand for structures, it’s a very marginal one, but we see it here and there.
Wehlert, KfW: The Uridashi market is pretty busy right now. We have done a number of deals this year already totaling €700m, so this market is more active than ever. We have also seen good levels of demand in currencies such as Turkish lira, despite the trouble in the currency. Euros and dollars aren’t quite as attractive in terms of the overall yield level, but then on the euro structured side demand has picked up and has become more interesting because some of the pension funds just need to hit a specific coupon. They have started buying and they can buy in big sizes.
Caridia, RBC Capital Markets: Given the much higher outright level of yields in some of the more peripheral markets, investors are less concerned about picking up an extra 50bp to go down the credit spectrum so they are happy to buy SSA paper. We’ve seen a much higher uptake for SSA paper in Turkish lira, South African rand, Brazilian real with the more attractive yield levels in these markets.
Vion, SocGen: There’s been a lot of competition for SSA issuers coming from banks looking for funding. When the credit landscape has become more solid, investors have realised that they were safe buying the structured notes issued by banks. Now that banks seem very flush with cash, it could be that we’ll get more demand for SSA paper due to better relative pricing, but there will be a lag in the timing before it happens.
Holmström, MuniFin: We’ve seen that competition not only from banks but also other SSA issuers. Looking for instance at structured issuance in Japan, the Scandinavian issuers have been dominant in the past but now we’ve seen, for example, some of the Washington supranationals looking at that market and we expect to see slightly less demand in future. That’s why we’re constantly looking at new products. One product that we’re finding increased demand for is single stock-linked Uridashi notes, the reason for this being that the volatility of the single stock is higher than the index, hence offering investors a more attractive coupon.
We are looking at these opportunities so that we can maintain a certain share of our funding in structured format because that’s still the market that offers the competitive edge from a cost perspective. These benefits we are the able to pass on to our lending customers.
GlobalCapital: And just on that note are there any other new pockets of liquidity that agencies should be looking at?
Finlayson, RBC Capital Markets: The best example is climate awareness bonds. That is a real trend at the moment and while there are pros and cons around them we have seen demand. Issuers are increasingly ring-fencing money for socially responsible investment, and there’s certainly a lot more demand than I thought there would be when I started looking at the products.
Meuwissen, NWB: The thing with those SRI bonds is that there’s no reward in the pricing. Certain investors may have a preference but still require the same yield.
Van Dooren, BNG: Kerr, is it a trend or is it hype? Two weeks ago we met investors and we asked all of them whether they would be interested in those kinds of bonds, and all the investors said they were not interested. Of course maybe it was the wrong bank organising our meetings or we met the wrong investors.
Finlayson, RBC Capital Markets: From some of the investors I’ve spoken to, there’s a balance between cynicism and the idea that you have to get into it. Increasingly there are more and more funds looking at this, with a number of large investors looking to divert funds to socially responsible investments. We have seen a lot of Scandinavian, German and French investors look to do that. Whether you think it’s a trend or hype, it’s pretty much one and the same thing. There’s a lot of discussion around it and as more and more issuers look at it and the market becomes more liquid I think it’s here to stay.
Meuwissen, NWB: For issuers it can be a good marketing tool. My understanding is that especially the boards are interested in issuing the things.
Goebel, Rentenbank: To tick a box.
Meuwissen, NWB: Yes, to tick a box, have a good story. Funding-wise it is a bit uncertain what’s really in it. It feels a bit hypocritical in the end, since there’s no reward there’s also no punishment. I can imagine that this market will develop and that there will be a premium in the future, but when that’s not there yet, the point in selling an SRI bond is debatable. The interesting point as an issuer can be that you reach investors which are not buying you now, so it can give diversification of your investor base. It is important that when you issue an SRI bond to get these specific investors in the books, not only the usual investors which don’t value sustainability.
When you look at us as an issuer, almost all of our assets do qualify, so I can imagine that we will also bring an SRI bond.
Arosenius, Kommuninvest: I strongly oppose the idea of creating this kind of semi-liquid or liquid transaction where the prices mean that it’s attractive enough for every regular investor to get involved and the potential ethical investors get crowded out. It’s potentially a helpful tool in private placement or in club deal format where you can improve dialogue with a known group of ethical investors and where you potentially get something back for offering the product, for example, by investors engaging with specific maturities which will fit your asset and liability management needs.
Meuwissen, NWB: As a bank you lend money to other authorities which are doing something ethical. And then you print a bond on that. You just tick some boxes and then you can call it an ethical bond but you just do your normal line of business, there’s not a real incentive in it.
Wehlert, KfW: It is more about awareness than the funding aspect. The topic of social responsibility and investment is definitely a growing area, and in Europe it’s broader than just the environmental aspect, it’s about social governance too.
In the equity markets it is priced in but it’s not priced into the fixed income market yet. We have good ratings from the ESG rating agencies, but it’s not something which you can price in like an AA or AAA.
I understand that some investors or issuers want to make it a bit simpler. They just say they want to have the environmental aspect and they want to have something which they can define, and that is the green bond. They want to buy a bond where they can say that with this investment they have reduced carbon emissions by x%.
There is some real demand from accounts in the US, which is a handful of people, so not a very large base but they definitely do buy. And there’s a big community in Europe thinking about this issue but not really having invented the idea of green bonds and being critical about it. Perhaps you can do something with it and use it for your marketing and so on. If you don’t have a product, nobody really listens to you. So I understand the motivation behind green bonds but it’s also something to be critically judged.
Meuwissen, NWB: Yes, it’s a bit cynical, because in the end it should be cheaper for the authority doing this, to do the good work.
Wehlert, KfW: But SRI investors say ‘why should we pay up to do that?’
Meuwissen, NWB: They are making a concession because it’s for a good cause. It’s a lot of effort as an issuer. And you can also say, all my bonds are green bonds.
Wehlert, KfW: We did that in the past and that’s not convincing. If we get critical questions, we can say that lately 40% of our financings were green, but we can’t say all our bonds are green.
Goebel, Rentenbank: I agree with Tom on that point. There is a risk that investors will think that if these are the green bonds so the rest of your balance sheet must be the dirty stuff. That isn’t worth the benefit you may gain from attracting new investors. I’m also a bit sceptical about the recent developments in the market like these Green Bond Principles, the tendency to regulate the market. We do hold a banking licence so we have already a load of real regulators breathing down our neck and I don’t need another bunch of self-declared regulators adding to that.
Vion, SocGen: From the investor side, the green philosophy has not been fully incorporated into the fiduciary duties of the investment managers. Sometimes the two concepts even oppose each other, with investors saying that to protect their end retail investors the yield has to come first. At the moment the two things are separated. If the green principles become incorporated into the duties then maybe we’ll have a better and wider market for green bonds. But for the moment we’re still not there. There is demand for the product though, it is rising.
GlobalCapital: One of the difficulties is in the definition. The best example I’ve heard is a hydroelectric power station because there’s clean energy but it also destroys a mountain while you do it. Is that part of the problem about doing this in benchmark format over say private placements?
Finlayson, RBC Capital Markets: It’s such a big concept, isn’t it? Hydroelectric power: on the one side it is green but the other side is destruction, so how do you define what’s green and what’s not? Definition is one of the things the Green Bonds Principles were trying to address. That’s the problem right now: no one really knows how to define it. If I have a hybrid car built in Asia which is shipped to Europe, is that green? It probably isn’t. How you really define what a green bond is and what green proceeds are is a problem right now.
Arosenius, Kommuninvest: And there is not a uniform standard or certification in the market for this. But now the rating agencies are taking it up and the banks are talking about it.
We have to wait for the US investors, because that is where this market is growing, possibly through some political encouragement. Of course, that’s why here some volumes are picking up too. We are contemplating an SRI bond for of all these reasons. As we don’t know exactly which standard to choose maybe it’s better to wait a bit and also wait for the investor volumes to pick up and for the market to settle down. Then hopefully we’ll have some sort of uniform standard for the proceeding.
GlobalCapital: And I imagine it’s quite expensive as well: the costs of monitoring, for example.
Jallport, Deutsche Bank: One of the issues that we’ve seen with these types of transactions is that because they’ve been priced flat to where the benchmarks are, sometimes they get momentum behind them and then you get your regular investors such as central banks coming in to these transactions. Then some issuers have had problems in terms of the allocations that they’re giving out because you don’t want to annoy your regular mainstream investor base but at the same time this is a product specifically tailored for these green investors. In combination with all of the preparatory work, it’s just become a bit of a difficult obstacle for a number of issuers to take forward. Having said that, once you can target a specific investor base, maybe it will develop.
Dohra, EAA: Maybe it’s more a product for a bank than an agency because this might give a bank the opportunity to raise money more cheaply for eligible businesses.
GlobalCapital: I would like to turn to an issue on the regulatory side. I’d like to hear both from the borrowers and the banks if anyone is worried that more banks may reduce their presence in SSAs or may exit the business entirely.
Orr, Deutsche Bank: Does anybody feel under-banked?
Wehlert, KfW: This market is not under-banked. There are still some newcomers in the business and all of the UBS people who lost their jobs when UBS exited the business have been soaked up by other banks. All in all, it is unpredictable.
Regulations come in and banks have to take measures to comply. You have to try to be prepared but any single issuer cannot do anything about it. You have to live with the banking base which you have, which is quite big.
GlobalCapital: One concern is the possible impact on secondary market liquidity. Is that something people have noticed?
Finlayson, RBC Capital Markets: Balance sheets cost more to run than they have done in the past given new regulations. There’s a lot of pressure and discussion, but also right now we’re not seeing that much secondary flow as investors aren’t selling. The increased focus on cost of balance sheets and the reduction in overall size of balance sheet is definitely a trend.
Caridia, RBC Capital Markets: A lot of people talk about the cost of balance sheet and regulation forcing banks to hold more liquid assets. This has impacted liquidity on the offer side — particularly at the very front end of the curve where there is less issuance
Vion, SocGen: It’s about cost of balance sheet but also the cost of doing repo. If you want to maintain a liquid market you have to be able to trade both ways. As long as the cost of repo doesn’t go through the roof, the market will be reasonably well composed. But it is certainly something that we are watching. In the past, issuers had the policy of not tapping bonds, fearing that it could be detrimental to existing investors. But now we’re actually almost in a reverse situation where by tapping a bond you make it more liquid and therefore, because many investors are subject to liquidity rules, they actually benefit from having more liquid issues. It’s a fine line to draw but it actually helps banks and the general market if issuers can tap their deals.
Goebel, Rentenbank: It’s intriguing in that context that one string of regulation such as the financial transactions tax says that dealing in financial instruments is a bad thing but then in the conditions imposed on the assets that banks have to hold for LCR purposes, our regulators are pretty much obsessed with prudent turnover statistics. What are we actually heading for here? Where is the staid, uniform regulatory approach to trading?
GlobalCapital: I’d like to ask a question about commercial paper. I know there are agencies out there that, for instance, run parallel ECP and US CP programmes. Is this something that other agencies are looking at doing? What are the advantages of running two programmes?
Meuwissen, NWB: The big advantage, of course, is reaching a wide range of investors. We started the US CP programme last year and it has been a big success. You don’t want arbitrage between your programmes so you try to make sure the pricing on them works out to be the same. But the maturities are different on the different sides and the body of the investor base is of course different. We don’t need that much in the money markets. We have an average outstanding of maybe €10bn-€15bn but we feel we could attract much, much more. Especially in the US.
Wehlert, KfW: It’s similar to MTNs, you have the euro MTN programme and the US MTN programme. The euro MTN programme is obviously much more active than the US MTN programme and on the money market side we find it’s very similar.
Nevertheless, it’s important to reach investors in the US and I understand you also can fund intraday under a US CP programme which is helpful for liquidity management if you have a dollar book. So it’s definitely beneficial.
GlobalCapital: There has been some consolidation in the money market fund industry because of the extremely low yields out there. Is that a worry in terms of demand for CP? It doesn’t sound like it.
Meuwissen, NWB: No, it’s OK.
Arosenius, Kommuninvest: We have a US CP programme on the to-do list. At this stage we don’t borrow that much but eventually, if needed, we might start it up, just to find another investor base and also in potential times of stress. We just don’t know when the next crisis could hit us and from where. But when it happens, a number of funding sources might disappear again, so from a risk diversification perspective it’s good to have a US CP programme. It’s the deepest pocket of short term liquidity in the world, so it would be good to have access to it.
Hansen, KommuneKredit: That’s probably also down to the size of your programme. We’ve been using the ECP programme for many years. For the sort of budget we’re running we get a lot of traction with many investors that can buy our ECP.
It’s working quite nicely for us and we’ve thought about looking to the US market. But there are a lot of practical issues you need to take into account and so we are quite happy with the ECP programme for the time being.
Holmström, MuniFin: We have an ECP programme. In the past we only issued very short euro denominated trades, more for cash management purposes. For the last two years we’ve been actively promoting it to investors and we started issuing in dollars as well. It’s been a very successful tool, at least for attracting new investors, especially central banks.
They at first get comfortable with your name in ECP and then they start investing in your bonds. Issuance volumes in our ECP programme have increased a lot because of this.
Robledo, Ico: The ECP programme is very convenient. It fits perfectly with our balance sheet needs, it’s cost-effective and it gives us access to some investors that we don’t have access to with longer dated paper.
Goebel, Rentenbank: We want to stick with our ECP programme but we have recently been advised that there might be a way to open that up to investors in the US, by amending the documentation. That’s something we’re looking into.
Dohra, EAA: When we started issuing commercial paper in 2010, we did it both ways by having a combined programme for ECP and US CP. We aren’t able to offer bonds on a global basis and we don’t have a US MTN programme but this is one way in which we can diversify our investor base into the US market.