Regulation creates risks and rewards for SSAs
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Regulation creates risks and rewards for SSAs

From eurozone debt problems and the reaction to the US tapering quantitative easing, to the impact of regulation, sovereigns supranationals and agencies have found themselves with plenty of obstacles to manoeuvre around since the financial crisis began. Nathan Collins looks at how they are evolving their borrowing strategies in the new environment.

The lesson for sovereign, supranational and agency borrowers from the years since the financial crisis began is that rules of the game apply to them just as they do to issuers with weaker credit ratings. The golden era that ran until 2008 may have seemed like it would last forever, but borrowers have had to reinvent themselves in the years since.

“What the crisis did was remind issuers of the risks inherent in the market,” says Olivier Vion, head of supranationals and agencies at Société Générale in Paris. “Before the crisis every deal seemed to be priced tighter than the last. It was easy for issuers to forget that there were risks. During the crisis issuers encountered volatility — and even market shut-outs — that created an emphasis on risk management.”

Just as banks have been required to hold liquid assets in case of a market shock, many SSA treasury officials highlight the importance of a conservative stance and being able to point towards a solid asset pool on the books, even if the regulations don’t necessarily require them to.

“As a supranational issuer we aren’t bound to meet the Basel III regulations like a commercial lender or some agencies are,” says Jens Hellerup, head of funding and investor relations at the Nordic Investment Bank. 

“However, we find it’s a positive to be able to tell our investors that we are working towards Basel III compliancy. As such we have a bigger focus on maintaining a large pool of liquid assets.”

While a conservative approach may be best when it comes to a well stocked asset base, issuers are increasingly seeing the advantages of a slightly more daring attitude when it comes to the timing of their own trades.

“There’s an element of being nimble,” says Kerr Finlayson, director on RBC Capital Markets’ SSA syndicate. “This historically wasn’t necessarily a concern given longer periods of stability in the market before the recent financial crisis. When conditions are good you have to be ready to move at short notice.”

A recent example is the reaction of public sector issuers to Russia’s occupation of Ukraine’s Crimea region. Market volatility on Monday, March 3 suggested an empty week in terms of primary issuance. However, within hours of tensions showing signs of cooling the following day four issuers had mandated banks for new benchmark deals. 

Syndicate bankers involved with the deals suggested that a desire to tap the market and take advantage of the window before the situation escalated again was foremost in issuers’ minds.

The changing cost of capital

If SSAs have had to come to terms with the idea of skirting around patches of volatility and being more practical in the timing of their deals, perhaps the bigger challenge is the impact of regulation — both on their own business models and those of the banks that they work with.

 “The biggest impact of regulation is on banks’ cost of capital,” says Ben Powell, head of funding at the International Finance Corporation. “Swaps and particularly cross-currency swaps have become more expensive, and there is a smaller field of potential providers.”

The increased capital cost to banks of providing swaps — and the corresponding increase in charges to issuers made by banks providing that service — has pushed many borrowers into setting up symmetrical two-way credit support annexes (CSAs), sharing the burden of posting collateral for a swap with their counterparties rather than leaving the bank to shoulder the spiralling costs.

While this has the obvious effect of cutting the cost for the issuers, there are also more intangible benefits to the signing of a two-way CSA. There’s more to choosing a syndicate for a deal than the cost of the swap they can offer, but without two-way CSAs innovative banks with high cost of capital run the risk of having their debt expertise priced out of the market.

“If the cost of posting collateral for swaps for an issuer becomes prohibitive you run the risk of losing the input of some lead managers as they refocus their coverage,” says Stefan Goebel, head of treasury at Rentenbank. “Sometimes the banks with the best distribution networks and ideas aren’t the same ones that can provide the cheapest swaps.”

The cost of cross-currency swaps is particularly punitive for counterparties, leading some to speculate that issuers may be less likely to venture outside of their home currencies in the search of arbitrage. The vagaries of the swap market have encouraged some issuers to avoid swapping the proceeds of foreign currency bonds if a practical use can be found for that cash.

“Over the last year we’ve combined our liquidity management and funding teams in one department,” says the IFC’s Powell. “This allows us to use the proceeds of non-dollar bonds to fund a portion of our liquidity portfolio without paying the cost of a cross-currency swap. This has been particularly true with Australian dollars and sterling.”

Issuers have also had to be more careful in choosing their swap counterparties. While once it may have been the trend to cut costs by looking at the lower tiers of banks, the European sovereign debt crisis has highlighted the importance of picking secure counterparties.

“Four or five years ago we saw SSAs reaching out to banks with lower credit ratings to secure lower charges for swaps,” says Bill Northfield, head of SSA origination at Deutsche Bank in London. “That stopped quickly when the debt crisis became apparent and the ratings of the banks, and the countries they were in, dropped further.” 

The impact on banks’ balance sheets of higher capital costs can also impact the support that lead managers give bonds in the secondary market. The lead managers’ duties do not end as soon as the deal is priced but, with pressure on balance sheets growing, the attention paid to supporting deals in the secondary market could shrink. While most issuers remain keen on employing a wide range of lead managers, this could change if they begin to notice a material difference in secondary performance depending on the composition of the syndicate.

“Issuers appear more willing to rotate banks this year even when the idea of pure rotation can be dangerous,” says Northfield. “Not all banks are alike and some are more dedicated to being involved in secondary trading after a deal has been priced than others. It can be dangerous to rotate, especially with new regulations constraining the sizes of banks’ balance sheets.”

Basel III creates opportunities

Regulation has cut both ways for SSAs, however. While the banks that provide swaps are being forced to increase their fees, they are also experiencing an unprecedented need for SSAs’ low risk and highly liquid bonds. 

With regulations such as CRD IV requiring banks to increase their buffers of liquid assets, bank treasuries have become major buyers of SSA debt (see separate chapter on p12). Demand is unlikely to slow in the near future and the tantalising prospect of renewed growth could even further boost demand for these liquid assets for liquidity buffers.

“The building of liquidity buffers at financials has been a great opportunity for SSAs,” says Société Générale’s Vion. “The demand from bank treasuries should remain strong as bonds roll over and, hopefully, economic recovery encourages more lending from banks leading in turn to larger buffers.”

But while many SSAs — particularly the sovereigns and supranationals — can boast coveted 0% risk weightings, those national agencies that do not benefit from an explicit government guarantee generally have to make do with weightings of 20% or greater. And here a struggle is underway to maintain that attractiveness to bank portfolios.

One issuer that has had to confront regulation more directly than most is Germany’s public sector agribusiness lender Rentenbank, the new recipient — as of January 1 — of an explicit guarantee from the German sovereign. 

The agency already held an Anstaltslast — an obligation from the government to ensure that Rentenbank held sufficient capital to pay creditors on time — but it was unclear whether such a guarantee was comprehensive enough to secure the issuer’s weighting.

“In order to safeguard our 0% risk weighting under changing regulations we have now received a full explicit guarantee from the German government,” says Rentenbank’s Goebel. “While the guarantee was incoming we made the process as transparent for investors as possible. With the new guarantee we actually have a number of new investors interested in Rentenbank’s deals.”

Bankers speculate that more agencies could follow Rentenbank’s lead and petition their governments or regulators.

“Issuers with 20% risk weightings will likely fight to change that,” says Vion. “Either they will try to gain explicit guarantees from their sovereigns, or they will try to convince their regulators to change the regulations. Of course, they might just decide that they’re comfortable paying slightly higher spreads than other issuers if it does not compromise their business model.”

Even if a push for 0% risk weightings doesn’t emerge, most bankers are unconcerned by the prospect of these agencies being rendered second class citizens in terms of demand from treasury accounts — even if they aren’t quite as good for filling out buffers, the more enticing yields on offer should keep interest strong.

“In theory issuers with a 20% risk weighting should find it a bit harder although this hasn’t impacted them in practice,” says Alex Caridia, managing director in debt capital markets at RBC Capital Markets in London. “The slightly wider spreads they offer are seen as a good way for a very conservative investor to pick up extra yield.”    

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