By far the most important development for the sovereign, supranational and agency bond market of the past few years has been the arrival of the European Union and its €150bn a year Next Generation EU borrowing programme.
The EU’s borrowing operation has changed utterly, even when compared with 2019. Then, the Commission borrowed €420m across three deals, the proceeds of which were lent back to back to its member states. In 2021, it has borrowed almost €200bn, according to Dealogic data, cementing it as by far the largest non-sovereign SSA issuer in the marketplace.
Even the €100bn Support to mitigate Unemployment Risks in an Emergency programme pales in comparison with the €800bn NGEU behemoth. SURE was funded entirely through syndications while, now, the NGEU has a full sovereign-like borrowing operation complete with a bills programme and regularly scheduled auctions.
These changes have, of course, meant changes for the banks that service it. Patrick Seifert, head of primary markets at LBBW, notes that, as well as participating in the bills and auction programmes, “there’s additional commitment, monitoring, promoting secondary flows, etc, and of course building the investor base remains an ongoing task for what will be the largest green bond issuer globally.
“These had to be set up quickly, and without face-to-face meetings, so that was a challenge for everyone involved with the European Commission and Next Generation EU.”
The borrower’s syndications still steal the show — especially the €20bn outing that wowed the whole market back in June. However, it is the auctions and bills programme, as well as the important decision to operate as a more traditional issuer, decoupling borrowing from lending, that do the heavy lifting.
That means the EU can access the market in its own time, waiting for appropriate conditions, and tailor the maturities it selects to investors’ tastes at the time (as long as it preserves its 15 year weighted average maturity).
“The changes have given the European Commission more flexibility,” says Seifert. This should lead to good deal outcomes even in more adverse market conditions and will be appreciated by long-term investors.”
Ben Adubi, head of SSA syndicate at Morgan Stanley, notes that the EU’s process of coming to market is unique, thanks to its own internal procedures. “It takes longer between the request for proposals and the announcement,” he says. “That has become a regular feature of the market now. It’s well understood and investors know how to adjust their positions accordingly.”
He adds that the extra time gives leads the opportunity to canvas investors more carefully. “That means we can really finesse the recommendation for the EU and approach the market with more visibility and transparency.”
Of course, any extension of the marketing process means increased execution risk, as the market can always change. But given the EU’s consistently exceptional demand, meeting investors’ needs precisely may be more important than timing the market.
Bund spread narrowing?
Last time it hit the market, the EU paid a spread of 31.4bp over the Bund. That spread could begin to close in 2022. As yet, the possibility does not appear to be being traded, but the ECB is believed to be mulling a change that would disproportionately benefit the EU and its supranational peers versus sovereigns and agencies.
At present, the ECB’s purchases of supranationals are capped at 10% of the Public Sector Purchase Programme. Given the EU’s extraordinary increase in borrowing, bankers believe the ECB is considering an increase to between 12% and 20%.
The former would probably make only a negligible difference, but the latter could certainly have a material effect on the spread the EU and its supranational peers pay to sovereigns, which would, of course, see their share of the ECB’s purchases decrease proportionally.
The EU is unlikely to supplant the Bund as the euro’s primary safe asset, but bankers say that they are beginning to encounter investors who make purchasing decisions based on an asset’s spread to the EU’s curve, not just to the Bund.
So far, competition between the EU and other top European supranationals and agencies has not been damaging. In 2021, the EU’s spread to the other top European supranationals and agencies has oscillated somewhat, generally settling between 1bp and 4bp tight of EIB, ESM and KfW.
In fact, the additional scale and liquidity the EU has brought to the euro market seems to be making a positive difference for its peers. GC
