No one will admit to it publicly, as under the European Market Abuse Regulation (MAR) it has been illegal to inflate orders since July 2016, but bond issue book sizes — especially those for a deal with a hype train as crowded as Saudi Aramco’s debut — are clearly no true indicator of demand.
Aramco closed with $92bn of orders, much of which will have come from the US and Asia, where European regulatory tentacles don’t always reach. But even in MAR’s core jurisdiction, this practice shows no sign of disappearing.
Record books have become run of the mill, particularly in the European SSA market. If a sovereign deal didn’t break records this January, it was because there was something wrong.
Italy and Spain — the more exciting end of the European sovereign spectrum — have notoriously well-fluffed books. Italy got its largest ever book in January — some €35.5bn of orders for a €10bn deal — then smashed the record two weeks later when €41bn flooded the book for its 30 year.
The book for Spain’s traditional 10 year visit in January exceeded €50bn for a time this year, before closing with €46.5bn.
The main culprits are said to be hedge funds. They have a reputation as ‘fast money’, ready to punt the deals in the secondary market and lock in a few basis points of profit. Anyone with that reputation will find their allocations slashed in favour of safer hands.
But when that happens, the next time that issuer comes to the market, the investors simply pump up their order even more.
“If you are going to give me only 5% of what I order, I’ll simply order 20 times as much,” seems to be the philosophy.
Everyone involved is in on the joke. Wags sometimes suggest that the way to curtail this practice would simply be for the syndicate to call investors’ bluffs and fill the orders they’re given, loading investors up with hundreds of millions of bonds for which they don’t have the capacity.
But, really, that would help nobody — investors would flood the secondary market with the bonds they over-ordered; issuers would get saddled with unwanted debt and a ruined curve; and investment banks would have some very angry issuers unwilling to offer them repeat business.
Thus, the pretence of sincerity survives. So if nobody is taken in by these inflated books what, one might fairly ask, is the problem?
By obfuscating their true appetite for a bond, investors create a false sense of demand. That could be quite useful for syndicates keen to advertise a book with plenty of ‘momentum’, but quite apart from the moral hazard, this kind of game-playing can cause real problems.
The book for Uzbekistan’s debut in February reached $8.5bn for a $1bn bond, with one international investor putting in an order for as much as $300m. But both tranches of that issue were down 0.7 points the day after pricing at par, and are still to recover to reoffer.
Inflation also adds a vicious headache to the allocation process. Syndicates cannot rely on taking orders at face value and must, via some form of sixth sense, intuit how much that investor actually wants — sometimes only a small fraction of the headline number. Over-allocate, and risk too many loose bonds immediately after issue. Under-allocate and you risk offending a good counterparty.
Getting the balance right is, arguably, part of what issuers pay their banks for — the elusive “art of syndicate”. But is the whole bunfight really necessary?
Still, there’s scant incentive for anyone in the market to change their behaviour. Making regulation is all very well — and a high profile scalp or two might make people take it seriously — but it is incredibly difficult for regulators to prove that an investor wasn’t good for their order of a few hundred million. One thing MAR has achieved is making sure any discussions of real demand steer clear of electronic channels and recorded lines.
In the meantime, a big book is an entertaining event for all concerned, but nobody should take the demand too seriously.