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SSA underwriting fees: a more modest proposal

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By Lewis McLellan
11 May 2021

The SSA syndication fee schedule is no longer fit for purpose, if it ever was. The EU has kick-started the debate, but the flaws in the business model go well beyond the issues the EU's fees grid has raised.

We can thank the EU for highlighting one flaw — fees that don't budge in proportion to the volume of issuance programmes make little sense. A discount for bulk business is simple common sense that few bankers would dispute. It is, after all, why they get to pay so little brokerage per volume than, say, a retail investor.

It is less obvious that the point at which a bulk discount kicks in should be between the $62bn KfW raised with syndications in 2020, and the roughly €150bn the EU will raise in 2022 but there is certainly a case to be made that the big borrowers in the SSA market should be eligible for similar treatment.

But that’s not the only flaw with fees. Some issuers point out that the existing structure means that banks are not incentivised to obtain the best cost of debt they can.

Banks will compete for mandates partly on the price they think the deal will clear at. But what happens once the mandate is won if no hard backstop all-in cost of funding has been offered? 

Since fees are proportional to the size of the deal, it is in bankers’ interests to advocate for a spread that is attractive to investors to ensure a large order book. This has two consequences. First, the banks’ underwriting capacities are very unlikely to be required. Second, they can talk the issuer into a larger deal based on the demand, and secure higher fees that way.

Of course, pitching cheap deals won’t win mandates in the first place, but the fact remains that fees that scale with deal size are not well designed to secure the best price for the issuer.

Fixed fees are an issue

Why have a fixed fee schedule at all? Market dynamics change, but for some reason, fees do not. Either the fee schedule was wrong for the conditions when it was set, or it is wrong now.

Few bankers will dispute the fact that selling SSA bonds is not as difficult as it used to be. Quantitative easing has left investors bursting with liquidity and the central banks lie in wait ready to hoover up between a third and a half of a vast chunk of new issuance. Underwriting risk is negligible.

These times won't last (probably), but that doesn’t mean the present fees are merited set, as they were, in times when syndications were a trickier affair. Suggesting that the status quo is a happy medium between the high fees deserved in difficult markets and the low fees justified in easier markets implies an enviable degree of foresight. How could anyone possibly draw up a table that would fairly balance these extremes?

It would be far simpler to implement a lower fee schedule for those instruments that are eligible for ECB purchases, which could then be discontinued when, or if, the purchase programmes end.

Funding SSA infrastructure

Besides paying for the work that goes into individual syndications, bankers often justify fees by claiming that they pay for the whole market infrastructure. Reducing fees, they say, would diminish the quality of ancillary services that issuers rely on — advice, trading and secondary market support. But do these costs scale with every deal? And yet the fee wallet has grown substantially over the past few years and especially since the cornavirus pandemic when borrowing requirements rocketed but so did QE.

While overall volumes raised through syndications have been fairly steady until the colossal increase in 2020, the amounts raised at the long end of the curve where fees are highest have climbed sharply. It’s clear that doing business at 15, 20 and 30 years in 2021 is no longer the tricky proposition it was in 2011. Already in May, we’ve had $239bn of syndicated supply at 15 years or longer, compared to $150bn in the whole of 2011.

Bankers are swift to warn of the consequences of lowering fees — reallocation of resources away from the SSA business and juniorisation of staff. But then they admit that this has been happening already, despite the fact they are making more money by doing more long dated business.

A services menu

Running an SSA franchise is an expensive business. There’s no doubt of that, and banks deserve to be compensated for the work that they do. What is unfair, however, is that every issuer pays the same regardless of the services they use.

Auctions are perhaps the prime example. It is well-known that primary dealers put in orders far in excess of what they’ll be able to sell, with government bond desks taking large losses to secure league table position. This is typically compensated for by a cheque in the form of syndication fees, won in part thanks to those league table heroics.

Without a more complex compensation structure, syndication fees need to be high enough to keep primary dealers invested in the business, but why should issuers that don’t require banks to run loss-making auctions pay the same fees? In effect, agencies subsidise the sovereigns. One solution would be to lower fees for those issuers that don’t have auction programmes. Another, simpler solution would be to lower syndication fees for everyone, but charge for auctions - although that would require what some might see as cartel behaviour on the part of the banks if they are to stop competing on price.

Trading is also lumped in as a bank service that issuers pay for via syndication fees. Some issuers demand a higher level of secondary market activity from banks, making markets to ensure they keep volatility to a minimum. Some request secondary market activity spreadsheets and use these to create league tables to help decide who gets the syndication mandates. This activity can cost banks money and, insofar as issuers encourage it, banks should be paid for it.

But why not bill for this activity separately? Issuers can decide whether or not they want secondary market support from their bookrunners beyond a stabilisation period for a new issue, and, if so, can pay for it. If not, they can take the consequences of additional volatility in their curve.

The much-vaunted full service package that borrowers fund with their syndication fees is an attractive concept, but this is the public sector and borrowers have a fiduciary obligation to taxpayers to pay as little as possible. It is hard for them to justify to their paymasters why they should pay higher fees when the benefits of doing so are not clearly quantified.

Packaging multiple services under one fee applied to every borrower is not a billing policy good for modern governments. Transparent, itemised billing that allows borrowers to pay for the services they judge to be worth the money is a better option.

Bankers will tell borrowers that they need to take a long term view of their relationships with investors, and that their advice and services are crucial to achieving this. They may be right, but it is only right the borrower that pays the piper calls the tune.

Now read the opposing View by Burhan Khadbai.

By Lewis McLellan
11 May 2021