Reasons to cheer
Periphery no longer plagues Europe
At the end of 2013 Ireland announced that it intended to leave its EU/IMF bailout without a supportive credit line and Spain is set to exit its bank bailout scheme early this year too.
The prospect that casualties of the sovereign debt crisis could resume borrowing as normal this year is a strong signal that the worst of the crisis that has dogged SSA markets — at times threatening the break-up of the currency bloc — for the last three years is over.
For Horst Seissinger, head of capital markets at KfW, the improvement in the European situation is an important reason to cheer in 2014 — although there is plenty more work to be done, he warns.
“One key message is the break-up scenario of Europe is over,” he says. “We now have the financial architecture in place to act fast and in an appropriate manner. But I don’t subscribe to what a lot of people are telling us, that the eurozone crisis is over. It’s not over as long as the unemployment rate for young people in member countries is 40%-50%.”
Resilient euro markets
The resilience of euro benchmark financing is set to remain in 2014. Euros remained open for benchmarks through several political events — such as an inconclusive result in Italian elections in late February and a US government shutdown in October — that would have closed markets in more fragile times. That sets the market up well for this year.
“Last year was an excellent year in euros and as far as we’re concerned it’s difficult to see why it wouldn’t be the same situation this year,” says Christophe Frankel, deputy managing director and chief financial officer of the European Stability Mechanism, and CFO and deputy chief executive of the European Financial Stability Mechanism in Luxembourg. “Policymakers, central banks and regulators have addressed European stability and liquidity, so I feel 2014 will be as positive as 2013 was.”
A wider range of benchmark opportunities
The euro/dollar basis swap leapt higher in the closing months of 2013 to levels which allowed dollar funding issuers who had been priced out since 2009 — such as the World Bank — to print benchmark deals. If that continues this year, it will allow issuers more options when considering their benchmark programmes.
“Euro benchmark funding is much more competitive than it has ever been,” says PJ Bye, global head of SSA syndicate at HSBC in London. “It’s positive because it gives large issuers a lot more options than when they were completely reliant on dollars. We’re not quite there yet but I could easily see euro funding costs being more attractive than dollars for a number of issuers in 2014.”
The euro investor base will be strengthened further by the arrival of central bank buyers, according to Goldman Sachs’s head of SSA syndicate, Lars Humble.
“The improving situation in Europe also means that diversification of central bank reserves out of dollar assets, which came to an abrupt halt during the eurozone crisis, is going to be an important factor in 2014. The euro market will be the main beneficiary of this trend, and as a result the backdrop for euro issuance is likely to remain constructive this year.”
And with euros open to more borrowers, that should make dollars a less pressurised market for those issuers which have large programmes in that currency.
Increased yields will attract new investors
The tapering of quantitative easing in the US will mean that yields will rise — painful in the short term but that will help the bid for SSA paper in the long term. SSA spreads tightened over 2013 and that raises the risk that investors will head elsewhere to look for yield.
“Long term institutional investors have been very reluctant to buy SSA paper when they see absolute rates at historic lows,” says Isabelle Laurent, deputy treasurer and head of funding at the European Bank for Reconstruction and Development, “so tapering will help re-engage this investor base with SSAs.”
Bid to continue
The liquidity coverage ratio, which requires banks to hold high quality paper — including SSA bonds — against potential cash outflows has established bank treasuries as buyers of SSAs.
That bid should continue. US banks are set to join in. The Federal Reserve, in October last year, proposed liquidity requirements for US banks that echo the Liquidity Coverage Ratio under Basel III. “Banks have become major investors in SSA paper because of regulatory developments,” says KfW’s Seissinger. “These will continue to play an important role. The question on heavy demand from bank treasuries is whether investors have filled the reservoir or whether some are lagging. Some are quite advanced, others are lagging.” |
Reasons to fear
The US Federal Reserve will reduce its asset purchase scheme in 2014 and the short-term impact on market stability could be big if 2013 was anything to go by. Comments about the start of the tapering by Federal Reserve chairman Ben Bernanke on May 22 last year plunged emerging markets into turmoil and stemmed demand for SSA dollar deals over the summer.
“Tapering will push rates higher,” says Lee Cumbes, head of SSA DCM at Barclays in London. “And although the Fed is largely expected to be more dovish in the near term, policy rates may well be hiked much faster when they do finally begin to rise. The timing to begin the whole process is still up for debate, but we seem to be talking about a matter of months.”
Regulation — the unintended consequences
“I’m absolutely in favour of regulations that improve market efficiencies, but I am concerned about the law of unintended consequences,” says Robert Stheeman, chief executive of the UK Debt Management Office. “Regulatory developments in Europe could have a significant impact on sovereign debt markets — sovereigns rely on those markets to fund themselves. We need responsible regulation with an eye on the far reaching impact.”
One area where regulation could hit borrowers where it hurts is the stricter leverage rules for banks. These restrict banks’ use of their balance sheets, and could hurt secondary market liquidity for SSAs. That could in turn hurt bank’s business models, reducing the incentives to remain as committed to the SSA market.
“The profitability of the SSA business should be a core concern for banks and for borrowers,” says Bill Northfield, head of SSA origination at Deutsche Bank in London. “Banks are having to become more and more selective over which borrowers they provide balance sheet intensive services for, such as primary dealerships, and whether that makes sense for them in terms of the business that they get from that borrower in return.”
An increase in the cost of cross-currency swaps could make it harder for issuers to fund outside their home currencies. The introduction of Capital Requirements Directive IV in 2014 brings with it the introduction of credit valuation adjustment charges — another cost to banks when they provide cross-currency swaps for their counterparties.
“Issuers are concerned about the regulatory impact on each bank’s ability to compete in the derivative space — which is critical to the healthy functioning of the primary market,” says Sean Taor, head of European DCM at RBC Capital Markets in London. “In the SSA sector there is a very wide range of CSAs among counterparties — some with cash two-way CSAs, some one-way, some with no CSA.
“While pricing differentiation between those different counterparties has been widening, the impact of regulation will likely widen the differentiation further as banks implement local regulatory charges. This may lead to issuers funding more in their home market to avoid the swap costs involved [of going elsewhere], or to match more closely where the funds are dispersed with local issuance.”
Political uncertainty in the US
The US government is set to resume a dispute over the country’s budget and ability to borrow early this year. The US government shut down in October last year, and during the 16 day furlough only one borrower, Kommuninvest, managed to print a benchmark in the currency.
“In the second week of the new year we will see the resumption of US budget discussions, potentially leading to another US government shutdown,” says Richard van Blerk, a funding official at the EIB. “In the beginning of February the debt ceiling problem will return, then the Treasury could move to special measures, which is pointing to March as the month the US government could actually default. That’s the doom scenario.”
Low swap rates
Tight dollar swap spreads — reaching as low as single digits in five years at the end of November 2013 — could make it difficult for the most expensive SSA issuers to offer enough of a premium over US Treasuries to attract investors to their benchmarks without compromising on their levels versus Libor.
“The performance of the SSA sector has historically been closely correlated to the level of swap spreads,” says Humble at Goldman Sachs. “With single digit swap spreads in dollars, market conditions were very challenging late last year. Investors are willing to give up liquidity to move out of US Treasuries into SSA paper but only if the pick-up is sufficient. With yields backing up, the backdrop is even more difficult as the pick-up becomes irrelevant in percentage terms.” |