With its shiny new status as the safe haven currency of Europe, its ability to provide duration at an attractive cost, a diverse range of instruments, the willing participation of a unique and undersupplied domestic investor base and growing international demand, the sterling bond market has become an increasingly important source of funding for international issuers.
This year it has enticed a record number of them from the triple-A sovereigns, supranationals and agencies to single-A corporates with a handful of financial institutions in between and it is easy to see why.
"Duration, flexibility and diversification are the main attractions for non-UK issuers," says Robin Stoole, managing director, head of bond syndicate at Lloyds Bank Wholesale Banking & Markets.
"While some international borrowers do need sterling and hence issue directly in the currency, others access the market purely for a combination of investor diversification and, oftentimes, arbitrage."
The figures speak for themselves. As at September 21, 2012, non-UK issuers had issued over £43bn ($70.3bn) compared with £39bn ($63.9bn) for the whole of 2011. And more supply is on the way, say UK bankers.
"I think the fourth quarter will remain strong as I do not see any of the dynamics changing so the rationale for buying sterling will remain," says Myles Clarke, global head of syndicate at Royal Bank of Scotland.
"I do not see a silver bullet coming out of Europe and, while the UKs fiscal policy continues to work for the international investor base and with more QE expected in November, a number of factors will keep yields low and swap spreads wide. This should result in more US and other blue chip issuers coming to the market before year end."
Barry Donlon, head of corporate syndicate at UBS, agrees.
"There is an enormous bid for new names giving diversification away from Europe, which I believe will keep going through Q1 and Q2 of next year," he says.
Donlon says the fact that BHP Billiton was able to issue a large sterling debut on September 19 a £1.75bn seven and 30 year bond lead managed by JP Morgan, Lloyds and UBS without a roadshow should encourage borrowers which had previously hesitated because of the investor relations work traditionally involved in accessing the sterling investor base.
"That deal marked a sea-change in the sterling market," he says. "It means that well known international companies can do deals without sending big teams over to the UK, something they might have thought was not worth their while without certainty of
Also, the precedents set by the likes of AT&T, America Móvil, Time Warner Cable and Siemens, all of which have executed big, cost-effective trades at the long end of the market this year, should make it easier to convince the smaller corporates that they can achieve size in the sterling market.
And the audience is there for them to do so, particularly the UK-based funds, which, in the last decade, have had a mass concentration in European names so have been overly exposed to certain areas of Europe, which has turned out to be very expensive for them.
"There is a big push by these funds to diversify, creating a receptive market for names like AT&T, BHP Billiton and other blue chip corporates," says Donlon.
Frazer Ross, managing director of corporate syndicate at Deutsche Bank, which was on the top line for the AT&T, Time Warner Cable and America Móvil deals, confirms that companies like these, which have no operations in the UK, only issue in sterling because it offers arbitrage and tenor if they need it.
"Ultimately it all comes down to cost," he says.
Ross reckons borrowers save anywhere between 20bp and 50bp on sterling trades.
"When you look at the value of 30bp on a £1bn 30 year trade, you are talking 10s of millions of dollars annually, which is a powerful reason to look at sterling," he says.
AT&T, which issued a £1.25bn 2044 bond in May at a spread of 173bp over Gilts, was estimated to have saved 25bp on what it would have cost in the dollar market.
"One of the consequences of the financial crisis has been a profound effect on the cross-currency bases, principally due to an excess of synthetic creation of dollar assets," says Lloyds Stoole.
"Before the crisis you rarely factored it into considerations around cost-effectiveness because it would be worth a basis point or two. Now it has a very significant impact on whether issuance in a given currency and swapping is cost-effective or not."
And while non-UK issuers would have had to pay a premium to domestic borrowers before the crisis, they are now able to access the sterling market at flat, if not tighter levels.
"Pre-crisis, people would buy non-European names but at a spread," says UBSs Donlon. "Now it is the case that investors recognise the need to diversify and they are willing to pay for it."
Duration, duration, duration
Apart from its appeal as the least volatile currency in Europe, arguably the main attraction of the sterling market is its ability to offer duration way beyond other markets and in off-the-run maturities that are not available in other sectors.
The euro market, for example, rarely provides opportunities beyond 15 years and while the dollar market does offer duration, it is only in five, 10 and 30 years. By contrast, issuers can pick their spot in sterling out to 50 years.
"The real beauty of the sterling market is the ability to provide ultra-long maturities," says Marco Baldini, head of European corporate syndicate at Barclays in London.
"In dollars, maturities for corporates are confined to five, 10 or 30 years with nothing in between, which is why issuers like Time Warner Cable and AT&T like to come to the sterling market because they can fill in their curves between 10s and 30s. That also plays into the hands of the life funds and pension funds which are very long dated in their view of the market. Gaz de France issued a £1.1bn 50 year that ability to get beyond 30 years is something unique to sterling."
Not enough bond to go around
The UK insurance companies and pension funds which typically favour long dated securities are hungry for assets and there is simply not enough product being issued, particularly at the long end, to satisfy their demand.
"There is a very, very strong bid for long dated product and lots of cash available but not enough issuance," says RBSs Clarke.
"The £1.25bn deal for AT&T shows the strength of that bid and the lack of candidates to fill it. There is not enough domestic issuance as the number of single-A blue-chip corporates looking for funding [is limited]. Some, like Tesco, for example, will only issue every few years while others are very well funded."
And, according to Jean-Marc Mercier, global head of syndicate at HSBC, the only meaningful way to penetrate the UK investor base is to issue directly in sterling.
"Demand continues to be very UK-centric, concentrated in the classic few hands of insurers, pension funds and some asset managers," he says.
"These investors all tell you they can buy euros and dollars and swap it back to sterling but really they only buy in size in sterling. So, if you have a big issuer which wants to have diversification and hit that pension money in the UK, the only way to get them into your investor base is to issue in sterling. In that sense, there is a big future for the sterling market."
Stoole at Lloyds, which led the sterling tranche of the BHP Billiton transaction along with JP Morgan and UBS, says he saw some of the largest orders he has ever seen from the big UK accounts in the BHP transaction.
"This is partly because it is a high quality new name so they were bound to have substantial room for the name but also because there are just not enough assets for them to buy.
"One of the reasons for the dearth of assets is that the traditional users of the sterling market, UK borrowers with sterling needs, have relied unusually heavily on the Yankee market instead because it has been so cost-competitive during 2012. The Yankee market has been a huge drain on already constrained supply dynamics."
Expanding investor base
While remaining an essentially domestic investor-driven market, the increasing involvement of international investors, be it the central banks or continental asset managers, has broadened its appeal as an issuing vehicle for all issuers.
"There has been more international demand in sterling than in the past, which is a result of the eurozone debt crisis" says Guy Reid, head of frequent borrower origination at UBS.
"It is not just the Asian central banks, which have always run sterling portfolios, but there has also been a lot of European real money demand for sterling plus demand from Swiss private banking and retail."
The EIB, which is the largest sterling issuer outside the UK Debt Management Office, is among those experiencing new demand for its sterling bonds this year.
"We have seen names that were absent from the market for quite a while with a few new investors participating this year," says Richard Teichmeister, the EIBs head of funding Europe (excluding euro) and Africa.
The World Bank had a similar experience when it issued an £800m December 2014 fixed rate bond in February.
"We had very nice support from central banks and we had new sterling investors that do not frequently get a chance to consider investments in World Bank," says George Richardson, World Banks head of capital markets in Washington.
Bill Northfield, head of SSA origination at Deutsche Bank, says that the number of central banks invested in sterling has expanded to nearly a dozen compared with two or three years ago when only a handful were active.
"This is a notable development for the central bank community," he says.
"And there are a number of different investors coming on board with respect to broadening the investor base. More real money investors on the continent and in Asia are buying sterling, all competing for the relatively small pool of supply. For example, some 80% of the £500m five year Finland FRN earlier this year was sold internationally to central banks and official institutions, compared to around 18% of the £500m five year Finland FRN sold to this same investor class in 2010."
The floating rate sector has provided non-domestic issuers, principally the sovereign, supranationals and agencies, with a vast source of funding in 2012, as bank treasuries flush with cash from their central banks, have looked for short dated assets in which to park their money. Year to date, issuance has exceeded £19bn compared with £18bn for the whole of last year.
Central banks are growing buyers of the product, as are the UK asset managers. As a result, the triple-A SSAs have been able to raise large volumes in this asset class and the number of new names jumping on the FRN bandwagon has offered investors a diverse pool of supply.
While the EIB has always been active in floating rate sterling and has a number of lines outstanding of benchmark size, this year, the market has seen a diversification of issuers with the likes of Cades, L-Bank, FMS Wertmanagement, KfW, NRW.Bank and Land NRW all taking decent volumes out of the market.
The EIB has raised 50% of its sterling funding in floating rate format this year, including a £1bn tap in July, the EIBs largest ever tap exercise.
"So far we have issued a bit more than £4bn, 50% of which has been in floating rate format, which is relatively unusual for us, as fixed rate issuance has traditionally been our main funding source in sterling," says EIBs Teichmeister.
"In the past, floating rate notes would be sold mainly to bank treasuries but this year the investor base has expanded to include central banks and asset managers, which in previous years, would not have been interested. For example, 50% of the £1bn tap of our January 2016 floater issued on 20 July was sold to central banks."
UBSs Reid explains the proliferation of FRN issuance being the result of SSA spreads entering Libor plus territory.
"We are in an environment where the economics work for the issuers and FRNs appeal to investors who are faced with low Gilt yields," he says.
"Although investors are not anticipating a rise in base rates many are concerned about a more general sell-off in fixed rate yields and the capital loss this results in. The demand for sterling floaters is very diverse. Some central banks are buyers and that pool of money is growing, but there is also a lot of demand from UK real money and European retail investors aside from the more usual bank treasuries."
From niche to core
The volume of non-domestic SSAs is close to last years total issuance of £21bn and bankers expect that figure to increase to around £30bn by year end with several issuers now considering sterling as their third core market after dollars and euros.
To a large extent, the increase in supply is down to the Bank of Englands latest round of quantitative easing (QE) and the shortage of Gilts, particularly at the front end of the curve.
"With £375bn of QE planned or executed and Gilt yields at the front end at extremely low levels September 2014 Gilt yields hit a recent low of around 4bp and the September 2015 8bp SSA deals coming at the front end at 60bp or 70bp over Gilts are a very appealing prospect for an investor looking to enhance yield," says James Solomon, sterling syndicate manager at RBC Capital Markets.
Cades is one of the issuers for which sterling is becoming more of a core market. Until mid-2010, the borrower viewed sterling as a private placement market where it issued only when there was an arbitrage. Then it realised the potential offered by sterling and now considers it to be a sector that can provide large volume as well as arbitrage, diversification and flexibility. For the past two years, Cades has raised around 7% of its roughly 28bn long term programme in the sterling market.
"We consider sterling as well as dollars as diversification markets where arbitrage is not the most important factor," says Pierre Hainry, deputy head of funding at Cades."It is also a useful market because from time to time we can issue taps that can be driven by two or three investors. The size of the tap can also be the same size as the original issue, which is not something we can achieve in the dollar market."