When the European Union succeeded in selling more than a fifth of its Eu5bn issue into Asia at the start of January, there was a collective sigh of relief from SSA bankers and borrowers. When this was followed at the end of the month by another Eu5bn deal, this time from the European Financial Stability Facility (EFSF), 38% of which was taken by Asian investors, market participants could scarce forbear to cheer. The Asia bid, so essential to the sector yet so elusive during the previous 12 months, was finally back.
That Asian investors should have shied away from European names during the continents sovereign upheavals is hardly surprising. Central banks, by far the biggest buyers of SSA debt in the region, are notoriously risk-averse and the eurozone turmoil, coming as it did soon after the global financial crisis, was enough to put the wind up far less cautious investors.
That is not to say that the Asian bid was entirely absent from the market last year. KfW, indeed, reports a record level of interest from Asia in its US dollar programme overall, the German agency placed 40% of its record $28bn issuance into the region and Asian investors took 61% of its $4bn 10 year transaction in September.
Yet KfWs success was in itself a symptom of Asian nervousness around European credits. With ever-increasing reserves, the regions central banks were hungry for diversification but most were only prepared to buy European debt if it came from a gold-plated, core country issuer. In light of the eurozones travails, they were also understandably reluctant to take paper denominated in the single currency.
So their return to the market in such size for a pair of euro denominated bonds that were an integral part of Europes recovery mechanism was both essential to funding that recovery and a crucial endorsement of it. Partly, their enthusiasm for the deals may be down to a sense of broader macroeconomic responsibility, according to Herman van der Wall Bake, head of global risk syndicate at Deutsche Bank.
"Asian central banks have continued to amass reserves and theyre willing to some degree to use those reserves to the greater good of the health of the global financial markets," he says.
"There is some risk-aversion pertaining to the peripheral space, understandably, but theyre definitely keen to support the broader EU efforts and they stepped up in those transactions when they were asked to do so."
Dealers also, however, point to the fact that the EU and EFSF deals ticked all the boxes on Asian investors wishlists. "Asian accounts want three elements they want the highest quality, they want the best liquidity and they want to see the potential for spread performance," says PJ Bye, head of public sector syndicate at HSBC. "With these deals investors cant doubt the quality, the triple-A is there to stay, the performance on both deals has been excellent and its hard to argue that a Eu5bn deal is not going to remain liquid over the long term."
Also enhancing the appeal of these deals was the fact that they were both effectively from new entrants to the market, the EUs bond being on behalf of the European Financial Stability Mechanism (EFSM). As Edward Mizuhara, head of frequent borrower syndicate at Credit Suisse, notes: "By virtue of the fact that the EFSF and EU deals were debut transactions, they became must-have deals."
And finally, because the bonds were designed to support sovereign issuers such as Greece and Ireland that no longer had access to the capital markets, they offered central banks a chance to get exposure to broader Europe without the credit risk associated with peripheral names. "Both the EFSF and EU are AAA/Aaa rated and the entities that theyre financing are not triple-A rated, so overall the quality of debt has increased by rating which will make it more attractive to Asian investors," says Sean Taor, global head of public sector DCM and syndicate at RBC Capital Markets.
But whatever Asian investors motivation, whether macroeconomic altruism or purest self-interest, the results have been more than satisfactory for SSA issuers. Taking their lead from the central banks, Asian investors are flooding back to the European market and getting ever bolder, even to the extent of looking at the previously shunned peripheral credits.
"The EFSF and EU deals had very good Asia participation, and the fact that we have now this mechanism to cope with the instability has persuaded some Asian investors to come back," says Rodrigo Robledo, head of capital markets at Spanish agency Instituto de Crédito Oficial (Ico). "My expectation is that well see Asian investors more interested in Spanish paper and in Ico paper. We are hearing that some of them are again actively looking at secondaries and are thinking about getting more involved on our trades."
Indeed, so adventurous are Asian investors becoming that Petra Wehlert, head of funding at KfW, anticipates a fall-off in demand for the agencys paper from last years peak. "Im sceptical that we can stay on that level," she says. "Transactions like the ones from the EU, EFSF and KfW have seen very good demand and the more confidence we see in the market, the less there is a flight to quality, which traditionally is beneficial to KfW."
Gaining acceptance for European credits in Asia has not, however, been an automatic process. Borrowers and bankers alike have had to put in an unaccustomed degree of hard work on the Asian side, as key accounts began drilling down much more deeply into credits, to levels that had not previously been considered necessary for most supranational and agency names.
"In the past when these borrowers went to see Asian investors the discussion was much more around issuance programmes, around liquidity in their paper and the relative value of their name versus other names," says Greg Arkus, managing director, debt capital markets at Credit Suisse in London. "Now if you look at the presentations that are being given, the focus is moving more to explaining the credit in finer details, so looking at the balance sheet, exposures and the credit."
Guy Reid, head of frequent borrower coverage at UBS in London, says Asian investors are also asking many more questions about the relationship between agency issuers and their respective governments. "They are focusing on the types of government support and timeliness of payment," he explains. "For government guaranteed issuers there is a lot more focus on the domestic economy and where their guarantors bonds and CDS are trading. Investors are now very sensitive to changes in annual issuance volumes and to the amount of short term debt that issuers have outstanding in the CP market whereas previously that was very rarely discussed."
That has been particularly true, of course, for peripheral credits. Icos Robledo says that, when his team made their annual round of visits to Asian accounts in November, most of the discussions centred around the agencys sovereign guarantor. "Every single investor was asking the same questions," he says. "They know Ico very well, theyve been buying Ico for the last 15 years, they know the quality of the guarantee but they wanted us to talk about the Spanish economy and the challenges Spain has ahead."
For him, the key to success in the Asian market is communication. "If they are not getting the right information, Asian investors are mainly driven by headlines and by rating agencies," he adds. "So its very important to visit them, to say, Look, in the Spanish economy we have strong fundamentals, weve made the reforms, the financial system is in a good shape, everything is going as expected and we offer you very good value. And the feedback we got from them was, Please keep us posted because we need to know what is happening in Europe."
And it is not only peripheral names that have had to work hard for their funding in Asia. As Bye at HSBC points out, the success of the EUs deal was both unprecedented and far from a foregone conclusion. "Theyve done a series of smaller deals over recent years for the balance of payments programme, back-to-back funding for the likes of Romania, and in all those trades the Asian component has been relatively disappointing compared to an EIB or KfW standard distribution," he says.
He attributes a large part of the 21.5% Asian strike rate on the deal to two years of diligent marketing in the region, an effort that he also says was responsible for attracting an impressive array of new accounts to the credit.
Investors develop palettes
Other issuers have also seen a broadening of their investor base in Asia thanks to a combination of increasing comfort with Europe, a continuing low yield environment and changing regulatory requirements.
"Some of the insurance companies and large bank entities, particularly out of Japan, as well as some of the domestic Chinese banks are all getting involved in the SSA space as a way of getting additional yield enhancement over Treasuries or European govvies," says Bye. "Generally banks, wherever theyre located, are under pressure from regulators to increase low risk-weighted assets on the balance sheet, so this type of paper is right up their street. Thats why you are seeing more Asian commercial banks, trust banks etc buying into SSAs than you did previously."
The search for yield is also driving even central banks, traditionally more comfortable with shorter dated paper, further down the curve. "Asian investors as a whole have become more open to buying longer maturities, so you see Asian central banks buying out to the 10 year maturity in both dollars and euros," says Arkus at Credit Suisse. "Clearly since reserves have built up so quickly they have to be invested across the curve, although that is highly yield dependent in the second half of February we saw yields sell off very aggressively but we have seen profit-taking since as yields have rallied back. If yields sell off again wed probably see a return of appetite for longer maturities."
Zuzana Kucerova, vice president, global risk syndicate for Asia at Deutsche Bank, agrees that demand for duration is re-emerging but likely to remain inconsistent. "Towards the year end with the low rates environment some of the clients had started to push duration a bit further just to get a bit more yield pick-up," she says. "We do have a few central bank accounts who like to see slightly longer deals, five to seven years, and some of them are happy to go up to 10 years as well, but the main concentration is still up to five years."
Beyond euros, dollars
When it comes to currencies, however, most bankers agree that the recently observed readiness of Asian investors to buy non-dollar assets is unlikely to prove a passing phase. "Over the last year weve seen concerns over the relative valuation of the dollar which has led some of the central banks to look at a broader range of currencies for reserve purposes, so weve seen an increase in terms of investment in the euro, albeit there was some hiatus at the height of the European crisis," says Arkus at Credit Suisse.
This change in investor behaviour should prove particularly beneficial to supranational and agency issuers, according to Bye. "Dollar investment, particularly from central banks, has always been much more widespread because the majority of FX reserves globally are still weighted heavily towards dollars. But the euro component is growing and there is more of an appetite to expand out of traditional Bunds and OATs into slightly higher yielding triple-A product," he says. "The EU and EFSF deals definitely played into that shifting investment pattern."
Bankers also report a marked increase in Asian interest in non-euro and non-dollar assets over the past year. "There was substantial demand for Aussie dollars throughout 2010 and a lot of demand for sterling this year," says Reid at UBS. "There has also been strong interest for Swedish krona and Norwegian krone from both central banks and retail investors."
Another development in Asia that has caught the eye of supranational and agency borrowers is the emergence of renminbi bond markets in China and Hong Kong. The benefits of issuing paper in local currencies such as Singapore and Hong Kong dollars have long been appreciated by credits across the sector, and the publicity surrounding recent RMB deals in the offshore Hong Kong market including three from supranational issuers, the Asian Development Bank (ADB), World Bank and IFC has generated considerable positive sentiment around the currency.
"When you issue in local currencies you broaden your potential investor base and you broaden name recognition, especially in a hot market like RMB," says Bye. "It raises the overall profile of the issuer and it may result in investors putting lines in place for that currency which can then be used for dollars, euros etc. It also helps establish relative value if issuers are funding in domestic Asian currencies at a certain spread relative to their peer group, then investors will use those spread differentials as a basis for their decisions in other markets."
Mizuhara at Credit Suisse agrees that issuing in local Asian currencies could be a valuable way for SSA names to reach a wider range of accounts in the region. "Weve seen this with regard to other currencies as they develop: Polish zloty, South African rand, Australian dollars, Canadian dollars and so on that the buyers of those are not necessarily the same buyers that will be buying EIB or KfW in dollars, euros and sterling," he says. "So theres definitely an opportunity to expand the investor base there because often those accounts are driven by the fact that they want to buy a given currency but dont want credit exposure."
Wehlert at KfW confirms that the German agency is looking at the RMB market but warns that swap constraints are likely to limit issuance in the near term. "Issuing local currency bonds is important to broaden our investor base and to support the countries we have very good relationship with in developing their own capital markets," she says. "In Hong Kong, Im sure we will see good demand for KfW RMB bonds, but before we have to solve the problem that the swap market is not really developed there."
And not only do issuers need to be able to access a swap market, they need to be able to do it at attractive levels. "Most of these higher rated supranationals and agencies look at arbitrage funding, and unless the funding is compelling in one swaps to dollars or another currency they wouldnt entertain it," says van der Wall Bake at Deutsche Bank. "In due course we will see more of them but near term, before a swap market develops, its unlikely well see more meaningful participation.
Robledo at Ico, however, insists that while funding levels are important, they are not the only motivation for issuing in new currencies. "We are exploring the idea of issuing local currency paper in Asia," he says. "Obviously it has to be attractive for us in terms of levels the level needs to be more attractive than you would achieve in euros but diversification is an important driver on our funding programme."
And although some local currency markets may take time to develop, the potential opportunities they offer for both borrowers and buyers are such that many bankers see them as a one-way bet.
"Local buying of local currency debt for those issuers will only increase going forward so its good news for the investors that they have the opportunity to invest in those currencies in the top sphere of issuance," says Taor at RBC. "Its also good for the issuers because it gives them not only attractive cost of funds, it also gives them a loyal following which will help them in other markets."
Of course, demand for European supranational and agency borrowers in Asia whether in local or core currencies will continue for some time to depend on whether Europe can continue down the road to recovery. If it wanders from the path again the sector will undoubtedly feel the effects, yet its hard to imagine Asian investors deserting en masse.Fortunately for harassed funding officials, with reserves accumulating rapidly, regulatory pressures increasing and financial sophistication spreading ever further across the region, the Asia bid needs Europe nearly as much as Europe needs the Asia bid.