Among European sovereigns, few saw their investor base revolutionised more starkly by the arrival of the euro than heavily indebted Belgium, which by the mid-1990s had a debt to GDP ratio of more than 130%. The result was that in 2000, the par value of Belgiums bond market equated to 135.6% of its GDP. That was higher than in any other European country bar Denmark, where the bond market dominated by mortgage rather than government debt was 160% of GDP in 2000.
Before the launch of the single currency, the relative size of the OLO (government bond) market denominated in Belgian francs exerted big pressures on the domestic investor base. "Before the launch of the euro, about 90% of Belgian government debt was held by domestic investors," says Anne Leclercq, director of treasury and capital markets at the Belgian Debt Agency in Brussels, which she joined just before the arrival of the new currency. "That was a serious problem, because if you look at the type of investors that dominated the market the vast majority were banks, most of which followed the same strategy. That meant that most of the investors in Belgian government debt were either buying or selling at the same time, which in turn meant that there was very little liquidity in the market."
Fast forward to the start of 2007 and the launch of Belgiums OLO 49, Eu5bn 10 year transaction led by ABN Amro, Deutsche Bank, HSBC and KBC. The bond generated total demand of about Eu16bn and Belgian investors accounted for just 20% of distribution, with the balance well spread among institutions in the UK (21%), France (18%), Germany (8%), Italy (7%) and Asia (7.5%).
Those distribution statistics may be par for the course in todays market, but in the days of the Belgian franc they would have been unthinkable. "It was essential for us to inject more liquidity into the OLO market by diversifying our investor base as much as possible," says Leclercq. "But it was impossible for us to do that before the launch of the euro because investors would not have been prepared to take the foreign exchange risk on the Belgian franc."
At the same time, says Leclercq, it was equally important for a borrower like Belgium to ensure that it could cultivate a new investor base quickly in order to compensate for the inevitable drift of Belgian institutional money overseas. "We knew that while foreign investors would become more interested in the Belgian market, Belgian investors would also start to look at other markets to diversify their portfolios," says Leclercq. "That meant that it was important for us to set up big marketing roadshows and to make sure we visited as many investors as possible."
Expansion beyond Europe
The development of the euro capital market has also helped to broaden some top quality issuers investor bases well beyond the European market, for two reasons. First, because the emergence of a credible alternative to the dollar as a reserve currency has clearly helped sovereign, supranational and agency borrowers as well as the highest rated banks to place a growing share of their issues with central banks outside the eurozone, most notably in Asia. Borrowers like triple-A rated Rabobank, for example, have reported a conspicuous increase in Asian central bank demand for their euro benchmarks, but so too have lesser rated public sector issuers, such as Belgium and Italy.
A second way the euro has helped SSA borrowers to diversify the currency mix of their funding and hence the breadth of their investor bases was in opening up a more liquid swap market. "Given the size of its funding programme, the Belgian Treasury could not possibly swap from other currencies into Belgian francs, because it would have had a huge impact on the foreign exchange market," says Leclercq. "Being part of the eurozone changed what we could do in terms of risk management, because it allowed us to borrow in the currencies and maturities where investor demand was strongest, and swap back into euros."
It has been the expansion of the depth and breadth of the investor base within the eurozone that remains the most impressive consequence of monetary union in terms of demand across several asset classes. "Euro area portfolio assets held in the euro area as a share of total international asset holdings of euro area residents has increased markedly over the period 1997-2006; by 16 percentage points for equities and by 46 percentage points for fixed income securities," notes the a report by the ECB and Goldman Sachs on the 10th anniversary of the euro. "Moreover, all major regions of the world, and Denmark, Sweden and the United Kingdom, increased their holdings of euro area assets (as a share of their international portfolio) over this period, but to a smaller extent. This suggests that the euro might have strongly stimulated portfolio transactions between euro area countries."
The highly granular and geographically diversified character of those portfolio flows has underpinned rising liquidity and ensured that demand in the eurozone is considerably more diverse than it is in the other main currency blocks. "It is clear that investor demand in the euro market is much broader than it is in sterling, which continues to be dominated by a handful of very large investors," says John Winter, head of European investment banking and debt capital markets at Barclays Capital in London. "But the euro market is also often less concentrated than the US dollar market. In the corporate market in the US, for example, there may be a lead order for 50% or more of a corporate new issue, which one would very seldom see in Europe."
The diversity of European demand means that when borrowers have been prepared to dig deep enough, more often than not they were able to mine a new seam of investor demand. That recognition has prized open a lively market for so-called regionally-targeted bonds in the eurozone, and in the process it has created opportunities for a raft of banks below the top tier players.
Domestic bias remains
While at a sovereign and supranational level the euro appears to have created a unified investor base, with national interests playing no more than a minor role in the allocation of eurozone-domiciled institutional funds, it is less clear whether the same is true in the corporate market.
As issuance in the corporate sphere gathered momentum in the run-up to the launch of the euro, it was fashionable to argue that in the new and highly credit-focused European debt capital market, corporate borrowers would find themselves competing with those in other eurozone member states on a completely level playing field.
Up to a point, the forecast was accurate. No longer could borrowers like KPN or France Telecom regard fellow issuers in the Dutch guilder or French franc market as their benchmarks. Instead they would be thrown into a competitive, Darwinian market alongside the likes of British Telecom, Deutsche Telekom, Telefónica and Telecom Italia.
In terms of primary market and secondary market pricing and more recently in the credit default swaps market it is clear that where comparable outstanding credits are available, relative value on a cross-border basis within the eurozone has become paramount since the launch of the single currency.
Less clear, however, is the degree to which investors have been able and willing to be entirely agnostic about national boundaries in the new issue market, especially in fragile markets. That was certainly the impression that was left on Terence Shanahan, head of securities syndicate at Société Générale in London, after a recent three week global tour aimed at eliciting investors updated views on the credit market. One of the conclusions he drew was that there is a very strong domestic bias among investors this year. "For example, in Finland I was told that although investors there are uneasy about cyclical corporates they would still be inclined to take a constructive view on a strong Finnish company coming to the market," says Shanahan, adding that he has detected a similar trend elsewhere in the eurozone. "One of the themes that came out of my talks with investors is that although they are nervous about the economy in countries like Spain and Ireland, Spanish and Irish institutions remain very comfortable with domestic credits."
That trend, says Shanahan, has also been discernible from the geographical allocation of several prominent corporate deals. In the case of a Eu1bn seven year benchmark from BT in June, demand was clearly led by UK and Irish investors, accounting for 31% of placement, with German accounts a long way behind (22%). Similarly, when Carrefour launched a bond of the same size and maturity, also in June, French buyers predominated with 30%, whereas they had only taken 19% of the BT issue. In the case of a recent Telefónica five year Eu1.25bn deal, Iberian and Italian investors accounted for 34%, whereas they had only made up 13% of the book for Carrefour and for 8% in the BT bond.
The view from over here
The conclusion from this analysis would appear to be clear enough investors will continue to gravitate towards companies in their immediate backyard, especially in turbulent times. That is entirely understandable, and springs from very natural cultural and linguistic preference, as well, perhaps, as a sense of allegiance towards companies perceived to be national champions. But it does mean that the distribution of investor demand for European corporate bonds appears to be very different from the US. There, Californian-based investors, for example, are much less likely to favour Californian credits over those from the other 49 states of the USA.
That does not mean that European investors have done less to diversify their credit portfolios than their US counterparts. "The euro never had as its primary objective the removal of national characteristics within Europe, and will not create the same cultural, legal or fiscal unity that you see in the US," says Dominique Jooris, managing director, financial institutions at Goldman Sachs in London. "But if you look at how much an insurance company in the US has invested overseas compared to an insurance company in Portugal or Spain, the Portuguese or Spanish investor would win hands down."