Since the subprime mortgage crisis brought many of the Wests financial institutions to their knees, a debate has raged over the way in which sovereign wealth funds, many of them in Asia, have been taking stakes in a growing number of banks and other companies in Europe and the US. Suspicious of their motives, politicians and other popular commentators have called on limits to such equity injections, or at the very least codes of conduct that bring about greater transparency.
However, others have seen the benefits that cash rich and long term investors can bring to the capital markets. And if those sympathetic to sovereign wealth funds investments wanted an example of their benign influence, they could do worse than look at the role of central banks in the upper echelons of the fixed income market.
When it comes to seeking large amounts of cash, neither sovereigns, supranationals nor agencies appear to have any qualms about going cap in hand to sovereign wealth funds, central banks and other institutions asking for a loan. Indeed those in Asia have been heavily courted by this class of issuer for many years.
Since last summer this investor base has only grown in importance, partly because, as in the equity markets, other buyers have not been able to stump up the cash.
"It is certainly the case that leveraged buyers in general have been more cautious as they cannot find funding for themselves with the ease they could in the past," says one SSA banker in London. "It is also fair to say that real money institutional accounts are very focused on the volatility in the markets.
"Therefore it has very much been the case that larger central banks have driven flows into the sector."
Brian Lawson, co-head of international syndicate at Nomura International in London, agrees.
"If you look at some of the recent distribution figures, it is clear that the SSA market is becoming more and more reliant upon top quality central bank buyers worldwide to drive benchmark transactions," he says.
Some of the most recent transactions to hit the market as this special report was going to press demonstrated the dominance of central banks at the top end of the bond markets. Cades and Bank Nederlandse Gemeenten sold 83% and 94% of $1bn Eurobonds into central banks in June, for example.
However, the story is not so simple as Asian accounts simply ramping up their SSA buying in line with the upward trajectory of their reserves. Central banks elsewhere have taken up much of the slack left by the reduced participation of some leveraged and real money accounts.
"While it has still been crucial to bring our traditional Asian client base into benchmarks," says Lawson, "newer central bank players from Europe, Latin America, the Middle East and Africa are also driving these transactions."
Despite the dominance of central banks in the books of the two transactions mentioned above, Asian distribution was a relatively modest 20% of the three year Cades deal and 22% of the five year BNG issue. This is in line with what other SSAs have been seeing.
"Orders out of Asia so far have been stable, at around 25%-40% of our benchmarks, depending on the currency and maturity," says Klaus Rupprath, head of capital markets at NRW Bank. "We see demand for our dollar paper, but in the past couple of months we have seen an increase in Asian demand for our euro issues, as they have become more interested in the euro currency."
Whether or not the absolute amounts of euro SSA paper going into Asia has increased is very difficult to calculate. Raw new issuance numbers suggest that it might not have, simply because the euro market has struggled to keep up with the pace of supply in the dollar market, where funding levels have been much more attractive to issuers this therefore offers no insights into whether Asian central banks have changed the currency weightings of their holdings or new purchases of SSA paper.
"For the past five years there has been a lot of speculation about whether Asian central banks have been increasing the weighting of their euro holdings," says Ed Mizuhara, head of frequent borrower syndicate at Credit Suisse in London, "but nobody knows for sure. One thing I can say is that I have yet to see any selling of dollars, although it could well be that they are putting a greater proportion of their new money into euros.
"But given the way that their foreign currency reserves are growing, they have plenty of cash to invest in euros and dollars whatever their exact weightings are."
Asian intelligence becomes crucial
"The boundaries where interest is forthcoming have become somewhat narrower," says one SSA banker. "We have seen a wonderful dollar market for the top quality supranationals and sovereigns, but others not in the highest tier have found the going tough and not so cheap."
This greater differentiation between credits and the price they need to pay has played out favourably for those that have stood up to the increased scrutiny.
"That is good news with respect to the work we have done in 2005, 2006 and 2007," says NRW Banks Rupprath. "They clearly understood that NRW Bank is enjoying the explicit guarantee of Nordrhein Westfalia, so there is no question that we are one of the safe havens in these turbulent days for investors, along with credits such as KfW, Landwirtschaftliche Rentenbank and L-Bank."
But not everyone has been so fortunate.
"Kommunalbanken, for example, engaged the market at levels wider than in the past, but only just got its deal done," says the SSA banker. "Meanwhile the EIB is selling out $3bn in five years in half an hour, which is no mean feat."
Kommunalbanken launched the $1bn three year bond, its first dollar benchmark in over a year in late May at 10bp through mid-swaps. Although the transaction was not fully subscribed at the time of pricing, Kristine Falkgård, head of funding at KBN in Oslo, said that the issuer was able to attract central banks that had not previously participated in its issuance.
"We have been engaging in investor dialogue throughout this year and the issue was also launched on the back of strong lead orders and very positive signals from key accounts during the soft-sounding process."
The kind of intelligence that can be gained from the key Asian investor base in the short term through soft-soundings and in the longer term by constant contacts with these accounts has become more crucial than ever given their growing share of distribution.
"To the extent that 20 accounts around the world can make or break a deal it is very important to know just what they are looking for," says a DCM banker in London.
However, the market volatility and short issuance windows has made this a delicate process.
"The big accounts can get fed up with being constantly soft-sounded when they dont really know if there is a deal on the way or not," says one syndicate official, "and you dont want to be wasting their time.
"Yet they can change their minds from one day to the next so you need to make sure you are up to date with their latest thoughts. Balancing these two factors is by no means easy."
Show me the benchmarks
The lower liquidity that has afflicted almost every fixed income asset class has also afflicted the SSA sector, making judging the correct pricing yet more tricky.
"In the wake of last years crisis and the lack of liquidity this year secondary trading in US agencies and the wider SSA market has been relatively low," says one syndicate official in London. "The sector has therefore traded much tighter. Relative value is therefore better gauged against where recent supply has come in the primary market."
The drying up of liquidity has made some of the Asian central banks reappraise their opinions of differently sized benchmarks.
"What we have seen, which is quite an interesting reversal, is that last year you often saw $1bn deals trading tighter than larger benchmarks by virtue of their scarcity. With a $3bn issue the last $300m-$500m could be left hanging around and put a drag on a deals performance.
"Today, the larger central banks actually probably prefer $3bn deals as they are perceived to retain greater liquidity, which is key."
Whether or not the big Asian accounts are right to behave in this way remains an open question, according to the SSA banker.
"It often turns out that if central banks buy all of a deal the difference in liquidity between a $1bn and a $3bn benchmark is not that big," he says. "All of the recent run of five year issuance quickly became illiquid, irrespective of its size."
While the difference in liquidity between sovereigns (outside their home currencies), supranationals and agencies and pure government bonds may have increased since last summer, investors have, according to one syndicate manager, sufficient compensation to continue to be involved in the sector as part of their core holdings.
"SSAs have underperformed as government bonds have outperformed," he says. "That is not a bad thing with regards to headline spreads.
"If an Asian central bank was happy to buy KfW at 10bp over Bunds before, it should be more than happy to buy it at 25bp over, because the difference in risk is still the same."
Meanwhile the tight funding levels that SSA issuers have been able to achieve on a Libor basis through benchmark issuance has meant that the cost advantage private placements have often provided has fallen, as they have not tightened in a similar fashion.
At the same time, some Asian accounts have become more conservative in their buying of MTNs."For us the core investors in Asia are the central banks and they have a preference for liquid instruments, mainly benchmarks, and also simple cashflow structures," says Frank Richter, head of investor relations at NRW Bank. "There is demand for structured products in general, from areas such as Japan and also Hong Kong, but in the last few months even these have been looking for simpler