Benchmarks still borrowers’ best friends

Issuers big and small remain convinced of the value of benchmarks, despite often better prices to be found in private placements or smaller bonds. Deal size, diversity of order books, name visibility and liquidity are the key attractions, which if anything have become even more appealing since the onset of the credit crisis. Philip Moore reports.

  • 19 May 2010
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"There is only one thing in the world worse than being talked about, and that is not being talked about." (Oscar Wilde)

The Swedish municipal lender, Kommuninvest, does not need to issue benchmarks. It explained as much last September, when it returned to the Eurodollar market after a two year absence, launching a $1bn three year transaction which found diversified demand across Europe and Asia. "With an annual borrowing programme of [an] estimated $8bn, Kommuninvest is able to fund its annual needs through the EMTN market," the borrower said at the time.

If it was straightforward enough for Kommuninvest to cover its 2009 funding requirement through MTNs, it was even easier in 2005, when it had a projected funding requirement of between $3bn and $4bn. But in January 2005, Kommuninvest launched its inaugural benchmark, covering a quarter of its borrowing requirement for the year at a stroke with a $1bn five year transaction via Credit Suisse First Boston, DrKW and Nomura.

Given the cost differential between benchmark issuance and funding via MTNs and other arbitrage-driven mechanisms, why would a borrower with a modest financing need such as Kommuninvest go to the trouble and expense of issuing in benchmark format?

"We developed a benchmark strategy well in advance of when we really needed it," explains Maria Viimne, Kommuninvest’s deputy CEO. "We had had a successful MTN and private placement funding programme for years. But we recognised that as our financing requirements rose dramatically we would no longer be able to depend on small transactions. We knew that our first benchmarks would be expensive relative to the private placement market, but we also believed that we could bring that price differential down as our name became more widely known and as we established ourselves as an efficient benchmark issuer."

That is the consensus view among the vast majority of supranational and agency borrowers. But it is only in the past decade that supranationals and agencies have accepted the value of benchmark issuance. They have had a number of good reasons to do so, in spite of the costs involved.

Firstly, for a sector with chunky funding requirements, benchmarks provide issuers with access to eye-watering volumes of funding in very quick order, which was invaluable in 2009. "As was the case in the sovereign market, in 2009 borrowers focused on issuing quickly in very large size because the outlook for the market was so uncertain," says Kentaro Kiso, head of MTN syndicate and the EMEA public sector group at Barclays Capital. "Benchmarks are a much more efficient way of doing so than a series of smaller, arbitrage-driven structured deals."

Size, diversity, visibility

Conventional wisdom has it that the associated benefit of size is investor diversification. Clearly, in most cases a well executed jumbo benchmark transaction, probably led by between three and six banks with a local and international presence, will deliver high levels of diversification, both by geography and investor type. Benchmark transactions will also allow issuers to reach the deep-pocketed investors with a minimum cut-off in terms of size and liquidity.

"There are plenty of investors that for internal risk reasons are not allowed to buy private placements," says Sven Lautenschläger, international funding officer at Germany’s L-Bank, which typically aims to raise a quarter of its annual funding needs through benchmark issuance.

"It is essential that we provide these investors with product, because they are significant buyers of L-Bank bonds and they provide important support in the secondary market."

Beyond size and diversification, a third advantage of benchmark issuance is the visibility offered by large, public transactions. "Even if your deal isn’t going to be bought by 500 investors from all over the world, a benchmark deal keeps your name on the screens. It ensures that traders and investors are asking questions and talking about you," says Bill Northfield, head of the sovereign, supranational and agency origination team at Deutsche Bank.

Not that borrowers always need to issue multi-billion benchmark bonds to encourage investors or the media to take notice of what they are doing.

There are plenty of other ways, beyond benchmark bonds, of winning friends and influencing people in a range of countries with a variety of values. Neither the IFC’s recent sukuk, nor the World Bank’s Green Bonds, nor the ADB’s Water Bond can be described as benchmarks, given their modest size, although the World Bank has now raised more than $1bn through its Green issuance initiative.

All three, however, are good examples of borrowers with chunky funding programmes successfully exploring inventive solutions for appealing to alternative pockets of investors.

The importance of the profile that borrowers achieve through successfully executed benchmarks is emphasised by virtually all supranational and agency borrowers. Take the example of an issuer like Nordic Investment Bank (NIB), which in recent years has used dollar benchmarks as the backbone of its funding strategy, with two or three benchmarks per year typically accounting for 40%-50% of its total funding needs.

The balance is generally contributed by issuance in a broad range of arbitrage-driven currencies. In line with that strategy, NIB was quick off the blocks with a $1bn three year benchmark in January 2010 priced at a tight 5bp through swaps.

Given that it has a relatively modest funding requirement, which this year will be in the region of Eu4.1bn-Eu4.2bn, NIB may appear to make disproportionately large recourse to benchmark funding. But Jens Hellerup, head of funding and investor relations at NIB’s Helsinki headquarters, says that the benefits of benchmark issuance have been extensive. "When we started issuing benchmarks in 2002 we had a lot of very positive publicity, which gave us access to many new investors and therefore helped us in a number of ways," he says. "I think benchmark issuance plays an essential role in building your name recognition."

EARNs earn their place

The benefit loosely described as "profile", however, means very different things to different borrowers. When they were establishing their benchmark programmes just over a decade ago, for EIB and KfW building a profile meant positioning themselves as surrogates for government bonds.

EIB was explicit about this objective when it launched its Euro Area Reference Note (EARN) programme in 1999. It announced at the time that "with this initiative EIB aims at reinforcing its position in the euro capital market and establishing its bonds as the best complement to those of major European governments".

Carlos Ferreira da Silva, head of euro funding at EIB, says that as a measure of its success, investors’ familiarity with the EARNs programme speaks for itself. "In the early days of the programme we needed to make a number of big regular investor and syndicate presentations," he says. "These days all we need is a conference call. Everybody knows exactly how we structure our syndicate and how the pot works."

KfW was equally unambiguous about its endgame when it launched its benchmark programme soon afterwards, describing itself as offering the risk of the Federal Republic of Germany with a yield pick-up. As Philip Brown of Citi (or Schroder Salomon Smith Barney as it was at the time) told EuroWeek in 2001, KfW’s euro benchmark programme "has essentially moved KfW out of the world of credit markets and into government territory".

In some respects, it was unrealistic for EIB and KfW to present their bonds as government proxies, given that they are not deliverable into the Bund futures contract. Nevertheless, and even allowing for recent concerns over the effect that a Greek bailout may or may not have on these lenders, bankers say that EIB and KfW have successfully embedded themselves as quasi-sovereigns via their benchmark programmes.

"Benchmark programmes from borrowers like EIB and KfW have been hugely successful at positioning them as proxies for agencies in dollars and sovereigns in euros," says Sean Taor, global head of rates syndicate at Barclays Capital in London. "The size of their issues has often been larger than sovereign borrowers in syndicated format, and they have built up a large following of investors who track them as sovereigns."

Others that endeavoured to do the same have been less successful. "There is always an assumption that supranationals and agencies compete well with sovereigns as rates products," says Christopher Marks, head of debt capital markets at BNP Paribas. "However, more credit-intensive products, such as covered bonds, may not now be so suitable for pure rates investors."

For some agency borrowers, using benchmarks to reposition themselves within a predefined peer group, or to differentiate themselves from others, has been essential for different reasons.

Germany’s NRW.Bank is a good example of an issuer with a substantial annual borrowing requirement and compelling reasons for distancing itself from the Landesbank sector as well as the local Land. "Our benchmark programme was an important way for us to differentiate ourselves from the Landesbanks and is a form of division of work with the local government," says Frank Richter, head of investor relations at NRW.Bank’s Düsseldorf headquarters. "The state of North-Rhine Westphalia is also active in the capital market, but we focus a little more on our international finding programme."

NRW.Bank has used its STERM (short term) programme as an innovative way of establishing its profile among investors. "That has been a way of branding our name and filling a gap between the money market and the bond market where there is a lot of demand from central banks," says Richter.

Standing out from the crowd

Benchmark issues gained in importance during the crisis as a means of positioning supranational and agency bonds in the context of an increasingly over-populated triple-A or quasi-government sector. That particular challenge was explained by IFC in April 2009 when it launched its largest ever benchmark issue, a $3bn five year global bond via BNP Paribas, HSBC and JPMorgan.

As the borrower explained at the time: "It is important for us to position IFC, on relative value, at the tightest end of the supranational range and for the credit to be well established, not only for the funding programme but for the rest of the business as well. At the moment, supras are caught between all the guaranteed paper on the one side and the very high priced high grade corporates on the other."

To other borrowers, profile can be important for the beneficial effect it has on the pricing of its broader debt issuance. Precisely measuring that benefit is more of an art than a science. But bankers insist that there is a link between the performance of benchmark bonds and pricing in other markets.

"Overall, a successful benchmark programme reduces a borrower’s funding costs because it ensures that non-benchmark deals continue to come at tight levels," says Nick Dent, head of rates syndicate at Bank of America Merrill Lynch. "It’s a lot easier to sell private placements and structured notes of names that have a clear yield curve or some sort of valuation out there. So it’s not just the liquidity, it’s then leveraging that off into other products."

Borrowers corroborate this view. "Strong performance of benchmarks can definitely help you to achieve or even to clear your targets in the private placement market," says Lautenschläger at L-Bank. "Additionally, if you have poorly performing benchmarks outstanding, investors will be less willing to pay a fair price for your private placements."

This symbiotic relationship, says Lautenschläger, can also work the other way round, with poor performance in the private placement market potentially impacting on how borrowers are regarded in the benchmark sphere.

"There is virtually no activity at a secondary level in the Schuldschein market, which is why borrowers need to be aware that the liquidity generally needs to be provided by the issuer itself, especially in times of crisis," he says. "In the secondary market we buy back between Eu500m and Eu1bn in Schuldscheine or MTNs every year. That is because if there are L-Bank Schuldscheine in the broker market that nobody wants to pick up, their spreads will go wider and wider, which will ultimately have an effect on your benchmark levels."

Others agree that there is a strong link between a successful benchmark programme and increased efficiencies in other markets. "Our benchmarks have been a good way of opening up new credit lines for our private placements," says Anders Gånge, head of the finance department at Kommuninvest’s headquarters in Örebro. "Our dollar benchmarks are the reason that some investors have taken the time to do their credit analysis on us, and once they have done that work they have been prepared to open new lines. We know that once those lines are open, investors that have bought our dollar benchmarks have also engaged in our private placements."

A further argument in favour of benchmark funding, which is also related to the issue of profile, is the role it plays in strengthening a borrower’s relationship with the investment banking community.

"We in the SSA community cover borrowers more intensively than any other client base on the planet," says Deutsche’s Northfield. "These are high volume, high frequency issuers and we need to maintain a dialogue with them about funding in the widest range of currencies, maturities and structures. That coverage is not free, and the fees that are payable by borrowers for benchmark issues are a good way of incentivising banks to maintain that coverage."

What is a benchmark?

So much for the benefits of benchmark issuance. But what, exactly, is a benchmark? The most obvious criterion is size, with $1bn or Eu1bn regarded as the bare minimum required for a transaction capable of stoking sufficient secondary market liquidity to be considered a benchmark able to act as a reference point for other issues.

There have, however, been phases in which even Eu1bn or its equivalent has fallen woefully short of the minimum that some issuers believed was a prerequisite for liquidity. In euros, the bar was raised most visibly when Freddie Mac barged into the market in 2000, announcing plans to sell at least Eu20bn a year through four benchmarks of at least Eu5bn issued on a calendar basis.

When EIB and KfW followed suit with Eu5bn deals of their own the following year, it seemed that a new, breakaway premier league of benchmark issuers had been established in the supranational and agency space.

It was not just the very public arrival of Freddie Mac in the euro market that raised the bar in terms of benchmark size. As KfW’s head of new issues Petra Wehlert says, another decisive factor was the establishment in 1999 of EuroMTS. The new electronic trading platform stipulated a minimum outstanding size of Eu5bn for what it described as "Eurobenchmark Bonds" for "government and quasi-government bonds".

That minimum size ruffled the feathers of a few borrowers concerned that they would be excluded from the super-league of rates-like products. The über-benchmarks of 2000 and 2001 did not, however, entirely rewrite the rules in the euro market, nor did they establish a new minimum size for benchmarks in the supranational and agency sector. Nor did the emergence of the Eu5bn benchmark mean that size became synonymous with liquidity.

Flexibility — not just liquidity

On balance, bankers and issuers say that it would be preferable to be able to offer their investors a flow of highly liquid transactions. But while borrowers with more modest requirements than EIB or KfW are limited in terms of the liquidity they can supply, they enjoy more flexibility as to market timing.

"We have to accept that when we’re issuing a Eu1bn five year benchmark we will typically be required to pay a spread over a Eu5bn KfW bond with the same maturity," says Stefan Goebel, head of treasury at Rentenbank, which generally commits itself to three or four benchmarks each year. With an annual funding requirement of around Eu10bn, that means that the size of Rentenbank’s benchmarks are unavoidably restricted, usually to between Eu1bn and Eu1.5bn.

"However," Goebel adds, "our funding requirement means that we have a lot of flexibility in respect of which markets we choose to tap and when we choose to do so. That means we can weight our funding efficiently towards the most cost-effective markets."

With very few supranational and agency borrowers able to push their way into the Eu5bn club, most are understandably adamant that a minimum size of Eu1bn is perfectly adequate both for them and for their investors. "We have always communicated to investors that we target a minimum of Eu1bn for our benchmark bonds," says Goebel. "If the size and quality of an order book allows for a larger transaction, we will consider an increase.

"There have been times when some investors have voiced concerns about benchmarks smaller than Eu2bn but I still believe that investors view a Eu1bn transaction with quality placement as perfectly acceptable. Indeed, in some instances investors have indicated to us that they would prefer a Eu1bn benchmark to remain oversubscribed to generate a strong secondary market performance than to be increased to Eu2bn."

The challenges associated with managing the liquidity arising from a substantial funding programme are not confined to the new issue market. For names such as EIB, taps have been an essential mechanism for managing the issuer’s maturity profile as well as maintaining and enhancing liquidity.

"We believe taps and new issues are complementary," says EIB’s da Silva. "It is crucial that we maintain new issue activity based on opening new lines for many reasons. They offer on-the-run coupons to investors, help to complete our yield curve and give added impetus to the liquidity of existing bonds."

Adding to the liquidity of outstanding bonds, says da Silva, is in line with EIB’s strategy of positioning its benchmarks as government surrogates. "Re-openings help ensure that our bonds are close to the size of government issues," he says. "For example, we have one outstanding EARN that is now sized at almost Eu10bn, which is appreciated by investors."

Da Silva insists that EIB’s taps are always tailored to investor demand, and that the proof of their popularity among investors is their secondary market performance. "We only re-open issues if we can be sure there will be no overhang of paper," he says. "That is why you see EIB re-openings for unusual amounts such as Eu1.75bn, which borrowers would normally round up. We’ve made a point of not rounding these figures up to print taps in a size that matches the book. The market is clearly happy with this strategy because our curve performed throughout 2009."

Da Silva adds that another mechanism for managing liquidity of outstanding benchmarks is EIB’s Liquidity Allocation Procedures (LAPs). "We issue through LAPs when we’re called by bank counterparts telling us they’re short of a certain bond," he says. "In those circumstances, instead of issuing a new tap of Eu2bn or whatever, we will conduct a survey among those that are short and ask how many additional bonds they need. A typical example is our Eu5bn October 2015 benchmark, which was originally issued as a 10 year bond some years ago. We have added Eu624m through a LAP, which corresponded exactly to the accumulated amount of shorts in the market."

Size not the only factor

Bankers say there are plenty of other considerations, beyond pure size, that determine whether a new issue can be regarded as a successful benchmark. "While size is still a determining factor, the quality and diversity of distribution is also vital in defining a benchmark," says Ulrik Ross, managing director and head of European public sector debt capital markets at HSBC in London. "If a deal achieves a certain minimum size, is bought by a diversified range of investors and performs in line with outstanding transactions, it can clearly be perceived as a liquid benchmark."

While Eu1bn or $1bn may be a convenient threshold for the size of a benchmark, it is less clear whether or not a bond’s benchmark status is determined by its maturity. "You could ask whether a Eu1bn four year issue should be considered a benchmark because it is in what seems to be an off-benchmark maturity," says BNG’s head of funding Bart van Dooren.

Some say that the answer to that question is no, with purists arguing that benchmark maturities in euros are five and 10 years, while in dollars they are two, three, five and (increasingly) 10.

That may sound like hair-splitting. But a stark reminder of the importance of managing the maturity profile in the primary market was delivered in April 2008, when an EIB Eu3bn EARN with an unusual seven year maturity fell flat on its face.

Euphemistically described by the borrower at the time as "challenging", much of the 2015 deal was left unsold. That, said bankers at the time, had more to do with the pricing than with the maturity per se. The argument ran, however, that EIB ought to have offered more of a pricing concession than it did in order to compensate for the unusual maturity of the EARN.

That seems harsh and arbitrary, and borrowers say that there is no reason why a well executed seven year deal should not be regarded as a benchmark. "A couple of years ago we had a book of more than Eu4bn for a seven year euro issue, and printed a Eu2bn transaction," says van Dooren. "Without doubt that was a benchmark issue."

At EIB, da Silva agrees that liquid bonds can and should be regarded as benchmarks irrespective of their maturity. "I would argue that all our liquid bonds are benchmarks," he says. "For example, we have outstanding 2017 and 2019 issues, but if we were to bring a liquid new issue maturing in 2018, I would argue that it would qualify as a benchmark even though it has an unusual eight year maturity. In our view, if it’s an EARN it’s a benchmark, whatever the maturity."

Borrowers also say that there is no reason why a benchmark programme can only be described as such if it offers investors a selection of liquid issues across the yield curve. Many supranational and agency borrowers either have no requirement to issue in certain maturities, or do not have funding needs large enough to justify benchmarks dotted up and down the curve. "We do not choose to be active in 10 years," says L-Bank’s Lautenschläger. "We aim to maintain a liquid curve out to five years, which is enough to give investors plenty of guidance points."

For some agency borrowers in Europe, it is also important to emphasise that a triple-A rating need not be a prerequisite for a successful benchmark programme positioned within the SSA sector. NRW.Bank’s rating, for example, is constrained by the Aa1/AA- rating of the Land of North-Rhine Westphalia, from which it has an explicit guarantee.

"That isn’t a problem in terms of access to most markets, because most investors see the German Länder as representative of the German economy," says Richter at the Düsseldorf-based bank. "But of course it does mean that investors ask for a small premium versus KfW of about 10bp or 12bp."

Nevertheless, as Richter concedes, NRW.Bank’s rating does restrict its access to the Australian dollar market, where a triple-A rating is required by domestic investors for repo eligibility. "Because we can’t offer quasi-statehood in the Australian market, investors there are unwilling to buy our bonds, but that is a relatively small market," he says.
  • 19 May 2010

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5 Deutsche Bank 24,623.55 77 5.51%

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5 SG Corporate & Investment Banking 444.17 3 5.37%