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Goodbye dollars, hello euros

24 Jun 2007

The euro market has many appeals for public sector issuers, not least because
arbitrage has continued to improve in the last year. Borrowers who might not have considered issuing in euros previously are now enjoying great depth of demand for their transactions. Hélène Durand looks at the dynamics at play — and whether the trend is

Guy Reid, UBS: costs of funding
in euros is improving and for many issuers it's their home market

here to stay.

Should anyone in the market have further doubts about how popular the euro has become for public sector issuers, these would have been blown away when the World Bank priced its first global benchmark in the currency in May, its first outside the dollar market since 1998.

The Eu1.5bn three year, via ABN Amro, Deutsche Bank and HSBC, was an overwhelming success attracting an order book of Eu2.5bn and achieving the tightest ever pricing for a three year bond by a non-sovereign issuer in the euro market.

The World Bank’s bond was a landmark transaction and highlighted a trend that began in 2006, when some issuers which had previously shunned the euro market priced successful benchmarks in the currency.

Instituto de Crédito Oficial is one example, Oesterreichische Kontrollbank another. "Previously, for the issuers with smaller funding needs, it made sense to just look at the dollar market given that it offered much more competitive costs of funding. Issuers with larger funding programmes obviously needed to spread the load and issued in euros, despite the higher cost," says Guy Reid, head of frequent borrower coverage at UBS in London.

"However, this has changed and with costs of funding in euros improving, issuers can not only take advantage of that but also the fact that the investor base is very deep and, for many issuers, it is their home market."

ICO, for instance, priced a three year in euros in 2006 and has so far successfully brought a three and five year deal in 2007. The Eu2bn five year, led by Barclays Capital, BNP Paribas and Deutsche Bank, was the largest transaction in the currency by ICO to date while the Eu1.25bn three year signalled the agency’s intentions to be a premium issuer in euros.

Improving costs of funds has been driven by the continuing widening of euro swap spreads since the end of December 2005. "In late 2005 the Bund swap spread was around less 10bp," says PJ Bye, head of public sector syndicate at HSBC in London. "Over the course of 2006 it widened steadily, reaching the mid-20s by end 2006 and is now moving closer to 30 through."

Reasons to be cheerful

According to Bye, this widening has been driven by a number of factors. The overall reduction of net debt issuance by sovereigns such as Germany, France and Italy has been one element behind the widening. The fact that growth in the euro zone has increased is another.

But attractive costs of funds is not the sole driver behind the popularity of the euro market — the depth of investor base it taps is another. ""When the euro market first began, the investor base in dollars was much deeper in terms of investors participating," says Reid.

"The legacy currencies simply did not have the same weight. However, this has now changed and issuers do see the euro market as a strategic one. Also, they feel that it is a good thing to have an alternative from the dollar market given that if liquidity collapses in dollars, the euro market is where they can raise size."

Sean Taor, head of frequent borrower syndicate at Barclays Capital in London, agrees. "By doing euro trades, issuers protect themselves against the potential deterioration of the dollar market. And it’s not just the benchmarks, but also the potential of accessing other markets such as MTNs. This is one of the reasons why the World Bank came to the euro market."

Earlier this month, Juan Limandibrata, head of funding at the Asian Development Bank in Manila, said that the ADB would consider funding in the euro market this year. "Our funding programme has increased from $4bn-$5bn, to $6bn to $8bn and given the fact that the cost-efficiency in euros has improved, it is possible that we will look at euros this year."

While the attractions of the euro market should not be dismissed, it is worth noting that issuance has so far been concentrated at the short end of the curve where the best arbitrage levels can be achieved.

"The euro arbitrage phenomenon is a short end one," says HSBC’s Bye. "The credit curve is pretty steep in euros whereas it is very flat in dollars. This differential still makes the dollar market more attractive for public sector issuers once you get much beyond three years."

Don’t dismiss the dollar

Not all are convinced that the euro phenomenon is here to stay and continue to advocate the depth of the dollar market. "We have actually seen European investors buying more dollar product this year as they have seen the performance of the asset class," says Nick Dent, head of frequent borrower syndicate at Merrill Lynch.

"The weakness of the dollar is attractive for some accounts and non-Asian central banks are more and more active. The audience for dollars has grown."

A reversal of fortunes for the euro market is still possible, however, should the arbitrage pendulum swing the other way. "The curve in dollars has normalised and is not inverted between two and three years anymore," says Stuart McGregor, co-head of public sector coverage at Merrill Lynch in London. "Should swap spreads in dollars continue to widen, and should the summer period be constructive, the short end of the dollar market could become competitive again. Public sector issuers are very dynamic and will be eyeing this development and will be focusing on where the demand is as well as the most competitive costs of funding."

24 Jun 2007