8Sovereign issuers are increasingly likely to forego an
auction process in favour of syndicated bond issuance, which gives
them the ability to target their bonds, achieve greater secondary
market distribution and glean information about their investor
base. Although syndication was once confined to peripherals, it has
become a cornerstone of the sovereign market. Neil Day
Buckling under the weight of unemployment, structural economic problems and the continued integration of the former communist East, Germany must be rueing its insistence on two of the key components of European Monetary Union (EMU): the straightjacket of the stability and growth pact, and a European Central Bank (ECB) aiming to outdo the Bundesbank's traditional zeal for fighting inflation.
But while the Germans struggle to come to terms with their self-imposed crisis, many of their European Union partners, including those that the pact and ECB were designed to rein in, have been enjoying higher growth, stronger public finances, and, in the international capital markets, a rally against the Bund. And such sovereigns have been increasingly turning to banks to help spread this message through the launch of syndicated government bond issues.
While the original syndicated government bonds launched at the start of EMU were launched by peripheral sovereigns seeking to defend their markets against the increase in competition, today's transactions are being launched from a position of strength.
Take the Kingdom of Spain, for example. Last year the sovereign for the first time used syndication for a government bond, but mainly because the maturity in question, 15 years, was an immature part of the euro yield curve and Spain, alongside other countries, felt that the novelty of the product meant that it required extra attention. For more regular issuance, auctions would continue to be the norm.
"While we are happy with our decision to use [syndication] for the 15 year deal, our policy is to use the procedure that is best suited to the instrument we are issuing," a Spanish treasury official told EuroWeek last October. "We have been launching new benchmarks - such as our five year in September - through our regular auctions and we will continue to use them."
It was therefore something of a surprise when the kingdom announced in late March that it had awarded BBVA, Citigroup/SSSB, Crédit Agricole Indosuez, Deutsche Bank and SCH the mandate for a 10 year transaction.
José María Fernández, head of the debt department of the Spanish treasury, explained that although auctions would remain the kingdom's regular issuance method, the use of syndication was appropriate because one of the aims of the transaction was to reach new investors.
"We have seen that some major investors are strategically increasing their holdings of euro denominated debt," he said. "We have therefore decided to take advantage of the benefits of syndication to try to increase the participation of these investors in our debt. Syndication enables you to optimise distribution, while offering a high level of liquidity right from the start."
But it was clear that Spain's performance against Germany was one reason why the treasury chose this year's new 10 year benchmark as the first for which syndication was appropriate. The previous 10 year Bono had been trading flat to Bunds for several weeks and Spain was keen that as many investors as possible were aware of the improvement in the sovereign's improved position in the market.
And by the time of launch, Spain's decision to use syndication had been vindicated. The sovereign achieved pricing of 10bp over the January 2013 Bund, equivalent to around 4bp over the German curve, having built a book of Eu10bn for the Eu5bn deal, Eu7bn of which held firm at the re-offer.
"It was a remarkable result for Spain to be able to capture so much of the upside of its recent performance," said Chris Lees, director, syndicate at Citigroup in London. "Spain has been trading rich against Bunds for some time, but it was nevertheless able to achieve a level that not so long ago would have been considered very tight."
Meanwhile Fernández, who described the spread as "great in historic terms", was keen to focus on the underlying reasons for the deal's success. "It reflects the performance of the Spanish economy, the achievement of a zero percent deficit, and the credible commitment of the government to continue its policy of fiscal discipline."
And he acknowledged the importance that syndication had played in the achievement. "Our primary dealers and, above all, the bookrunners did a great job that enabled us in the context of sound economic policies and fiscal correctness to reach the tight end of spread guidance," he said. "The use of syndication enabled us to communicate our story to investors, to reach new accounts, to build a very large order book and to price the transaction at a competitive level."
While Spain was slow to be won over to the arguments in favour of syndication, others have a long track record. For the Kingdom of Belgium, for example, syndicating new benchmarks is standard practice.
But for Belgium, too, the practice has become a way to highlight its achievements on the economic front.
When the sovereign approached the market for the first time this year, it was with a Eu5bn 10 year deal via Citigroup, Dexia Capital Markets, SG and UBS Warburg. An order book of Eu10bn enabled pricing of 16bp over the Bund, 1p inside Belgium's old 10 year benchmark.
Officials at the bookrunners and co-leads said that the pricing was aided by the sovereign's track record in syndicated deals. "The pricing at the tight end of the range reflects the way in which the deal was handled and also the market's recognition of Belgium's strategy of launching syndicated liquid benchmarks," said Olivier Habay, senior manager, origination and syndication at Dexia Capital Markets.
But equally important was the ground that the sovereign has made up against core European government bond markets in recent years. In 2001, Belgium's 10 year benchmark was launched at 40bp over Bunds, in 2002 at 25bp over, and this year's at 16bp over. "The fact that the kingdom has been able to contract its spread so dramatically was a strong selling point," said Allegra Berman, head of frequent borrower coverage at UBS Warburg.
In mid-May the kingdom was readying its second new benchmark of the year, this time a circa Eu5bn five year issue via ABN Amro, Barclays Capital, Fortis Bank and KBC. And early indications suggested that Belgium would again achieve a tight level against core Europe.
"Belgium trades very rich to Bunds in five years," said one banker in early May. "The March 2008 OLO, an old 10 year, which trades at a cash price of 110.00, is 10.5bp through swaps while the Bobl 141 trades at 12.5bp through." But the banker nevertheless expected the deal to attract a high volume of orders. "Investors remain concerned about the core credits and there is a huge appetite at the moment for diversification out of Germany and France," he said.
At the Belgian Debt Agency, head of front office Anne Leclercq says that the sovereign's ability to price at such tight levels is a reflection of both general market conditions and the kingdom's achievements.
"Interest rates have been low and swap spreads have narrowed, and this has helped peripheral government bonds in general," she says. "But on our side, we believe that the major driving factor has been the fiscal discipline of the kingdom. It has been in line with the stability pact targets, and even in the years like this when economic growth has been low, this discipline has been maintained."
Also important, says Leclercq, has been the kingdom's use of syndicated issues to build up a liquid benchmark market. "Syndication has worked very well for us and we have not been surprised to see other sovereigns take the decision that it could be useful for them too," she says. "It has now become a real cornerstone of our issuance strategy and every time we launch a new benchmark through a syndicated issue it really achieves the goals that we are aiming for.
"When the euro was introduced and we began this strategy, the wider diversification of our investor base was the main target, but this was also one of the conditions for developing a highly liquid market."
Just how large an issue and large a book can be created through syndication was clearly demonstrated by the Republic of Finland in mid-February. The sovereign then launched the largest ever single tranche fixed rate euro denominated bond, a Eu6.5bn syndicated three year government bond via ABN Amro, Deutsche Bank, Merrill Lynch and Nordea.
The transaction eclipsed the 2013 issue Finland launched in April 2002, which had also totalled Eu6.5bn, but which had included a Eu500m tranche retained by the Finnish state treasury for its own repo facility. The size of this year's issue was made possible by the size of the order book, over Eu12bn, and demand was boosted by a simultaneous Eu2.1bn buy-back of Finland's 9.5% March 2004 line.
Satu Huber, director of finance at the state treasury, said that the sovereign was able to take advantage of its higher funding needs for this year - resulting from higher redemptions - to go out with an initial size of Eu5bn rather than Eu3bn-Eu5bn, and that the success of the buy-back made an even larger transaction possible.
"Considering the size, it was an exceptionally smooth process," said Paul Richards, head of the public sector and debt transaction groups at Merrill Lynch. "A full Eu7bn of orders came in on the first day, which was an astounding result and allowed us to push down pricing to the tight end of the range."
Having been marketed at 10bp-12bp through mid-swaps, the transaction was priced at less 12bp, equivalent to 11.5bp over the 5% February 2006 Bobl 137, or just 2bp over the German curve.
The buyback operation and new benchmark were just the latest part of Finland's programme of constructing a liquid and transparent market, and demonstrated the benefits of such a strategy. "In the past few years, Finland has rebuilt its euro curve with successful new issues, while buying back high coupon off-the-run issues," said Paul White, co-head of debt syndicate at ABN Amro, "leading to the improved liquidity and performance that we have seen. The 2007 and 2013 benchmarks were well received and have performed well, generating strong momentum for any Finland offering."
Finland also benefited from its scarcity and economic soundness. "Finland is such a rare name in the market, usually tapping the market only once a year with a new issue and then with few auctions," said Ralph Berlowitz, head of frequent borrower syndicate at Deutsche. "Its credit quality is excellent, its annual funding volume is limited and its budget is in very good shape."
It is not just euro zone sovereigns that have been taking advantage of investors' desire for diversification. The Kingdom of Denmark in early May took advantage of strong demand for five year sovereign paper when it launched a euro benchmark transaction via ABN Amro, Deutsche Bank and JP Morgan.
Denmark launched its transaction just ahead of deals for Belgium and Finland that were expected to add Eu10bn of five year supply to the market and in a week curtailed by holidays. But the sovereign was nevertheless able to build an order book of Eu8bn and increase its transaction from the Eu1.5bn minimum to Eu2.3bn -- the maximum possible under its foreign currency requirements for the year.
"This was a tremendous success that caught the imagination of the investor community in a holiday-shortened week," said White at ABN Amro. "Denmark is a rare commodity, with solid triple-A ratings, affirmed by Moody's this week. Recent supply has been light and, with a liquid current coupon issue ahead of the upcoming sovereign supply, the issuer timed the transaction well."
The sovereign was able to tighten pricing from original guidance of 20bp over the Bobl 141 to eventual pricing of 18bp over. "We started with price talk of 7bp-9bp through mid-swaps, which equated to the 20bp area over the Bobl," said Carl Norrey, head of public sector trading, syndicate and origination at JP Morgan. "That was consistent with Denmark's 2007 benchmark, non-government issuers such as the EIB, and with euro zone peripherals.
"However, we have seen massive cash demand for the five year part of the curve and could therefore revise price guidance to 18bp-19bp, and finally price the issue at 18bp over."
The pricing equated to just 2bp over the German curve and resulted in a level 3bp inside Denmark's old 2007 issue - a benchmark premium higher than any seen this year. "Normally, you can achieve a premium of 1bp-2bp on new government benchmarks," said Ralph Berlowitz, head of frequent borrower syndicate at Deutsche, "so the level that Denmark achieved was amazing. It also puts them in line with all the triple-A euro zone sovereigns."
Sales, nearly all of which were for cash, were almost 50% to fund managers and 20% to central banks. Ove Sten Jensen, head of government debt management at Denmark's Nationalbank, told EuroWeek that he was particularly pleased with the demand and distribution.
"We are very happy with the very solid order book and the broad group of investors that we reached," he said. "The book contained the sort of names that one would hope to see involved in such a deal."
Denmark's policy is to take advantage of its foreign currency borrowing needs to launch one euro benchmark a year. Jensen says that such a strategy is most convenient for the central bank's needs, while at the same time allows Denmark to strengthen its euro investor base.
"We are very public in our strategy," he says, "which is to issue one euro in benchmark size annually in the five year maturity. This is a long term policy and a strategy that we are very happy with."
Dutch wrestle with
While syndicated transactions appear to hold such clear advantages for sovereigns, not everyone is convinced that they are the right strategy to follow.
The Dutch, for example, have until now preferred to stick with their traditional auctions. But even they are now looking at ways of taking advantage of certain aspects of syndication.
"We are working at the moment on an additional issuance method to be used alongside our taps, called the Dutch Direct Auction (DDA)," says a spokesperson for the Dutch State Treasury Agency (DSTA). "The primary dealership, where we sell the bonds directly to the primary dealers, has been working very well. So well, in fact, that in a way we almost forgot about the end investors. We now want to give more attention to those end investors."
Announced in February, the system will allow investors the possibility of placing orders for paper via primary dealers in DSLs. The DSTA hopes that this will both increase the participation of end investors, such as insurance companies, pension funds and asset managers, in its market, while fostering a better dialogue between the issuer and investors.
"In order to be able over the long run to issue products that are in the interest of both investors and the issuer, we need to have more contact with them, and through the DDA system we will accomplish just that," says the DSTA spokesperson. "To a certain extent it has several similarities with a syndicated issue, while at the same time it has similarities with a Dutch auction. It is like syndication in the way that there will be a bookbuilding process and we will be pricing the issues over a reference bond, and it is similar to a Dutch auction in terms of allocation and pricing."
And although allocation will depend primarily on the level at which investors place their order, the DTSA will exercise some discretion over which accounts receive paper. "The primary dealers will tell us the name and category of the client that they are placing an order for and we will distinguish between the two types of account: trading accounts and real money accounts," says the DSTA spokesperson.
"At the cut-off price the real money accounts will have priority in the allocation over trading accounts."
Unlike syndicated transactions, no bookrunners will take the lead in DDAs, which the DTSA hopes will lead to an equal effort from all primary dealers. The spokesperson explains: "All the primary dealers are able to participate in the DDAs on a level playing field."
Just how well this will succeed in attracting the attention of banks and thus investors is unclear. One of the incentives for banks to perform well in syndicated issues, whether leads or co-leads, has been the possibility of winning mandates in the future. But the DTSA is confident that its primary dealers will do their job.
"There are fees available for the primary dealers to incentivise them to target end investors," says the spokesperson, "but also, and perhaps more importantly, there is the fact that these banks are part of our primary dealership under which they have to take into account all their rights and obligations."
Only when the first DDA is launched late in the second quarter or early in the third quarter will it become clear just how successfully the Dutch have balanced the advantages of auctions and syndications, and what price the new system will lead to. "The proof of the pudding is in the eating," says the spokesperson. "But we are confident that this method will encourage the participation of end investors and lead to the performance of our bonds afterwards, while still giving us the best possible price."
The DTSA argues that not all of the claims that have been made about the advantages of syndication are as clear cut as they might appear. While issuers such as Belgium and Finland have clearly been able to broaden their investor base through syndicated benchmarks, the Dutch have not had problems increasing international participation through auctions. According to figures compiled from the DTSA's primary dealers, non-domestic participation in DSLs has increased from 50% in 2000 to 60% in 2001 and 70% in 2002.
The DTSA spokesperson further argues that if a large size is what sovereigns are targeting, auctions for Germany and France have shown that auctions need not be smaller than Eu5bn.
But even the French have understood the advantages that syndication can offer for certain products, specifically its French inflation-linked OATis and euro zone inflation-linked OATeis - even if Agence France Trésor (AFT) continues to use auctions for its nominal bonds and is now auctioning some inflation-linked products.
"We use syndication only when there are good reasons to do so," says Benoit Coeuré, Agence France Trésor's deputy chief executive, "that is either for new products, or for products where there is a specific technical content or a need to educate investors. That was the case with the OATi and OATei.
"But it is important to note that we only used syndication for the first issues. The July 2013 OATi that we launched this year was issued through an auction because we felt that the OATi market is now much more mature and that we no longer need to have syndications for this type of product. Nevertheless, we certainly keep open the option of using syndication for more complicated products, such as launching a long dated OATi or OATei."
The wisdom of the AFT's strategy is confirmed by investors. "If investment banks are hammering on your door to see you and bringing along officials from the Trésor to explain their strategy, then it means that the education process is that much quicker," says one. "If it was just done quietly through an auction, it would probably be more of a domestic market, but as it is, because the people involved have been all the big banks, it has meant that a lot more people have got involved much quicker."
The investor also feels that syndication can add to the liquidity of a deal. "Syndication improves liquidity to an extent," he says, "because it gets the investment banks involved from day one and they all clamour to get involved in the issuance process - no doubt so they can earn their fees. But that has an ongoing benefit because it means that they tend to trade such deals more actively and a broader investor base is involved."
France's only peer in the euro zone inflation-linked market, the Hellenic Republic, certainly found strong and widespread demand for its syndicated debut when it increased its transaction from Eu700m to Eu1.25bn in March. Led by JP Morgan, National Bank of Greece and UBS Warburg, the 2025 deal attracted an order book of some Eu1.5bn.
Such was investors' interest in the transaction that Christoforos Sardelis, director general of the Greek public debt management agency (PDMA), was almost overwhelmed. "This is the first time in the four years that I have been in this job that investors have called me directly to ask me to increase a transaction," he said, "and when we held a conference call, there were 58 investors on the line."
Sardelis was particularly pleased to be able to increase the size of the transaction so that the issue would qualify for a wider range of indices and so that he could allocate more bonds to key accounts.
Further inflation-linked supply is set to come from the Republic of Italy and other sovereigns are watching the market carefully to see what opportunities emerge. Bankers are clearly working hard to persuade more countries to launch syndicated inflation-linked transactions as investors say that they are regularly being called by banks wanting to know if they would be interested in buying such deals for one sovereign or another.
But sovereigns are being more guarded in their approach. "There has of course been a lot of demand for inflation-linked bonds and we have been watching the market, and it might allow an interesting diversification of our investor base and also our interest rate risk," says Leclercq at the Belgian Debt Agency. "But our focus is still on our issuance strategy of launching large liquid benchmarks.
"Our financing needs are not small, but there is nevertheless a limit on what we can do. Eu25bn is enough for two large benchmarks in a year, but not sufficient for us to be able to diversify into a whole array of different instruments. For the time being we will continue with our successful strategy."