Traditional arbitrage markets such as Aussie, Canadian and Kiwi dollars might not be as attractive as they have been in the past from a pure cost perspective, but demand for highly rated bonds in these currencies from local and international investors is growing. The volume of funding now available has led issuers to take the non-core currencies more seriously.
It is rarely wise to put all your eggs in one basket, and this is as true for the leading international bond issuers as anyone else.
The dollar market might have provided the most attractive sub-Libor funding levels this year, but, apart from US-based issuers, it would be difficult to find any borrower that has relied on just that currency.
Issuers such as the European Investment Bank and KfW Bankengruppe, which have funding programmes of around Eu50bn, also rely heavily on the euro market, which, despite the poor arbitrage available, offers a consistently deep pool of money. Institutions that are politically inclined also get the chance to be part of the European project.
However, alongside their benchmark programmes or, for those with more modest requirements, benchmark issues, supranational and agency issuers increasingly talk of having other "pillars" to support their funding needs.
KfW, for example, has its euro and dollar benchmark programmes, but these form merely one pillar of its strategy. The other two are targeted issues and private placements.
Even an issuer with the relatively modest funding needs of Kommunalkredit, whose $5bn is less than one 10th of what KfW must find, has more than one pillar to its funding programme.
Indeed, while KfW manages with three, Kommunalkredit has four: benchmark dollar issuance; structured private placements; retail targeted bonds in Europe and Japan; and smaller institutional markets such as the Australian and Canadian dollars, sterling and Swiss franc.
The amount of funding issuers draw from this last category, which is often described as non-core currencies, is sometimes comparable with what they raise through either dollar or euro benchmarks, but usually comes in a much larger number of smaller issues.
"The problem with most of these markets," says one frequent issuer debt capital markets (DCM) official in London, "is that although they are interesting from the perspective of diversification, they are not very deep. If you are a big issuer, C$1bn [$850m] is not that much and you cannot do more than perhaps one or two Canadian dollar globals a year, as the market has capacity limits.
"So while it is interesting that there are some arbitrage opportunities from time to time, they are still very much seen as peripheral markets that come and go from one year to the next."
Canadians, Kangaroos get a kick
But some peripheral markets are providing issuers with growing amounts of funding.
The Canadian dollar market, for example, was boosted this year by the removal of the Foreign Property Rule in April. This had limited domestic investors' holdings of foreign assets to 30% of their portfolios, but now they are free to invest more widely and are gradually diversifying.
"It is not as if a light switch has been flicked," says Paul Eustace, a syndicate official at TD Securities in London. "They have not suddenly started buying anything that moves. But progressively they are looking at more and more foreign issuers of bonds as well as subordinated debt and foreign equities."
Several issuers cite the removal of the Foreign Property Rule as a reason for taking the Canadian dollar market more seriously to diversify their sources of funding, even if the arbitrage there is not especially enticing.
"Most of the issuers who are motivated to get in front of a new investor base are not typically looking for a huge saving," says one banker in London. "It would be more in the order of 1bp-2bp, or even flat to core markets, because they are getting in front of a whole new raft of investors. And Canadian dollars is particularly interesting because of the removal of the foreign ceiling."
The Kangaroo market has also come on in leaps and bounds in recent years, and should be further boosted by the creation of the planned Future Fund.
"The Aussie government has been in surplus for quite a long time now and is looking at taking those surpluses and putting them in a fund for the future," explains one banker. "A lot of the money in that fund, which is scheduled to grow to A$22bn [$16bn] in the next three years, is specifically going to be invested in very well rated bonds, so the Kangaroo market will benefit from an additional kicker of money."
Getting with the programme
To meet the growing institutional demand for their bonds, frequent issuers are approaching these non-core markets in a more strategic, if not programmatic manner, taking account of local preferences.
"We have a benchmark programme that defines any minimum volumes and the style of issuance in euros and dollars, but we do not have such set standards for the other, non-core currencies that we operate in," says Julia Hoggett, global head of capital markets at Depfa Bank in Dublin. "However, they are becoming an increasing part of our programme."
As well as its dollar and euro benchmarks, the German-listed, Irish-registered public finance bank has launched issues in sterling, yen, Canadian dollars and Swiss francs this year.
"What we try to do is understand the intrinsic nature of each of these markets and what we are competing against," says Hoggett. "Fundamentally we are bringing triple-A products in those markets and therefore we need to understand what other triple-A issuers are doing in those markets — be they domestic or otherwise — and meet those key characteristics.
"We don't make any specific commitments, but we do try to make sure that if we are bringing a relatively sizeable transaction in the public markets in those countries and in those currencies that the deal is at least consistent with investors' understanding of what a reasonable triple-A asset would look like."
KfW has been one of the biggest issuers of Kangaroo bonds in recent years and has also launched large issues in other peripheral currencies. The German development bank has also raised its standards in such currencies.
"In these markets our goal is to give investors the confidence that we are approaching the market on a long term basis," says Horst Seissinger, head of capital markets at KfW in Frankfurt. "We therefore aim to ensure liquidity in our bonds and syndicate them. We cannot always do that — for example, if a deal is driven by a handful of lead orders — but we try to make sure that such issues are appropriately sized."
KfW also tries to maintain liquidity by tapping its deals regularly.
The largest issuer in the Kangaroo market, however, is another German agency, Landwirtschaftliche Rentenbank. It has more than A$4bn ($3bn) of paper outstanding and has raised some A$2bn this year.
"The semi-governmental issuers — like New South Wales or Queensland — are still somewhat more liquid than our Kangaroos, while CGBs [Commonwealth Government Bonds] are very liquid," says Stefan Goebel, co-head of funding at Rentenbank in Frankfurt. "However, our transactions with outstanding amounts of A$500m to A$1.6bn are considered fairly large and liquid for non-government paper."
When in Ottawa...
According to Eustace at TD, the type of approach that such issuers are taking should be more than enough to ensure that these borrowers are well received by the respective domestic accounts. He says that in Canadian dollars, for example, domestic investors are happy to switch from local benchmarks into deals from foreign issuers.
"Liquidity is sufficient for the Canadian investors in these types of bonds," he says, "with the long dated Depfa deals that we led this year being C$300m-C$500m. We also did a deal for Rentenbank last year that was C$1bn and KfW issued a 10 year that was C$1bn as well."
And dealers treat investors just as well in peripheral currencies as in the core markets, says another banker. "Like anybody, if we sell a decent ticket of a deal in the primary market to an investor, you are obliged to take that investor out at a sensible price in the secondary market or he won't call you any more," he says. "It's as simple as that."
However, Canadian investors, while free to invest in a manner more closely aligned with their international counterparts are not necessarily craving the same type of benchmark product.
"The Canadian investor base is a little quirky," says Eustace. "I don't expect them to be huge buyers of the kind of big benchmark deals for EIB or KfW that we see in dollars or euros. They are essentially looking for product that provides them with a pick-up versus domestic names."
For many investors in Canada, the curve of the Province of Ontario is their benchmark, given that it is the biggest issuer in the domestic market. "Invariably when we are speaking to accounts about potential investments they are looking for something that pays a spread over the Ontario curve," says Eustace. "Clearly issuers like EIB and KfW are going to struggle to do that given where their funding targets are versus Ontario."
Just as in the US dollar market, the expensive targets of the very highest quality triple-A names means that there is room for less pricey alternatives. The two deals Depfa launched in Canadian dollars this year, for example, a 20 year and a 30 year, were sold at a spread over the Ontario curve, with 7bp-10bp over Ontario considered a level that Canadian domestic investors consider very interesting for triple-A assets.
Asian central banks diversify
Changes in the make-up and regulation of local investor bases have increased demand for the bonds of supranational and agency issuers — but so has the altered behaviour of the largest international bond buyers.
"Some of the Asian central banks are diversifying their portfolios to buy many more Kiwi dollars, Aussie dollars and Canadian dollars," says Allegra Berman, head of frequent borrower origination at UBS in London, "and there is definitely a sense of currency diversification on their part that has been evident throughout this year and much more so than last year."
Seissinger at KfW reports that investors are crossing over from one pillar of its funding strategy to another. "We have seen more and more investors in these currencies from our euro and dollar benchmark programmes and the most important issues for them are acceptable bid/offer spreads and the ability to buy our bonds in the secondary market, if we are not present in the primary market," he says.
The reasons for international investors' moves into non-core currencies are, in some cases, not hard to fathom.
"In New Zealand dollars this year new issuance has been at record levels as yields have approached 7% across the curve for what is seen as a proxy US dollar investment," says Eustace. "The range that the New Zealand dollar trades in versus the US dollar is not particularly volatile and is something that can be easily managed, and in return you get around 300bp of extra yield."
Conveniently, the likes of Asian central banks have not been overly fussy about the types of security they will buy.
"Some of the bigger investors who have large pools of cash to invest on a monthly basis are going to be more flexible than somebody who has a very limited amount of money to invest," says one syndicate manager. "They will therefore buy Eurobonds, Kangaroos, New Zealand dollar globals — they don't really differentiate between them. Provided it has the right rating and it pays a level comparable with where the issuer might fund in euros or dollars, then they will have a look."
They are likely, however to have certain size requirements. "A big investor is probably not going to take more than 30% of any transaction," says the syndicate manager, "just because they want to feel that there is some underlying liquidity left in the deal away from the portion they have bought."