For many investors seeking high quality paper amid extreme volatility last year, supranational debt was an attractive option. But borrowers still had to address issues such as liquidity and competition from other triple-A credits. EuroWeek finds out how successful they have been.
Gumersindo Oliveros, director, treasury finance department, World Bank
John Borthwick, manager, funding operations, International Finance Corp
René Karsenti, director general of finance, European Investment Bank
What have been the most important changes to the markets in the past year and how have you responded to them?
Gumersindo Oliveros, World Bank: The most significant change in the bond markets in the past year has been the introduction of e-technology. Market participants have been setting up and expanding their e-commerce capacities to increase transparency, efficiency and access to information. Our role at the World Bank has been to become a catalyst for change in this process.
We issued the first fully integrated e-bond in January 2000, offering investors electronic distribution (through on-line brokerage firms as well), real time electronic bookbuilding, electronic trading and an investor on-line service. Since then, more than 300 bonds have included one or several of these characteristics. We are now looking at ways in which we can leverage e-technology in other areas of treasury operations.
John Borthwick, International Finance Corp: The last year has been fairly stable from the perspective of a supranational issuer, with no major changes. For the most part, it has been a continuation of trends from earlier years. We have seen limited demand for emerging market currency debt, and limited demand outside Japan for structured product, while US agencies have played a major role in the mainstream markets. Towards the end of last year and into 2001, there has been a renewed flight to quality in bonds, which has been to the benefit of supranationals, at the expense of corporate issuers and equity allocations in investor portfolios.
René Karsenti, European Investment Bank: There has clearly been an increase in the focus on secondary market liquidity and we have reacted to this change in each of the markets where we have a presence, the major ones being euros, sterling and dollars.
In euros, for instance, we established our Earns programme in an effort to provide investors with ultra-liquid transactions. We are extremely pleased each of our benchmark offerings between three and 10 years is currently quoted on the Euro-MTS exchange.
In sterling, too, we are committed to maintaining a market and liquidity is a vital factor as we seek to offer investors an alternative to Gilts. In dollars, our aim is for our issues to be very actively traded. Liquidity is a key point for a credit of our quality.
Why do you think triple-A borrowers trade so cheaply in euros compared to how they have in the past and relative to where they trade in US dollars?
World Bank: The market for bonds denominated in euros is much more fragmented than the US market. There are many different types of triple-A borrowers for whom the euro is the home currency -- sovereign borrowers, supranationals, agencies, banks with a special relationship with their government, and corporates. Investors may have different views on credit quality depending on which country they are from or against whom they are benchmarked. This creates difficulties with credit differentiation.
IFC: That is a good question and I have not heard a good answer from anyone. There are differences in the investor base, such as an increase in the number of bank managed funds, for which the 20% risk weighting may be a problem compared to the risk free status of agencies such as KfW. I also think there are intra-eurozone credit issues involved ie where all the sovereigns trade in relation to each other.
EIB: That is an important question. On the supply side, the market has benefited from the natural consolidation of 12 European markets and the emergence of a corporate market, while supply of Pfandbrief paper has also remained constant. The outcome of these trends is that investors now have a huge range of investments from which to choose.
On the demand side, however, there is some reason for borrowers such as ourselves to be concerned. Outside Europe, demand for euros in Asia and the US is fairly weak, although appetite from accounts in non-Japan Asia has increased recently. We have a large business presence in Asia and the lack of demand has had an effect on our funding levels. Obviously, the weakness of the euro itself also influences demand.
What is the most important deal you have launched in the past year and why was it so important?
World Bank: We think that strategy is more important than individual operations. If the strategy is well executed, all 194 deals launched last year made an important contribution. The e-bond mentioned earlier could be highlighted because it broke new ground and had to overcome unusual obstacles and the scepticism of many market participants. Our issuance in Mexican and Chilean pesos also broke new ground and were important not just for us but also for the authorities in those countries, which are clients of ours on the lending side.
IFC: The most important deal was our inaugural global dollar bond, which marked the first time we had marketed ourselves to the US domestic investor base. Our decision to launch in global form was a reflection of the changing nature of the institutional dollar market, where the US agencies had to a significant degree become Treasury surrogates, and contributed to eliminating the major fragmentation of the dollar market. In the past, IFC had taken advantage of that fragmentation and been able to borrow via Eurodollars at a lower cost than issues targeted at US investors. In the last year, however, the pricing anomalies largely disappeared and made a global bond the natural choice for IFC.
EIB: Rather than any one deal, we would say that the most important development in the past year has been our Earns programme, under which we now have around Eu35bn in supply. This represents around half of our outstanding debt, which is extremely pleasing. We also have the largest presence on the Euro-MTS system among non-government borrowers. Away from euros, we feel that the e-bond we launched in sterling about a year ago was an important transaction for us.
Do you have any ambitions to be regarded as a government bond surrogate? If so, what elements of your funding programme are targeted towards this goal?
World Bank: We offer large, liquid benchmark bonds in several currencies and investors benefit from the yield pick-up, safe-haven status and portfolio diversification. These instruments provide investors with an alternative to government securities. As governments reduce their borrowing programme, these alternative investments become all the more important to investors.
IFC: We have no such ambitions. In view of our size, we only need to borrow about $4bn annually.
EIB: We have already stated publicly that it is our intention to become a complement to triple-A sovereign debt in euros and sterling. While we are not a government borrower, our paper is among the most expensive non-government issuance and we are treated by the market as a very high quality borrower.
To this end, we have established large benchmark programmes and included dealer groups for our transactions. Our futures trade close to benchmark government bonds.
Do you feel that too great an emphasis is placed on size when people are discussing liquidity? And is the importance of liquidity being overplayed?
World Bank: A bond cannot be liquid unless it has a certain minimum size. However, size alone does not determine liquidity and there are some very large issues that become illiquid fairly quickly. The quality of placement, commitment by intermediaries to market-making, and borrower franchise are key factors in determining liquidity. For investors that actively trade their bonds, liquidity is critical since they need to know that, even in times of volatility, they will find a reasonable bid. Expectations of what liquidity means vary substantially depending on the type of product -- the definition is much more stringent for benchmark issues than for structured financing, for example.
IFC: Liquidity per se is not being overplayed. The question is what constitutes liquidity. One large issue on its own will not necessarily do the job, as a part of facilitating liquidity involves offering other bonds that investors can switch in and out of. We frequently ask banks what constitutes the minimum acceptable size for an issue to considered liquid, and the consensus seems to be that $1bn offers adequate liquidity. While advocates of $2bn-$3bn make their case that this has become the minimum "liquid size", even those bonds lose their liquidity, albeit somewhat more slowly than a $1bn issue.
EIB: While it is true to say that too great an emphasis is placed on deal size, we do not feel that the issue of liquidity has been overplayed. That is a vital ingredient for any borrower looking to attract institutional demand. Size is by no means the only yardstick for issuance, however, and it is important to strive for price transparency and a tight bid/offer spread, as well as including market making commitments and repo arrangements.
With greater competition for funds and the relative cheapness of triple-A product in euros, are you being more active in niche currencies and structured issuance, possible employing MTN programmes more actively?
World Bank: We continue to issue in those currencies where there is the strongest demand for our products and where we can raise funds at a fair price from a diversified investor base. Clearly our presence in euros is limited because we believe that triple-A credits are not appropriately priced in that market. We have a long standing presence and continue to provide product regularly in all other market segments. Over the years, we have invested in system infrastructure and the modelling skills of our structured financing team to position ourselves on the cutting edge of activity in that sector.
IFC: We have always been very active in niche currencies and in issuing structured debt. IFC has been unable to raise competitive funding in euros, apart from through structured issuance.
EIB: We are active in other markets, but that is by no means a new development. As a large and frequent international borrower, we have to diversify our methods of funding. We currently have a vast range of investment products, tailored for pockets of demand for retail, institutional, index linked or other paper.
We can swap the products into plain vanilla issuance if we so choose, but our array of on-lending needs means that in some cases we do not need to swap the product. In sterling, for instance, we have launched a RPI linked bond. We are also a player in emerging markets, where we have natural needs in those currencies for local projects.
How much flexibility do you have in your funding programme, in terms of the currencies and structures that you can use? How do you take advantage of this?
World Bank: We have built a great deal of flexibility into our funding programme, both in terms of currencies, maturity, timing and type of product. This is by design, so that we can respond rapidly to changes in investors' needs and issue the products they want when the bid is strong, or stay out of the market if conditions warrant it. Flexibility has served both our investors and our clients well as it provides choice and strengthens security performance.
IFC: We have considerable flexibility as IFC is effectively raising dollar Libor-based funds on an after-swap basis. As long as we can hedge a borrowing back to dollars and can comfortably value and manage the accompanying swap exposure, IFC can avail itself of a wide variety of funding opportunities.
EIB: Our EMTN programme allows a fair degree of flexibility, while we also have a range of domestic and international MTN programmes for central and eastern Europe. At present, we have a huge range of funding instruments available to us and that is always expanding.
Is the development of local markets in the regions you lend to something you aim to help? If so, how do you do this?
World Bank: Very much so. We give a great deal of attention to the development of capital markets in developing countries as part of our issuance strategy. We have specialized in opening up new markets, ie becoming the first foreign issuer in new markets, and last year we did that in Mexican pesos and in Chilean pesos. We also look at ways in which we can fit issuance opportunities with developing a triple-A yield curve in a new market, extending the maturity etc. It is critical that we work closely with the authorities and foreign and domestic banks to ensure that the appropriate infrastructure for issuance is in place (for example custodial and settlement aspects) and that all execution and distribution aspects conform to international standards. These operations contribute directly to treasury objectives and to the broader mandate of the World Bank.
IFC: We have always made it an important part of our funding activities to be among the first to borrow in new emerging market currencies. IFC considers this an integral part of its capital markets development mandate. By helping to develop these bond markets, IFC will help make it easier for its clients to ultimately access international investors and to borrow in their own currency.
EIB: Most certainly. We see the development of local markets as a part of our mission and we are doing the same thing in central Europe now that we did in western Europe in the days before EMU. In a way, we act as an icebreaker for fresh markets, bringing in new tenors and structures.
One key element of that strategy, as mentioned above, is that we have a natural need for the local currencies, so unlike other borrowers we are not reliant on the swap rates. That does not mean that we never swap the proceeds.
Is there still the enthusiasm in the market for electronic syndication, distribution and trading that there was early last year? And what have been the real concrete benefits of the introduction of the internet into the bond markets?
World Bank: E-technology is changing the bond business in a fundamental way, but many of its advantages will only be tapped over time as investments in technology are made and cultural reluctance is won over. The question is not whether we will move to e-capital markets, but rather when that will happen and how the new structure will look. Contrary to others, we foresee significant value added from intermediation in the new environment, but the nature of the service and relationship is bound to change in a structural way.
As regards benefits, the dissemination of issue related information via the internet is now common practice, but few are fully using the advantages of the wider placement that can be achieved through electronic distribution tied, for example, to on-line brokerage. We found the real time electronic bookbuilding extremely useful -- it provides much greater control over pricing -- but it is used only by those borrowers that want to become actively engaged in the launch process and it demands effort and responsibility that some borrowers would rather leave to intermediaries.
On the trading side, we have seen a proliferation of electronic trading platforms that have demonstrated the efficiency and pricing advantages that can be achieved through electronic trading. We think that the next move to multi-dealer, multi-product, single access platforms will further enhance efficiency. Open architecture models should also be watched closely.
In brief, the use of internet technology has provided a very useful start, but more should be expected over time.
IFC: The initial hype has largely worn off and those aspects of e-bonds that made real contributions to how the business is done will stay, while other aspects have faded away, at least until technological issues are overcome (for example common platforms). Being able to view bookbuilding via the web is useful for issuers, while the secondary trading potential has yet to establish itself. The best issuers to ask about this are those who have been major proponents of it -- such as the World Bank in dollars and the EIB in sterling.
EIB: Perhaps there is a little less enthusiasm for electronic syndication nowadays, but that is more because it has become less of a novelty and more of a regularly used method. It is a standard feature for our deals. E-bonds, in our opinion, certainly increase transparency and enable deals to reach smaller investors in the marketplace. While we consider e-technology an efficient and very important tool, however, we believe it should complement rather than replace existing methods of distribution and trading.
What are your main goals for the remainder of the year?
World Bank: Overall, our main objective is to raise funds from a diverse investor base at a fair price for both our investors and our clients, the developing countries. We hope to contribute to this goal through innovation.
IFC: IFC's major undertaking for the remainder of this fiscal year is its second global dollar bond.
EIB: Our funding needs for 2001 amount to some Eu33bn and we have already raised approximately Eu11.5bn equivalent in euros, sterling and dollars. Our goals for the year include extending our yield curve in euros on the Euro-MTS platform, probably through a long dated benchmark later this year. We will also continue to tap existing deals in euros and sterling as a means of enhancing their liquidity.
As well as maintaining diversity in euro and sterling product, we also intend to open new lines in dollars, while another area for development will be our eastern European presence. *