Euroclearability opens doors for corporate issuance
The outlook for Turkish Eurolira trades, which had been expected to be bright until investors took fright at the unrest in the streets earlier this year, now seems more challenging. In Russia, meanwhile, the hope is that the recent change to make government bonds Euroclearable can pave the way for easier issuance by corporates, writes Philip Moore.
Until political and social unrest gripped parts of the country in the middle of this year, Turkey was regarded as one of the most promising countries for global local currency issuance. The first issuer to tap international demand for Turkish lira debt, at the end of January, was Baa2/BBB rated Akbank, which is projecting a compound annual growth rate in its loans of 20% between 2013 and 2015, with deposits expanding over the same period by 16%.
This projected expansion mirrors the broader forecast growth in the Turkish banking industry over the next few years, which is expected to ensure that the leading banks continue to explore a broad range of funding opportunities. International issuance by Turkish banks more than trebled in 2012, from $2.5bn to $7.9bn.
Initial price guidance on the five year Reg S/144A Akbank issue, led by Bank of America Merrill Lynch, Citi, Deutsche Bank, HSBC and JP Morgan, was in the 7.6% area, which equated to 127bp over the Turkish sovereign. The final order book reached around TL2.9bn ($1.5bn) from more than 100 accounts, allowing for pricing a TL1bn deal at 7.5%, the tight end of revised guidance, or 111bp over the sovereign.
The Akbank notes are clearable through Euroclear and Cleastream, with principal and coupon payments made in Turkish lira. Investors also had an irrevocable option of electing to receive the principal and coupons in US dollars, giving investors more flexibility. Distribution was well-diversified, with 46% placed in the UK, 38% in the US, 7% in Germany, 5% elsewhere in Europe and 4% in Turkey, the Middle East and Asia.
Demand was led by funds, which took 82%, followed by banks and private banks (11%) and pension funds and insurance companies (7%).
The Akbank curtain-raiser was followed soon after by the first transaction in the lira market from a Russian bank, with Sberbank issuing a five year Reg S TL550m bond via HSBC, JP Morgan and Sberbank CIB. This was another landmark for the market as it was the first ever Turkish lira transaction for a non-Turkish emerging market borrower. The Sberbank issue priced at 7.4%, which was 10bp through the Akbank deal despite being in Reg S-only format.
Again, UK investors led demand, accounting for 39% of distribution, with 14% going to Germany/Austria, 12% to Switzerland, 11% to Asia and 24% to other European markets.
“The bond allows international investors to take a complex view on FX exposure to Turkish lira across the most high-quality Russian quasi-sovereign credit,” notes an HSBC deal review. “This is a unique opportunity that was unthinkable a couple of years ago and proves the ever-increasing role of EM credit in investors’ portfolios.”
A notable feature of Sberbank’s Eurolira trade was that the proceeds were not swapped, even though the borrower achieved significant arbitrage of at least 75bp versus its US dollar curve. The objective of the transaction, however, was always to generate local currency funding to channel into its Turkish subsidiary, Denizbank, which Sberbank has recently acquired from Dexia.
The third issuer in the Eurolira market in 2013 was Garanti Bank, which launched its TL750m five year debut deal in early March via BNP Paribas, Deutsche, Goldman Sachs and Standard Chartered. The coupon on the Garanti issue was 7.375%, and demand reached TL1.2bn, with UK investors accounting for 38% of allocation, 29% going to the US, 27% to Europe and 6% to Asia and the Middle East. As with the other Eurolira deals, asset managers were the drivers of demand, taking 79% of the Garanti trade.
Selim Kervancı, head of banking and capital financing for Turkey at HSBC in Istanbul, says that although the long term prospects for issuance of internationally-targeted transactions in Lira are bright, the immediate outlook is not encouraging, given expected policy changes at the Fed coupled with the unrest in Turkey, which have led to portfolio outflows and pressure on the currency.
According to a note sent by Standard Bank’s Tim Ash to clients in August, between the middle of May and mid-August, net outflows from Turkish bonds and equities reached $3.3bn. “Given the huge starting stock ($165bn, 20.6% of GDP), this is moderate,” noted Ash.
“Following the successful deals for Akbank, Sberbank and Garanti, there were a number of other banks that were interested in issuing, but that interest has fallen away for the time being,” says Kervancı. “Over the short to medium term I think the market for issuance of Eurolira paper will remain challenging. Until the currency market settles down, it’s unlikely that we will see any issuance.”
For now, that will mean that Turkish banks continue to be the dominant issuers in the local bond market. “The local bond market is growing very gradually,” says Kervancı. “Last year, total issuance was around TL22bn, out of which about TL20bn was issued by the banks. In 2013, year-to-date issuance has already reached about TL18bn. Again this has been dominated by the banks which have accounted for about TL15bn of the total.”
“The other theme we’re seeing in the local bond market is the extension of tenors,” adds Kervancı. “The average tenor of issuance last year was about one year. This year it has been extended to about 1.2 years. This increase in average tenor is being driven by the expansion of the Turkish investor base with demand growing from pension funds, asset managers and to a certain extent insurance companies.”
The market for local currency rouble bonds has come a long way since the European Bank for Reconstruction and Development placed the first issue in the market by an international financial institution in May 2005. Proceeds from the Rb5bn floating rate transaction, led by Citi and Raiffeisenbank Austria, were used to meet the growing funding needs for the renewal of Russia’s crumbling municipal infrastructure, as well as the financing of SMEs with little or no foreign currency income.
The EBRD announced at the time that it had been tapping the local currency market for short term promissory notes for some years, but that it had also been working with the government and market authorities to “prepare access for foreign issuers including financial institutions to longer term rouble resources that the bond market [could] provide.”
Since then, rouble funding and the development of the local rouble market has remained an important part of the EBRD’s broader issuing strategy. “We’ve been issuing in domestic and Eurobond format since 2005, because Russia is our largest country of operation,” says Isabelle Laurent, deputy treasurer at the EBRD in London. “10% of our total lending is in local currencies, with the rouble the most important of these.”
“Back in 2005 the investor base was purely domestic, and was dominated by banks,” she adds. “Since then the investor base has broadened and foreign buyers are much more active, although foreign demand has been very volatile at times of political uncertainty.”
To date, international participation in the rouble bond market has been limited to dedicated EM accounts that have set up arrangements with a domestic agent bank to clear in the local market, MICEX. Those unable or unwilling to do so have had the alternative of offshore Eurorouble bonds issued by multilaterals.
That may be about to change, because an important landmark for the development of local currency global bond markets was passed in February when Russian government bonds — OFZs — became Euroclearable. “That has removed a big headache for international investors because it does away with the requirement to appoint local custodians and local agent banks to settle the bonds and handle the currency,” says Jones at HSBC.
According to research published by HSBC, in anticipation of Euroclearability, foreign ownership of OFZ bonds more than doubled between mid-2012 and June 2013, from 10.7% to 27.7%.
The expectation at the time was that eligibility for settlement via Euroclear would soon be extended to Russian corporate borrowers, adding considerable depth and variety to the rouble market. At Citi, vice president and head of local debt capital markets for Russia, Yury Kiselev, says that Euroclearability outside the government bond space is not yet a done deal. “There are plenty of arguments for and against Euroclearability, and there is still no agreement on when this will become effective,” he says. “It was originally expected on January 1, 2014, but there are still some uncertainties to be resolved on tax issues.”
Kiselev says, however, that the longer term impact of Euroclearability ought to be positive for the broader Russian capital market. “Euroclearability is an important step towards making the market more transparent, but it needs to be coupled with improved corporate governance,” he says. “We are also waiting for agreement on and introduction of trustee and tax gross-up language.”
Another barrier to Euroclearability across much of the Russian corporate sector, says Kiselev, is that in many instances denominations are too low. “We still have bonds with denominations below Rb1,000, which means that by default they will be subject to the retail directive, preventing them from being opened up to global investors,” he says.
This, he adds, is one reason why in the case of a recent Rb20bn transaction for Vnesheconombank (VEB), regarded as an important test of international demand for rouble debt, distribution was limited to select accounts rather than on a global basis. The VEB issue, priced at a coupon of 7.65%, which was led by Citi, Raiffeisenbank and VTB Capital, and generated total demand of Rb52.4bn.
While domestic banks accounted for more than 60% of the book, the most notable element of demand was the 13.4% that came from overseas. VEB announced at the time that it was “particularly pleased” to have seen “many foreign investors who did not participate in local issues in the past.”
It is issues of this kind, say bankers, that will open up a much wider globally-targeted market for rouble debt more effectively than supranational issuance. “Sophisticated investors looking for Russian risk don’t want to buy supras at 50bp through OFZs,” says Jones at HSBC. “If they like Russia they want to get paid for holding Russian credit.” An increasing supply of Euroclearable paper may give them many more opportunities to do so.