Following a hectic but highly successful year, sovereign borrowers in Northern Europe will face a formidable funding challenge in 2010. Total borrowing requirements will remain at very high levels, driven by persistently high deficits. At the same time, however, with monetary easing coming to an end, the easy liquidity that many sovereign borrowers were able to access in 2009 will begin to recede, especially in the second half of 2010.
In the EuroWeek Northern European Sovereign Borrowers Roundtable, borrowers and bankers look back on the experience of 2009 and forward to the challenges and opportunities of 2010 and beyond.
Participants in the roundtable, which took place in November, were:
Greg Arkus, head of sovereign, supranational and agency debt capital markets, Credit Suisse
P J Bye, managing director, debt capital markets syndicate, HSBC
Myles Clarke, joint global head of the frequent borrowers group, RBS
Dr CarlHeinz Daube, managing director, German Financing Agency (Finanzagentur)
Kentaro Kiso, head of MTN syndicate and the EMEA public sector group, Barclays Capital
Teppo Koivisto, head of finance, Finnish State Treasury
Anne Leclercq, director of treasury and capital markets, Belgian Debt Agency
Stuart McGregor, head of EMEA public sector origination, Bank of America Merrill Lynch (BAML)
Philippe Mills, chief executive, Agence France Trésor (AFT)
Martha Oberndorfer, managing director and head of funding, Austrian Federal Financing Agency (OeBFA)
Robert Stheeman, chief executive, Debt Management Office (UK)
Sean Taor, head of SSA syndicate, Barclays Capital
Moderator: Phil Moore, contributing editor, EuroWeek
EUROWEEK: Looking ahead to 2010, what are Northern European borrowers’ likely funding requirements and what will the main drivers of issuance be? Let’s begin with France, which has an issuance target net of buybacks for 2010 of about €175bn, doesn’t it?
Mills, AFT: That’s right. On the supply side we have already announced a preliminary funding programme as we do every year at the time of the draft budget. Our indicative requirement for medium and long term debt will be €175bn. But the size of the final requirement won’t be known until the end of December.
There are three important reasons why the €175bn will not be the final figure. The first is that the budget deficit for 2010 is based on a conservative GDP projection for next year. The second is that we have engaged in a buyback programme of several billions of debt that mature in 2010. The third is that the funding draft was based on calculations made before the announcement earlier this month of the details of what the English press is calling the "Sarkozy bond". In France it is known as L’Emprunt National, and it will finance a number of high priority areas to accelerate growth of the French economy.
The global amount of this programme won’t necessarily have an impact on the overall financing requirement for 2010, because it’s possible that other means will be used to finance the Emprunt National. For example, some of the funds that were lent to the French banks in order to improve their solvency ratios are now being repaid to the government. It is probable that some of those repayments will be used at least partially to support the Emprunt National’s operation.
Oberndorfer, Austria: Our issuance in 2010 is expected to be lower than it was in 2009 because, although the budget deficit will be similar, redemptions will fall.
The budget for 2011 and 2012 will be compiled in late 2010. Given the redemption schedule, we expect funding needs in 2011 and 2012 to remain below the 2009 level.
EUROWEEK: According to government forecasts released earlier this year, Germany’s deficit will exceed €50bn in 2009 and rise to €90bn in 2010. What are the main drivers of this deficit and what impact will it have on Germany’s total funding requirement for 2010?
Daube, Finanzagentur: The federal government used various mechanisms to slow down the impact of the financial crisis. The Financial Markets Stabilisation Fund and two economic stimulus packages were the main drivers used, both of which resulted in additional burdens for the fiscal budget 2009. Further developments are currently under review.
EUROWEEK: The UK has a jaw-dropping gross Gilt issuance programme of £220bn for 2009-2010. But is it fair to say that the outlook for public finances in the UK and therefore for Gilt issuance are much clearer than a year or so ago?
Stheeman, DMO: That is true, for three reasons. First, I am assuming that the plans for quantitative easing are now much clearer. Second, there is also much more clarity about the likely cost to the government of various interventions in the financial services sector.
And third, all the major political parties are agreed on the need to tackle the issue of the deficit decisively. I think the market is generally of the view that that process will begin next year regardless of the outcome of the UK’s election.
I’m not saying things will necessarily be any easier in 2010 than they were in 2009. But at least we will all have a much better idea of what we’re up against next year.
Leclercq, Belgian Debt Agency: The drivers of our issuance in 2010 will be the classical ones of the budget deficit and redemptions. That’s a little bit different from 2009 when we had three drivers — the budget deficit, redemptions and the consolidation of short-term borrowing which we did in 2008 in order to refinance the capital injections which we needed to make that year. We consolidated part of that into longer term debt.
In 2009 we had space to convert short term borrowing into long term funding because the amount of redemptions was smaller than usual.
We certainly had a successful year although it didn’t look as though things were going to be easy at the start of 2009. We all remember what a difficult month January was. The main problem was to assess where the market demand was and to work out which maturities would work best because there wasn’t much information coming from investors.
A second important element which was difficult to determine was what kind of premium we would have to pay in order to make a syndication successful. The secondary market could only provide you with a slight idea of the level at which you’d be able to issue a good size transaction. Because there wasn’t a lot of natural demand you had to create demand yourself by making sure the premium was high enough to encourage investors to buy.
But then the market turned in March and investor interest in sovereigns revived. Sentiment generally became more optimistic. It also created more clarity on the premiums at which you could clear bonds.
So when we look back on 2009 I think most sovereigns had a pretty successful year with a lot of front-loading before the summer holidays.
EUROWEEK: Looking around Europe at the end of November, have most borrowers in Northern Europe now completed their funding programmes for the year, and are they now starting to pre-fund some of their programmes for 2010?
Mills, AFT: By the end of November we had almost finished our issuance programme for 2009. We still have one auction to go in the first week of December. So we are very comfortable about pre-financing for 2010, which we are doing in the usual way through buybacks of debt maturing the following year. That is a process that has already begun, and so far we have completed buybacks worth several billion euros. I can’t be more precise about that because we don’t release exact figures on the subject until the end of December. But what I can say is that our target is usually around €10bn and we are confident that we will be able to achieve that by the end of December.
Koivisto, Finnish State Treasury: The favourable demand conditions have created some pre-funding by certain issuers during the autumn. Finland decided to issue a new 15 year bond in October due to favourable market conditions, although the original plan was to introduce a longer dated bond next year. Clearly one motivation was to avoid the potential congestion of Q1 2010. However, in case of Finland, our budget structure does not allow a window for pre-funding for the next budget year. So, in order to execute the deal in 2009, we had to replace two bond auctions to keep the amount of long term funding as budgeted.
Leclercq, Belgian Debt Agency: We planned a total issuance of €30.5bn. By the beginning of September we had done €29.4bn. We had a September auction that normally would have been €1bn but because market sentiment was so strong at that time we decided to take the opportunity to hold a normal size auction of €2.5bn, which could be interpreted as partial pre-financing.
Our November auction will be totally a pre-financing for 2010. But the important point is that it is a pre-financing not because we think 2010 is going to be a difficult year, but because as such we can take advantage of the positive trends we’re seeing in the market now and try to lighten the load for 2010.
EUROWEEK: How easy will it be for markets to absorb the huge volumes of new issuance from sovereign borrowers that we can expect to see next year?
McGregor, BAML: I don’t think I would use the word ‘easy’! Of course it won’t be an easy task, not least because there is still so much uncertainty about the strategies that the Bank of England and the ECB will use to exit from the programmes they used to inject liquidity into the market in 2009.
But at the start of this year there was some concern about whether sovereigns would be able to raise their funding requirements for 2009. Now, there is much less anxiety about the size of sovereigns’ borrowing requirements because one lesson we have drawn from the crisis is that there is a price for everything. That price will fluctuate as investors’ perception of relative value in Europe changes. But it is no longer a question of whether governments will be able to fund themselves, but of the pricing level at which that funding is raised.
Taor, Barclays Capital: I agree that 2009 has been a much more successful year than many people would have envisaged. The burden of responsibility was very much on sovereign borrowers to lead the recovery in the market, and had their deals failed it would have had serious repercussions for the wider market. So the European sovereigns should take credit for executing their funding plans as successfully and as thoughtfully as they did.
Looking ahead to 2010, however, our house view is that interest rates will rise after the summer in the US and the UK, and in Europe in 2011. With quantitative easing also coming to an end in 2010, the big question is what impact the removal of all this liquidity will have on the market.
Bye, HSBC: We’re very positive about the outlook for 2010. There is an awful lot of cash in the system, so we aren’t reliant on a very small number of investors to support sovereign deals. We’ve seen 200-300 individual tickets coming into some of the larger transactions, ranging from €50,000 to several hundred million, but issuers aren’t hostage to any particular investor group as there is such a large amount of liquidity spread across Europe. Also, there is still limited appetite from European fund managers to diversify back into equities, particularly now after the strong rally we’ve seen off the lows. Hence the focus will remain on opportunities in the fixed income space.
I don’t expect there to be any major issues in selling sovereign debt in 2010 as long as the borrowers don’t get too aggressive with the pricing they try to command. I see no sign of that happening, because almost without exception deals that have come to market this year have been fairly priced. There were some relatively high new issue premiums at the beginning of the year when markets were very volatile, but as we’ve come towards year end we’ve seen situations where sovereigns have even issued with negative new issue premiums, particularly with the UK Gilts.
Koivisto, Finnish State Treasury: Yes, I believe there will be enough demand to absorb the supply, but competition for the investors will be even tougher in 2010 among the issuers. Firstly, adding up the corporate and sovereign supply, the total supply will not increase substantially. Most likely we will just notice a degree of shift from corporate demand to higher quality sovereign debt. Furthermore, referring to my previous answer, it is likely that the institutional investors are more risk-aversive in their long term strategic allocations. That would support the demand for fixed income products.
The banks have already played a role in this year’s issuance, while improving their balance sheets, by loading up with zero risk sovereign debt — I believe this will be the case for 2010 as well.
The increase in regulation will be evident, in the quest for a more stable financial environment. I assume the main bulk of new regulation initiatives will be introduced by the Basle Committee to the national regulators. The aim of regulation is not to influence demand, but it is a consequence or even a side-effect of regulation.
EUROWEEK: Would it be fair to say that there was an unusually high dependence on short term issuance among eurozone borrowers in 2009, and that this will need to be termed out as it matures in 2010 and 2011?
Oberndorfer, Austria: Our strategic focus is on longer dated paper and we did not change our stance on this in 2009. However, we gained from the low money market levels by favouring a combination of short term and long dated issues. The share of short term issuance in our overall funding plan is typically in the range of 3%-7%, and we plan to stick to this range as we target maintaining a low overall rollover ratio in the single-digit area. This rollover ratio is now around 7% of GDP, compared with a eurozone average of around 12%, which underlines our conservative funding strategy with regard to refinancing risk.
Daube, Finanzagentur: Expanding our use of money market issues was the most flexible way of responding to our increased funding volume in 2009. Another decisive factor was the strength of demand for shorter dated instruments.
Mills, AFT: It is true that in 2009 we have issued a lot of bills, just as all other European governments did. It may interest you to know that we have also issued less than we usually do in these circumstances. Bills issuance usually rises dramatically when sovereigns have an economic slowdown or a recession. During the last recession in 1992-93, and also in the slowdown in 2002-03, all the unexpected supplementary deficits were financed through BTFs [treasury bills]. This time BTFs have only financed around 50% of the additional deficit. The balance has been financed through increased use of medium and long term instruments.
That has meant that although in 2009 we increased the size of our BTF programme, we were also able to increase our issuance at the long and very long end of the curve. We have issued about €29bn of debt securities with a maturity of 15 years and longer, which represents about 18% of total issuance. That is much higher than in 2008, when it was around 10% of the total.
By increasing issuance of BTFs but at the same time increasing issuance of long term instruments, the average duration of the French debt hasn’t been changed by the response to demand for short and long term securities.
Clarke, RBS: Whether or not it was due to the market not being open at the longer end of the curve, it was not a bad decision to make use of bill issuance at a time when rates were so low at the short end. The problem with that is refinancing risk given that rates must rise at some point.
Arkus, Credit Suisse: Sovereigns clearly took advantage of decent demand at the front end of the curve. At the start of the year, investors were especially defensive, and given that sovereigns needed to increase their funding, short term debt was an obvious solution.
But if you look at duration for most sovereign borrowers throughout the course of 2009 it has remained relatively stable. And some sovereigns have even been able to extend duration slightly in 2009, which suggests that the increase in issuance has been across the curve rather than being weighted towards at the front end.
Taor, Barclays Capital: There was certainly heavy use of bills in 2009 and we are expecting an increase in net bills issuance of about €40bn next year. But to put that into context, European reliance on bills is only about half of what it is in the US.
Bye, HSBC: One characteristic of sovereigns’ funding strategies this year has been their flexibility, both in the way they have approached the market by using syndications, and in terms of choosing the right maturities at the right time. That was especially evident in the second half of the year when there was a very strong bid for duration, which encouraged issuers to come to the market with 15 or 30 year transactions, and even longer dated issues than that in the case of the UK.
EUROWEEK: Did it become easier to issue in longer maturities as the year progressed?
Mills, AFT: Not at all. The process began at the very start of 2009. We issued €3.4bn of longer dated paper in January, €2.9bn in February, €2.7bn in April and €2.8bn in May, and we did our very successful €6bn syndication of our new 30 year April 2041 4.5% OAT in June. We tapped the 2041 benchmark in November for more than €2bn via an auction. So longer dated issuance for us was really more of a story for the first half of 2009 than for the second half of the year. I would say it was a first half story for the big triple-A issuers, such as France, Germany and the UK. It became more of a story for the others in the second half when the big three had demonstrated that it was possible to issue successfully at the longer end of the curve.
Taor, Barclays Capital: As you say, France and Germany were probably the exceptions to the rule. More broadly, investors were clearly a lot more risk-averse at the start of the year, which was reflected in the maturity profile of the early deals. For example, Austria did a €3bn five year deal, instead of a 10 year deal which it usually does at the beginning of the year. Ireland syndicated a five year deal when it would normally have only syndicated in 10 years. So a lot of the early issuance was at the shorter end of the curve than usual.
Bye, HSBC: We saw some highly successful long dated deals in the second half of the year, often from borrowers tapping the longer end of the curve for the first time. Finland had never issued a 15 year deal before; Ireland’s 15 year benchmark represented the first time they had been in that maturity for many years and they had certainly never raised anything like €7bn in one shot in that tenor.
So there were plenty of examples of strong long dated deals very much tailored to investor demand. The sovereigns clearly benefited from a lack of alternative product in that part of the curve. Competition from the government-guaranteed sector was concentrated at the short end, and although supranationals and agencies have been more active in the five to 10 year space, very few have gone beyond that. For the most part, investors searching for duration had to buy either corporates or sovereigns, and sovereigns offered liquidity, credit quality, and in some cases attractive spreads as well.
Arkus, Credit Suisse: Clearly the return of risk appetite was an important feature as the year progressed. As spreads narrowed between the core and the peripheral eurozone markets, investors started to look further down the curve in search of enhancing yields. As a result, the execution risk at the longer end has been reduced over time.
Clarke, RBS: There were both credit and curve dynamics at work during the year which opened and closed the issuance windows at the longer end. It got easier for everyone in the second half but that’s not to say the market was completely closed. The 10/30s curve vacillated between +90bp and +50bp but what was attractive at the long end for investors at certain times was not so attractive for issuers.
EUROWEEK: What is your expectation for 2010 of the balance between bills on the one hand and longer dated, 15 year plus issuance on the other?
Mills, AFT: If possible, we will aim to start reducing the overall share of bills in the issuance programme and in the debt’s stock. Bills are tools to be used in a slowdown or a recession. When you’re in a recovery phase, their total share can start to decline.
In terms of longer dated issuance, we are a demand driven borrower so total issuance will depend on the level of demand. If we see opportunities to issue at the long and very long end of the curve we will take them. As you know, France was the euro area’s pioneer four years ago in the market for 50 year bonds. If it is possible to introduce a new 50 year benchmark, I would be pleased to do so. And if the opportunity arises to introduce a 40 year issue I would also be delighted to do so. It all depends on demand.
Koivisto, Finnish State Treasury: In the case of Finland, we have not experienced any jumps in rollover ratio. In previous years, our T-bill funding has been roughly 50% of the total annual gross borrowing. In 2010 and beyond, when our funding programme is larger, a smaller proportion of gross borrowing will be executed in T-bills.
Arkus, Credit Suisse: With the yield curve being very steep there is obviously a high opportunity cost in remaining defensive and investing at the front end. We have seen better liquidity in the market, particularly at the intermediate to long end of the curve which should make investors more comfortable with longer dated exposure. Several sovereigns have already taken advantage of that, most recently Greece. Going into next year I expect that issuers that need to put new longer dated lines in place will do so in the early part of the year. And those that have existing lines will probably add to those positions.
Clarke, RBS: There is more than one way to add duration. One is to issue long dated conventionals. The other is to issue linkers. A 20 year conventional can be approximately replicated in duration terms by a 15 year linker. So I expect to see more issuance of both linkers and longer dated nominals.
EUROWEEK: What impact (if any) is rising competition for funding from the SSA sector having on pricing dynamics in Europe?
Oberndorfer, Austria: Thus far, the additional funding needs of the SSA sector have been well absorbed by the market. Investors are still risk-averse and have therefore created healthy demand for SSA bonds. Equities and other asset classes such as ABS, hedge funds and private equity are not expected to get back to levels seen in 2006 and 2007 in the near future. We therefore expect healthy demand patterns to continue to be favourable for the SSA sector.
Overall, we see further potential for spread compression, since high quality sovereigns continue to trade at elevated levels compared to the swap curve, particularly at the longer end of the curve.
Clarke, RBS: The main factor in 2009 has not just been competition among SSAs. The main source of competition for European sovereigns came from the government guaranteed market. At RBS, we estimate that since the schemes began we’ve had the equivalent of about €725bn of government guaranteed issuance, which we expect will drop to €50bn in 2010. So the crowding out happened not within the SSA sector but because of this new form of issuance.
EUROWEEK: But that government guaranteed issuance was concentrated in the one to three year maturity bracket, wasn’t it?
Clarke, RBS: Sure. But by pushing levels out at the short end it also had a knock-on effect on pricing in longer dated issues.
EUROWEEK: How has the composition of France’s investor base developed in terms of geography over the last year or so? One trend in some sovereign markets in 2009 has been the so-called localisation of demand.
Mills, AFT: We’ve seen an opposite trend. We have seen an increase in the stock of debt of the French state owned by non-resident investors. If we look back to the beginning of the crisis in the summer of 2007, at that time according to balance of payment figures published by the Banque de France, about 60% of our debt was owned by non-French investors. The latest figures, updated at the end of the second quarter of 2009, show that this has risen to 66%. So there was no redomestication of demand during the crisis. Quite the contrary.
A good indication of this long term trend was the order book for the 2041 benchmark: 70% of the accounts served in the syndication of that deal were non-French, with demand from the Netherlands and Scandinavia.
EUROWEEK: Is the increase in overseas participation due to a conscious push to market your bonds to non-French investors?
Mills, AFT: I wouldn’t call it a conscious push towards overseas investors. We have been making a conscious push to diversify our investor base. A logical consequence of that is for more bonds to be placed outside France. But I have no implicit or explicit target. The important thing for me is that we’ve seen increased diversification during the crisis. We’ve also seen an increase in demand from accounts which were previously not interested at all in sovereign debt in general and in French debt in particular. For example, I’ve just returned from Switzerland where I met a lot of private banks which before 2007 weren’t at all interested in buying sovereign debt. Now they are interested in having exposure to these securities for part of their portfolios.
Of course this is all due to the flight to quality. A very important consideration is not just the quality that sovereign bonds provide, but also their liquidity. All investors have discovered or rediscovered the value of liquidity.
EUROWEEK: Does this lead to a re-emergence of the battle of the benchmarks between France and Germany that everybody was talking about a few years ago?
Mills, AFT: I don’t see my relationship with other triple-A borrowers in Europe as a battle. If we are fighting a battle, it is a joint battle to build investor diversification. As Robert Stheeman has said, we are much more complementary than competitors.
EUROWEEK: Returning to the composition of sovereign borrowers’ investor bases, is it fair to say that increased funding requirements across the European SSA sector is making it more important for issuers to diversify their investor bases?
Oberndorfer, Austria: Austria has been catering to international investors for a long time, and we issued our first US dollar bond as early as 1958. We therefore have a well-established and diversified investor base both with regard to regions and investor type.
Asia is also a very important investor base for us. We have been active in that region for decades, supplying paper in various currencies. We saw increased demand from Asia for our last syndicated US dollar bond issue in September 2009: 47% of the order book went to this region, which was significantly more than during the first half of the year when we noticed some concern among investors regarding the eurozone during our Asian roadshow.
Koivisto, Finnish State Treasury: In general, larger issuance volumes create pressure to widen your scope for funding. There is a plenty of unexploited potential for euro sovereigns in the dollar market, but the dilemma is that those issuers who are most desperately seeking to differentiate their funding have probably also the most limited window in dollars. We will continue to issue occasionally in dollars through our MTN programme, but I think with our relatively small funding programme in the coming years we will concentrate on euro benchmark issuance to provide our share of liquidity to the euro area bond markets.
Daube, Finanzagentur: We are permanently looking at ways of diversifying our investor base. But before using any innovations that may help with this process we have to analyse very carefully whether or not they are in line with our main target of achieving cost savings for the issuer and attractive investment opportunities for investors. Unless those objectives can both be met, we feel under no pressure to explore new funding tools.
So far, the only foreign currency we have issued in is dollars. Our view is that issuance outside euros should have the sole purpose of exploiting arbitrage opportunities. This means we would need to identify rare situations in which funding in one currency is able to demonstrate an all-in cost advantage compared with an issue in euros.
With regard to the Asian investor base, that has always been very important to us, as have all international investors. According to our estimates, they accounted for more than 50% of secondary market demand in 2008. Asian investors are very open-minded about the currencies and instruments they look at, so we ensure that we maintain regular communications with them.
Arkus, Credit Suisse: Many European sovereigns, such as Austria, have a long tradition of serving foreign investors in their own currencies, such as yen, Swiss francs and Australian dollars. We have seen sovereigns accessing alternative currencies for diversification, with the main goal of doing so being the need to achieve competitive funding versus the domestic market.
That means that it is important to maintain an active dialogue with investors to educate them about each country’s debt needs. We have seen European DMOs going out and directly marketing to investors across the world. As volumes increase and issuance becomes more competitive, we’ll not only see a continuation of that process but also the benefits of it will be clearer.
EUROWEEK: Dr Daube has mentioned Germany’s very successful dollar benchmark, which was clearly one of the highlights of the year in the European sovereign market. But a number of other European sovereigns also enjoyed success in the dollar market in 2009. Will this trend continue to gather momentum in 2010?
McGregor, BAML: I would certainly agree that Germany’s dollar trade was one of the highlights of the year. The Finanzagentur waited patiently for the sun and the moon to be aligned and the result was a trade that everybody agrees was a big success.
Looking more generally at the dollar market, although euros are becoming an increasingly important part of global investors’ portfolios, there is a very large universe of investors that remain focused exclusively on the dollar market. We’ve seen many of the European DMOs launch very successful syndicated dollar deals this year, although the total proceeds that have been raised in the market are still modest compared to the euro and sterling markets.
European sovereign borrowers have made it clear that they will continue to look at the dollar market, but only if the economics make sense. Would they continue to make aggressive use of the dollar market if the basis swap deteriorates dramatically? I would be very surprised, because the depth of the euro market is phenomenal.
Bye, HSBC: I agree that issuers won’t come to the dollar market regardless of cost. But if it’s close, the diversification benefits will outweigh the need to make major cost savings.
With the basis swap at such attractive levels this year, issuers have been able to save 15bp or 20bp over their cost of euro funding, which has been a pretty easy decision to make. Will we see sovereigns continue to do large dollar deals if they can only break even or have to pay a few basis points to access the market? We suspect that they will be willing to do so, because they won’t want to concentrate all their firepower in one market.
There is a strong natural bid from the central banking community for sovereign paper. This was less apparent at the beginning of the year, when central banks were more risk-averse than they have been traditionally. But over the last six to nine months we have seen most of the central banks that were active one or two years ago come back to the dollar market. They remain risk-averse to a degree, which means they are reluctant to move too far down the credit spectrum, but high quality sovereign paper is right at the top of their list.
Taor, Barclays Capital: The dollar market has been a very important source of funds for European sovereign borrowers this year. There has been over $40bn of issuance this year compared with $16bn last year and just over $5bn in 2007. So the pick-up has been dramatic.
I share the view that the dollar market will continue to be very important for European sovereign borrowers. As well as the cost advantages, the dollar market gives issuers access to a new investor base, which will be especially important next year, given that there is expected to be a lot of congestion in the new issue market.
Clarke, RBS: Particularly if they were registered with 144A or global documentation, dollar deals did encourage US investors who you would otherwise not see in your book to get involved, partly as a way of diversifying away from the GSE story. That allowed for genuine diversification which didn’t cost anything and in many cases helped sovereign borrowers to beat their euro curve — 144A or global documentation compounds the diversification benefits of issuing in US dollars.
Bye, HSBC: There was very clear evidence of that in the dollar deals Spain has done this year. Back in February Spain brought a $1bn three year deal without 144A language at mid-swaps plus 70bp. When they came back to the market in September the pricing was considerably more aggressive but they were able to raise $2.5bn in the same maturity bucket. Admittedly, market conditions changed enormously during that period, but Spain’s decision to go down the 144A route and tap into the domestic US investor base was absolutely key.
EUROWEEK: Can a successful dollar benchmark also have a beneficial knock-on effect for European sovereign borrowers in their core euro market?
Bye: Yes. The majority of FX reserves are still denominated in US dollars. Central banks are more likely to diversify into a new name via dollars than via any other currency, and once they’ve bought a European sovereign’s debt in dollars, they will naturally be more willing to take a closer look at the same issuer’s debt in euros.
EUROWEEK: On the subject of investor diversification, is there any link between the increasing popularity of syndications and the pursuit of a wider investor base? Was investor diversification one of the reasons why the UK’s DMO embraced the syndication technique in 2009?
Stheeman, DMO: No. I know that for some borrowers investor diversification is an explicit aim of syndication. That is a perfectly legitimate reason to use syndication but it is not the reason we chose to do so. We use syndication purely for longs and linkers, and we do so mainly in order to better align our supply with pension fund demand.
Clarke, RBS: The DMO is in a very different position to most other European sovereigns because the sterling market is dominated by UK investors. That means it doesn’t raise any eyebrows if it sells 90% or 95% of a deal to domestic investors. That is what you would expect. But for continental European issuers the argument is that they can sell to investors in other jurisdictions in the same currency.
Bye, HSBC: More broadly, I think there is a clear link between the use of syndications and increased investor diversification. A narrower universe of investors participates directly in auctions, even though some large accounts will place orders direct with the primary dealers.
A syndicated deal gives investors much greater certainty of whether or not they will be allocated bonds, and a much clearer indication of what the final price will be. So without a doubt the syndication process maximises your chances of placing bonds with as many investors as possible.
EUROWEEK: Belgium did a highly successful syndicated deal in June. What is your general philosophy towards issuing in syndicated format? And is it possible to compare the costs of syndication versus auctions when you take into account the possible benefits of greater size, liquidity and distribution?
Leclercq, Belgian Debt Agency: We’ve been doing syndicated deals since 1999, so we have quite a good track record in the market. We decided to issue in syndicated format because a benchmark needs to be sufficient in size from its launch. For a smaller borrower such as Belgium it would be impossible to issue in a size of €3bn to €5bn in a single maturity and in one go in an auction. That is simply a risk that we aren’t prepared to take.
The second positive point about syndication is that you decide on the timing; you choose your timing depending upon when there is demand in the market, whereas in an auction you have a pre-scheduled calendar and you can’t move the timing.
A third very important point about syndication is that there is direct investor participation. As an issuer we have a very hands on approach to syndication. We try to steer the allocation to ensure that there is good diversification between domestic investors on the one hand, and foreign investors on the other. And within the grouping of foreign investors we aim to steer the allocation mainly towards real money accounts. Typically, we aim to have 75%-80% real money accounts and 20%-25% trading accounts. We mustn’t underestimate the importance of trading accounts which create the float that is necessary to support the performance of the bonds in the secondary market. Finding the balance between real money accounts and trading accounts is important to us.
Towards the end of 2008 and in 2009, the balance sheets of the banks were shrinking which meant they were unable to warehouse the bonds on their books so having investors participating in the syndication is a very positive point.
Another benefit is that it gives the primary dealers an incentive to work on your behalf and to make sure that your debt is well distributed, because participating as a joint lead manager in a syndication is strong recognition of the work they’ve done.
Koivisto, Finnish State Treasury: If I could just add a point about issuance techniques: market volatility and lack of liquidity have favoured a more hands on process of syndications as a method for funding. In addition, elevated funding volumes have driven issuers to consider alternative methods of issuance instead of outright auctioning. One important advantage of syndication for the issuer is better control of investor allocation. I cannot see any serious drawbacks of syndications for a small sovereign issuer like Finland.
EUROWEEK: What are your plans for syndicated issuance in 2010?
Koivisto, Finnish State Treasury: Larger funding volumes create the need for diversification in methods of issuance. However, Finland will shift into a more ‘hybrid’ strategy in 2010 by launching two euro syndications and intensifying activity in auctions to a quarterly basis.
Leclercq, Belgian Debt Agency: We generally aim to launch a 10 year syndication in the month of January. But I imagine January 2010 will be a little more crowded than it usually is because there are a number of other issuers which have not issued [in that period] before that are now at the forefront. I’m talking about borrowers like Ireland and Finland.
For 2010 we plan €32.75bn in OLOs, with three syndicated issues which will account for between €12bn and €15bn. And in order not to weigh too heavily on the market we will probably aim to hold more auctions than our usual total of six.
EUROWEEK: What about Austria? Can you describe the OeBFA’s general philosophy in terms of the division of funding between auctions and syndications?
Oberndorfer, Austria: Austria typically conducts one or two syndicated issues per year, depending on the size of its funding programme. One of those syndications is usually launched in early January, traditionally making Austria the first sovereign of the year to enter the euro market.
We issue bonds via a syndicate when we want to establish a new point on the curve or when we want to attract a specific investor base. The amount is typically subsequently increased through auctions in order to enhance liquidity.
The main advantage of syndications is that they provide the opportunity to influence the final allocation of the issue, both with regard to investor type and geographical region. This is not the case in an auction format where you have no say over the final allocation which is determined solely on the basis of price. The main disadvantage is the additional fees payable to the bank syndicate.
When choosing the syndicate, we make sure that the dealers who do the best job in terms of primary and secondary market trading are rewarded.
We feel that a combination of auctions, syndications and other instruments is a valuable and viable strategy for any market circumstances.
EUROWEEK: We’ve already talked about Germany’s successful US dollar benchmark in September. More generally, however, has there been any change recently in Germany’s attitude towards syndicated deals?
Daube, Finanzagentur: Our auction system is well established and our main funding channel. Both the issuer and the banks in the Bund Issues Auction Group feel extremely comfortable with the system for a number of reasons. It is obligation free for both parties. It carries low costs for the issuer and low risk for bidders because allotment decisions are made just minutes after final bids are submitted. And it enhances participating institutions’ reputation and improves their prospects of winning ancillary business with the issuer.
That ancillary business could, of course, include participation at some stage in a syndicated issue. One reason why the Finanzagentur may favour the syndicated method of issuance is when it is aiming to reach new investors by stepping into non-core markets. One example is issuance in foreign currencies, such as the US dollar benchmark you mention.
Also, in some rare cases the issuer may be prepared to pay additional fees for advice if it helps achieve better pricing or hedging in new instruments.
EUROWEEK: The fee payable to the banks is often cited by sovereign borrowers as an important reason for not using syndication. But isn’t it the case that this fee can be partially or even wholly compensated for by the benefits that syndication offers in terms of size, pricing, liquidity and distribution?
Stheeman, DMO: We have done some internal analysis on this, and although we have shared this information with the Treasury we don’t think it would be appropriate to release it publicly. As I said to a Select Treasury Committee meeting some weeks ago, it would be ill-advised to assume that auctions are cost-free, or even to assume that auctions come at a lower cost than syndications over time. That is because, at the risk of stating the blindingly obvious, syndications involve an explicit cost whereas auctions involve an implicit cost.
We have calculated that the fees on our recent 40 year index-linked syndication probably cost us less than 1bp on the coupon cost over the life of the bond. If that is the case and if we were to compare those costs with a putative concession that we may be paying at an auction, or with those of an auction that clears with a long basis point tail, it is reasonable to assume that syndications are a very cost-effective way of financing part of our programme.
Leclercq, Belgian Finance Agency: In terms of determining the real cost of syndicated issuance, the first element is of course what you pay as a fee. But over and beyond that it is very difficult to give an exact idea of how much you pay on an all-in basis.
When we look at our auctions in 2007 and 2008, the very intense competition that existed among the primary dealers to win market share in the primary market meant that the bids they put into the auction were quite aggressive, which is a positive point for the taxpayer. But the fact that you can achieve such a large size through a syndication, which is so supportive of liquidity, is also a very important factor.
EUROWEEK: Philippe, you’ve already mentioned your very successful 2041 deal. How, if at all, has the AFT’s philosophy towards syndications changed in 2009?
Mills, AFT: We haven’t changed our philosophy at all. We have been used to doing roughly one syndicated deal every year and a half and that was the case during this recent crisis. We did a syndicated deal in February 2008 and again in June 2009. And we used syndication only on one or two specific bonds where it is very important that they are not squeezed. So we use syndication for longer dated bonds and for some linkers.
The decision we took to syndicate our new 30 year bond in June was a very pragmatic one. We were able to tap our previous 2038 benchmark quite significantly in the first half of 2009. We also became aware during roadshows and meetings with pension funds and fund managers from the Netherlands and Scandinavia that due to the way they manage their balance sheets they wanted a new product in that maturity. We also became aware that they wanted it soon and for a significant amount. So for us, to ensure smooth execution of the issue, it was better and less costly to do it through syndication than via an auction.
EUROWEEK: We’ve heard a number of mixed views from the borrowers around the table about the merits of syndications versus auctions. Let’s give the bankers the opportunity to give us their views on the benefits of syndication.
Taor, Barclays Capital: I think the figures speak for themselves. Excluding the UK, there have been 27 syndicated European sovereign deals this year, compared with 14 last year. Total volumes in the syndicated market are up by about 2-1/2 times this year, compared with a 44% rise in overall volumes.
There has also been an increase in the size of deals. Last year there was only one syndicated deal from a sovereign over €5bn, which was Ireland’s long 10 year issue. This year there have been 16.
In previous years, auctions accounted for about 90% of European sovereign issuance, so there must be some very good reasons explaining why sovereigns in Europe are syndicating twice as much as they used to. Those reasons include being able to target investors, having more control over the pricing and deriving comfort from the knowledge that the bonds will be distributed to real money investors and perform in the secondary market.
McGregor, BAML: I would say that virtually every syndicated deal launched by European sovereign borrowers this year has either met or exceeded expectations. The market for liquidity is very competitive and syndicated deals have proved their merit as a way of giving issuers confidence that they will be able to execute deals at good levels.
Bye, HSBC: Sovereigns are inevitably going to be regular issuers in the market via the auction process but they don’t want to be in the market too often because it can dilute the scarcity factor and overwhelm investors. So it is preferable to come infrequently but with much larger deals, which syndication allows sovereigns to do.
Clarke, RBS: There is also the question of deal size. Syndications are an efficient way of reducing big ticket execution. When you start to feel uncomfortable about the capacity of your auction system to handle bigger tickets, that is where syndication jumps in.
But I would also echo Robert when he says that a key objective that is met by syndication is to align supply with demand at the long end of the market. An important element of the syndication process is that it enables you to engage that much more closely with investors. Some of the problems that investors have is that their tickets are too big for them to execute efficiently in the secondary market. This is especially applicable to ALM-driven demand from pension funds at the long end in the UK and the Netherlands. Those investors are much more likely to come forward with big tickets and give the issuer better execution in the syndication process than they would in an auction.
EUROWEEK: Do the bankers around the table feel that issuance volumes of syndicated bonds may now have reached a plateau?
McGregor, BAML: Not necessarily. We would expect there to be more issuance at the long end of the curve next year, which suggests more syndicated trades. It may be that more borrowers will adopt the UK DMO’s model next year, committing themselves more formally to syndicating their ultra-long deals.
EUROWEEK: How important is it for sovereign borrowers to explore potential innovations as a way of reaching into a new investor base?
Stheeman, DMO: That is not a hugely important priority. We believe we get the best value for money and the best execution by issuing into benchmark issues, which allows us to command a liquidity premium.
Having said that, I wouldn’t want to create the impression that we are fundamentally opposed to innovation. Using syndication, for example, was a very significant innovation for the DMO.
Clarke, RBS: I would agree. Innovation for innovation’s sake is not cost-effective. Sovereigns need to focus on getting large deals executed efficiently and at the lowest all-in cost to the taxpayer.
EUROWEEK: On the subject of innovation, what became of the UK’s plans to issue sukuk?
Stheeman, DMO: That would of course be a decision that would be taken not by the DMO but by the Treasury, which I believe is still very open to the idea.
I think that one of the reasons why we haven’t issued sukuk is that as the financial crisis intensified we saw huge amounts of liquidity not just chasing flight to quality assets, but also looking for the structures that are the easiest to grasp. That is why some of the alternatives labelled as innovative would probably cost us more in the current uncertain environment than they would in normal markets.
Oberndorfer, Austria: We have had a diversified range of funding sources and instruments for many years. For example, Austria started to use syndications and introduced its EMTN and treasury bill programmes in 1999. This year, we have tried to make the environment less stressful for our primary dealers by introducing parallel auctions on our electronic platform.
Because we already have this range of different funding instruments in place, we have not made any major changes to our financing programme by introducing new products. However, we are always prepared to analyse new opportunities and to check if they fit our risk-return profile.
We have also devoted more resources to the field of investor relations. We recognise that even for a triple-A rated sovereign, investors no longer regard the information contained in the ratings reports as sufficient. They demand that the issuer communicates its credit story clearly and regularly. We have addressed this demand by providing more documentation on our website and by doing more roadshows and making more presentations than ever before. We have also introduced an annual review and other measures to make it easier for analysts to find relevant data on Austria.
Our impression is that these efforts have been well received and that we are recognised by investors as a reliable, predictable and transparent issuer.
Daube, Finanzagentur: Continuously improving our investor marketing has also been an important priority for us. This will be further enhanced as we expand our investor base.
Leclercq, Belgian Debt Agency: We’re a frequent borrower and our aim is to build a liquid market in our core products. Moving towards more funky products isn’t part of our mandate.
On the other hand we can certainly do something different in the sense that we created an EMTN programme in 2008 and under that programme we can issue straight bonds in dollars or other OECD currencies swapped into euros, or floaters, or inflation-linked issues swapped into Euribor. But aside from that it isn’t our mission to move away from more plain vanilla issues. The potential for reputational risk is too high. If you sell bonds to investors and something goes wrong because the market turns against the structure you’ve devised, the consequences could be very serious.
EUROWEEK: How much use have you made of your MTN programme?
Leclercq, Belgian Debt Agency: We’ve now issued almost €3bn off the programme. The aim is to continue to generate 10%-12% of our annual funding programme through the MTN programme — no more than that.
So the MTN programme is very positive because it relieves the pressure on your overall funding programme, if indeed there are pressures. We need to issue about €32bn in the OLOs which is quite moderate. But at the same time the MTN programme offers the opportunity of attracting some attention because you’re doing something new. That may create some positive spill-over into your regular programme.
It also provides the opportunity to meet other pockets of investors. On our roadshows, we usually meet investors who buy in euros. But doing some dollar issuance through the MTN programme, for example, has given us the opportunity to further diversify the investor base.
We’re a small issuer and we haven’t had to deal with major shocks, and sometimes it can become a little boring always telling the same story and selling the same products. So doing something more innovative and more spicy can help to attract investors’ attention and make sure you’re on the map.
Oberndorfer, Austria: We have facilities in place allowing us to issue in all major currencies, including a Japanese shelf registration and a Kangaroo programme. Being able to issue in currencies other than euros is crucial for maintaining a diversified international investor base.
The most important foreign currencies for us are US dollars, Swiss francs and Japanese yen. The share of foreign currency issuance depends on the underlying supply and demand patterns and on the economics compared to an outright issue in euros, since our appetite for assuming foreign exchange risk is quite limited.
Naturally, we ensure that we pay close attention to the relative positioning of comparable domestic and international issuers when we explore opportunities in foreign currencies.
Koivisto, Finnish State Treasury: Finland uses its MTN programme as a supplementary vehicle for funding. In 2010 we might be slightly more active in our MTN issuance, but with our credit outlook and relatively small funding programme there is no reason to turn opportunistic. All in all, we are talking about an MTN funding target of a few billion euros.
Kiso, Barclays Capital: It is essential that once a sovereign borrower has gone to the trouble of setting up an MTN programme it should make the best use possible of it. That means not just accessing dollars but a range of other currencies.
Belgium and Portugal are good examples of sovereigns that have approached the market very flexibly. However, a number of issuers, especially sovereigns, set the minimum sizes of their trades quite high, at $250m or $500m. If you set the bar much lower than that, at $50m or $100m, you open the door to a whole new range of international investors. Buyers of currencies such as Japanese yen, Norwegian kroner, Hong Kong dollars, New Zealand dollars and so on are not typically the same as those who would come into issuers’ euro and US dollar benchmark programmes.
EUROWEEK: France has a track record of innovation. Is the AFT experimenting in any way with its issuance?
Mills, AFT: The president has made it clear that the Emprunt National has to be financed in the most cost-effective way. If the most cost-effective way is to finance it through simple, liquid products, that is what we will do.
It’s true to say that we’ve been innovative in the past and we will continue to be so. But I’m not sure that being innovative requires us to be funky. I’m not sure that I would be very good at that! Innovation for us will mean replenishing our curve for linkers and to do a very long term bond if the demand is there. We will also look at floaters, in both short and long term maturities. We will look to see if a dollar benchmark can make sense, and perhaps look at a new maturity for our nominal bonds. For example, we are looking at the possibility of introducing a new point on the curve between five and 10 years, perhaps a seven year benchmark.
At a recent EPDA conference there was a panel of strategists from the big banks and their consensus was that large triple-A issuers like ourselves should stick to large, liquid and transparent products.
EUROWEEK: As the Netherlands is one of Belgium’s closest neighbours, is the Dutch Direct Auction an alternative that you’ve looked at?
Leclercq, Belgian Debt Agency: The Dutch Direct Auction has been around for many years, and so have our syndicated deals. The syndicated deals we’ve done have proved to be a very efficient method for us, so although we have of course analysed the way the Dutch manage their issuance, we have decided that we are very happy with the system we’re using at the moment.
Stheeman, DMO: When we consulted on potential supplementary issuance programmes in December, the two areas we wanted feedback on were syndication, which everybody liked, and the Dutch Direct Auction, which they didn’t like. That surprised us, because we think the Dutch system is an interesting alternative.
A similar thing happened to us before, in December 2005, when we consulted on the issuance of our first ultra-long bond. One idea that I thought was a good idea then was an annuity bond, where the cashflows are effectively annuities. So in the case of a 20 year conventional bond, for example, the investor would receive the same annual cashflows over the life of the bond comprising a growing portion of principal and falling coupon repayments — so avoiding a large principal repayment at maturity. I thought that would be a very popular idea because it would much more closely match the liabilities of pension funds buying long dated bonds.
Again, to my surprise there was virtually no positive feedback whatsoever. It became clear that the market wants standardised, liquid instruments and if you deviate from that format your primary dealers are less interested.
EUROWEEK: In terms of innovation, the DMO has made good use this year of the post-auction option facility. To what extent have borrowers around the table made amendments to their auction techniques?
Oberndorfer, Austria: The auction mechanism for Republic of Austria government bonds includes a non-competitive bid feature on the day after the auction. This is a well-established means of recognising the efforts of the primary dealers. Eligibility depends on how active dealers have been over the past few auctions.
Daube, Finanzagentur: The post-auction option facility has not come up in our talks with Bund bidders. However, should that prove to be a successful add-on to auctions, we will certainly remain open-minded about it.
Taor, Barclays Capital: It’s not an innovation, but an important change this year has been that issuers have ensured that they have a more active dialogue with their primary dealers. They’ve been asking for more feedback about where demand is strongest in order to extract the most value from their auctions.
McGregor, BAML: I’m of the old school, which says that if it’s not broken there’s no need to fix it. Markets have come through a very tough period very well indeed, so although there may be some tweaks such as the ones we’ve seen in the last with the UK introducing mini-tenders, I don’t see the need to make any major changes.
EUROWEEK: What do issuers expect from the inflation-linked market in 2010? As France has made extensive use of this market, would the AFT welcome more issuers coming into this asset class and bolstering liquidity in the linker sector?
Mills, AFT: Of course. To have a deep and liquid market is a good thing for everybody. So to have supply from countries like Germany or Spain is very positive. At the peak of the crisis we saw that linkers were less liquid than nominal bonds, so it will be interesting to see how much newcomers help to restore liquidity across the curve in the linker market.
We have taken a very cautious approach to the linker market recently because the level of demand at the end of 2008 and the start of 2009 was quite low, so we have not issued very much this year. But in the last two auctions we have been able to issue volumes at the top of the indicative range, so we are able to auction the same amount that we were issuing before the Lehman collapse. We’re hoping this is a good sign of recovery in the linker market, and we believe we will be able to issue a lot more in 2010 than we did in 2009.
McGregor, BAML: Obviously the more borrowers that come into this market the better. The entry of more sovereign issuers into the inflation sector will also encourage more investor bases to develop. When Germany entered the market, for example, it was noticeable that a new group of German investors emerged.
Nobody knows if inflation is 12 months or three years away in Europe, but everybody believes it will become an issue again before long, so the linker market is definitely one area where we are building up our capabilities. Looking out over the coming 12-24 months I think linkers will become a more entrenched part of the plain vanilla market, rather than being seen as a more exotic asset class.
Taor, Barclays Capital: The linker market has always been very important to us. Clearly volumes have taken a step back this year because we have been in a deflationary environment. But going forward it’s going to be an extremely important hedging tool for investors and a key source of funding for borrowers.
Bye, HSBC: The UK has been phenomenally successful in bringing inflation-linked deals via syndication because there is structural demand for this product in the UK which has not been satisfied so far by rising Gilt issuance. I don’t see any problems with the UK issuing a large volume of inflation-linked bonds either by syndication or auction. The DMO has had the market virtually to itself with minimal competition from the likes of Network Rail and the odd corporate.
The level of demand is less clear cut in Europe. Recent supply has tested the depth of the market. When France, Germany and Italy all came with inflation deals in quick succession it created an overhang of paper which investors weren’t able to absorb quickly. I definitely see demand returning over the course of 2010, but right now it is too early in the cycle.
Daube, Finanzagentur: Over a long term horizon we want to build up our linker market with regular issues and taps in benchmark size. As we do in the nominal market, to support liquidity in the linker sector we participate in our own secondary market.
The broadened investor base for linkers, however, does not always have the same demand across the whole curve. Finding the point at which strongest demand coincides with market conditions allowing for a reasonable cost of funding might be one of the main challenges that lie ahead for the inflation-linked market.
Leclercq, Belgian Debt Agency: Because our total funding requirement remains moderate compared with the large inflation-linked issuers like France, Germany and Italy, we have decided not to issue public linker bonds. But if there is demand from the private placement side we might decide to issue linkers under the MTN programme. In that case we would not keep the inflation risk on our books, but swap it into a nominal bond product instead.
Oberndorfer, Austria: Our strategy is similar to Belgium’s. So far, we have issued inflation-linked paper on a private placement basis only, because the economics of a public issue do not seem promising enough to us. We assume that most investors favour paper linked to the harmonised CPI which is not exactly the same as the domestic measure of inflation. The basis risk between the local and the European CPI needs to be borne by the issuer and should be compensated for appropriately.
Kiso, Barclays Capital: On the MTN side we are starting to see more interest in inflation-linked structures coming from the retail side as short term rates stay low and governments’ QE programmes continue. As inflation picks up next year I imagine we will receive more enquiries about structured inflation issuance with much longer duration.
Clarke, RBS: We spoke earlier about innovation. The inflation-linked market is still relatively young. It is still a specialist product and so for borrowers that want to explore innovative opportunities the inflation-linked market may be a good way to go, for a few reasons. First, as the phase of falling prices unwinds next year and we move into an inflationary environment, inflation-linked products’ time will come. Second linkers naturally extend the duration of a borrowers’ liabilities. So the inflation-linked market ticks a number of boxes.
EUROWEEK: To what extent are sovereign borrowers exploring the potential of retail targeted deals?
Leclercq, Belgian Debt Agency: We have a retail programme which has been in place since the early 1990s. Every three months we open a new retail line usually in the three, five or eight year maturities depending on where market preference is. But it’s not a programme that issues a great deal of bonds. This year we issued €750m in retail targeted bonds, which is a small amount relative to the total size of our funding programme. There is regular demand for the bonds from people just rolling over their redemptions but it’s not a product where there is a lot of appetite.
EUROWEEK: So that really is the Belgian dentist?
Leclercq, Belgian Debt Agency: Yes. Although the Belgian dentist usually prefers to go for something a little more funky!