Western European sovereigns alone will need to raise over €950bn in 2010 — no surprise then that the hearts and minds of the major international banks are focused on winning the mandates for the portion of that debt to be issued via syndication again next year. Jo Richards asks a selection of borrowers how they award this prestigious business and bankers on how they win it.
Sovereign syndications have been in plentiful supply this year — Eu153bn as of mid-November compared to Eu69bn in 2008 according to HSBC — and the business has been extremely profitable for banks.
But it is business that requires the entire might of the banks behind it — trading, sales, research, debt capital markets, syndicate, derivatives, MTNs, commercial paper, technology and, of course, a selection of senior management to be wheeled in and out at the crucial moment. Every aspect has to be fully committed and the entry cost is very high.
"The investment in being a primary dealer is far more than buying bonds in auction and secondary trading," says Stuart McGregor, head of EMEA frequent borrower coverage at Bank of America Merrill Lynch.
"You need a dedicated trading team and distribution network, a meaningful investment in technology to participate in the various trading systems and to monitor market moves and size of trading. In addition, with non-domestic issuance, many sovereigns currently have one-way collateralised swap agreements in place that can prove capital-intensive."
And sovereigns are very demanding clients with a long list of requirements and each has a different methodology for grading its primary dealers. Long gone are the days of best price wins the deal. To stand a chance of winning mandates, dealers have to be positioned high in a sovereign’s ranking.
"We could not win a mandate from a sovereign unless we were able to get high marks across the whole scorecard," says Sean Taor, head of SSA syndicate at Barclays Capital. "It is more the whole package than one specific aspect that wins mandates.
"We have to be strong on trading and distribution. The DCM role is crucial. Knowing your client is probably more important now than it ever was because of the volatility in markets. Syndicate ties in all those pieces and it advises the client on the technical aspects, such as pricing and timing."
But despite the high cost involved, sovereign business is now central to a bank’s strategy in debt capital markets.
"Sovereign business is the most important franchise we have," says Taor. "It might not be the best paying franchise but it gets the biggest focus globally from the senior management because sovereign business gives a footprint into the country and opens doors to other business."
Primary market share of primary importance
For the frequent issuers, the most fundamental requirement in choosing lead managers in domestic currencies remains primary market share in auctions and the share varies from country to country.
Belgium, for example, requires a duration-weighted basis of at least 2% in its treasury certificates and OLOs, the UK 2.5% and Italy a minimum of 3% up to a maximum of 6%. Germany, which does not have primary dealers but has 28 banks in an auction bidding group, requires its members to buy at least 0.05% of annual volume.
Anne Leclercq, director of treasury and capital markets at the Belgian debt agency, says awarding a mandate is a recognition for primary and secondary market work carried out by primary dealers, together with the qualitative advice given throughout the year.
"We have an elaborate evaluation system that takes into account both long and short term performance," she says.
"Our primary dealers are ranked in accordance with their primary market share, which is duration weighted, and on their secondary market shares in various sub-sections. Customer volumes are most important as is e-platform business, which requires a lot of work and attention because a primary dealer has an obligation to make markets and provide price transparency. Final distribution to real money investors is also key. Inter-dealer volumes are taken into account but that has the lowest rating."
Leclercq also looks at different elements like advice given, the marketing banks can arrange, how the roadshows went, what new pockets of investors they can find and how much they contributed to the roadshow. Contributions to Belgium’s commercial paper programme and MTN programmes are also taken into account.
As one of the more frequent issuers, Republic of Italy also has a very sophisticated method of ranking its primary dealers but, when choosing its lead managers, market share alone does not win a deal.
"We look at the ranking of our primary dealers to see how they are performing in the primary and secondary markets," she says. "But, if a bank in the low part of the ranking has strength in the particular segment in which we want to issue, we will consider them. First of all, we want our transactions to go well, so we want a bank that has experience in the particular market we are looking at and one that has strong distribution to good quality investors. We want a transaction to be priced correctly and for the execution process to be smooth. Also, the capability to be confidential in the preparation phase is important."
Italy’s euro transactions typically have five lead managers and its dollar deals three and Cannata always tries to ensure that the banks can work well together.
"We want the group to be in agreement on how the transaction should be developed, what they see as correct in terms of value and type of investors," she says.
At the same time, Italy tries to avoid giving mandates to the same banks.
"We want to involve as many primary dealers as possible in our syndications," she explains. "If it is in line with our target of having a good transaction, we do try to have some turnover."
Being a primary dealer in multiple jurisdictions also helps win sovereign business says PJ Bye, head of public sector syndicate at HSBC in London.
"It shows you are active in a broader range of government product and so will see more cross-border investor flow than specialist houses. That is definitely a differentiating factor when issuers choose banks for the top line and for the duration management role."
Secondary share
Secondary market participation is equally important for most issuers, which require their dealers to contribute an individual share roughly equal to that achieved in the primary market. Quoting effective bid/offer spreads in regular market size and posting prices on e-platforms are also prerequisites.
Germany first and above all takes primary market participation into account when it awards its very rare syndications, of which there have been only four in the last nine years — two in euros (both inflation-linked bonds) and two dollars bonds.
It requires the members of its auction bidding group to buy 0.05% of annual issuance volume but while a bank’s secondary market activity is appreciated by the German debt agency, it does not count when mandates are being awarded for syndications.
"The Finanzagentur itself operates in the secondary market so we are different to our peers in Europe," says CarlHeinz Daube, managing director at the German debt agency.
"We do very much appreciate secondary market participation of our banks but we do not closely monitor whether and to what extent they participate. Quite a number participate for Bunds and Bobls, others for 30 year issues and inflation-linked, and quite a lot participate along the whole curve but it is completely up to them. It has no affect on which banks are mandated for our syndicated transactions.
"We first look at whether a bank is specialised in the particular instrument we are going to sell. Then we look at a bank’s participation in auctions in the course of the last years and whether a bank has been mandated by Germany for a syndication in the past. We like to be transparent in our decisions."
Next year Germany is planning a 30 year linker, the first in its history, and Daube expects the deal will be syndicated.
"If we do issue a 30 year linker next year, we will look at where banks rank in 30 year linker league tables. Then we would compare where these banks are graded on our ranking system. It is basically just a ranking on figures, so, if there should be any complaints that Germany is more in favour of bank x than bank y, it can be justified in a transparent way."
The extras that count
Many sovereign issuers set great store by a bank’s participation in T-Bills, commercial paper, derivatives and liability management.
The Republic of Finland is a case in point. Next year Finland will have two or perhaps three syndications, instead of its traditional one per year and its business is always hotly contested for by its primary dealers.
"What we have to do is not only primary business but secondary business and overall debt management as well," says Ari-Pekka Latti, deputy director of the Finnish State Treasury.
"It also involves a wide variety of debt management, including derivatives, liquidity and repos. That is the kind of palette we have here at the state treasury and we expect our primary dealers to be active in many of those activities.
"Before 1998, debt managers used to award mandates on how much a bank bought in auctions. Then we and others added secondary market liquidity and looked at a bank’s turnover in various other instruments as well. In recent years we have added liquidity management, reverse repos and also derivatives volume plus qualitative evaluation on collaboration overall. It has to be quality traction between us and the banks and the best banks are those that can and are willing to combine their resources for our use."
Apart from ranking and competence in specific markets, the advice given to clients is key to winning mandates, says Massimo Antonelli, director in the frequent borrower group at Royal Bank of Scotland in London. "The quality of advisory services that a bank offers to the client plays a very important role. A bank needs to put itself in the issuer’s shoes and help them to answer some important questions. These could include: does the deal make sense strategically, is it a good practical moment to issue, are there any risks involved, what message do I want to convey to the market, how are investors positioning, what is the best price I can get away with to be efficient for the tax payers while not putting off investors, what is the best execution strategy? Once you are able to answer all these questions and convince an issuer that the time is right to issue, you are in a strong position to be in the close circle of banks that could potentially be short-listed."
Another set of rules for dollars
Dollar issuance has been in vogue this year for European sovereigns and is likely to remain so in 2010 as issuers continue to seek new investors to take down their debt.
A different set of criteria are used for awarding dollar mandates, which for most sovereigns is based on arbitrage as they have to beat domestic funding costs, and sometimes the deciding factor is price.
"Sovereigns, unlike some of the supranational and agency issuers, do not tend to award strategic mandates on the tightest bids even for their arbitrage funding," says Bye from HSBC. "In euros, there is less focus on the last basis point. It is more about the strategic advice, execution ability and quality of distribution rather than the most aggressive price.
"On the dollar side, there is more focus on price because these borrowers are often dependent on the arbitrage. They have to beat domestic cost of funds to justify doing the trade but even then they do not tend to award mandates via formal bidding competitions."
Experience in executing dollar bonds is high on the list of borrowers’ priorities when choosing its leads.
Bank of America Merrill Lynch’s McGregor says that while primary dealer rankings are still important in foreign currency issuance, they are not as formulaic as in domestic transactions.
"A proven track record of leading successful deals is obviously key but advice on market conditions, arbitrage and execution risk is also significant," he says.
"The biggest hurdle for a borrower in the dollar market is negating execution risk so you want a lead manager who is active in that market, someone who has been involved in recent transactions and has a proven track record. That is where trust comes into it — trust in the advice being given. It is very important to understand what a client wants to achieve when they issue in foreign currencies."
Pressure builds for 2010
Choosing lead managers will be even more crucial next year as, not only are sovereign syndications likely to increase given the success issuers have enjoyed in 2009, but bankers believe sovereign deals will face increasing competition in what many predict will be a spread widening environment.
Paul Tregidgo, vice chairman of debt capital markets at Credit Suisse, says that, while the questions borrowers ask remain the same, a lot more attention is paid to the answers. "Due-diligence by borrowers has always been strong, but I think banks are really put through their paces now, and properly so, because the consequences for the client of banks not delivering a decent execution to the market are much more significant. The consequences of a failed or poorly executed deal in the context of much larger financing requirements are greater than in the days of commodity issuance for relatively limited size. There is increased attention now on the quality of execution."