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Thursday, 23 November 2017

DCM 2006 - First mover advantage

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The habit of larger institutions to fund at the beginning of the year, or front load issuance, has increasingly become a prominent feature of the SSA market in recent years. While it has been historically cost effective when responding to investor demand, is it necessarily the right course of action? Rachelle Horn reports.

Supranational, sovereign and agency (SSA) issuance from European borrowers in the first quarter of 2005 amounted to €292bn equivalent, more than double the same period in 2001. As a proportion of the yearly total, first quarter issuance has become increasingly important over the last five years. In 2005, for example, it amounted to 42% of the annual total, while the €61bn issued in Q1 2001 translated to just 33% of the final amount for that year.

There has clearly been an increasing trend of larger borrowers front loading, and the driving force behind this development is clear to see. Borrowers with higher volumes to raise are naturally keen to get their funding underway and this preference invariably coincides with strong demand present from investors at that time of year.

"It is apparent that if you look to the beginning of the year, the investment community is in a period of reset," said Christopher Marks, head of investment grade corporate DCM at BNP Paribas and previously head of European SSA. "There is a necessity for investors, having licked their wounds or celebrated the previous year, to express their views in the market."

"It is effectively a self fulfilling prophecy," explained Carl Norrey, head of SSA at JPMorgan. "Investors and issuers both have reason to promote this feature of the market. Sovereign issuers for example, whose funding requirements are linked to a much more rigid structure, are often keen to get ahead in their funding, while investors, whose willingness to participate and invest is maximised in January, are looking for a market with transparency and liquidity."

Investor demand aside, when looking at the year as a whole, Marks also points out that: "If you slice into the year there aren't necessarily that many workable weeks. By the time you have excluded most of July and August, especially in Europe where a large number of investors are away for extended periods of time, and with Thanksgiving effectively signalling the close for the year, you only have six or seven months of real working time, the majority of that being in the first quarter."

The right approach?

More than just a first mover advantage, the tendency to front load effectively becomes self-fulfilling in that early issuance leads to early coupon payments and strong redemption levels in that part of the year. As such, the trend shows little sign of shifting, but as to whether it is actually a good thing for the market is debatable.

"Front loading of issuance helps to re-establish benchmark levels," explained Norrey. "You may, for example, have coupons that are off market, and as a

result prices that trade away from par may not be representative of where the market really is."

With borrowers ready and willing to create fresh supply in the market and investors eager to participate, a new secondary flow of activity is undoubtedly created. On the other hand, there is an argument that the smaller borrowers, who have more flexibility and the luxury of waiting, sometimes achieve better results. However, the ability to wait does not necessarily translate into better funding costs.

"The smaller issuers will probably have to wait for some of the large deals to come and go but when the second tier of frequent issuers does come to the marketplace, it becomes easier to determine within a very small range where the correct price should be, as you have more depth and consensus," said Norrey.

"It's more a matter of risk/reward analysis," said Stefan Goebel, co-head of funding at Landwirtschaftliche Rentenbank. "You may be able to raise funding very cost effectively at a later date, but you then have to make sure that the market conditions are favourable, and while you may have the full attention of investors, if there is no market window, you can simply run out of time."

EU accession countries have been quick to recognise that the early months of the year provide the best issuance window in terms of investor demand, with countries such as Hungary and Poland both issuing the majority of their total funding in the first quarter. In terms of cost efficiency, however, László Búzás, deputy CEO at AKK, Hungary's debt management agency, said: "It is not always a foregone conclusion that the best funding is to be found in the first quarter. For instance, last October we issued a €500m seven-year floating-rate note at historically tight levels for Hungary of Euribor plus 7bp."

While endorsing the trend has historically been cost effective for borrowers, "front loading of issuance has not been so much of a feature this year," explained Marks. "We have to differentiate between US dollars and euros, as those two markets are at very different points in the rate cycle. The dollar market has not been providing the kind of arbitrage this year that was previously available, so issuers have therefore had to rethink the levels that are available to them."

Indeed, total Q1 issuance in the European SSA sector has decreased for the first time for a number of years and is some 15% down compared with the same period of 2005. What remains to be seen is whether this indicates a relaxation of this trend and if so, whether it will result in a more opaque market.

As one banker put it, concentrating issuance at the early part of the year has, by and large, led to an improvement in liquidity and transparency. After five years of accepting this as the norm, however, the situation could be set to change as borrowers feel less obliged to conform to historic patterns.

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