Thursday, 13 December 2018

IFR Outlook for International DCM Roundtable 2015: Part 3

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IFR: What do the issuers think about this shift in the market, Morven? I’m referring to the allocation process, the ever-bigger buy-side pools, and the move to buy-and-hold behaviour etc?


Morven Jones, Nomura: Every issuer wants the best of all worlds. They want the best price, they want the right allocation and they want the deal to perform in the aftermarket. Getting all those things aligned is not always possible. Different issuers vary in the way they look at the market. Some are very focused on the distribution and the allocation; some less so. They just want a successful deal. They want the right price, they want the right size and they move on.



The obvious point really is that the banks have to make sure we inform, advise the issuers as much as we can on the market conditions. And on what the right behaviour is at a particular moment in time, in terms of the pricing, in terms of going for the size versus the book, and in terms of the allocation process. So it’s really a combination of those things.



IFR: To what extent do you think regulatory intervention in the allocation process or improving transparency around allocation is a good or a bad thing? I’m not entirely sure that regulators know what their end-game is but do you think for the long-term good of the market that changes need to be made in the construct of the new-issue process?



Morven Jones, Nomura: This is quite a sensitive point. My personal view is that the fixed-income market works very well in terms of the ability to distribute debt, in terms of the ability to allocate to investors. I think the process generally works well. If you went for full transparency in the sense that there wasn’t really an allocation process because you don’t make any judgement as to where you allocate bonds, you end up just with an auction.



I think there is general acceptance that resorting to an auction for every debt-raising situation is not the right way to go because of the importance of distribution, the importance of allocating to proper end investors, maintaining a stable secondary market, and all those things. Putting it all together, my view is that the market works pretty well. Are there areas where you might tweak it? Possibly. But I think fundamentally, it’s proved to be pretty successful.



Fred Zorzi, BNP Paribas: I share Morven’s view. Is the regulator right to ask the question? Yes. It’s a fair question. But the proof of the pudding is in the eating. I agree the market has worked quite well and it’s the banks’ responsibility to make sure that this market works.



Everybody knows about order inflation. The banks try as best as they can [to deal with it]. They certainly don’t promote inflation but it’s something the regulator, at some stage, will need to look more closely at. A lot of firms have internal compliance rules that don’t allow them to inflate. Some don’t; I think it’s the minority. But it’s very difficult to fix an average.



Auction processes are neither in the interests of real-money investors nor in the interests of issuers, which could well see their primary and secondary pricing widening. The best way to answer any regulatory concerns is [promoting] best-practice and in the way the bond market functions. And if I look over the past 12 months, I personally think that’s been the case.



Soren Willemann, Barclays: On this issue of transparency versus allowing issuers to decide who they borrow money from. I have a hard time seeing how you can reconcile this into a pure auction [context]. If you have a pure auction process, it’s like a lottery. An investor gets the bonds. Fine. But they can sell them the next day so you risk having people flip the bonds in the secondary market instead of finding the people who really want to own then.



Morven Jones, Nomura: Let’s be clear. In a pure auction environment, on the one hand you can say: “OK well I’m addressing all the transparency points and so on, and I’ve removed all levels of judgement required in terms of where the bonds go and how they’re priced, etc”. But the other angle is there needs to be an after-market. There needs to be a service for investors to be able to sell positions when they need the liquidity. So there is inter-dependence here between both the primary market and the process, and the secondary market to support the ability to generate liquidity on an on-going basis.


IFR: What roads do electronification or other tech solutions take us down?



Fred Zorzi, BNP Paribas: It’s coming and it will be different. Several banks, including us, are working on direct access for investors. But what will it mean? It means the time in getting information from the issuer to the investor will be shorter. It won’t mean the end of the salesperson. The salesperson will have more time to bring added-value rather than doing book-keeping and taking orders. So that’s one step and I will think it will improve the dialogue.



In improving transparency and allowing accounts to place orders directly, it’s going to be a lot more difficult for investors to hide behind a salesperson if they inflate orders. Will it lead to some issuers willing to do auctions? We’ve seen it in the past but it hasn’t worked. It’s a cycle; every three to five years it will come back. Electronification is the way the market is evolving but for me, it’s more to give more information to investors rather than giving more power to issuers.



At the end of the day, every investor is a lender to an issuer. There needs to be a relationship between the two. Like all lending relationships, it has to be based on trust; it has to be based on confidence. I don’t think automatic processes are going to get us there of themselves.



IFR: By all means comment on electronification but my follow-up question as we look ahead is on the issue of the consumption of sell-side research under MiFID II. Is this something on your radar screen or on the credit market’s radar screen?



Soren Willemann, Barclays: Absolutely. On research, the rules aren’t final yet, so we don’t really know how the unbundling story breaks down between equities and credit but we’ve definitely been looking at it very closely.



One thing that’s probably going to come out of this is that as with many attempts from the regulator to increase transparency, second-order effects are not necessarily well understood. One of the effects could be that it will massively benefit the big banks and big asset managers because large asset managers have people who can do the analysis while smaller funds will have to pay hard cash to people such as me in a big bank who have the resources to do the analysis.



So you get more transparency in terms of what you pay for and how the allocations break down, but the end-game risk benefiting big firms more than it benefits the people in the street.


Ashish Dafria, Aviva Investors: Taking electronification and then the research questions, these are fair debate to have. They are linked. On electronification, I agree with Fred. How far it goes remains to be seen but it is a trend and it is going in that direction.



What needs to be tied into the overall regulatory discussion is: does that lead to or that should lead to changes in the new-issue process? One of the things that got talked about is standardisation in the fixed-income new-issuance process. Not quite all the way to where equity is, but something along those lines. It’s an idea of worth debating, worth considering.



From the MiFID II regulatory perspective, as Soren said, it’s at a stage where the rules are not final yet, so it’ s little bit premature to comment on it. But from our narrow perspective, we don’t view it is a risk. But it is important for the regulator to have an open dialogue with all parties, because to Soren’s point, I think it has potential to impact overall functioning of the market.



IFR: I wanted to move on to look at 2016. What’s the issuance outlook?



Morven Jones, Nomura: If we’re looking at the international bond market, volumes have been down this year, driven partly by declines in SSA; not necessarily because of market conditions but because we’re emerging from a crisis and there has been less need for debt from those entities.



The bank sector has been down quite a bit. Some of that has been due to less need due to shrinking balance sheets but it’s also our observation that quite a lot of banks have just held back from issuing because they’ve not liked the conditions; they’ve not liked the pricing and they’ve been able to avoid having to go to market.



On the corporate side, it’s been a pretty robust year. Corporates are still carrying record amounts of liquidity compared with before the crisis and I don’t really see that changing. Debt-financed M&A has been pretty buoyant so that’s been a pretty strong market.


Next year, I think the public sector will be similar; maybe a little bit down on this year but not that much. Corporates: it’s more difficult to tell although I find it hard to see a big uptick in corporate supply.



FIG is probably the area where we expect quite a bit more as the banks respond to TLAC and MREL. As those things hopefully become clearer, it will give the banks a framework against which to really start deciding what they need to issue and how much. That’s probably where we expect the biggest increase in activity relative to this year.



Ashish Dafria, Aviva Investors: I think the conditions remain in place for a healthy year in issuance next year. Some of the things we talked about: the late cycle US behaviour and issuance from that segment into the euro zone are likely to remain a theme; European disintermediation is likely to remain a theme. As the cycle advances in the euro zone itself, I think that should lead to issuance.


From an issuance perspective we tend to talk about gross issuance but for investors, it’s important to think about issuance net of redemptions. Next year is a meaningfully lower redemption year. It typically follows a five/six year cycle so next year redemptions are lower. Automatically from our perspective, it means a higher net supply.



Fred Zorzi, BNP Paribas: I think M&A will continue to be a driver. Simply looking at high-yield this year, whether it’s in Europe or in the US, M&A has been responsible for more than a third of the use of proceeds; way more than LBOs, which were less than 10% of the market. So M&A will remain a key driver.



I think the wild card is on the financials side. Yes, TLAC, although the banks will have until 2019 as a first step so I think it’s going to be gradual. The question is going to be: are we going to have unified TLAC rules? Is it going to be different by country? I would say at this stage, it’s difficult to say. And that’s going to be important because banks will only start issuing when they have clarity. So depending on where you are, we expect more supply.



Everybody talked about a shortfall of potentially US$600bn and everybody was predicting a massive shortfall in Tier 2 but we are still waiting for the issuance. We should at least continue to see at least a steady development but it’s going to be challenging and volatile.



Soren Willemann, Barclays: Picking up on the demand point, one thing that will be different next year compared to last year was that a lot of the rally we had at the beginning of this year was because of the ECB: QE displaced a lot of investors from government bonds and covered bonds into corporate credit. We don’t think that’s going to happen in the same way if the ECB expands QE.



The other aspect is that after what happened with Volkswagen and Glencore. All the people who left covered bonds or Bunds at -20bp for highly-rated Germany companies got their fingers burned owning Volkswagen bonds. They’re probably willing to accept -20bp/-30bp on a Bund, rather than having to take that loss one more time.



So we think the ability of ECB QE to affect the corporate credit space in Europe is going to be much reduced. It’s going to depend much more on what happens in the US around how much American companies are going to issue into Europe given the spread pick-up people can get here. It’s going to be much more determinate for our spreads than the ECB.



IFR:I’d like to go back to you, Ashish, on the issue of this financials. We have agreement that we’ll see more financial issuance but I’m very curious about differential pricing between the various buckets of capital and funding from AT1 right up through to senior.



Bearing in mind bail-in, the expectation is that senior debt will have to be much more richly priced to find real favour with investors. How much time do you spend on relative value in FIG debt issuance?



Ashish Dafria, Aviva Investors: Quite a bit. And the real answer ends up depending on what week it is, and what jurisdiction you’re talking about. And I say that only half jokingly, because there is a lot of uncertainty around how this evolves.



But we view it as a pretty ripe area for us to pick relative value and generate performance. And you’re right; it does have implications not just from a fundamental bank perspective, but what it all means in terms of overall issuance.



We certainly have positions and views but it’s dynamic and it’s evolving. And it is different for different jurisdictions so it’s a very different discussion we have for US preferreds as opposed to AT1 here.



Audience question: Soren, you talked earlier about the link between the VIX and the new-issue calendar. Who initiates that, the issuer or the investor?



Soren Willemann, Barclays: That’s a very good question. From our perspective, we care about this as we need to think about how much we can expect to see in the secondary market and how much inventory we have to carry. The European market is quite different from the US in the sense that there’s much more dialogue between investors and issuers. In Europe, it’s the issuers who are very concerned.



Investors signal a disinclination to buy because they’re uncertain. And issuers wait until things are more stable, so from our side, on the secondary trading side, it feels like the issuers who fall back because they sense that the investors are not there.



Ashish Dafria, Aviva Investors: And you need to be aware of the link between strong performance and inflows. The link between high inflows and strong performance is quite tenuous. It’s somewhat academic but there is a stronger link between higher performance and inflows. If you have high performance, you’ll start to see the inflows, with a lag.



IFR: Gentlemen: thank you for your comments.

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