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Thursday, 23 November 2017

Non-Core Bond Markets Roundtable 2006: Transcript

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IFR: Issuance in non-core currencies is primarily driven by arbitrage, but to what extent does diversification play a part in the decision-making process?

Eila Kreivi (EIB): For the EIB, given the size of issuer that we are, the diversification really plays a larger role for us in the overall picture than, for example, arbitrage conditions would. We have to fund around €50bn a year and last year we did some 13% of that in non-core currencies, which for us includes everything other than euros, US dollars and sterling. In the first couple of months of this year, we have already done more than half of the total amount that we sold in the non-core market last year, which means that at the end of 2006 we will have significantly increased our volumes in these markets.

There are also other factors for us. In areas like Eastern Europe, the Balkans, the Mediterranean and parts of Africa, we have a pioneering role to play, together with the authorities, in opening up new markets. In some of those cases, we have been somewhat easier on our targets in order to get certain deals done, so for us, diversification is really the key.

Michael Gower (Rabobank): For us as well, diversification has always been one of the key reasons why we look to new currencies. Clearly Rabobank does not benefit from any supranational or sovereign guarantee in the way that the other issuers around the table do and to that extent we do not necessarily have the pricing tension possibilities that are perhaps available to other Triple A rated issuers. The arbitrage available in these currencies is attractive and many of the investors who buy niche currency paper are not the standard names that you seen in other transactions. We think it is very important to push these currencies. The EIB numbers are very interesting as ours are very similar and of the €22bn we raised last year, more than 10% came from niche currencies.

From a cost perspective it has clearly been the most attractive funding out of anything we have done on a senior basis. As a bank, as well as a Triple A, we also look to be an innovator in markets and try to work with a lot of local authorities in opening new markets for financial institutions as well as for other Triple A borrowers.

Stefan Goebel (Rentenbank): In 2005 we raised roughly 30% of our medium and long-term funding away from US dollars or euros. Three years ago we would probably have looked at the non-core currencies merely from an arbitrage perspective and would have expected funding levels to be better than in euros or dollars. Now it is US dollars that generally provide the best arbitrage and the euro cost of funding is also improving.

Still, the arbitrage from non-core currencies is satisfactory overall, but the diversification of the investor base has become increasingly important and we take a strategic approach to non-core currencies, providing that two criteria are fulfilled. First the currency should have a proprietary investor base that cannot be tapped into with the core currency product.

Also, there should be a reasonable likelihood that there will be persistent demand from this investor base across the entire maturity spectrum.

Dean O'Hara (RBC Capital Markets): Initially, these markets were viewed as a diversification play, but what we are finding from the borrower side is a big question mark as to whether those markets are sustainable enough to develop a genuine funding base on an ongoing basis. That is something that we are often asked about the Australian dollar market.

What is more important now to some of the borrowers is the sustainability of those non-core markets going forward, where diversification and arbitrage have clearly been the first points on the agenda. I would like to think that Australian and Canada are two markets that are certainly going to be sustainable given that we have reached critical mass in Australia and expect to see the same in Canada over the next few years.

Holger Kron (Deutsche Bank): If you look at the smaller currencies, then borrowers are obviously looking to reach a new client base. If a borrower on one side, and an investor on the other side are going to approach us with certain demands, for one it is an arbitrage deal and for the other it is diversification.

But betting on these currencies means that you are entering an area where liquidity is usually pretty poor – perhaps not in the Aussie or Canadian dollar markets – but if you look at all the other currencies like Icelandic kronor, for us as a liquidity supplier, the key question is how we can sustain these markets going forwards to support the service to both issuers and investors.

Amir Hoveyda (Merrill Lynch): Our experience points to four drivers from issuers considering non-core currency markets. Definitely it has to be attractive from a cost of funding perspective, but that is just one part of the equation. The other is the appeal of a strategic diversification of the investor base, but ease of documentation is something that we have certainly come across, and in that respect, the Canadian dollar market is a particularly easy market for issuers to access.

Finally, a liquid swap market is a pre-requisite, because seldom do non-domestic issuers want to keep the proceeds in the local currency in question. In the Maple bond market for example, the largest and most sophisticated issuers are looking at all of these components in choosing which markets to access.

IFR: But are these markets likely to be only attractive to institutions with very large borrowing requirements, and therefore a need to diversify, and are these markets going to remain forever niche?

O'Hara: I think Amir is right in that the cost of entry into those markets can be determinative of whether a borrower enters that market. It is certainly the case in Australian dollars and in Canada that the port of entry is relatively straightforward and as a consequence, smaller borrowers can access that market on an ongoing basis. But the barriers to entry in some other currencies are much higher, making it difficult for smaller borrowers or those that have no name recognition.

Hoveyda: I think these markets will evolve. Obviously name recognition is a key driver for the first wave of issuers, but once a market has been established it is open for lesser known names. There has to be some name recognition for a market to get going, but once that has been established, the market can move on. In the Canadian dollar market, we are now looking at names that we would not even have considered as potential issuers 12 or 15 months ago.

It is similar from a structure perspective, in terms of access to the capital space, we obviously did a lot of work, starting with the most investor friendly form of regulatory capital, and we are now looking at moving beyond that into more subordinated, perpetual forms of capital. So we are definitely seeing greater receptiveness by the investor base to less recognisable issuer names as well as more subordinated and more complex structures.

Gower: I think that there is also a very noticeable split in the nature of the investors in these emerging currencies because whilst name recognition is ultimately very important, particularly if you want to be able to diversify from a structural perspective, there is clearly still a lot of ratings sensitivity.

For European retail, which represents a significant portion of the market in Slovak koruna and Hungarian forints, there is less name sensitivity than ratings sensitivity, particularly where smaller borrowers are concerned. If you have a Double or Triple A rating, even if you are not very present in the market, I would still imagine that there is a fair amount of access to cost efficient funding.

Kron: It really depends on the development of the market. In Czech and Slovak especially, we see that domestic accounts are willing to buy on a ratings basis so a lot of issuers can enter the market even if they have not been present in niche currencies before, but for Mexican pesos at the moment, there is not such a good window for unrecognised names. There are differences in each individual market, but generally, if you have domestic accounts looking to buy the currency, then they are much more open to lower tier names.

Kreivi: I think that we have seen this in Eastern Europe where the EIB has probably opened most of those currency markets. We have typically been the first issuer and others have followed, but when there are no active issuers left, then we have moved on too.

IFR: What is the scope for growth in some of the new currencies that were opened in 2005? We have talked a bit about sustainability but is there medium-term value for investors, and what are the opportunities and risks in some of the very newest currency markets?

Kron: I would like to start with the example of Icelandic kronor. Until the middle of last year there was nothing in the currency, but by the end of the year there was somewhere in the region of €2bn equivalent so obviously there was a very strong push with investors. The main borrowers were the Triple A names that usually enter new markets and the investor base is mainly professional accounts who wanted to play the carry trade.

In the end we have come to the question of sustainability – the market had a setback by Fitch downgrading the rating and the currency took a 12% dive. Investors lost not only the carry, but a lot more. Ultimately we are talking about a country with a population of just 300,000, and within five months €2bn equivalent was drawn into this tiny currency.

Obviously high yields are the main driver of new markets and in the current low-yield environment, investors love to buy double-digit yields, but in the process, they are probably missing something on the risk side.

Opportunity versus risk is a key question and I have a feeling that is sometimes a part of the research that has not been done. These currencies offer an opportunity and as an investor, you can significantly boost returns but proper timing is essential and going into a country like this before the currency moves can be very risky. In Eastern European currencies, we have seen that if you invested after the currency weakness, you had very good returns.

As a general rule, I would say that the first question should be about currency risk and the second question should be about the opportunities and yields on offer. For an issuer it is an important question too as a bad investment can eventually be damaging.

IFR: So you are saying that it is not just a question of sustainability but also one of responsibility?

Kron: Of course. Why does a borrower sell niche currencies? Because they want recognition and diversification and the ability to grow their funding capabilities, and with the sort of currency move seen in Icelandic kronor, you can really harm those goals. It is unlikely to harm the bigger names, but those who try to become more active in those markets can really suffer. It can be a very risky route to go into niche currencies if you do not get the risk perspective right from the beginning.

Hoveyda: Maybe it is also important to distinguish between certain non-core currencies where there is a legitimate domestic underpin, which is the case for the Maple bond market where there is C$1.2trn of pension fund money that has just been unlocked and is looking for a diversification play. If you look at the Mexican peso market, the three largest investor categories; pension funds, mutual funds and insurance companies together account for US$115bn of assets under management with between 18% to 25% of annual growth over the last six years. That is a legitimate domestic market that underpins the foreign issuance and offers a very different proposition to those currencies that are really being bought by non-domestic investors expressing a view on the currency and only really looking for a yield pick-up.

Kreivi: I agree with you. Where you have the support of the domestic investor base, I think there are better prospects for sustainability in the long-run. The Mexican peso development is very interesting as we have a retail-oriented market emerging in Europe that has been followed by domestic interest and now, the two are beginning to come together as a single market.

We have also sold more than half of our Botswana pula bonds into domestic investors and the Egyptian pound transaction saw a reasonable stake going to domestic accounts.

Gower: What has certainly caught us by surprise is how quickly the domestic markets have become institutional. In a lot of these currencies one would assume that it is a retail play or perhaps a hedge fund or euro convergence play, but increasingly all of the more obscure currencies have become dominated by institutions which, from a reputational perspective, make us feel a lot more comfortable that there are investors taking an educated and experienced view on buying paper.

As Amir said, there are real investors looking at this stuff, and once you get the domestic markets really developing, it is good for everybody – underwriters, investors and borrowers, and with a bit of luck, those markets are here to stay.

Goebel: I have the impression that it is first the non-domestic investors who show an interest in getting exposure to a specific currency and are looking not only for a deposit product, but also for a more bond-like product. Then the banks and investors force the development of a yield curve in that currency that had not existed before, and probably would not have been established from the domestic issuer and investor base as quickly.

Rentenbank is typically a trend follower rather than a leader in niche currencies as we need external market data on swap rates for our mark-to–market requirements to get new currencies signed off. We monitor all of these new markets and after the first few trades you tend to find the interest rate curve being published regularly and after that comes the swap market. Sometimes the swap curve is there before the bond curve, then it extends, but in the majority of these currencies, the development seems to be pushed, at least from our perspective, from the outside.

IFR: There seems to be a lot of kudos attached to being first into a market, but should sustainability be a requirement before banks and borrowers jump into these markets?

O'Hara: From our perspective, sustainability has become increasingly important. The Icelandic kronor issue that Holger raised is clearly something that we see, as a firm with a reputation, as somewhat of an issue. Internal discussions about emerging market currencies and whether we will be in them or out of them, are ongoing. Those that appear to be unsustainable we prefer not to be involved in but that can change over a period of time as those markets develop. Some currencies that are not sustained by a domestic core market have shown greater volatility and we have seen that play out in Icelandic kronor, where there is probably not a core supporting domestic bid.

Kreivi: From an issuer's point of view there is high reputational risk in being first into markets and although we have opened many markets, we continue to decline certain currencies or structures for this reason. Any market that we are active in has to have some maturity before we do anything because we have quite stringent internal requirements.

For example, we have to be able to value these deals, and there has to be enough liquidity and information about all the necessary parameters such as rates and swaps before we even enter a market. Even in the mainstream currencies, we have to consider the reputational risk when looking at new structures.

Kron: To be successful in any market, you do not need to have the first print but you should be in the first wave because investors and borrowers will only listen to your ideas if you are actually in the market rather than watching from outside. Certain markets are very difficult to enter as the swap market and domestic liquidity might be a problem in creating deals. Sometimes you need to look at alternative structures, for example exposure to Brazilian real is only possible by a currency linkage but it is a great currency with a very good story and we think it is important to be active in that at this early stage of development.

Sustainability is very important – you need to be able to sell the investor something that is worth buying and that is far more important that being first into any market. On the other hand however, if an investor asks to buy a certain risk, it is part of our job to deliver what the client wants and we aim to assure an ongoing service to our clients. We are actively pushing in markets, but only where we believe there is some sustainability.

IFR: The abolition of foreign content limits for Canadian fund managers has unlocked a massive pool of funds. Technicals obviously remain important for the market to develop, but to what extent will this new-found demand drive issuers into the market even if technicals fail to shift in issuers' favour?

Hoveyda: We have seen the cost advantage erode over the last 12-18 months but that has certainly not diminished the volume of issuance in the market.

The appeal of strategic diversification, the ease of access from a documentation perspective and the liquidity of the swap market are all elements that continue to drive the attraction of this market for issuers.

As the investor base matures – and that is something that I think were are certainly seeing – the number of investors participating in new transactions has grown considerably. When we did the C$700m deal for RBS last year, which was a very large transaction for that market, we saw the number of investors in the mid-teens and that worked well, but with more recent transactions such as Network Rail and MetLife, we have seen in excess of 30 investors participating.

In the same way that it is the most sophisticated and largest issuers that are first to jump into new markets, from an investor perspective, it is the bigger and more sophisticated investors that are the first to take advantage of the regulation change, but now others are following.

The depth of the market is certainly increasing, and that furthers the appeal of accessing that market from a strategic perspective rather than just an opportunistic arbitrage driven consideration, and also increases the size that can be achieved in those markets. So we are optimistic about the sustainability of the Canadian dollar market, even if, as we have seen, the arbitrage is, over time, eroding.

IFR: You say you need to build a mature investors base, but in Canadian dollars there was already an existing mature investor base, they simply had the foreign investment restrictions removed.

O'Hara: I think the parallel to draw is against the Australian market, which we have seen evolve over the last five years and we expect to see the evolution of the Canadian market occur in a similar manner. Initially there was a finite universe of borrowers prepared to commit to the market so early, the Triple A borrowers were first, followed closely by financial institutions, which see the market as an opportunistic diversification play.

Then, as we are seeing in Australia at the moment, a reduction in the ratings criteria from the investor base will bring more Single and Double A names into the market. As Amir rightly points out, there is a continuum of products that will then evolve once the senior debt market is properly established, and I think that we are not too far away from seeing that happen in the Canadian dollar market. We saw a wave of issuance in 2005 and even heavier issuance at the beginning of 2006, which only points to the evolution of that market through the remainder of this year.

Gower: Another very important point that we considered when we first went into the Canadian market two years ago, prior to the emergence of the Maple bond market, was that fundamentally there is such a lot of cash in that market relative the rest of the global investor base, that for an issuer like Rabobank, it is simply too big to ignore. Even before the foreign content rules were lifted, we priced a C$1bn five-year in late 2003. The response from the domestic investor base was quite surprising and everybody was asking why a European bank would want to borrow in Canadian dollars.

O'Hara: I think the impetus for investors in Canada to be outward looking has been the abolition of foreign content rules and now that foreign investment is on the agenda, investors have the ability to step outside of their domestic comfort zone. Two years ago, international issuers were something of an anomaly in Canada, but borrowers like Rabobank going in early have been an important catalyst for investors to take a look at new names.

Gower: Unfortunately the arbitrage has moved away over the last 12 months, but markets are dynamic and Canada has certainly established itself as a viable alternative for large volume borrowers. For the issuers sitting around this table, I think it is an obvious alternative when moving away from the core three currencies and in volume terms, there is significant opportunity available for anybody wanting to issue in size. As in Australia, and sterling to an extent, the swap market and basis market have a huge impact on borrowers who do not have local reference currency.

We have been fairly open in saying we would have loved to have done more in Canadian dollars the last 12 months but we just do not have the need for the currency. There is sometimes a lack of understanding of how borrowers operate outside the confines of Canada, but as time goes on, with help from banks like RBC and Merrill Lynch, that education will take place and it will be helpful for borrowers without question.

Goebel: There is certainly a risk that the basis swap has a negative impact on the arbitrage for borrowers like Rentenbank, who only have euro-denominated assets and swap everything back into euros.

On the other hand, I think the investor education process, at least from our perspective, has only just started and the investor base is fairly large. It is a big market and the potential to broaden the investor base for Rentenbank is still huge, as is the potential to establish our views on relative pricing vis-à-vis Canadian provinces and make some progress there too.

At present, the domestic investor base feels comfortable with a foreign Triple A name like Rentenbank and reprices it to a certain degree versus Canadian provinces, which certainly has the potential to create ongoing demand for Canadian dollar product.

Kreivi: When Dean says that he thinks the parallel is the Australian dollar market, my answer to that is I certainly hope so!

Gower: So do we!

Kreivi: Obviously it took some time in Australia and will probably take some time in Canada as well. We only saw the changes last year and many investors have yet to change their internal benchmarks, guidelines or mandates. We are in a similar situation to Rentenbank in that we are being compared to domestic provinces, which are Double A or even lower rated, therefore creating some technical pricing difficulties.

Obviously the investor base is huge and very interesting for us, but given the fact that the domestic market is indeed very domestic, it is difficult to create the kind of price tension that we can see in Australia where participation from Asia and Europe allows us to sell much larger deals.

Currently, deal sizes are still rather small at C$200m–C$300m and we are a large borrower and not the cheapest borrower either, but what we can provide is liquidity and a yield curve, which not every issuer that plays in smaller volume can. But so far, it has been difficult for us to bring these advantages to the game.

O'Hara: If the evolution of the Canadian market is in parallel with the Australian market, then it is worth remembering that a lot of the first Australian Kangaroo transactions were very domestically focused. But the last couple of years have seen a good run in the currency and brought in more Asian demand.

So too, I would suspect that if and when the Canadian market evolves, we will see better penetration into Asia and Europe, simply as a function of investors looking for interest-rate differentials in the same way they were looking for that in Kiwi and Aussie dollars over the last 12–18 months. Certainly it is RBC's view that we are not trapped in the domestic market and we are not exclusively selling to domestic Canadian accounts.

Kreivi: The thing that helps Australia and New Zealand are the yield differentials, which we just do not have in Canada right now.

Hoveyda: I guess the counter to that is the sterling market. That has been going for a while and still remains fairly domestic.

Kron: For us, the key is the basis swap. We see the arbitrage as our window to act and obviously it is not very supportive at the moment. The development of our Canadian accounts is definitely due to yield differential and currency vies, but this is not very compelling compared to Aussie or Kiwi.

We do not see any big change in flows in the near future but when the yield differential changes, or the currency view changes, we will be there to work with the new opportunities.

IFR: Do you see a time coming when the Canadian benchmark moves away from provinces, or is that still a long way off?

Hoveyda: It was interesting that we managed to price Network Rail through Ontario and I think that times are changing and relative value assessment is also evolving from a domestic investor base perspective. The domestic references no longer necessarily set a floor that cannot be breached by foreign issuers who have better credit ratings.

Network Rail was in that sense something of an event and a very important one for us to see happen. I think it is going to mean that other references can be established without being held back by the domestic minimums.

Gower: It is also important to look at the secondary market. Just as it was in Australia or New Zealand four or five years ago, the difference between primary and secondary spreads is fairly dramatic in Canada at the moment, and I certainly think that with the issuance that we have done, spreads have tightened dramatically.

If you look at relative value in secondary markets, it is much less than in a primary phase, which of course in Europe has almost disappeared and in Australia and New Zealand has reduced dramatically. I would be hopeful that over a period of time, where investors are willing to accept less of a new issue premium, primary will begin to trade more in line with secondary, and then we will hopefully get the relative value necessary for an issuer like the EIB to set up a curve through the provinces.

O'Hara: It is clearly an education process for investors and the domestic market in Canada too. It is really a question of the domestic accounts understanding the credits that have come into that marketplace. As Amir rightly points out, we should see many of these deals price through Ontario, there is no doubt about that from a European perspective.

However, we need to respect what is going on in Canada and that is the foundation that has been laid over a number of years. The education process that borrowers will go though in that market in the next 12 to 18 months will play an important part in the process of pricing through provinces.

While there will still be a relative value against provincials as they represent the deepest and most liquid part of the market in the sector, the drive for issuers to price through those levels will be more significant as investors become educated in the credits that do come to the market.

IFR: Although the foreign content limits have been removed, how quick have investors been to change their internal mandate?

O'Hara: We are starting to see the real ramifications of foreign investment this year rather than last year. Our view at RBC is that mandates do take some time to change and that was never going to happen overnight. Through 2006 we will really start to see the impact of those legislative changes. The impetus to change those mandates is in part a function of increased volumes and those houses that have not made the necessary changes will come under greater pressure as the market develops.

Gower: Investors in Canada have been fairly open with borrowers in pointing out that a lot of these mandates cannot change on a 12-month basis. We spent a significant amount of time in Canada in 2005 and investors told us that 2007 was really the earliest point that they could talk of with any certainty of having changed the mandates. I think that this year will still unfortunately be a frustrating one, but hopefully we should turn a corner at the end of 2006, and from 2007 it should be all systems go.

IFR: What are your expectations for the development of the Maple bond capital securities market? We have seen significant growth in Lower Tier 2 issues but will we see the market develop right through to Tier 1?

Hoveyda: Yes, I certainly hope so.

It is an evolution and we have to establish the asset class starting with the most investor friendly, which is Lower Tier 2, and then move on from there. We consider the opportunity to be there and the receptiveness is certainly there given that the desire for yield should support the evolution into perpetual, Upper Tier 2 and Tier 1. We also expect to see the market evolve away from the banking sector and there is definitely an opportunity for an insurance hybrid and even corporate hybrids.

O'Hara: The Canadian market also benefits from being a very deep, liquid and well understood Tier 1 and hybrid market in its own right so I think the evolution from a

Tier 1 domestic name to a Tier 1 offshore name is a fairly simple process.

IFR: Will it simply evolve out of a search for yield as investors go further down the subordination curve for a yield pick-up in a tightening spread environment?

O'Hara: I think so. Most corporates will continue to achieve the best Tier 1 placement in their domestic markets unless there are arbitrages in particular markets. The US and 144a space was very big two, three and four years ago. The Maple bond capital securities market is likely to evolve but it may well be on an arbitrage basis rather than as a regular source of Tier 1 capital.

Gower: The development of the market comes back to the point of whether the market is driven by the banks or by the investors. At the moment, the deepest subordinated stuff is being driven by the bank community. As Dean says, for investors, the fact that the product already exists in the domestic market in its own right means that there will be a natural evolution. Size is an issue for borrowers like ourselves and although there have been some significant transactions, there have not been that many. But there is a currency question as well. At the subordinated level, if you do not need Canadian capital, what are the alternatives for getting the regulatory capital you need and the currencies you need. Subordinated swaps are always an interesting discussion point regarding whether they will migrate from Lower Tier 2 to Tier 1, but there is certainly potential there. Again, I would still currently view it as an arbitrage market to tap in smaller size as opposed to a core market where you would look for the most capital.

IFR: New Zealand dollars represented a surprising growth market last year with the additional emergence of a Kiwi Global market. Is there any sustainability or was that growth just a one-off?

Goebel: The dynamics of the New Zealand dollar market are somewhat different from those in Aussie dollars. We have issued a lot of New Zealand dollars into the Japanese retail markets in Uridashi format. We were not able to partake in these more institutionally targeted Global New Zealand dollar transactions, but the growth was driven by a significant widening of swap spreads, which in turn was a function of foreign investors buying the entire spectrum of New Zealand dollar government bonds. Since then we have seen some swap spread volatility and it remains to be seen whether the issuing opportunities will be there going forward.

Kreivi: We issued quite a lot of Kiwi dollars last year as well, mostly in the public Eurobond format and not so much in the Uridashi market. Clearly we saw the demand coming from Asia and Europe because of the swap spreads and because of the pick-up over government bonds. My feeling is that since these investors, who probably had no Kiwi dollars in their portfolios a few years ago, have now come up to a certain level, there will be some consolidation. The story is not over as the market still looks attractive but I do not think it will continue at the same pace as last year.

Kron: I absolutely agree. It had a fantastic development over the last few years, primarily due to Asian demand. But now we are seeing Asia selling the currency bit by bit. It is not in any significant size at the moment, but they are coming in as sellers, which is a new development for the market. In the current environment we need to think about a change of the interest-rate cycle in Japan. This means cheap borrowing and investing in high-yielding currencies might change. It is not going to happen overnight, but the first ones are beginning to pull out now and although it will take a few years, demand for Kiwis will reduce. On the other hand, we have a lot of maturities coming up in the next few months so the market should be supported in the medium term, but in the long term there will be an impact as the global picture changes.

O'Hara: I think Holger is right. What we saw in 2005 was some investors growing up with that market. It was considered to be the poor cousin to the Australian market and probably remains so to some degree given that there is a large Kangaroo market away from the Eurobond market in Australia as well. The parameters of the Kiwi market itself have changed to such an extent that the development we saw in 2005 would be hard to repeat. In a global context, in the same way that the ebbs and flows in the Australian market will occur, clearly that is going to happen in the Kiwi market. As Eila alluded to, there has been a watershed in 2005 and the market is now perceived by investors to be more significant, albeit from a very small base, than it was 18 months ago. A repeat of 2005 is unlikely as it was such a good year that it would be unrealistic to think that we would see that again, but only time will tell.

Gower: The domestic market in New Zealand has been virtually non-existent and it is interesting that over recent months we have had more and more questions asked of us as a borrower about our interest in getting into that market. But from a pricing perspective it is of no interest whatsoever and domestically we cannot view it as an arbitrage currency at all as it lies dramatically outside any pricing targets we have. If you look at pricing relative to the Euro Kiwi market it is quite interesting that there is such a dramatic difference because in Aussie dollars that has all but disappeared. Whether, as Holger pointed out, as the macro change happens that dynamic will also shift, is also interesting for us as a borrower. I do not think it is going to be dramatic in size and volume but it could eventually present an arbitrage opportunity if the domestic investor base needs to get hold of the assets and they are simply not available.

O'Hara: What is interesting is that we are also seeing an evolution in the New Zealand Eurobond market, where over the last 12 months, transactions have increasingly been large in size, and that does not even include the Global transactions. I wonder if that is a function, as Michael points out, of there being a lack of a domestic Kiwi dollar market, so there is only one source through which demand for assets can be met, and that is through the Eurobond market.

The Global transactions last year were driven by a handful of investors and when those investors are not participating in that market, the market tends to disappear. But clearly we are seeing a move towards larger individual transactions in that Kiwi Eurobond market, which I think is a useful development in itself.

IFR: The Aussie dollar market was somewhat overshadowed by Kiwi last year, but the Kangaroo market has seen massive growth over the last couple of years. Will the Kangaroo and Euro Aussie markets continue to operate separately, or will they converge into a single market?

Goebel: We used to issue a lot of Aussie dollars in the Eurobond format, but also with definitive notes known to appeal to retail investors. But throughout 2005, we did not issue any Euro Aussie notes at all.

To me, that means either the institutional part of those transactions, which has always been there, has disappeared, which is not the case, or the institutional bid has switched to the Kangaroo market. In 2005 we only issued Aussie bonds as Uridashis to Japanese retail investors or as Kangaroo product.

As far as I can see, that means this convergence has more or less taken place already. Looking at the real liquidity of the Kangaroo market, the superiority of the instrument for the institutional investor over the Eurobond product is quite obvious and it is perfectly easy to clear through the European clearing systems so what is the downside for the European investor?

O'Hara: The view at RBC is that they are two different markets. However, we manage all Aussie dollars as one platform and one franchise. I am interested in Stefan's comments because I think that what we tend to do is look at the client and see where the best bang for their buck is in that market. The retail franchise in Euro Aussie is clearly still alive and well. The number of transactions in that market in volume terms was actually up in 2005.

Whether there is an amalgamation of the two comes down to a question of mandate and perception. Domestic institutions do struggle at times to buy Eurobond transactions but that is a mandate issue rather than anything specific to the market. There is a desire by domestic investors to buy locally produced transactions, or go to the Kangaroo rather than the Eurobond markets.

However, for a long time, there was a lack of understanding of the credits being issued in the Eurobond space. With the evolution of the Kangaroo market, that anomaly has disappeared so it does raise the question of whether there will be a further amalgamation of the two markets in the future.

Gower: I wonder if there might be a slight differentiation between the sovereign, agency and supranational borrowers on the one hand and the financial institutions on the other. We have not found the amalgamation taking place at all.

Clearly there is some overlap but we have raised in total over the last 12 months around A$2.25bn, which has been pretty evenly split between Eurobond and Kangaroo.

In terms of the number of transactions, it has been much smaller in the Kangaroo space as they have been bigger deals, but, as you mentioned, there is definitely a clear preference from the domestic investor base to buy Kangaroos as opposed to Eurobonds. Perhaps name recognition will help that process, but for us it has been a fairly marked difference between the two markets.

O'Hara: I would suggest that in Asia – excluding Australia – there is no differentiation between the Eurobond and Kangaroo space. It is just a bond in Aussie dollars and investors are happy to buy it. The differentiation is more prevalent in Europe, and certainly the retail sector in Europe has always bought Eurobonds, likes the Eurobond format and the annual coupon, and will continue to buy those bonds.

Kron: I would add that if you look over the maturity of a bond, in primary markets you probably have some separation, but over the life of the bond you see the two markets merging.

At the moment, you get intrinsic value for certain institutional investors and it does not really matter whether it is in Kangaroo or Eurobond format, it is the intrinsic value that the investor is looking at. When investors compare the same name in these two formats in the secondary market, they are going to buy the cheaper one, and their decision will have little to do with the legal format of the bond.

O'Hara: That is an interesting point. In primary markets there is still a clear differentiation between the two markets, but in secondary markets it is certainly not as prevalent.

Eila: Our experience is very similar to Rentenbank's. From our point of view, the two markets have totally merged. I cannot even remember when we last issued something in Australian dollars in a Eurobond format other than in the Uridashi market, but it was certainly more than two years ago.

For us, the pricing has converged and, apart from the situation where a European or Asian investor wanted an tailor-made transaction, I do not see any reason not to do a Kangaroo because then you can include domestic investors as well and perhaps do larger sizes too. I was in Asia at the end of last year and was frequently asked why we do not do more in Australian dollars, so I think the demand is very strong and we will see more and more in issuance from that market in the future. The Australian dollar market has now matured and opened up with demand out of Asia and Australia with a good bid seen from Europe and the US as well.

Hoveyda: We have had a presence in Aussie dollars for some time and have definitely seen a convergence. We are not necessarily building the platform, but we hope to do more in the market.

IFR: What are the growth prospects for Kangaroo issuance this year?

Goebel: In 2004 and 2005 we had an aggregate volume of A$3.75bn in Kangaroo format. This year we have not yet been able to tap the Kangaroo market as the arbitrage has deteriorated somewhat since a wave of new borrowers entered the market.

That has certainly moved the basis swap, and from our perspective, in the wrong direction. I still think that we will have an opportunity this year to further develop our Kangaroo programme, to which we are very committed, and it is only a matter of timing. Thus I am confident that this is a market with a very good future.

IFR: And what about the capital securities market in Aussie dollars? It appears to be quite well developed.

Gower: We are hugely encouraged by our outing there the year before last as the depth of the market is quite dramatic. We had always hoped it would be substantial, but I think the scale of the interest from institutions there surprised everybody concerned in the transaction, including the leads.

Hoveyda: Absolutely, and both in fixed and floating rate format.

Gower: Absolutely, and I think they do it increasingly as they become more educated and more sophisticated. Investors have realised that reverse enquiries can actually have a dramatic influence on what borrowers do and how borrowers come to market.

Certainly the way that we looked at the market was very much in response to those requests. As a borrower we try to be responsive in every way we can and that particular transaction was very much a response to what investors had asked for, both in terms of size and structure.

IFR: What is going to drive growth in non-core markets? We have obviously seen a lot of new currencies but is that where the growth lies, or is it going to come from new structures and new investors for example?

Kron: The global currency and interest-rate landscape will probably be the main driver of growth, in particular the Japanese and US interest-rate cycles, and therefore the global yield story.

First of all, people need to decide where they want to invest and whether that is bonds, equity, commodities or housing. As we have recently seen, many investors are pushing out of these markets and into commodities and equities – particularly the retail community. So ultimately the non-core currency market, which has a 30% retail arm, is suffering from asset allocation, which is proving to be negative for the development of the market.

But going forwards, I think we will see bigger transactions in developed markets because key institutional investors want to see more liquidity. I am pretty certain that we will open up more currencies, for example the Romanian leu and the Russian rouble seem to be on the agenda. We have recently seen more activity in Africa and I think that we will see much more activity in Egyptian pounds, although it is likely to be the established professional investor rather than the retail investor who will look at these currencies.

New currency activity is likely to be concentrated in Africa and Eastern Europe and perhaps even Latin America as we have seen a fantastic start to the Brazilian real market.

IFR: Does the Brazilian real need to become a settlement currency before we see further growth in that market?

Kron: In our experience the currency linkage structure has been very well received. Obviously the investor has to be educated on the risk that is being bought, but in the end, investors are buying into a different currency yield curve with the comfort of a well-known issuer. It really comes down to whether investors want to buy yield, and as long as yields in Europe remain low, there will be growth in these markets.

O'Hara: It comes back to what we discussed earlier on about interest-rate differentials and currency views. I am sure that we will see more currency markets opened as there is a distinct cachet amongst investment banks to be the first into new markets. Whether we want to admit it or not, it is something that banks are actively pursuing. There are borrowers with very large funding programmes and clearly they want to diversify the investor base. Where that is viable and where currencies offer the right scope in terms of interest-rate differentials and currency view, we will see more markets opened this year. But where we are seeing currency weakness, and where we are seeing those interest-rate differentials contract, I think you will see those currencies drop away.

IFR: Do you see growth as absolute or is it just a case of funds shifting from one market to another?

O'Hara: I do not think that growth is absolute, I think it is just a shift and it will continue with the ebbs and flows of the market – we have certainly seen that in Turkish lire versus South African Rand so far this year. The rand is under pressure and lire is flavour of the month, but I am sure we will see that cycle change over time. I am not sure whether there is exponentially more growth in terms of cash going into those markets, but there is certainly an ongoing shift from one currency to another as interest rate differentials shift over time.

Goebel: I think our investor base is still growing as we see both a domestic and non-domestic institutional bid on many of the currencies we offer, so there is a limited crowding out effect.

Kreivi: If we look at the investor side, I think that the demand for diversification and yield is not going to go away. I can even imagine that it is growing in absolute terms as when visiting Asia, we heard so much about currency diversification out of dollars and into euros, and even towards higher-yielding currencies.

There will be some new currencies introduced for sure, some of which will be shorter lived than others. Most of the non-core currency issuance has so far come from European borrowers with euro-based needs.

Pricing has been converging and at the same time, the basis swap is getting more and more expensive between euros and dollars, while arbitrage conditions in euros are improving.

What we do not yet know is whether borrowers will be as hungry for non-core currencies in the future as that trend continues.

Goebel: I agree with that. There are a lot of questions behind the future development of these markets both from the borrower side and the investor side, not only across the fixed-income product, but also across the entire spectrum of investment opportunities. If structures emerge that help investors to deal with the absolute low yield environment in the Eurozone and US dollars, then a 200bp or even 400bp pick-up elsewhere might be irrelevant unless there is a very compelling currency case. Ultimately, there are a lot of variables and it is very difficult to make projections.

IFR: Will you actively be looking at new currencies this year?

Goebel: We started issuing in Icelandic kronor only this year. We are not typically at the forefront of these developments as we need to establish a swap curve, government bond curve and ideally also a basis swap curve before we can issue, so it can take some time for us to sell new currencies. I do not see us issuing in Brazilian real or Botswana pula for example, it may or may not happen, but we are not aggressively pushing for it.

Also, given our relatively limited funding requirements, we are very content with the diversification that we already have. In 2005 we issued in 14 different currencies, which is a record for Rentenbank, so we have already seen tremendous diversification of our currency base. Obviously we will be watching the developments and do not rule anything out.

Hoveyda: There appear to be two categories of currency, as we discussed earlier, those that are underpinned by an indigenous, domestic bid and there we will definitely see secular growth. We need to offer a greater array of structures, perhaps structured notes, and we will see more underwriters providing liquidity and swaps. In the markets where there is no domestic underpinning, it is a means for financial investors to find yield, and that is more cyclical.

As rates start to rise, as we are seeing in yen, euros and dollars, the attraction of venturing out into exotic currencies will be reduced and those markets could fail to grow. Markets that represent a pure yield play are more exposed to global interest-rate evolution and in a rising rate environment, those currencies that have no intrinsic attraction other than yield will certainly suffer.

IFR: What about competition from other underwriting banks? We have seen banks jumping into the Turkish lira market but will that continue?

Hoveyda: Competition will definitely increase. We are developing currency trading in markets where we have historically had significant presence but drew back after 1998.

It is an area of interest, but we have to remember that some of it is cyclical and some of it is secular and the two are not going to behave in the same way as rates rise.

Gower: As a borrower, we are extremely bullish on how we view non-core markets. They have become increasingly important to us from a diversification perspective, from a cost perspective and all of the other reasons that we have discussed.

We view the rising interest rate environment as a fundamental threat. A lot of non-core activity is a carry trade – getting a 9.5% yield in 12-months is very attractive, but that is going to be eroded.

That said, what keeps us fairly happy with the way these markets will develop is that as the underlying investor base has become more institutional, we have seen a number of plain vanilla currencies become a little more exotic in terms of the structure that borrowers are using.

In general, the structured note market has been very quiet this year relative to last, but what has increased dramatically is the volume of structured notes in niche currencies. For borrowers able to execute those sorts of products and for institutions able to buy them,

I think that is where the real growth is.

Gower: It is not just going to be the supranational or Triple A communities looking at these currencies: we are going to go further down the credit spectrum. But whether that increases the volume of cash available in absolute terms, I think is debatable.

Kreivi: In overall terms, we are also bullish on the non-core markets, so if we did 13% of our total funding in those markets last year, we think it will be in excess of 15% this year.

IFR: Have lower-rated credits already come forward looking at opportunities in the non-core markets, or is that still some way off?

O'Hara: Lower credits are a natural evolution of these markets – as with all markets, it is the Triple A universe that is the first to take advantage of the opportunities. The EIB has been first into several of the markets, and there are clearly going to be those issuers that require far more certainty of these currencies before they dip their toes in the water. There have already been developments below the Triple A universe in three or four markets this year and we continue to see an increasing number of enquiries.

Kron: Investors are prepared to look further down the credit spectrum and take Triple B risk for the yield pick-up and we expect to see such transactions emerge, particularly in countries where governments are expensive.

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