Sovereign Bonds Roundtable 2009: part II
IFR: What is the view on the liquidity situation at the moment from the investor side?
Grodzki: We are not discontent with the current liquidity situation in government bonds. What we do worry about is the corporate market. We are concerned about certain changes in bank capital regulations which are currently being discussed but yet to be implemented. That could force a couple of the banks to hold much higher capital levels to support trading books, which would undermine liquidity and corporate bonds.
But we also are worried about the sustainability of demand for government bonds if inflation was to rise and if yields were to go up again, which they did in the early part of the year.
Thanks to the recent return of economic concerns, governments were able to place enormous amounts of debt over the past two weeks. But if it had not been for the slight cooling of economic optimism in the marketplace it would have been a lot more expensive for governments to do that.
And there is an almighty dilemma building up for governments going forward: on the one hand they want to stimulate their economies; on the other hand if that happens rates will go through the roof and the debt level will become unaffordable. That would force them to reflate, which is very detrimental for any fixed-income investor.
IFR: What are reasonable terms for the execution of secondary business from the point of view of banks, investors and sovereigns?
Whelan: From the UK's point of view, we very much like to see the market find its own level rather than trying to force a particular outcome. We observed that obviously the price of access to bank capital did go up during the earlier part of the crisis. Consequently, we saw bid/offer spreads go wider.
But more recently, a number of banks have been making quite big investments in the sovereign business and that has acted to reduce these spreads again. We are very happy with the way things have panned out.
I certainly agree that the value of liquidity was strongly underlined, particularly in the autumn of last year.
IFR: In terms of liquidity, in reality there appears to be little difference between syndication and auction. But is there a perception amongst investors at all, or even banks, that if you involve yourself in a syndicated transaction you are going to get some kind of better deal?
Shane: To the extent that it takes out some of the uncertainty for investors, yes. There is a lot of price action that surrounds auctions. Although that is diminishing, we have seen markets cheapening going into auctions. Timing for investors is key as to whether they leave orders with banks and whether that auction price is actually going to offer the best terms. So you tend to get a lot of customer trades that happen before, during and after auctions, whereas in a syndicated process there's very clear transparency in terms of what is fair pricing.
It is clear for everyone to see that the uncertainty is taken away from investors; and that is what they really want. It is a lot easier from that perspective.
It is also very hard for us when it comes to getting allocations for customers in the auction process. Protecting accounts on allocation is sometimes more challenging in the auction process, whereas with syndication investors can feel more comfortable with the likelihood they will get what they are expected.
IFR: Maria, when you were saying you are getting more investors directly bidding in auctions, you mentioned that your syndication focus would be towards the longer end. What are the actual attractions of syndication? Is it a price discovery process or is it the fact you could possibly bring an issue without disrupting the secondary market too much?
Cannata: As far as price discovery is concerned, the two methods are quite similar. Even in auctions, we're talking about looking at pricing movements and so on.
Obviously, in a syndication process, at the moment of pricing, this is the most crucial aspect in managing the exercise. You have a clear reference and this is crucial for good execution.
In the long end, in our opinion, there is also a necessity for a more direct dialogue with investors, not particularly for the execution, but to understand what the price guidance should be and what the relevant aspects of the transaction are. That could make the difference between success and a disappointing transaction.
It is important to establish a direct dialogue with investors. So for that reason we prefer to use syndication to launch a deal in the longer end and in the inflation-linked sector.
IFR: Given that the announcement of a deal can lead to spread widening, have you had to change the way you bring a transaction to the market or your management process?
Ezquerra: It is always a difficult question. In auctions you obviously have a concession, but perhaps it's not as visible as when you are focusing on a syndication, so it does not hurt as badly!
But it is true that when you go into a syndication and you announce a deal, the secondary market obviously suffers. On top of that you have to pay an extra concession. And that is really the point of establishing a dialogue, to work out what the correct concession is. Although it is very difficult to pin it down.
IFR: Does that depend on the quality of the credit?
Ezquerra: It depends on investor appetite and market liquidity. If you have very good appetite for the bond, obviously you are going to have a smaller concession to pay. In a less liquid market movements are exaggerated so that the secondary market suffers more.
In our case, the effect on secondary market prices in the two 10 year syndications we did in January and a couple of weeks ago were different; in the later one, the secondary market underperformance coming into a syndication was much less pronounced.
And a similar thing happened with auctions in January and February; it was horrendous looking at the pre auction performance of bonds, whereas now they sometimes even outperform coming into the auction as people realise that the market is far too short.
So it does depend on the country, but I would say especially on the general tone.
IFR: But with regard to the recent Ireland 10-year, the secondary seemed to have moved an awful long way before pricing. It was a huge move that you don’t really see on top-quality names.
Bignier: While we saw this significant move around the Irish 10-year, I tend to agree with Enrique. When a transaction is announced it is not always the case that the underlying bond is repriced.
For example, we managed Greece, the 10-year tap, and we were of course expecting of course a repricing of the underlying bond by 5%. It tightened and we managed to close the transaction 1bp below its secondary curve. So, yes, it really depends on the general tone and on the liquidity.
IFR: One thing that was written after that deal was that the decision to carry out the sale by syndication perhaps reduced the effect of a potential widening in the secondary market. Is that a valid point?
Whelan: If you think of the auction concession as basically the price you are paying the dealers to take the stuff on their books and sell on to the investors, clearly that pricing is going to vary according to balance sheet constraints, market volatility, and the like. So that will go up and down all the time anyway, and you can see how general conditions affect that. It's not a science; it is more of an art trying to monitor it.
In syndication the same things happen but it is slightly differently put together. You would expect to see some potential risk to secondary market liquidity just ahead of the deal. It stands to reason: you have this very large line coming and people are waiting tensely to know what is going on in the market, which is to some extent potentially being controlled by a sub set of dealers. It may be that the dealers are worried that they might be aversely affected. But the up-side is that you are hopefully involving a lot more investors, so there is less actual balance sheet requirement that you are placing on the dealers and these things off set each other. But every single deal is going to be different.
Over time, you get significantly different outcomes, never mind the method, you are achieving slightly different things. You can do size with syndication, and as an issuer you can know more precisely who your investor base is. It doesn't mean you don't go through to that investor base through the auction method, but it's more visible and you can control the allocation for a syndication in a way you can't realistically do through auctions.
They achieve slightly different things, but I would say that overall they are just different ways of accessing the markets.
IFR: Transparency and greater size seem to be the key points. You raise £7bn through syndication, could you have done that through an auction?
Whelan: That would have been a very large auction! We have had auctions of £5bn or so, but much shorter-dated; in terms of the actual risk we are sitting on in the market, it is much, much lower.
So it's two or three-times the size of a normal auction that we would do in the longer maturity area. So for us it certainly offers a chance to achieve a much bigger size, which is helpful if you are launching a new bond and you want to have some kind of benchmark status quite rapidly. But at the same time you are putting more event risk around it because you are hitting the market on that particular day, as opposed to something across the year. So, there are always pros and cons.
IFR: And are fees the only down side?
Whelan: On fees, there's a potential state management issue because clearly fees are being paid invisibly through concessions when you hold auctions. But the headlines might not reflect that.
IFR: How about from an investor perspective then? If the sale of government bonds is accompanied by a sell off of the surrounding issues, what does this mean for you?
Grodzki: We try to position ourselves for that by anticipating the timing, size, the likely tenor, and hopefully taking advantage of the ensuing price movements in the marketplace. So it's a challenge but it is also an opportunity to benefit from price reactions which fall in line with predictions.
To some extent of course that is not always possible. There is always the risk that you get caught out, but you might also get caught out by the behaviour of other investors as much as by the behaviour of issuers.
Certainly, it helps if communication undertaken by the issuer to the market is clear, consistent and helps the market to avoid getting wrong footed. So, investors, especially long-only buyers, don't want to consistently be given the wrong message.
It is to be hoped that issuers appreciate the steadiness which we can provide to the market and to the placement of that debt. We definitely like to receive guidance, which makes it easier to purchase bonds.
Bignier: As far as electronic platforms are concerned, my view is that the situation has improved significantly since the beginning of the year.
If the bid/ask spread was 75–120 cents, depending on the maturity, we are now somewhere around 12 to 50.
Of course, we are definitely not where we were in the past but I think we can see an important improvement.
Nevertheless, I would say that we are going to see a switch from the electronic platforms to B2C business. This started at the end of 2008 and the trend is increasing. As a banker, from my point of view liquidity is probably even better than it was before; the B2C market is growing more and more. And why is that? For several reasons.
The first reason is the balance sheet issue that occured in 2008. The second reason is that we face, all of us, strong market concentration in the banking community.
A third reason is the change of the investor base. I think that the disappearance of the hedge funds significantly reduced the liquidity on the electronic platforms, although that doesn't mean that we don't work with hedge funds or that we don't work with final investors directly.
All the electronic platforms will have to put up with much more competition in the future. For us liquidity is there, the volumes we are trading in the secondary market are higher than in the past, even though we are less present on the electronic platforms.
What is important for a sovereign is that the paper is placed with the investor and not left on the balance sheet of a bank.
Given that there are a lot of electronic platforms now coming into the market, it will make for a difficult period. I think 70% of the business is done away from the platforms.
Proni: In terms of execution of late, yes, absolutely.
Bignier: We can't say that there is no liquidity, it’s just that there is less liquidity on the electronic platforms.
Proni: There are two points to make: Firstly, when you talk about the growth of the B2C sector, there is a fairly sizeable B2C sector on the electronic platforms. I would be interested to hear your views on the development of that area. My second point is that the bottom line for an issuer is to get their paper placed with investors, rather than seeing it lying on banks' books. There is something to be said about the price discovery process. Whether the investors hold it or the banks hold it on their books, if this stuff just stays locked up in a vault and no one knows what level it is supposed to be trading at, I'm not sure that adds value to a market.
Bignier: Absolutely, I fully agree on that, but it's a price discovery process much more than a tool to measure liquidity.
Cannata: For our part, not only are we thinking about how to evaluate value correctly but also what is happening in the B2C market. We already do this, but certainly in the future we will have to give some consideration as to how to keep this type of liquidity.
But it's also true that this is a market that does has not the requirement of continuity of quotations like the B2B platforms. It is important to ensure transparency for all the markets.
Proni: Particularly when those prices are executable, because that is essentially putting your money where your mouth is.
Bignier: That is a stock exchange process.
Proni: It is an exchange, essentially.
I am not sure whether we want to go there in terms of wider debate with respect to the fixed income market platforms becoming more like exchanges. That was the source of a great deal of controversy a couple of years ago.
Ezquerra: It's strange how the debate changes when it comes to direct access for investors. It is something that is no longer a conflict.
Proni: I find it interesting, if not paradoxical, that on the one hand I’m hearing about the growth of the B2C market and on the other hand we are pretty much at the moment in suspended animation – if not approaching a near death experience – when it comes to third party access to fixed income markets.
Shane: The other big challenge in the B2C market is at the moment – and I think there is going to be a lot of change – we're all interested developing our own in house platforms for customers. We want to deliver research and every form of different product, all in one place – all this kind of information flow. So we are all trying to win customers to our own in house schemes.
There are also third party schemes at the same time and there is going to be an issue about how it all settles down. It's not practical that an investor has six or 10 different banks all providing trading platforms that they look at. They are only going to end up with one or two.
At the moment we are fighting a fight and we all hope it is our system that they go for, but I think there is going to be a leveling of the playing field.
Proni: There will be a shake out. The electronic platform industry in the fixed-income world is still pretty young. It's still going through a process of evolution, however fast that might be, that makes it quite difficult to forecast where we are going to be even in the relatively near future.
Shane: I agree with that.
Bignier: I think we will hear different needs from the investor base. The large investors would probably be very keen to have access to our B2C platforms, the big ones who put very large orders.
But there is another market, which is made up of the medium-sized investors who favour some banks versus others due to relationships.
So, there are two categories of investor, and I would say that in the eurozone they are more or less equal. Certainly, in France we have very large medium-sized investors with whom we definitely enjoy direct contact and privileged access and it's the same in Spain too, for example, where we have very deep penetration.
It depends on each bank, but on the SocGen side we offer privileges to some medium and small ones. The big ones, of course, have access to the B2C platforms and that’s another way to cover them. So, my view is that there are two types of investor market that will be living together and their needs are different.
Shane: The general message that I would want people to take away from this discussion is that liquidity in the sovereign bond markets is actually as good as ever; certainly the customer believes it is. And while there are other references, when we look at the B2B and we think that it is still a dislocated market, hopefully clients are left with the impression that this is most liquid asset class that there is in the fixed income world.
It goes right back to what was said earlier about government-guaranteed bank issuance: it is still a very different product. The liquidity is still extremely different between the two asset classes.
But you can see that the sovereign market, whether you look at bid/offer spreads, premiums or new issues, by every metric we have come a long way since January. And we are still in the midst of a terrific healing process. Whatever your views about the next six months or so, as to whether the general markets have difficult times ahead, I think that in the sovereign space we actually have the worst times behind us – certainly in the sense that concerns about the capacity to issue.
That is not to say that we won’t have inflation scares and concerns about yields and specific idiosyncratic risk about fiscal deficits. But then it’s a question of ratings actions and things like that. In terms of the general market as a whole, I think it's come a long way.
Click here for Part three of the Roundtable.