Friday, 20 July 2018

Up Front: A world turned upside down

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Qatar last Wednesday raised US$5bn with its first sovereign bond issue in two years

Qatar’s US$5bn triple-tranche bond last Wednesday showed that the gas-rich country is one of the most highly sought after sovereigns.

Qatar’s US$5bn triple-tranche offering last week was further confirmation of the shifting axis in the financial world. While debt-ridden governments and banks in Europe struggle to access the capital markets, Qatar sailed through, generating a US$9.5bn order book.

It’s been a similar story for other highly rated borrowers in emerging markets in recent months – America Movil, IPIC, Petrobras, Teva, to name just a handful. These have managed to execute deals quickly and in size – a considerable achievement given the state of the markets.

In reality, these are no longer traditional EM credits but high-grade names with access to a diverse range of investors.

America Movil, for example, has raised the equivalent of US$5.5bn this year in five different currencies, including from the conservative sterling market. Its €1bn 2019 notes issue on October 24 achieved the lowest new issue premium of any borrower in Europe since the sovereign crisis intensified in the third quarter.

One bank has identified 100 similar companies around the world that have an emerging markets postcode but are global leaders in their field. The list will only grow.

And as Qatar proved, the transformation is taking place at the sovereign level too. Since Lehman Brothers went bust, EM sovereigns have received a net 120 or so upgrades (that is, upgrade notches set against downgrade notches), while developed market sovereigns have received a net 70 downgrades.

Or take CDS spreads as another indicator. Brazil’s five-year CDS spread is trading inside that of France, as is Peru, Panama, Israel, South Africa and others. Even Kazakhstan is trading only 74bp wider.

Sure, the differential between France and Kazakhstan seems unsustainable and illustrates the panic being wrought by the eurozone’s failings. And clearly, as Europe’s crisis worsens, EM countries will be impacted. But there’s little denying either that the traditional lines of investing between developed and developing markets are breaking down.

Time to explain CDS

On the face of it, an Italian directories firm and the sovereign nation of Greece have little in common. But both have brought into the spotlight the shortcomings of a financial product that has become a mainstay of risk-managers and risk-takers alike – the credit default swap.

The triggering of SEAT Pagine Gialle’s CDS this week will be welcomed by many. But it fails to answer some glaring questions about the potential pitfalls in the market for CDS referenced to high-yield debt.

Like doubts over Greek CDS – regardless of whether it ends up triggering – these issues cannot be dismissed as merely academic any more. Whether the pro-CDS lobby likes it or not, the past year has harmed the instrument’s reputation in the eyes of investors.

Yes, it’s true that these are not new issues. High-yield credit events are often complex, with complicated debt underlyings and restructuring scenarios that can undermine CDS protection. At the same time, it has always been the case that sovereigns – and corporates for that matter – can avoid a credit event through a voluntary restructuring.

But arrogantly assuming all CDS users should know this information, while characterising the current furore as “overblown”, completely misses the point.

Clearly, a good many actual CDS users didn’t properly understand the product’s potential shortfalls – and many have said as much to IFR.

Instead of blindly insisting that CDS always behaves exactly as it’s supposed to, its supporters would be better off explaining precisely what that is.

An axe to grind

There is now no doubt that European banks are upping the pace of their efforts to offload Asian loans as part of their deleveraging exercise.

So-called “axe sheets” – lists of loans on offer in the secondary market – are getting longer and reaching more Asian trading desks. It comes as little surprise that the sale sheets from French lenders, which have announced significant deleveraging plans back in Paris, are among the longest.

Known to be conservative in their use of balance sheet in Asia, the French lenders are taking the same approach on their secondary sales. Most of the paper on offer is from good quality Asian credits being sold at close to par.

That tactic, however, isn’t going to yield any quick results. Potential buyers are prepared to wait, believing the sellers will drop their prices further as the European crisis drags on. The sellers, meanwhile, are reluctant to take big write-downs from selling well below par, which would do further damage to their already wounded balance sheets.

As long as this uneasy stalemate continues, primary markets will remain under heavy pressure. The discounts on offer in the secondary market may not be deep enough to draw crowds of eager buyers, but they will still force borrowers to pay up even more to attract lenders to new financings. That will ultimately weigh on earnings and the region’s economic growth at a time when the rest of the world is looking to Asia as a safe haven.

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