Bookrunners face increased liability after World Online IPO ruling

European capital markets come of age It is a little more than a year since our capital markets were in complete disarray. And yet today, fingers crossed, it appears that we are on the road to recovery. Confidence has been restored and investors have emerged from their cash shells to start financing companies in term markets. As a consequence, corporate bond spreads have fallen in the past six months, equity prices have rallied since their spring lows, loan pricing appears to have peaked, and banks have been able to start the long process of un-hooking themselves from central bank life-support systems. The critical cornerstone of our capital markets this year has been the government support provided for the banking sector and the wider economy through various capital, liquidity and guarantee schemes. There are huge challenges ahead, but investors are increasingly of the view that the worst is behind us. Looking for life Wind back to the beginning of 2008, however, and it was not clear - even to the highest-quality corporates - how they were going to fund themselves. Up to mid- 2008, munificent markets provided for all their financing needs – in spades! But in January 2009, issuers faced a challenging time with little or no certainty. Thankfully the European bond markets found their feet and ultimately were able to provide for the funding requirements of most European corporates, in what has turned out to be a year of record volume for our market. Indeed, this year may have seen the structural re-balancing of the European capital markets, redressing a historical corporate reliance on bank lending. Having said that, at the time of writing, there is increasing optimism that risk appetite will return to bank loan markets in 2010. The downward pressure on pricing suggests that investors are anticipating this trend. Our capital markets franchise At Lloyds, we have been keenly focused on helping our clients to source new and larger pools of liquidity. Our DCM team has moved from outside the top 20 last year to number four this year in the overall sterling bond league tables, while our financial institution team has been responsible for some “firsts” in the capital markets – pioneering liability exchanges, structuring a new contingent capital asset class, and leading the way on government-guaranteed debt issuance. This is a reflection of both the timing of our growth in debt capital markets as well as the trust our clients place in our execution skills. Next year? So, what does 2010 hold for us? Well, if 2009 was the year of the corporate, 2010 will likely be the year of the financial institution, and we are likely to see a flood of new bank issuance if secured and unsecured demand continues to improve. There is also much talk about a resurgence in M&A activity. Corporate leverage ratios have reduced and - with equity levels still historically quite low - deal flow is likely if financing is available. That’s a big “if”. But Lloyds will continue to lead the way in this financing challenge, putting our balance sheet to work where appropriate, in order to get our economy moving and offering innovative capital markets solutions as part of our relationship offering.

German construction company Hochtief was keen to carve out its concessions business. It believed the assets were being undervalued by analysts and the wider market. Yet this starting point meant it had its own minimum valuation in mind to justify the up to €1bn Hochtief Concessions IPO. A valuation of that order might have been achievable at another time, but forcing the IPO into 2009 made the hurdles too great to overcome. Despite this, the banks, adviser and companies pursued the deal to the last, even though at no point was there even a hint of the deal gaining momentum. Coming into the home straight the book was looking slight – German accounts were putting in orders, but there were few from internationals. The leads tried to put on a brave face, saying there was interest but investors were waiting to see if others would come in first. Citigroup, Deutsche Bank and Goldman Sachs were joint global co-ordinators and Barclays Capital was joint bookrunner. Calyon, Commerzbank, HSBC and RBS were co-lead managers. STJ Advisors acted as IPO adviser. Sales teams were desperate for a message to deliver to clients and, in a last-ditch attempt to turn interest into orders, they were told on Wednesday morning that the book was about 50% covered and would close as planned at the end of the day on Thursday with no further updates. Away from the deal there were questions as to how that message could possibly help. And it did not. Some orders came in, but others left the book and a few investors prepared to attack the stock on its debut, knowing the deal would be weak. "In the past couple of days we went from thinking it would get done, to hoping it could," said one of the bookrunners, admitting there were hopes of a "positive event" in the last days. Despite saying there would be no more updates, on Thursday afternoon the leads tightened guidance from €24–€29 to €24–€25. Again, away from the deal there were cries of confusion as to how this might help the deal. One senior banker away from the deal speculated that it was simply to stop a flow of orders below the range. On Thursday evening the €882m–€1bn IPO was cancelled. Feedback ignored Hochtief said in a statement: "As a result of the most recent disturbances in the international capital markets, the capital market environment has deteriorated decisively. Under these conditions, the target value defined by the two companies cannot be realised." Many thought that was a preposterous statement to make on the same day that Bank of America Merrill Lynch raised US$19.3bn in common stock. The success of the €806m IPO for African distribution company CFAO and its subsequent positive aftermarket also puts this claim into stark relief. In fact the issuer had an ambitious valuation, reflected at the bottom of the €24–€29 price range, which was always going to be hard to achieve. Junior syndicate banks said they were surprised when the price range was set as it clearly ignored much of their feedback. Investors had been looking for €20 at the bottom of the range. Hochtief Concessions is a bundle of assets, with most of the value wrapped up in six airports. Investors were invited to look at each asset separately to build a DCF model. Not only was this time-consuming, it also led to wildly different values because of small differences in assumptions on each asset. Many investors preferred to look at NAV and apply a discount. Their discount was much greater than the 22% offered at the bottom of the range. Recent IPO successes have been achieved because realistic issuers have accepted that if they want to come now at the end of the year when the IPO market is tentative, they must come cheap – other than PGE in Poland. Some rivals suggested that pulling Hochtief Concessions was devastating for the IPO market across Europe, but that is clearly not so. CFAO and Yoox traded up after their IPOs. Delta Lloyd is now above its issue price and Gartmore was more than 50% covered after just three days of roadshows

Ongoing constraints in the bank market and an unprecedented surge in investor demand for bonds have combined to cause seemingly permanent changes in the funding landscape for European borrowers. The supply of, and demand for, liquidity have aggregated in the bond markets in a manner never seen before in Europe, such that record issuance volumes have been met by even greater demand. As a result, the bond markets are arguably in far better shape now than we would have dared hope six months ago. In terms of the liquidity on offer and the extraordinary rally in credit spreads since the post-Lehman “wides”, the European bond markets are in rude health. Arguably the best illustration of this “levelling of the playing field” between the US and European markets was February’s jumbo bond offering from Swiss pharmaceuticals company Roche to fund its acquisition of Genentech (see detail in Farouk Ramzan’s article). While the Roche example above clearly shows the enhanced overall depth of the European markets, it simultaneously raises questions as to the relative depths of the euro and sterling markets in the context of this new paradigm. After all, in certain key respects, the sterling market has for a long time more closely resembled the dollar market. Firstly, it has been established far longer than the euro market. Secondly, the sterling investor base is relatively homogeneous and dominated by a relatively small number of key accounts, similar to the dollar investor base. The euro investor base, by contrast, is much more fragmented and diversified. The dollar and sterling investor bases are also largely dominated by a single jurisdiction, whereas the euro investor base is far more geographically diverse. It is worth examining, therefore, whether the deepening of the European market is largely a function of the ongoing development of the euro market, or whether the sterling market has stepped up to the plate in a similar manner. The 2009 issuance statistics are staggering. They clearly demonstrate both the huge increase in demand from traditional bond investors and the augmentation of the investor base, prompted by a material uptick in retail demand. Considering just corporate issuance, where the increase is most pronounced, year-to-date the combined euro/sterling issuance volume is just shy of €290bn, versus a full year total for 2008 of €152bn (using average euro/sterling exchange rates). At the end of the third quarter, corporate issuance volumes were up nearly 90% on 2008 and 45% up on the current record year of 2001. Citius: sterling steps up a gear The sterling market has more than held its own during this transformational year in the European bond markets. Although euro issuance volumes have typically dwarfed those in sterling and continue to do so, the increase in euro issuance volumes in 2009 versus 2008 is 93% (€244bn versus €134.1bn), whereas the equivalent increase in sterling is a staggering 146% (£37.6bn versus £14.4bn). In 2008, sterling issuance constituted 9.7% of the European aggregate – this has risen to 13.4% in 2009, despite a 10% decrease in the sterling/euro exchange rate during this time. A comparison with 2001, the next busiest year, shows an increase in euro issuance volumes of 47%, whereas in sterling the increase is 95%. So, although the euro market remains a substantially deeper source of liquidity, the sterling market has become an increasingly significant component of the European bond market. Fortius: investor appetite strengthens Another significant development in the European markets has been a sharp increase in tranche sizes. In euro, the global record was set by Roche’s €5.25bn 4-year bond and as a consequence €2bn-plus tranches are now seen frequently. The two largest sterling transactions ever were brought to market in 2009, with Pfizer and EDF both issuing £1.5bn tranches at the long end. Previously, a benchmark was broadly considered to be £300m, with £500m considered quite large. The average tra

Last week Delta Lloyd's Amstelhuys subsidiary issued the first fully syndicated Dutch transaction since May 2007. To the surprise of even those involved, the €904.5m Arena 2009-1 RMBS proved a blow-out, with the leads – Natixis, Rabobank and RBS – closing the books after just a few hours in a bid to head off massive oversubscription. The transaction, which priced at the tight end of spread guidance, went on to perform well after being freed to trade. The transaction was also notable because, unlike the only two UK RMBS deals to have been sold to third-party investors this year, it did not require a massive lead order. "The granularity of the order book meant the issuer was not beholden to any single investor," said Tim Michael, an RBS syndicate manager. Even more encouragingly for a market that has long been over-reliant on the bank bid, the deal also attracted a lot of interest from real-money investors. "I was pleased to see many new real-money accounts. This is a very positive development," said Hendrik Jan Luikinga, a director of Amstelhuys. The deal was structured into two Triple A (Moody's and S&P) rated A1 and A2 classes of two years and 4.9 years respectively. Both were publicly placed. Below them stood five subordinate classes (four rated and one unrated) that were retained by the issuer. The deal's stand-alone structure was also notable for not requiring the overlay of a put back to the issuer, which led Luikinga to observe that the deal's success "represents a clear validation of plain vanilla structures". The only non-traditional feature of the deal was a punishing coupon step-up at the call dates of the A1 and A2 notes of double the initial credit spread. Although Delta Lloyd has to date exercised all the call options on its RMBS deals, this feature was clearly necessary to banish lingering investor concerns about extension risk. Ongoing analysis of the performance of the deal should be straightforward, as the structure does not allow for pre-funding, loan substitutions or further advances. Noteholders benefited from excess margin on the interest swap of 50bp, a reserve account of 0.5% of Classes A–E (which does not amortise) and a liquidity facility of 2.5%. But how much does it cost? Whether the deal made sense from an economic point of view is more debatable. Although the loans originated this year are economically funded through this securitisation, "pre-crisis mortgage loans cannot be funded at levels where we now are," Luikinga conceded. Since approximately 70% of the loans were originated more than a year ago, it is fair to assume that the weighted average yield on the portfolio of assets is below the weighted average cost of liability debt financing. This is likely to have been mitigated to some extent by the swap provided by Rabobank. Nonetheless, Luikinga felt that in view of the current "much more capital-intensive environment", it made a lot of sense "to take advantage of any opportunity to diversify funding". He said that the proceeds of the deal would be used to pay down internal and external funding incurred over the past two years. Another potential stumbling block was the collateral which, though prime, contained 17% of high debt-to-income and loan-to-income loans. Investors had 3-1/2 days, between the book going subject and the deal pricing, to do the necessary credit work. Although some dropped out, there was no material impact. The €189m two-year A1 class priced at the tight end of 110bp–120bp guidance, at one-month Libor plus 110bp. It was approximately 5.5 times covered in three hours, with 45 orders receiving allocations in this tranche. The UK and the Netherlands took around a quarter each, with Spain allotted 16%, followed by Switzerland and Italy at 4% each. Asset managers took just over half the class, with banks taking 37%, insurers 7% and pension funds 4%. The €643.5m 4.9-year A2 class also priced at the tight end of guidance at one-month Libor plus 140bp and was approximately 2.25 tim

We are now nearly through 2009, the sky has not fallen in, the loan market is still alive and functioning, and - while it is a long way from being healthy - it is no longer in intensive care and in recent weeks has shown signs of a making a full recovery. The loan market’s survival is due to a combination of necessary innovation and the resurgence of the corporate bond market as an alternative source of liquidity. And the market has certainly changed and adapted, to the extent that the characteristics of the new loan template have become clearer – participants are now focused on what the market will look like in the future rather than whether it will exist at all. To this end, pricing, M&A volumes and the recovery of the leveraged market are all phrases that have re-entered the lexicon of loan bankers. Innovation has driven the emergence of the forward start facility (FSF) in the corporate loan market this year. However, its role as a funding tool for corporates is gradually dissipating as we see a return to normal refinancings and corporates have greater confidence in the future availability of financing. Nevertheless, the FSF will still be used by weaker credits that continue to find difficulty in accessing funding from the capital markets. Has pricing hit a ceiling? Loan portfolios are amongst the largest and most capital intensive risk-weighted assets held on banks’ balance sheets. As both funding costs and risk premiums increased during the market dislocation, return requirements for banks increased – forcing European lenders to increase the margins on new transactions and refinancings. Following the unprecedented action of governments and central banks across the globe in attempts to alleviate the banking crisis, there have been some recent signs that pricing has now stabilised and there is increasing evidence that it has started to reduce in the investment-grade space, particularly for the better rated names (see figure 1.1). Sentiment is improving overall. This is under-pinned by the success of a number of deals in the western European market which have been finely priced but have secured an over-subscription (such as Auchan, SAP, Schneider, ABB, and RWE). Average pricing in the second quarter of 2009 for triple-B rated companies was 197bps (Thomson Reuters/ Euromarket Loan Pulse), while average single-A rated pricing was 157 bps (same source). However, single-A rated lending has recently fallen to 100bps and may well be going lower. Importantly, pricing remains very much dependent on the characteristics of each individual transaction and is a function of credit quality, sector, purpose, liquidity and available ancillary business. Certainly, as pricing begins to find its equilibrium, attention will shift to whether or not banks will be willing to lend at low margins without any access to ancillary business. The market will likely pan out in one of two ways – either lending needs to become more attractive via higher pricing or ancillary business needs to become a more explicit part of the lending agreement. M&A needs stronger foundations M&A activity over the first half of 2009 dropped to US$1,100bn, the lowest semi-annual level since the first half of 2004. Corporates’ ongoing focus on de-leveraging, via asset disposals, rather than on undertaking strategic transactions is critical to the continued inactivity in M&A. The ability to raise financing has also been a significant barrier to activity, particularly in Europe where corporates are more reliant on bank funding than in the US. Raising capital via the bond and equity markets has helped mitigate this to a certain extent, a key example being Holcim’s recent announcement that it would fund its €1.2bn acquisition of Cemex’s Australian operations entirely through a rights issue. However, this financing avenue places restrictions on undertaking confidential transactions, unlike the traditional underwritten loan which is only syndicated on deal announcement. Leveraged ma

The resounding success of the latest Australian RMBS to be launched without government assistance has raised hopes that demand from overseas investors will help support a market revival, despite lingering regulatory uncertainties. The A$1bn (US$927m) Torrens Series 2009-3 was remarkable primarily because of the size of the overseas bid, mainly from Europe. In fact, demand was so robust that the deal was increased from an initial A$500m and closed on December 2, two days earlier than planned. Of the 15 investors in the deal, some 40% by value came from overseas. Only four were bank balance-sheet buyers, while the rest were real-money investors, indicating a genuine return of appetite for risk-weighted returns, rather than purchases for the sake of regulatory compliance. "The emergence of interest from offshore real money investors could potentially fill the void left by bank balance sheets as they view the asset class in Australia in a very favourable way," said Rod Everitt, a director on the Aussie dollar syndicate desk at Deutsche Bank, which arranged the deal. The return of overseas investors is particularly welcome because the market is attempting to get by without the support of the Australian Office of Financial Management, which has been buying RMBS to support the country's smaller mortgage lenders. Moreover, it may alleviate worries about proposed regulatory changes that have called into question the future appetite of local bank buyers for structured finance. In early September, the Australian Prudential Regulatory Authority released a consultation paper that reviews existing liquidity risk management standards required of Australia’s authorised deposit-taking institutions. The review of regulation "APS 210" has caused a great deal of uncertainty because Triple A rated RMBS notes may no longer qualify as "liquid assets" under tighter standards proposed by the regulator. If this was the case, and the regulator is due to finalise the new rules in the first half of 2010, Australian banks that had bought these notes primarily to meet regulatory obligations to hold a certain level of top-rated assets may turn away from the structured finance market. It is hard to gauge the direct impact of APS 210 on bank demand for recent non-AOFM supported RMBS deals. But it has been blamed for holding back the flow of new (unsupported) deals coming to market. However, the latest Torrens trade may provide a glimmer of hope through the confusion. "The level of offshore interest has been really surprising," said one banker away from the deal. "It could counterbalance any reduction in demand from bank balance sheets as a result of APS 210." Ian Makovec, a director of securitisation and asset finance at Westpac, said investors in Europe have started dipping their toes into the secondary markets back home and also exploring markets overseas to park excess cash. Westpac was a joint bookrunner on Torrens. From that point of view, Aussie RMBS is attractive. In a recent Moody’s report comparing the RMBS markets in Australia, the United States, Britain and Spain, the ratings agency wrote: "One of the hallmarks of the Australian RMBS market is its outstanding level of collateral performance." In the longer term, though, it is clear that the Australian structured finance market will have to address liquidity issues to ensure that bank investors do not disappear entirely from the market. "I would have thought that the industry is going to have to consider developing the liquidity aspects of RMBS to assist their acceptance as liquid securities for the purposes of APS 210," Makovec said. The Torrens transaction securitised a portfolio of Australian prime residential mortgages originated by Bendigo and Adelaide Bank and its subsidiary National Mortgage Market. The deal consisted of an A$915m Class A tranche, rated AAA/Aaa (S&P, Moody’s), with a weighted average life of 2.8 years, which priced at 135bp over one-month BBSW. This was the only tranche that w

It is fair to say that the numbers of bond market commentators who wistfully proclaimed: “I remember exactly what I was doing when Kennedy was shot,” has diminished with time. There is a notion that the modern-day equivalent approximates to: “I remember what I was doing when Lehman went bust.” Irrespective of whether the demise of Lehman had the same impact on the global cultural landscape as the assassination of Kennedy, it is fair to say that the post-Lehman era heralds a very different banking landscape, globally. More than a year on from the 15 September 2008, change in the debt capital markets has involved a fundamental shift in the volume, structure and responsiveness of the markets. This is more potent than the hiss of disapproval from polite society that meets any admission about actually being a banker. Away from "column-inch politics", the European debt capital markets have filled the breach created by a clear decline in bank debt liquidity (see Ian Fitzgerald’s article) and moved towards a US model of re-balancing the dynamic between bank debt and public bonds. But before this thesis is developed, it makes sense to put into context the volumes of issuance from investment-grade corporate issuers on a pre- and post-Leman framework. If the pre-Lehman capital market world could be likened to the “Nouvelle Cuisine” era (pretty on the plate but not much of it and what you got had rather a lot of froth on it) then the post-Lehman capital market world would have to be the “back to basics, good honest produce” school (much more volume on the plate and much less fiddly). The volume of new European corporate bonds has broken all previous records to the extent that by November this year €288bn of new bonds had been raised in euro, versus €138bn for the whole of 2008 (an increase of 108%), and £47bn in sterling, versus £17bn last year (an increase of 176%)1. This has been an outstanding outcome keeping in mind that many market participants predicted last year that access to the bond markets would be limited for quite some time. As regards the complexity of bond markets in the “new and honest” 2009 paradigm, where “simple is good”, it is clear that the demand for complicated corporate hybrid bonds has reduced dramatically. Only now, at the end of the year, are we hearing of a cautious return of hybrid conversations in discreet corners of the euro market. The historic reliance of European corporates on the bank debt market (as opposed to US corporates that traditionally tap the capital markets on a more regular basis) created significant (re)financing challenges during the crisis. Indeed, with banks’ CDS rocketing to levels never before seen (Morgan Stanley’s 5-year CDS peaked at 1,300bp in October last year), their cost of funding increased dramatically. As a result, banks were not only unwilling to lend to each other but, in an unprecedented move, unwilling to lend to their corporate clients due to liquidity scarcity. Government intervention on a worldwide basis helped to restore some confidence in the system, but CFOs and treasurers still had to adapt to a new environment with limited financing options. This created an opportunity for the European bond markets to come into their own and do for European corporates what the US market had been doing for years – provide deep pools of liquidity outside of the bank-lending market. Even top-rated borrowers changed their funding strategies substantially and moved away from the bank debt market. Roche (A2/AA-), for example, managed to finance the US$45.7bn Genentech acquisition directly in the bond markets without the need to arrange a loan as interim financing. However, only a very limited number of borrowers could raise such an amount in the bond markets under unique circumstances. Roche benefited from extraordinary demand and issued US$42bn equivalent in three jumbo multi-tranche transactions over a period of two weeks: the first a US$16.5bn in the US; the second a euro/sterling issu

Bank of America Merrill Lynch reached an agreement last week with government regulators for the repayment of the US$45bn it received under TARP. The move will make it easier for the bank to find a replacement for CEO Ken Lewis and may pressure other financial institutions to repay government assistance. However, the costs of repayment may be higher than had been previously expected. BofA Merrill would be the first to repay funds out of the seven institutions that received "exceptional" assistance from the government. The bank initially took US$25bn in October 2008 as the government looked to stabilise the financial system and an additional US$20bn in January to help it absorb the costs of the Merrill Lynch acquisition. The second infusion was viewed as "exceptional assistance", subjecting the firm to government scrutiny above and beyond that of other TARP recipients. In particular, executive pay packages had to be approved by Kenneth Feinberg, President Barack Obama’s special master for executive pay. The restrictions on executive pay have hampered the search to find a successor to Ken Lewis and were a primary motivation for the TARP repayment. The bank recently announced that BofA CFO Joe Price and Barbara Doeser, its head of mortgages, would have their salaries reduced, based on the recommendations of Feinberg. Repaying TARP would free BofA Merrill from Feinberg’s scrutiny, although he would still have the ability to claw back pay if it were deemed excessive and not in the public interest. Citigroup, the only other commercial bank that received "exceptional assistance", recently indicated its desire to repay TARP as fast as possible. BofA Merrill officials remain committed to naming Lewis’s successor by December 31, which is when Lewis has indicated he will step down. BofA chief risk officer Greg Curl is one of two internal candidates being considered; Brian Moynihan, head of consumer banking, is the other. Both were instrumental in recent negotiations with government regulators. The bank could still appoint an external candidate, despite the tight timeline. Citigroup director Michael O’Neill and New York Mellon CEO Robert Kelly are reportedly among the candidates that have rebuffed overtures. If an external candidate were chosen, it is possible that Lewis could stay for an interim period to help with the transition, according to sources at the bank. "Getting out of TARP will give a different spin on negotiations with potential CEOs because of the additional flexibility on executive compensation," said Alois Pirker, research director for wealth management at Aite Group, an advisory firm to the financial services industry. "It also gives the new CEO flexibility to lay out a strategic direction." Still, the tight timeline could favour an internal candidate. Curl, who spearheaded negotiations of the repayment with regulators, was seen as an early favourite because his background in commercial banking and risk management would withstand government scrutiny. Moynihan, the long-time head of investment banking at Bank of America and former global head of wealth management, may be a more viable candidate given less government scrutiny. What is the cost? Hammered out over weeks of negotiations, the terms of the agreement suggest that government regulators are erring on the side of caution. The Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency all had to sign off, leading to protracted negotiations on various financing packages. BofA Merrill will fund the repayment through a sale last week of US$18.8bn in common stock and US$26.2bn of excess liquidity. Another US$5.7bn of equity will be raised from a combination of asset sales of US$4bn and US$1.7bn in restricted stock to be issued instead of cash for year-end compensation. Pro forma, Tier 1 capital would stand at 11%, up from 12.5%, as of September 30, although the contribution to Tier 1 from common capital incr

For market professionals, however, the return of conversations away from liquidity are welcomed, and they have returned with a vengeance. In the past six months, topics on which we were engaged with clients prior to the crisis - economic capital, return on equity (RoE), refining capital structures and capital transactions that maximise the efficient use of assets - have all returned. On the regulatory front Basel II (or potentially Basel III) and CEBS have been joined by the discussions about rating agency actions and rating methodology changes, in whichever jurisdiction a bank operates. And now contingent capital is filling up the headlines in both the financial and popular press – whoever said banking was dull. If we recap the last two years briefly, as there is probably not an adult (or child of a banker at least) alive who has now not heard of Lehman, sub-prime or leverage, we move from a banking crisis and a recession, recapitalisation of banks via both government support and capital markets activity to the introduction of probably the most expediently adopted global product in the history of capital markets – the government-guaranteed bond.1 But over the two years, we have seen a movement from panic to product innovation on a global basis, with bankers and governments combining to resolve the crisis with numerous central bank schemes. The gap filled by these various schemes will now come into focus as governments and central banks gradually withdraw the schemes, begging the question of who, or rather what asset class, will fill the void. High liquidity driving market Once the initial capital and liquidity problems were resolved, the senior debt markets returned quickly for certain names and became more reminiscent of the previous bull years with spread tightening, limited or no new-issue premiums, and oversubscription the norm. High liquidity has been driving the market, albeit in the primary market rather than the secondary. The recovery followed into covered bonds, albeit assisted by the European Central Bank's repurchase scheme, and capital, with even the asset-backed securitisation (ABS) market now starting to show signs of life. Liability management transactions have been both a form of capital raising (and indirectly loss absorption) and capital maintenance. One aspect that perhaps gets overlooked on the exchanges was the fact that they kick-started markets and helped both senior debt and capital to return. The liability management transactions have moved on from purely being a means to raise core Tier 1 capital, as asset values have recovered and bank capital markets have re-opened for many, to pro-active capital management. Ratings agencies have undertaken reviews and changed methodology in most areas, whether it is on an institution basis or on different asset classes, including covered bonds and capital. On the capital front, these reviews have culminated in multiple downgrades in many cases. This has also limited some investors’ ability to invest in the asset class and this could also be further limited by changes in capital rules that will require real loss absorption. This comes at a time when increases in capital and the quality of capital will be of utmost importance. There are various numbers being touted about the amount of total capital that European institutions will be required to raise, and €500bn seems to be a common estimate – assuming Tier 1 capital ratios are increased to around 10%. This is at the same time as the large redemption calendar for institutions starts in earnest in 2010 and for each year after that, so capital will inevitably become a scarcer and more expensive resource. And now that the US & UK banks have fully stress tested their balance sheets, the focus has shifted to Europe. Comfortable with innovation Innovation though is something that the capital markets have become very comfortable with over the years with the transition of capital structures, from the original perpetual pre

A NT$17.1bn (US$532m) Taiwan depositary receipts issue from Hong Kong-listed Tingyi is set to drive TDR fever to new heights. The deal is the largest ever TDR in and also the largest public equity offering in the country since the onset of the financial crisis. Tingyi, which is the biggest food and beverage firm by market value in China, opened books for its TDR last Wednesday. The deal comprises 380m TDRs at NT$43–$45 each, representing a 6.3%–11.2% premium to the closing price in Hong Kong on the same day. Issuance at a premium would once have been impossible in Taiwan, a market which has traditionally been less exciting – and less excitable – than its Hong Kong counterpart. But the TDR market has been on fire since its revival following a NT$3.26bn offering from Want Want China in April and local investors are willing to pay over the odds to get in on the action. "Everyone wants to grab a piece, as Tingyi is a leading player in China’s food and beverage market," said a Taiwan ECM banker. "It’s a good chance to invest in a high-growth Chinese stock. Previous experience also shows that investors can usually make quick bucks from TDRs." Six companies – Want Want China, Ju Teng International, Yorkey Optical, New Focus Auto Tech, Vietnam Manufacturing and Export Processing (VMEP) and Solargiga Energy – have issued TDRs so far this year. With Tingyi’s deal, TDR issuance will reach NT$30bn in 2009. Barring Solargiga, which priced last week and will only start trading this Friday, all the offerings traded well in the aftermarket following strong demand from investors. VMEP, which started trading last Thursday, soared to its 7% daily upside limit on its first two days of trading. By last Thursday, the TDRs of Want Want China, Ju Teng, Yorkey Optical and New Focus Auto were between 44% and 110% above issue price. Tingyi’s deal, which prices this Tuesday, is expected to be another blow-out. The book is already several times covered and the syndicate banks have not been required to underwrite any shares. Over 20 banks have joined the syndicate, which is led by Sinopac Securities. Hong Kong-listed Taiwanese company Neo-Neon also hopes to get through the market window before the Christmas break to complete its TDR listing. The company plans to raise NT$2bn by selling 140m TDRs (79.2% primary/20.8% secondary). Lead underwriter Fubon Securities will open the books this Wednesday with pricing slated for December 15. Retail investors’ sudden affection for TDRs has, however, worried Taiwan’s regulators. The authorities are concerned that investors will get burnt once the excitement ends and TDRs trade back to normal market prices. As a result, the regulators in mid-November introduced a new measure to improve liquidity in TDRs. Issuers have to sell up to 30% of a TDR float to retail investors (up from 10%) if their level of subscription passes a certain threshold. This is expected to result in a wider distribution of the TDRs and reduce the concentration of TDR holdings in the hands of institutional investors. In most of the offerings done earlier, retail investors could not get their hands on the deals in primary as institutional investors snapped up the offerings. The intense competition between the institutional and the retail bid explained the significant rise in the prices of the TDRs in the aftermarket. It is not clear whether the introduction of the new measure will achieve the desired objective. VMEP’s offering was launched after the new measure came into effect and as per the rule had to reallocate the shares to accommodate a 30% retail component following a 27-times oversubscription. It managed to achieve a strong run in the aftermarket following continued strong demand from retail investors. No doubt the strong performances so far has prompted others to line up with their TDR offerings. At least five other companies, including Sandmartin International and Kith Holdings, are queueing up.

Banks are facing tens of billions of dollars in lost revenue annually, as increased competition between firms and new derivatives rules designed to clean up the industry eliminate important sources of cash in the over-the-counter business, according to estimates that surfaced last week from JP Morgan. Top management at the US bank estimates that it alone could lose between US$2bn and US$3bn a year as a result of proposed legislation to force more trades through exchanges and central clearing. Senior bankers at a major European house have similar estimates of up to US$2bn in lost revenues annually. A drop on that scale would imply tens of billions of dollars in lost income across the entire industry. "Management acknowledged the potential challenges of increased regulation," Bernstein analyst John McDonald wrote after meeting JP Morgan's investment bank chiefs, adding that the bank's biggest concern was that all derivatives would be shifted to exchanges, "limiting the company's ability to create customised products." A handful of banks are expecting record income from their derivatives units this year, boosted by supernormal profits from their OTC businesses. The space has seen the retrenchment of many large firms, leaving those that remain to share the spoils of wider spreads and reduced inter-bank competition for bespoke trades. That is likely to change next year as regulators on both sides of the Atlantic force more trade through exchanges in an effort to reduce systemic risk. That would eliminate the cash that banks pick up by acting as brokers to clients. In addition, a move towards central clearing would increase the cost of the bank's own trades, and possibly reduce client flows. Timothy Geithner, US Treasury Secretary, last week told a Senate hearing on derivatives that regulators should seek to maximise the number of contracts that are required to be centrally cleared, urging them to "carefully police any attempts by market participants to use spurious customisation to avoid central clearing." "The whole industry is scared about this," said one equity derivatives head at a European bank. "If they go all the way with some of the US suggestions it's going to be a disaster for the swaps market and a disaster for a lot of equity financing transactions. Of course, this is going to impact on all of our plans for 2010 onwards." Derivatives accounted for about 8% of JP Morgan's total revenue between 2006 and 2008, according to estimates, and many banks are already examining new sources of revenue as they seek to plan the shape of their businesses going forward. While some are seeking to extract extra cash by expanding their derivatives advisory services, others are planning to capture revenue from the alternative investment industry by creating their own highly-specialised investment products using derivatives (see "Dynamic space hots up"). "Volumes are clearly shifting away from the over-the-counter arena," said one derivatives flow head at a US bank. "On top of that, spreads have compressed massively. This business is going to become much less about the prices you quote, and much more about client relationships and the package of services you provide to them."

The men at the top of the International Capital Market Association are fairly pragmatic when it comes to regulatory progress in the financial sector. Their response to concerns over the speed of the recent establishment of new European supervisory bodies and the European Systemic Risk Board is no exception. "I would have been concerned if, after great statements of intent, nothing then happened," says chairman Hans-Joerg Rudloff. "Will it be perfect? No. We have to accept there will be teething problems." The European Commission is hoping for the new bodies to be signed off this year by member states and to have them up and running in 2010. On the drawing board is a European Banking Authority, a European Insurance and Occupational Pensions Authority and a European Securities and Markets Authority. The debate over these agencies is typical of the now very fast moving regulatory environment with which the banking industry is struggling to keep pace. But in principle, many in the industry see the establishment of these new bodies as positive. "I think it's a major improvement, it's a pragmatic step," says ICMA president Rene Karsenti. "The EU is setting up these authorities under existing structures, which will save a lot of time. It follows on from recommendations in the excellent de Larosiere report." Jacques de Larosiere chaired a committee on EU financial supervision at the behest of the European Commission and published a report on the matter in February this year. Its recommendations are widely seen as the roadmap for future EU regulation. Karsenti said that while the UK will face more supervision from the EU, at the same time UK supervisors will be able to have more scrutiny of other European supervisors. "When you look at London, which hosts many continental European bank subsidiaries, this is a plus," he says. Finding the right balance That does not mean that there are no concerns. "The subtlety will be to get the balance right between the three ESAs and national regulators going forward," says Martin Scheck, ICMA's CEO. Echoing similar concerns by the UK government, ICMA worries that these new bodies may unduly dilute the authority of national regulators. After all, these have a greater familiarity with the players in their jurisdictions and it will still be down to individual states to bail out struggling institutions. But pan-European bodies can clearly be a success. "The most admired framework is the ECB," says Rudloff. "It has specific roles assigned to it from long treaty negotiations, it is the most advanced body, I would say, and has to be otherwise you cannot have monetary union. But this is certainly not the case on the regulatory front." EU states are still sovereign and they will still act in their own national interest during times of crisis, he adds. "These co-ordinating bodies are just one bridge towards a future with less national parameters. At the moment there’s no emergency legislation and there’s no framework in place." Needless to say, ICMA is voicing its concerns on these issues to the relevant European authorities. "They clearly do take notice of what we’re saying and they do listen to the industry," said Scheck. "There is an ongoing dialogue." ICMA was consulted by the de Larosiere committee, for instance, and has had input into many other European regulatory proposals. One current ICMA recommendation is for the Commission to hire more market practitioners who understand the industry, to help with its now considerable regulatory workload. "We talk to regulators with the specific aim of ensuring that what’s coming through will improve market efficiency and infrastructure," says Scheck. He argues that ICMA supports regulation, but wants to ensure that rules are properly thought through. "Some of what is being proposed is rather rushed. There’s a lot of political and public pressure to do something quickly. It is incredibly important that the views of the market are taken into account. We want a safe