Sovereign Bonds Roundtable 2009: Participants

The sovereign market faced two main challenges this year: a growth in its own capacity to raise ever larger amounts of debt, and the additional competition posed by the government guaranteed bank sector. The participants at this year's IFR Sovereign Roundtable were generally in agreement that neither of these had significantly changed how national debt offices go about their everyday role of financing their budget deficits. The means by which financings have been achieved have, nevertheless, had to respond with a degree of innovation to ensure investor appetite remained sufficient during this testing period. The divergence between some sovereign spreads within Europe earlier in the year presented savvy investors with an unprecedented opportunity, albeit one made more obvious by hindsight. The notion that there was a high probability of a Eurozone breakdown has now been reversed. Although it is not business as usual, most participants agreed the market has returned to much more stable conditions. Business with customers has led the way back from the depths of the market's disruption, although business to business activity is taking longer to resurrect. The role of electronic platform trading is still considered integral to turnover, but the rebuilding of bank balance sheets has further to go before pre-crisis levels of activity can be restored. While the spread differentials within Europe have significantly improved, the well-being of the patient is better assessed by comparison with its neighbours. Although there have been successful fund raising operations carried out by some central European and Balkan states, the use of emergency funding measures provided by the European Community and the IMF may present more cost effective financing for some countries. For most, however, the worst appears to have past. By embracing different methods of selling debt, investors’ reach has also been extended. Some countries have turned to syndication to minimise the market disruption surrounding government bond auctions earlier this year. For others a more flexible approach to setting the size of auctions has contributed to more successful pricing outcomes. Sovereigns are spending more time monitoring the performance of the banks responsible for the distribution of debt as a central pillar of their issuance strategies. Fears remain that the recent improvement in market conditions may be transitory or that economic recovery will put yields under pressure. This could potentially lead to even greater pressure on the refinancing needs of the sovereigns and has already led to an increased appetite for inflation-protected debt. Several participants expressed concerns about this scenario while accepting that, for now, the fixed income market is likely to be supported by a lower equity risk profile. That will itself contribute to the normalisation of fixed income market conditions.

The sovereign market faced two main challenges this year: a growth in its own capacity to raise ever larger amounts of debt, and the additional competition posed by the government guaranteed bank sector. The participants at this year's IFR Sovereign Roundtable were generally in agreement that neither of these had significantly changed how national debt offices go about their everyday role of financing their budget deficits. The means by which financings have been achieved have, nevertheless, had to respond with a degree of innovation to ensure investor appetite remained sufficient during this testing period. The divergence between some sovereign spreads within Europe earlier in the year presented savvy investors with an unprecedented opportunity, albeit one made more obvious by hindsight. The notion that there was a high probability of a Eurozone breakdown has now been reversed. Although it is not business as usual, most participants agreed the market has returned to much more stable conditions. Business with customers has led the way back from the depths of the market's disruption, although business to business activity is taking longer to resurrect. The role of electronic platform trading is still considered integral to turnover, but the rebuilding of bank balance sheets has further to go before pre-crisis levels of activity can be restored. While the spread differentials within Europe have significantly improved, the well-being of the patient is better assessed by comparison with its neighbours. Although there have been successful fund raising operations carried out by some central European and Balkan states, the use of emergency funding measures provided by the European Community and the IMF may present more cost effective financing for some countries. For most, however, the worst appears to have past. By embracing different methods of selling debt, investors’ reach has also been extended. Some countries have turned to syndication to minimise the market disruption surrounding government bond auctions earlier this year. For others a more flexible approach to setting the size of auctions has contributed to more successful pricing outcomes. Sovereigns are spending more time monitoring the performance of the banks responsible for the distribution of debt as a central pillar of their issuance strategies. Fears remain that the recent improvement in market conditions may be transitory or that economic recovery will put yields under pressure. This could potentially lead to even greater pressure on the refinancing needs of the sovereigns and has already led to an increased appetite for inflation-protected debt. Several participants expressed concerns about this scenario while accepting that, for now, the fixed income market is likely to be supported by a lower equity risk profile. That will itself contribute to the normalisation of fixed income market conditions. Click here for Participants.

IFR: How do you think the creation of the sovereign-backed bank asset class has affected borrowing in the capital markets since its inception late last year? What funding options are being considered by issuers in response to this – and higher sovereign funding needs? Zeina Bignier (SG CIB): The creation of GGBs (government-guaranteed bonds) has not really hampered primary market activity. The increase in sovereign supply has largely been offset by the decrease of senior debt in the financial sector. In 2008, the financial institution arena of course included covered bonds and, including these, it accounted for around €463bn that year. As of today, the financial institution sector, including the GGB market, is around €272bn. Compare that to what the market was last year over the same period, which was €360bn; the €463bn was for the whole year. The effect that GGBs have had on the market had more to do with the announcement of the schemes which affected spreads in the market. They paid a much higher spread than sovereigns or agencies (certainly, the old agencies, like EIB and KFW). I would say that the competitive supply has triggered a widening in agency levels, and to a certain extent sovereigns. But in terms of capacity, I think that the market has absorbed this new asset class pretty well. Daniel Shane (Morgan Stanley): Initially there was concern in the market, but not so much about the supply as such. The point you make is an absolutely accurate one in that people saw this replacing a lot of covered bond issuance. So, I don't think it was so much of cannibalising of demand but more an impression of the contingent liabilities that it was potentially creating for sovereigns. That was one concern that people had. But I think that, very quickly, the market understood this was a very different asset class from sovereign bonds. Sovereign bonds offer liquidity; sovereign government-guaranteed bonds comprise a much more fragmented market. We've seen government-guaranteed issuance in the market already from numerous different agencies that carry specific guarantees, and they've always traded at a premium and with different degrees of liquidity than sovereigns. It was really a different asset class and it did not create additional supply in the market. It was offset by the drop off we saw in senior bonds and covered bonds. Georg Grodzki (LGIM): I would agree with the notion that the asset class has not necessarily grown at the expense of others, but we have certainly seen rivalries between government bonds and government-guaranteed bonds and between covered bonds and government-guaranteed bonds. So the relative value propositions in the market have shifted dramatically. We see it as a transitory asset class and would not feel comfortable with sustained high issuance volume of government-guaranteed bank debt. Banks should be able to fund themselves without an explicit guarantee. We are fully aware of the implicit support and we have the research resources in place to unmask any residual risk. So for us it's a symptom of the aberration in the marketplace, which, hopefully, will end soon. We therefore assume that it will not have a lasting effect. IFR: The first guaranteed trade came at 25bp over swaps; did that strike you as the correct level? Shane: There was also the US dollar equivalent, when we saw Goldman Sachs with the first dollar transaction around the plus 80bp level over swaps. I think there was a sudden shock surprise in the market that this was going to have a repricing effect for a whole range of different asset classes. You can't say sovereign issuance is completely exempt from that, but I think the majority of the impact was very clearly on the supranational and agency sector. My perception is that there is a strong differentiation between this asset class and sovereign – pure sovereign – bond issuance. The likes of EIB and KFW obviously did see their spreads gap out substantially at the time, and this was very much in

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 exerci

IFR: How do you think we stand with regard to risk appetite? Ezquerra: We were talking about how to measure liquidity. Now it is: how do you measure risk appetite? That is even more difficult! There have been a number of surveys saying that risk appetite is back to top levels, but then you think: what is risk appetite? And it seems that risk appetite is buying Greece at 200bp over swaps or ourselves at 80bp over Bunds and then saying: I’ll take more of that. That is not real risk appetite, frankly. Nor is having the national champions of each country issue a Pfandbrief and saying it's wonderful because risk appetite has returned. Let's hope there's more to it than this because we still have a long way to go. Shane: Risk is better measured by whether the high-yield markets get back on their feet. Ezquerra: We really need them to get back on their feet, and not just have top credits being less differentiated. There is still a long way to go; non guaranteed issuance by middle-tier banks, for example. But the signals are quite positive and, touch wood, we’re past the worst. The sovereign markets have shown that they can stand up and be counted and we hope that we won't have any big systemic problems, but the road ahead is still long. Bignier: I think that risk appetite can only be measured amongst the European sovereigns to a certain extent. There is little risk there, even when a Triple A rating is not awarded. I think risk appetite can be seen in the CEMEA country market, Poland being an example. There was a very difficult period last year when the CDS of CEMEA countries was very high, with Russia around 1,000bp and Romania 800bp, and we were wondering whether there was any interest at all. But we reopened Poland this year and we managed to bring Slovakia and Slovenia. I know that they are in the eurozone now, but for Slovakia and Slovenia we had to battle a little bit with the market to be able to launch the transactions. Poland, on the other hand, was surprisingly easy. So, the demand is there. Croatia came to the market a few weeks ago, Lithuania as well. It was slightly difficult but they managed to close the transactions, and there is other Eastern European country looking to come to the market. In the dollar market we saw Qatar go pretty well, and CDS is generally continuing to narrow. The current levels reflect that the appetite for the risk is back. Nevertheless, I think that we will stabilise around here. The general economic environment remains fragile, especially in Eastern Europe countries and Russia. Proni: Our experience with countries such as Poland, Hungary, the Czech Republic and Lithuania tells us that they are not going anywhere. It is quite difficult for us to find banks which are willing to support liquidity in them. So, if that is a measure of risk appetite, I would agree with Enrique that there's not much of that yet – especially in, let's call them semi emerging or semi core regions. We are talking to a number of market-makers and there seems to be some interest coming back, but it's all fairly lukewarm at the moment. I remember in late 2003, before the enlargement of the EU, all these countries were the perfect convergence play; they were going to join the euro within the next three years. It’s funny how memories can sometimes be quite short. Bignier: In 2006, Hungary issued a 10-year at mid-swaps plus 18bp. Proni: Exactly, there you go; and where is Hungary now? Bignier: Hungary did manage to come back to the market and I think they will probably look at it again in 2010, but they issued in the 10-year in March 2006 at mid swap plus 18bp. Proni: And three years down the line no one wants to touch it. Bignier: No, there are still some fears surrounding Hungary and we will test the market in the next weeks with Romania. Now there is the IMF package that gives the market some comfort, but even with the EC package to Eastern Europe countries, for Hungary it's still difficult for them to come to the market.