IFR DCM Special Report 2014

For years after the financial crisis, the mere mention of the word provoked fear and loathing in Brussels and Frankfurt. To European legislators, securitisation meant asset-backed securities, an asset class tainted by its links to subprime American home loans. When those mortgages went toxic in 2007, they sowed the seeds of a global financial crisis whose impact still continues to reverberate across the continent. Despite undergoing a “near-death experience” in 2008 and 2009, said Alexandre Vigier, head of financial institutions securitisations, Europe, at Credit Agricole, when new issuance slowed to a virtual halt, the market somehow endured, much as rats or cockroaches outlast nuclear blasts. That it survived at all despite a supremely hostile regulatory environment is testament, said Vigier, to its role as a “unique and diversifying funding source [that remains] invaluable for certain issuers”. It also benefited from the fact that simpler types of securitisation – those with less risk and opacity and fewer layers – continued to be favoured by a stubborn group of investors. But that aside, the downsizing of a once vibrant asset class is astonishing when viewed from any angle. Having recovered to a post-crisis high in 2011, when new issuance reached US$128bn, the industry slumped anew, falling to US$105bn in 2012, and US$87bn in 2013. Bankers sold US$57.3bn through the first nine months of 2014, against US$59.3bn in the same period a year earlier, according to data from Thomson Reuters. “European securitisation has been moribund since the 2008 financial crisis,” said Tom Budd, co-partner-in-charge in London at law firm Gibson Dunn. Yet the night, as the saying goes, is always darkest before the dawn. The market may not entirely have risen off the slab, but more investors, notably in the relatively underdeveloped European market, are keen to buy asset-backed paper than at any point in the post-crisis era. Losing the hostility There is, said Laurent Mitaty, global head of securitisation at Societe Generale, a “lot of buying appetite” among investors “keen to buy ABS paper”. Yet that demand is not being met by supply, which continues to be choked off by the relatively high cost of issuance and, until recently, by the undisguised animosity of European lawmakers. Yet that could all be about to change. In early October, regulators edged closer to approving the securitisation of more assets, notably auto, consumer and small-business loans. The draft of a measure drawn up by EU financial services chief Michel Barnier pointed to a future in which eurozone lenders would be permitted to issue a wider range of asset-backed paper. The rules provide a fascinating insight into how quickly regional thinking about ABS has changed. European legislators are loath to fully endorse an asset class they long ago learned to abhor. But they recognise the pressing need to inject more capital into the flagging eurozone economy, and to find new ways to help firms meet their funding needs by tapping markets, rather than capital-constrained lenders. Nor is issuance the only factor to guide thinking here. New regulations were drawn up with a secondary purpose in mind: to help make regional lenders better at withstanding shocks. Proponents hailed the decision, which comes at a time when eurozone nation-states are under threat of slipping into recession, some for a second or a third time. Damian Thompson, head of asset-backed finance, Europe, at RBS, said the move was “long-term very positive for a number of reasons. Our view is that it brings other investors to the table: investors who may not have looked at these products since the financial crisis, or may never have looked at them”. It was also, Thompson said, likely to “transform” the market, by heaping pressure on regulators across Europe to make the asset class more accessible and investible. Thompson points directly to Solvency II and Basell III capital regulations, both of which remain, he said, “ver

Sometimes, the hardest thing to do is to spot something that isn’t there. Prior to the financial crisis, the existence of a thriving, liquid secondary bond market was a given in the developed world. Debt was issued, resold, and resold again. Investors bought, held and traded bonds with the studied and natural ease with which one, say, hands around a bowl of bar nuts. Wind forward to late 2014. Secondary bond market liquidity still exists, much as those old VHS cassettes that were once displayed with pride on a prominent shelf still lurk somewhere in an attic or basement. “Banks still act as active intermediaries,” said Jean-Marc Mercier, global head of debt syndicate at HSBC, continuing to operate as active intermediaries, particularly when it comes to supporting the issued debt of prized clients. But the size of the market has shrunk as liquidity has drained from it, a situation that, said Fred Zorzi, co-head of debt capital markets at BNP Paribas, “isn’t going to change any time soon”. In a particularly damning report, issued in September, BlackRock painted the picture of a “broken market” desperate for reform. Hammer blow The hammer blow has come from tighter regulations. Designed originally to curtail leverage, a glut of new rules has instead undermined the willingness of lenders to make markets in corporate and in some instances also government debt. Banks that once thought nothing of running sizeable risk positions have been forced to adjust to an uncertain and rather hostile new world. Costs have soared on all sides, with lenders forced to hire new staff not to sell new bonds, or trade them with peers or investors, but to comply with stringent compliance rules. Banks, said Tim Hall, global head of debt capital markets at Credit Agricole, have been given “little choice but to adjust their trading books accordingly”. Armin Peter, head of European debt syndicate at UBS, said that by attempting to make the market a safer place, rule-happy regulators have merely succeeded in “making the asset class more uninteresting, so investors simply aren’t engaging to the extent that they were in the past”. The loss of a once-vibrant secondary debt market has been the source of much grief on all sides of the financial spectrum. Banks, already reeling from public and political opprobrium and an onslaught of regulations designed to rein in their more reckless tendencies, have been forced to retreat from a market that not so long ago was a true revenue-generation machine. The industry was dominated by size and risk appetite. Profits soared at lenders able and willing to hold hefty and risky positions on their books. Yet a once highly profitable slice of the financial services space has, in the space of a few short years, become an ancillary business to many lenders. “One of the traditional engine rooms of revenue generation at banks in the past was secondary trading,” said Sean Taor, head of debt capital markets, Europe at RBC Capital Markets. Yet falling volumes first trimmed, then slashed, earnings. With profitability down and regulatory costs still rising, “some banks are being forced, even now, to make cuts in their headcount on the sales and trading side”, Taor notes. Financial institutions have excised entire trading teams from their books, with bankers winding up on the buyside or looking for work. Brave new world To be sure, banks learned to adapt to the brave new world, as they always have. Afraid of or unable to run a big secondary book, lenders have turned to the increasingly influential primary bond market for succor. “If you’re not taking risk to earn money in [the] secondary, then you become more dependent on primary business to meet your overall profit targets,” said Credit Agricole’s Hall. A dependency on primary profit has, in a short span of time, become “part of the ‘new normal’”, he adds. “Banks generally have to rely more on primary business, as do investors. Primary doesn’t chew up much capital, and it gets you close

Indeed, the sector surprised issuers, managers and investors right from the start. Jermaine Jarrett, head of high-yield bond syndicate at Credit Agricole, expected rates to go up by mid-year and spreads to widen. Neither happened. “We expected the pace of opportunistic refinancings to slow and that new issuance would be more event-driven,” he said. Again confounding expectations, refinancing bounced to record post-crisis highs while acquisition-driven financing was one of the great unheralded capital markets stories of the year. Looking back, the early part of the year seems like another country. Volumes were high but not startlingly so. It was only when France’s Numericable and Luxembourg’s Altice joined forces in April to buy Vivendi’s phone unit that the market found a higher gear. That deal made history twice, both in terms of its overall size and the total books, with the €12bn equivalent trade securing US$100bn in orders. Some deal tranches were 10 times oversubscribed, ushering in a stellar few months through early summer. Nor was that the only deal to whet investor appetites. Wind blew into the market in June to issue a bumper €4.575bn mix of euro and dollar-denominated floating and fixed-rate paper, taking total issuance by the Italian telecoms firm to €8bn equivalent in just three months. Syndicate bankers were hard pushed to remember a better and more protracted passage of time for European high-yield. Lulls and jumbo deals And the deals just kept coming. Total European high-yield issuance hit US$145bn in the first nine months of the year, up from US$100bn in the same period a year ago, according to data from Thomson Reuters. Total global issuance hit a record US$505bn in the first nine months of 2014, beating the US$454bn posted a year earlier. Nor, unlike much of the post-crisis era, has the year been one of long lulls punctuated by a few, frenetically finalised jumbo trades. Smaller trades have kept the markets rolling along, boosted by first-time SME issuers from the likes of France, Germany and Italy. Such deals may take longer to get to market, and bankers have at times grumbled at taking on quarter-billion-dollar deals when most, said Paul Gibbon, head of leveraged finance capital markets at UBS, would “prefer to be processing larger US$400m, US$500m, deals which exhibit better liquidity in the after-market”. But the fact that first-time European corporate issuers from the likes of France, Germany and Italy are willing to make the journey at all is testament, said Tanneguy de Carne, head of non-investment-grade capital markets at Societe Generale, to the market’s increasing “depth and maturity, as well as proof that the market is accepting more mid-cap corporates”. It hasn’t been entirely smooth-sailing. Deal activity slowed sharply in late July and August, as investors took fright at a frothy market and uncertainty in Ukraine. Many saw that as a logical reaction, said Chetan Modi, co-head of European leveraged finance at Moody’s, to “a market that had grown too fast and was looking for a trigger, and Ukraine happened to be trigger”. Funds flowed out of loans and bonds; pricing fell back. Hitting the skids A scattering of deals also hit the skids. In late July, French industrial firm Winoa pulled a planned €260m non-call, senior secured issuance. The following week, Poland-based retailer EM&F’s attempt to complete a €240m print of senior unsecured notes stalled, despite talk of a chunky yield estimated at 8.5%–8.75%. In truth, neither sale was ideal. Winoa was undermined by misgivings about the speed with which private equity major KKR sought to refinance a firm it only bought in early 2014, with investors casting their minds back to Gala Coral’s accelerated 2011 bond sale. EM&F was hobbled by more strategic concerns. There was, said Credit Agricole’s Jarrett, a “lot of doubt about their future. They sell books and music in Poland and Ukraine and the increase in competition – we know Amazon is com

Amid accelerating demand among sub-investment-grade borrowers, issuance of bonds in euros is up 18% year-on-year, according to IFR data, reaching €878bn. Issuance in US dollars, meanwhile, has declined by 3% to US$2trn. Behind the jump in European issuance is a mixture of technical and fundamental economic factors. On the technical side, the five-year eurodollar asset swap rate has declined significantly from the 70bp–80bp highs seen in 2013 to as low as flat in April, before widening slightly to 13bp in the recent period, according to Citigroup pricing. “We are witnessing increased investment flows into Europe, particularly from Asia and primarily China, and whereas historically many of those firms would have issued in dollars to buy assets in Europe that is no longer the case, matched funding is prudent risk management” That means non-European companies are able to issue much more comfortably in euros and swap back to their domestic currencies, and in response Europe has seen a slew of firms from Asia, the Middle-East, Russia and Latin America tap the European markets in the recent period. Perhaps more importantly, the fundamental landscape has shifted, with foreign direct investment flows recovering sharply in recent months, said bankers. The most recent European Commission statistics show EU-28 inward flows in 2013 were 12% above EU-27 flows in the previous year (Croatia became a member in July 2013). Prudent risk management “We are witnessing increased investment flows into Europe, particularly from Asia and primarily China, and whereas historically many of those firms would have issued in dollars to buy assets in Europe that is no longer the case, matched funding is prudent risk management,” said Hakan Wohlin, global head of debt origination at Deutsche Bank. “We would observe that while there is no particular reason to diversify from dollars, the view the further east you go is that it may make sense not to have all of your eggs in one currency basket.” Some 15 Asian corporates (ex-Japan) have issued euro-denominated bonds since the beginning of last year in deals worth €6.4bn, according to Dealogic. One example was Bharti Airtel, India’s largest mobile-phone carrier, which in May offered euro-denominated securities for the third time in six months. The rise in appetite for euro-denominated funding has played out in bank revenues, with year to-date European bank DCM revenues reaching US$5.3bn, according to data provider Dealogic, compared with US$4.7bn for the same period in 2013 and US$4.2bn in the same period in 2012. US DCM bank revenues, by contrast, have declined, with banks posting US$6.3bn of revenues in the year to-date, compared with US$7.2bn in the same period in 2013. “If you look at the growth of the market in Europe, it’s a structural shift, fuelled by deleveraging among European banks,” said Mathew Cestar, head of leveraged finance in EMEA at Credit Suisse. “In the past six years in Europe the high-yield market has grown four-fold, which represents a tremendous reshaping of the pool of capital.” High-yield primary market volumes in Europe were €92.5bn in the year to-date, according to Credit Suisse, compared with €63.4bn in the same period in 2013, with the bank predicting annual issuance will hit a record €130bn in 2014, smashing 2013’s €87.4bn record. Continental divide The total European high-yield market is now around €292bn, compared with €58bn in 2008. That’s still small compared with the US$1.4trn US high-yield space, but while the US market has grown by about 50% since 2008 the European market has expanded by 500%, In addition, European high-yield has outperformed US high-yield in five of the past six years. With companies in Europe at a different stage of the credit cycle to their US counterparts, the trend is set to continue in the coming years, said Cestar. “The refinancing that needs to get done in the European market place is around €305bn in the next few years, which is a large chunk of busin

In the years immediately following the financial crisis, bank lending for just about anything in Europe, including infrastructure projects, fell apart. However, such liquidity constraints now appear to be water under the Mersey Gateway Bridge. Enticed by low default rates and relatively wide loan margins, some European banks – nine from Scandinavia, Germany, the Netherlands and most recently France – that exited the infrastructure space following the crisis have returned, market participants say. “Within the EU, banks and institutional investors are trying to figure out where to put money to work to optimise risk and return in a market where returns are being squeezed by expansionary monetary policy,” said Andrew Davison, senior vice-president, infrastructure finance, at Moody’s. Top of the list “Infrastructure is now at the top of the list for many organisations. For banks in terms of loan margins and for bond investors in terms of credit spread, the sector is more attractively priced than other asset classes,” said Davison. There’s also this: “Most of the banks lend on a floating basis, and most borrowers prefer to borrow on a fixed-rate basis,” said Priya Nair, managing director, infrastructure and structured DCM at Royal Bank of Canada in London. “As a consequence, the bank loan product can be lucrative to banks as typically borrowers will seek long-dated swaps to match the corresponding loan. The swaps can be capital-intensive but lucrative, nevertheless.” This renewed interest from the bank market brings additional competition for assets to a sector already crowded with infrastructure funds and institutional investors looking to pick up yield. At the start of the fourth quarter, there were a record 152 infrastructure funds targeting an aggregate US$95bn globally, according to Preqin, the alternative assets data provider. And while not all of those funds are seeking assets in Europe and the UK – as of Q4 2014 some 68 funds were targeting Europe specifically – this is precisely the geography garnering the most attention from institutional investors. Preqin currently tracks 675 European investors with an allocation to infrastructure opportunities, 41% of which are a form of pension scheme. Of those pension schemes, 71% are seeking European investment opportunities, either exclusively or as part of a more global mix, according to survey results released in July. “The demand from institutional investors has increased, in terms of the number of investors, the ticket size that each investor is able to contribute and the terms that they’re able to agree to,” said Stewart Robinson, European head of project bonds at Societe Generale. “Appetites have changed drastically.” Societe Generale and Credit Agricole acted as co-lead arrangers on the recent €430m project bond that provided funding for the A7 federal highway in Germany, which was priced with a 2.957% coupon. The project was the latest of five supported by the European Investment Bank’s Project Bond Initiative, which supplied a further €170m in subordinated debt. Indeed, efforts to stimulate the project bond segment of the market – including the EIB initiative and the UK Infrastructure Guarantee programme, which provides a monoline-like bond guarantee and earlier this year backed roughly €340m worth of bonds to help fund the Mersey Gateway Bridge project – are at least part of the reason institutional investors have begun paying more attention. “Investors have seen the EIB saying, ‘I’m here, I’ve done due diligence, and if I’m willing to be in this transaction in a subordinated position does that not give you comfort that you’re in a senior position’?” said Katrina Haley, head of structured bonds EMEA at HSBC, which arranged the Mersey Gateway bond transaction. “In that respect it’s been very successful. Is it essential any more, do you need it? Perhaps not so much. Most issuers now have a choice of debt sources, and that’s something that a couple of years ago they didn’t hav

European banks have enthusiastically been raising Tier 1 capital all year. Around €85bn is the total expected for the whole year, according to UBS and with roughly €50bn raised by the end of the summer holidays the rest of the year was always going to be busy. The reason for the capital-raising is bank compliance with Basel III. In the aftermath of the debt crisis, strict guidelines were set up by the Basel Committee on Banking Supervision in July 2011 to boost balance sheets. Rather like schoolchildren faced with a Monday morning assignment, the rush has been on. Certainly, September started with a bang. Almost before bankers had put their bathing suits back in the cupboard to be forgotten for another year, Spain’s largest bank, indeed the eurozone’s largest bank, Banco Santander hit the markets. On September 4, it sold a €1.5bn equity convertible euro Reg S issue with a low trigger of 5.125%. The perpetual non-call seven-year bonds were priced at par to yield 6.25%. It was followed a day later by UniCredit, Italy’s largest bank, which sold a €1bn perpetual non-call seven-year bond offering, again at par, to yield 6.5%. A good start by any reckoning, but almost before the markets had a chance to draw breath, they were hit by three more deals: HSBC, Credit Agricole and Nordea. HSBC sold a hefty US$5.6bn-equivalent triple-tranche deal denominated in US dollars and euros. The US$3.75bn of US dollar tranches were split into US$1.5bn of 5.625% perpetual non-call five-year notes and US$2.25bn of 6.375% perpetual non-call 10s. The remainder chased a €1.5bn 5.25% perpetual non-call eight-year tranche. It was almost immediately followed by Credit Agricole with a US$1.25bn perpetual non-call five-year at 6.625%. And the week after that by Sweden’s Nordea with US$1bn of perpetual non-call five-year notes coming at 5.5% and US$500m of perpetual non-call 10s at 6.125%. Alternative routes What is significant is that all the names that are mentioned are major and systemic banks. It is also worth looking at currency. At the beginning of the year, with a need to boost their capital adequacy ratios and Tier 1 capital, European banks started to raise the money that they needed in US dollars. In particular they went down the Reg S offshore route. This avoids much of the tiresome documentation issues that issuers have to face when going to the onshore US market – the 144A route. It appeared a smart move, with heavily oversubscribed deals from Asian and European accounts. In early May, for example, Spain’s largest bank, Banco Santander, priced its debut US dollar Additional Tier 1 bond issue. It was a US$1.5bn perpetual non-call five-year bond offering that attracted more than US$10bn of demand. And UBS saw similar enthusiasm for its US$2.5bn 10-year bullet Tier 2 issue that attracted more than US$7.7bn of orders. CoCo the summer Before the summer break, the last European bank to raise AT1 was Deutsche Bank, with a mammoth deal at the end of May. Germany’s most significant bank raised €3.5bn in a three-tranche sale of contingent capital bonds. It sold a US$1.25bn tranche at 6.25%, a €1.75bn tranche at 6% and a £650m tranche at 7.125%. What made the deal stand out – aside from the size of the trade itself – was that the book was more than seven times covered with more than €25bn of orders. The reason for the attraction of the US market is not hard to divine. Part of the challenge with euro issuance is the low absolute rates in euros. “If you price at mid-swaps plus 350bp that gives a coupon of only 4%, which is seen as too low by some for subordinated risk,” said Barry Donlon, head of capital solutions group EMEA, at UBS. That is one of the reasons that issuance in euros has tended to avoid the non-call five route, preferring non-call seven or non-call 10 structures. “While cost in terms of spread and yield is important, actually raising the capital in the currency that the bank needs is crucial”    The investor base for US dollars is generally bro

“We live in two different worlds/That’s why we’re so far apart. You made your world out of vows that are broken/I built a world in my heart.” The venerable American crooner Hank Williams’ words could have been woven explicitly to describe the increasingly estranged relationship between European banks and the companies they once funded. Once upon a time, the interests and needs of lenders and corporate borrowers across the region were, as the Chinese phrase goes, “as close as lips and teeth”. Banks, operating in a deregulated and highly leveraged world, lent to corporates of all shapes and sizes, who gobbled up money then came back for more. But that was before a financial crisis that transformed – and continues to transform – the relationship between funding provider and funding subscriber. Banks, particularly the European garden variety, simply aren’t disbursing as much capital as they once did. Total lending by regional banks slipped to US$819bn in the first nine months of 2014, from US$858bn in the same period a year ago and more than US$1trn in 2011, according to data from Thomson Reuters. The list of reasons behind this seismic change is long and complex. Stiffer regulations have ratcheted up the cost of lending for banks already struggling to slash headcount, trim costs and adapt to a slower-growing world. Many emerged from the darkness only to find that valued corporate customers, unable to secure capital from traditional lenders at critical moments, had turned to the bond markets for financial succour. Facing new threats “As a result of the banking crisis, many borrowers realised they couldn’t just rely on bank lending – they needed to diversify their borrowing sources in order to better manage any possible future financial shock,” said Demetrio Salorio, global head of debt capital markets at Societe Generale. Even banks desperate to lend found themselves often outgunned by the debt markets on price. In the aftermath of the financial crisis, many expected the banks to bounce back to reasonable health sooner rather than later. Lending would resume in force as corporates returned to the hand that had always fed them. That has not happened “We originally saw this as a cyclical change. But many, certainly in the legal community, are now wondering whether it will be permanent,” said Tom Budd, co-partner-in-charge in London at law firm Gibson Dunn. There has been, he adds, a general “loss of loan issuance appetite among US as well as European banks”. Nor does the problem have any kind of short-term solution. Disintermediation in the banking market is playing out over a period of years not months. Many of the tougher regulations designed to underpin and circumscribe the activity of banks for decades to come – Dodd-Frank, leverage ratios, the Volcker Rule, Basel III – “won’t come fully into effect until 2018 or 2019 or beyond, so it’s more of a drip feed process, with banks changing slowly over time”, said Russell Schofield-Bezer, head of debt capital markets, EMEA, at HSBC. “We are probably two or three years into a 10-year process. Look at it on a quarterly or an annual basis and you may miss the bigger picture.” There is also a fundamental long-term change under way, in terms of how corporates meet their funding needs. Banks aren’t entirely out of the picture, of course. They continue to lend strongly to their most hallowed blue-chip clients, while many make much of their renewed willingness to lend to small and medium-sized enterprises. Faded attraction True or not – many point to a paucity of credit demand among European SMEs, and even many larger regional industrial firms, while many smaller corporates, said HSBC’s Schofield-Bezer, have opted to “cut back on long-term investments and to husband capital” – that overlooks a few simple facts about the state of the banking sector in general. For one thing, bank loans just aren’t as attractive as they once were, for either lender or borrower. Banks’ required equity capital ha

Record debt financing by emerging market issuers taking advantage of deep pools of liquidity are beginning to generate jitters that they may be getting out of their depth. Appetite for risky assets cooled in August, and in September the International Centre for Monetary and Banking Studies in its annual Geneva Report warned that a “poisonous combination” of record debt and slowing growth could presage another global crisis. Most estimates point this year to at least US$400bn of issuance by EM sovereigns and corporates – vigour that has taken some by surprise. Adam Borneleit, a product manager at BlueBay Asset Management, said: “Initially, we thought new issuance would be a lot lower this year, especially after the spike in rates last year and some concern around the fragile five EM countries, and at the beginning of the year issuance was a lot lower. “It picked up in the summer, although total issuance will still be a tad below last year’s: JP Morgan’s estimate for this year is about US$337bn of new issuance in EM corporates and that compares with US$362bn last year, so roughly US$25bn less in issuance this year than last.” “Precipitous” fall Paul Tregidgo, vice-chairman of DCM at Credit Suisse, points out that these high levels come despite a “precipitous” fall this year in Russian and Russian-related issuance – which last year made up about 13% of the US$420bn coming to market. “JP Morgan’s estimate for this year is about US$337bn of new issuance in EM corporates and that compares with US$362bn last year, so roughly US$25bn less in issuance this year than last” “We are on pace for a record year out in the EM debt markets and that is doubly impressive when you consider a major player – Russia – has not been a significant part of that supply. Investor demand continues to be strong across the entire corporate sector – investment-grade and high-yield,” he said. Data from Thomson Reuters in July showed international sovereign bond sales reaching US$69.47bn in the first six months of the year – a staggering leap of 54% on the same period in 2013. Notable issues were Kenya’s US$2bn debut and Ecuador’s US$2bn comeback. Marcus Svedberg, chief economist at emerging and frontier markets asset manager East Capital, believes greater EM issuance in bond markets is merely a reflection of increased activity across the board. “We have had lots of interest in all different kinds of emerging market assets; in corporate debt, in both local currency debt and FX, and in different high-yielding products – and to me it is a sign that, despite all the problems that we are having in the world, there is lots of liquidity and lots of appetite for yield,” he said. While many sovereigns have done relatively well in recent years, pick-up in demand for EM corporate issues, which offer significant spread gains over developed markets, is a key feature of the market. There has also been growing issuance in euros because of a cost arbitrage and the desire among strategic issuers to diversify their investor base. Borneleit at BlueBay said: “Dollars are always a big liquid market, but what we have seen this year is that there has been growth in euro-denominated issuance as a proportion of the total, and that makes sense – the euro economy is a bit weaker, European rates are lower, and the view is that those rates will stay lower for a bit longer than in the US. That said, it is still small – €33bn compared with US$217bn year to-date [as at September 15].” Investment-grade debt, driven by Chinese and Latin American state-owned enterprises, has also grown at the expense of high-yield. The regional picture suggests the big issuers are China – whose state-owned enterprises have driven Asia ex-Japan – and Brazil and Mexico, which have benefited from an apparent flight to safety as supply out of emerging Europe shrinks. Tregidgo of Credit Suisse said: “The market that has outperformed in terms of volume has been Asia ex-Japan – last year the region contributed US$115b

This year may turn out to represent something of a turning point in the arduous debates about global warming – far from being settled, it does appear at least to have arrived at the conclusion that evidence for man-made climate change is irrefutable. Consensus may finally be in prospect in sweeping arguments that have ultimately turned on a fundamental philosophical axis: is it possible to have both economic growth and a clean environment? It seems that we may be able to have our cake and eat it. In a flagship report released in September, the Global Commission on the Economy and Climate refuted the idea that we must choose between fighting climate change or growing the world’s economy. This conclusion is likely to be of paramount importance to the development of the Green bonds market, where rapid growth has spawned a similar debate. Changing attitudes Changing attitudes towards how capital markets view the green agenda were very much in the air at last month’s UN Climate Summit in New York, where investors representing more than US$2trn under management issued a statement committing to grow a global market in Green bonds and were backed by development banks and issuers. UN Secretary General Ban Ki-moon ensured that Green bonds were a key area of discussion. The role of capital markets in battling global warming is a crucial issue because public sector funding alone stands no chance of resolving our planet’s most pressing problems. An offspring of the multilaterals, Green bonds took off in 2013, with the Climate Bonds Initiative expecting US$40bn issuance this year and US$100bn in 2015. As both products and the issuer base have broadened, attention has moved to questions of sustainability. Standards and criteria are now the key themes of discussion as the market wakes up to the risk of “greenwashing” – highlighted ahead of the climate summit when civil society groups urged Ban to prevent abuse in the Green bond market. Stephanie Sfakianos, head of sustainable finance at BNP Paribas, said: “I think market participants are very cognisant of this. You do run the risk that an issuer can be potentially cutting corners on the greenness of the transaction, and it is a risk that people are very aware of. We are all making sure that issuers understand that taking a short cut would be an own goal of the worst possible kind, so I don’t think anyone is sleepwalking into that kind of disaster.” Green Bond Principles A key development earlier this year was agreement of the “Green Bond Principles”, voluntary best practices thrashed out by a consortium of investment banks, and subsequently of a structure to govern them under the International Capital Market Association. But as attention to standards grows, so does the fear that imposing something more strenuous at this stage could do more harm than good. “You do run the risk that an issuer can be potentially cutting corners on the greenness of the transaction, and it is a risk that people are very aware of. We are all making sure that issuers understand that taking a short cut would be an own goal of the worst possible kind, so I don’t think anyone is sleepwalking into that kind of disaster”   “Opinion is divided, there are still people – and I’m probably more at the stringent end – who feel we need to be relaxed, that the market won’t grow if we aren’t, but I think there are also people who also feel that there’s almost no point in this market if it isn’t going to be moderately stringent. I don’t think there’s a consensus – but people are aware there are dangers of that approach as well,” said Sfakianos. There is nervousness because standards impose costs and while leading issuers such as the multilaterals have so far been shouldering these, this is less attractive in the corporate space. Sabine Miltner, group sustainability officer at Deutsche Bank, said: “Mainstream investors want to avoid complicated standards that create additional costs and make their life more difficult. If the market

In the US, the private placements market has matured into a major component of the financial landscape. No such behemoth exists in Europe. A series of regional offerings are, however, emerging in response to the retreating bank loan market, which has left a void for financing small and mid-cap companies, or those that are unrated or not well-known. Private placement also proved itself to be reliable and steadfast throughout the crisis in 2011–12 while many other markets were only open intermittently. Europe wanted its own version to secure steady financing for its smaller companies. Talk of a European private placement market remains potentially misleading because what exists is very fragmented. But then, talk of a US market is equally misleading, given that well over 50% of issuance in that market comes from outside the US. Nearly 20% of it is even in foreign currencies – mainly sterling, euros and Canadian and Aussie dollars. In Europe, France, Germany and the UK have emerged as the main hotbeds of activity. Each has its own legal and cultural nuances, but they do share some characteristics. Size European deals tend to be much smaller than US ones, ranging down to as small as €25m, though the typical range would be €50m–€250m. The European market has also been more receptive to crossover credits than its US equivalent, and is more flexible in terms of tenor and how deals can be structured. The French private placement product is essentially listed, a structure that was selected for the convenience of its principal investor base, French insurance companies. About 2-1/2 years old, it is still in its infancy. But from a standing start it has now done more than 60 deals. The majority of them offer debt with tenors of five to seven years, shorter than the typical duration in the US market, about 80% of which is for seven years or longer. Even within France each deal uses different documentation and execution procedures, but efforts are being made to increase standardisation. Most deals have been executed for entities that have been listed, but with private marketing. Germany The German Schuldschein market is arguably the most comparable to the US market, being the most established. It offers a greater choice of tenors, with the majority less than five years but around a third coming in a five to seven-year duration – and some longer than that. It is popular among issuers in the German-speaking jurisdictions of Europe in particular and has repeat issuers that are well-known to investors. But foreign issuers are showing an increasing interest, with France and the UK successfully issuing. US subsidiaries of European insurers such as Alliance and AXA have also raised money in this market, with much of the paper snapped up by banks, insurers and corporates. In the UK, the product takes the form of direct loans by non-bank financial institutions, with no middleman institution being involved. Bulldog market Even before private placement started taking off in Europe the UK was doing its own deals, with institutions such as M&G having been active for years. Social housing and infrastructure have also emerged as active sectors, with financial institutions happy to conduct their own due diligence. “The Bulldog market has been around for years and has grown, but remains modest in both amounts invested and numbers of active investors,” said Michael Thilmany, managing director for private placements at HSBC. “Today, there are about a dozen US insurance companies that lend sterling or euros which they usually swap back into dollars but occasionally hold,” he said. Other markets have also grown up around specific sectors that can be viewed as precursors to a broader European private placement market. The institutional term loan market, for example, has emerged as an alternative in the infrastructure space, with deals that look like loans but with a longer tenor, in some cases offering seven, 10 and even longer maturities. “There are still fe

In mid-May, British care homes group LNT Group wanted a 10-year £51m fixed-rate loan to refinance existing debt and release capital to build six to eight new care homes. The company could not find a lender at the tenor it needed. “It used to be that you took out a medium-term loan. You would buy a care home, take out a MTL for 15 years and agree to a price. That product no longer exists,” said Lawrence Tomlinson, of the Yorkshire-headquartered group. Tomlinson said the cheapest loan option that was put on the table was a three-year loan from a bank. But he was adamant that he did not want to go through the same rigmarole every three years. He wanted to concentrate on running the business, rather than having to spend time raising money to grow. The company took out a loan, not from a financial institution but from insurance firm Legal & General. Given that it is a private deal, neither LNT nor L&G are especially forthcoming on the cost of the loan, but both companies say a useful marker is what other, unrated private-sector companies are paying for their 10-year debt.  A happy ending for LNT Group, but the challenges that Tomlinson had in raising capital highlight the difficulties that face small and medium-sized companies. Although they make up the majority of companies in Europe – 70% is the most commonly cited figure – bank loans to corporations have been on a steady decline since 2008. This is despite frequent encouragement from the European Central Bank. In August, ECB president Mario Draghi said at a meeting of leading central bankers in Jackson Hole, Wyoming: “I am confident that the package of measures we announced in June will indeed provide the intended boost to demand, and we stand ready to adjust our policy stance further.” He was referring to the cut in European interest rates to record lows and a series of measures aimed at kick-starting lending to businesses. He returned to the theme at his regular monetary meeting with members of the European parliament towards the end of September, where he emphasised a common monetary policy stance and to create favourable conditions for money to reach the real economy. “Our measures are aimed at lowering interest rates for the private sector and 80% of its financing goes through banks,” he said. It simply isn’t working. The Eurozone Purchasing Managers’ Index released towards the end of September, which reflects eurozone business activity, had dipped to a nine-month low of 52.3. Even worse, the manufacturing PMI for Germany, Europe’s largest economy, had crashed to 50.3, its lowest reading since June 2013.  The elephant in the room is Basel III, the guidelines set by the Basel Committee on Banking Supervision in July 2011 to boost balance sheets and avoid another debt crisis. Since the crisis, banks have retrenched considerably. And it is this that is at odds with any expectation that they might extend loans. In short, banks have neither the appetite nor impetus to increase lending. As Anthony Fobel, head of direct lending at BlueBay Asset Management, put it in stark terms: “For a bank to invest in sub-investment-grade debt under Basel III, it needs to set aside 10 times the capital it does for investment-grade debt.” What has been getting the attention is the idea that SMEs might issue debt. Not only has the ECB essentially introduced negative interest rates as a boost to the economy, but it is also using various ideas to engage in public debt type issuance. While this is fine in theory, the reality is rather different. As one banker pointed out: “In the US, the bond market has been there for 100 years. It was set up to fund the railways. In Europe, it is only 40 years old. It is simply not mature or flexible enough yet”. That might be harsh conclusion, but with a grain of truth. “Accessing the rated market is not an option for SMEs,” says Allen Appen, DCM financing solutions at Barclays. “And the ability to access the unrated market is the preserve of only the large

Over-the-counter derivatives have been under pressure on multiple fronts for some time, as new clearing, capital and funding requirements ramp up the costs and complexities of trading. The consequences of those increased costs ripple far and wide, but debt capital markets have seen a significant impact as issuers look to hedge their exposures as cost-efficiently as possible. “The changing landscape of legislation has affected derivatives markets more widely than expected and the costs and consequences of those changes will absolutely have an impact on the type of issuance, maturity of issuance and sometimes the geographical region and currency of issuance. There is now a lot more dialogue between banks and issuers on where the charges are coming from and how they can be reduced,” said Sean Taor, managing director and head of European DCM and syndicate at RBC Capital Markets. The most obvious cause of the increased costs is central clearing, a key component of the G-20’s 2009 commitment to reform OTC derivatives markets. Mandatory clearing of interest rate swaps and credit default swaps began under the US Dodd-Frank Act last year, while European regulators are in the process of implementing similar rules through the European Market Infrastructure Regulation. It is the banks that face the central counterparty as members and thereby incur the operational and collateral costs of clearing, but those costs have to be passed on to the client. Other regulations such as the Basel III capital and liquidity rules are also driving up the costs of using derivatives. As banks come under ever-increasing funding and balance sheet pressures during the phase-in of Basel III, they have had to add significant charges for uncollateralised swaps. Inversion in decision-making The higher costs have caused an inversion in the decision-making process for many issuers. Where hedging decisions would historically have been taken after a bond mandate had been placed, the new regulations mean many issuers will often now think about the derivatives first, given that hedging is rarely optional. Although derivatives and DCM teams might already work closely together on deals, banks’ success in financing is increasingly becoming dependent on their expertise in derivatives. “Historically, swaps were generally considered an ancillary business opportunity driven by a financing event. But since the financial crisis and given the various regulatory changes, banks are having to make adjustments to pricing, factoring in not only credit charges, but various funding and capital charges as well. “Consequently, the provision of the derivative component for a new issue has become a lot more important for issuers, sometimes to such an extent that bond mandates are driven by banks’ provision of swaps capacity,” said Chris Rees, co-head of DCM in the risk solutions group for Europe, the Middle East and Africa at Barclays. Not all derivatives are affected by the regulations in equal measure, of course. Longer-dated swaps and cross-currency swaps stand to be hit harder as a result of their greater risk profile, which has led some issuers to opt for greater simplicity when hedging. Swedish power company Vattenfall is one example of a corporate issuer that has deliberately looked to cut down its derivatives exposures in recent years. “The regulations have certainly changed the way we look at things and we want to simplify and streamline our operations with as few outstanding transactions as possible. We are now more likely to go directly to the currencies we want to borrow in, rather than borrowing US dollars and swapping into euros, for example. If we can effectively hedge 80% of our exposure in this simplified way, that’s probably good enough,” said Johan Gyllenhoff, group treasurer at Vattenfall. “We used to regularly put new interest rate swaps in place to hedge our debt portfolio but over the past couple of years we have tried to close out deals where possible, so if we want