Full steam ahead

Funding conditions remain benign as the buyside and sell-side alike grapple with similar circumstances. While the former continues searching for incremental returns in low-yield shallow soil, the latter enjoys mixed fortunes, depending on which end of the ratings spectrum they are. For higher beta borrowers, demand assumed significant proportions, the flip side of the coin being that some highly rated issuers looking to the euro market in particular found spreads and yields so compressed that they began to struggle to find willing buyers of their offerings. Even before the ECB announced its well-flagged €1.1trn QE programme in January, things were moving apace in Europe. Government bond yields then dropped to fresh lows, turning negative in a number of cases, and creating an element of confusion among investors historically programmed to minimise risk by buying the highest rated assets. The situation on the other side of the Atlantic threw up a similar scenario, with rates not assuming the velocity of upward trajectory many had assumed. Clearly, a fresh approach was required, and the best part of €180bn of corporate debt in the European market in the year to end-May demonstrated that buyers were not averse to broadening their horizons, given that it represented a 31% increase on the previous year. And, naturally, the juicier the yield the better, as evidenced by a 50% increase in corporate hybrid issuance. Volumes in the high-yield market also rose in lock-step. For investors, there was little alternative to a risk-on stance, something that could be taken as QE efficacy as money moved down the funding food chain. But artificial situations are just that, and it was clear something had to give. A sandstorm ensued, with yield levels reversing from ultra-low to just low. Nerves in bond markets that have revived fears of a crisis have been blamed by traders on liquidity distortions. Ample monetary liquidity coexists with a shortage of trading liquidity, constraining the market’s ability to absorb shocks and further exacerbating the risk of volatility. One cause of liquidity problems is regulatory change to ensure lenders boost levels of risk-weighted assets. Since 2008 regulators have forced banks to pile capital up like grain in a silo, most recently through strictures about total-loss absorbing capacity on globally systemically important banks, or G-Sibs from the Basel-based Financial Stability Board. Compounding this is regulatory one-upmanship. Just 12 days after TLAC’s introduction, the Europeans again unveiled their own draft rules, MREL. Two sets of regulations, both building sandcastles. Indeed, regulatory anxiety is everywhere. US authorities have grown jumpy about the use of covenant-lite leveraged loans, and China has been stacking up rules to tackle provincial debt, spawning a market in municipal bonds in conditions where a default seems likely. The leveraged loan market demonstrates how, historically, the causal chain of volatility can so often be traced archeologically back to the US. For example, leveraged buyouts – a homespun symbol of the pre-crisis boom – are back with a vengeance. Leveraged loans styled on those across the pond are now growing popular in Europe as bank lending loses its appeal and the region develops an appetite for takeovers. The Europeans are also being lured by another American mirage, proposing a capital markets union to shift the burden of financing away from banks to DCM. The financing of M&A through leveraged loans negotiated in centres such as Hong Kong is increasingly copying US architecture, and China’s muni market also attests to its taste for the American financial flavours that, like bubble gum, have gained such global appeal. When the latest storm subsides and the dust settles, the landscape will look both reassuringly familiar – and yet eerily different. To see the digital version of this report, please click here To purchase printed copies or a PDF of this r

For structured finance deals using separate special purpose vehicles, credit is attributed to the relevant parent group of the originator of the underlying assets. An exception to the rule of rolling up to the parent level has been made for sovereign borrowers: agency, regional authority and state-owned corporate borrowing has generally been shown separately, regardless of the degree of government liability for the debt involved. Sovereign borrowings include only syndicated capital markets transactions, not borrowing through auctions of treasuries or other similar methods. Transactions involving financial or corporate borrowers in which the debt is explicitly guaranteed by a government will be classified as agency debt. Issues that do not have an explicit government guarantee will not be credited as agency debt, irrespective of the stake owned by the state. Loans bookrunner league tables do not include club transactions, but the corresponding borrower tables do. A new table has been added on page 17: Top 10 CoCo Bond Issuers. For any data queries, please contact Ian Willmott (bonds) on +44 (0) 207 542 4376 or Ewelina Jarecka (loans) on 44 (0) 207 542 2246. To see the digital version of this report, please click here To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

In Coleridge’s Rime of the Ancient Mariner, a group of shipwrecked sailors are left isolated and idled far from shore and wracked with thirst. Wherever they look they see water – yet they cannot drink a single salty drop of it. Debt bankers, investors, issuers, and even financial regulators, must know the feeling. For these days, debt is everywhere, clogging up the machinery and lying stagnant in deep, illiquid pools. In every typical month more is issued than is redeemed, while less, as a share of the entire universe of active debt securities, is actively traded. The world is literally swimming in debt, yet ever fewer funds, lenders, and investors actively see value in the simple process of buying, holding, and trading the stuff. Why is this – and more to the point, do any solutions to the market’s malaise exist? A few short years ago, market-making and proprietary trading worked together in reasonably sweet harmony. They acted like shock absorbers, smoothing price volatility, driving liquidity flows through the secondary markets, and instilling confidence in primary issuers. That confidence, and that liquidity, is now gone. Most financial institutions simply cannot hold as much debt as they once did. Lenders in Europe and beyond are under increasing pressure from any number of regulators to boost their levels of risk-weighted assets, and to hold fewer liabilities on their books. Since 2008, the inventories of US corporate bonds held by broker-dealer banks has plunged to US$50bn from US$300bn, according to research from CQS International. “With regulators asking banks and broker-dealers to create ever larger capital buffers, inventories have been going down, despite there being so much debt around in the world,” said Jerome Legras, head of research at Paris-based Axiom Alternative Investments. This is not a new phenomenon. Liquidity has long been a pressing issue for bond traders, investors and issuers. In part, this stems, as so much does, from the events of late 2008. Deep mismatches “The financial crisis deeply changed the way that market-making works,” said Eric Cherpion, global head of DCM syndicate at Societe Generale. “It created deep liquidity mismatches. And either due to risk management, or due to new or rising capital constraints, banks have less gunpowder at their disposal, so they need to be doubly convinced that they are stepping into the market, or into a debt security, at the right level.” That in turn creates a clear mismatch, notes Axiom’s Legras, between what brokers can sell, and what traders can manage. “Liquidity,” he said, “is becoming increasingly hard to find. It’s especially hard for major funds that manage hundreds of billions of dollars’ worth of bonds, and that may need to sell a few hundred million dollars’ worth of bonds in a day. That presents a challenge.” As everyone is by now painfully aware, there are no simple answers to this conundrum. Rather, there are an awful lot of unpalatable solutions (some of which contradict other well-meaning solutions), and an even larger measure of unanswered questions, all of which pervade the thinking of regulators and traders constantly waiting for the next systemic crisis or flash crash. The latest market spasm occurred in early May, when volatility in 10-year US Treasury yields hit levels not since last October. “You have a banking community with less and less balance sheet to deploy. The waning levels of liquidity out there, and the waning ability of the market to absorb shocks, merely exacerbate the threat of volatility” There were differences between the two events. Last autumn’s so-called flash-crash was stoked by traders betting that US interest rates would stay low. This year’s bond rout, which briefly caused recalibrations of European sovereign debt, put a rocket under yields in US and German 10-year debt, forcing the market to judder and spasm. Seeking culpability, traders returned to the source, blaming the market’s dearth of liquidi

Europe has long looked enviously at the US financing regime. There, about 70%–80% of debt finance is raised in the bond markets – roughly the proportion that is provided by bank loans in Europe, as is also the case in Asia. The Capital Markets Union is Europe’s latest attempt to edge towards the US model, shifting the burden of financing away from the bank market and on to the debt capital markets. The US DCM culture is partly a product of its history. When its robber barons conquered the interior they needed more capital than its young banks were able to provide, forcing them to turn instead to private investors via the bond markets. Having grown up in this environment, US corporates are used to issuing bonds, and the process that goes with it. In Europe, many corporate treasurers are accustomed to the far simpler process of arranging a loan with their bank manager. For them, the prospect of compiling a prospectus and going on roadshows seems more arduous. Ultra-low rates mean that for those that can still secure a loan from a bank, that route is cheaper than issuing bonds in Europe. This may change over time, as it did, briefly, during the financial crisis. But even if it doesn’t, corporates will still be better off diversifying away from the bank market. “Financing on the capital markets will increase costs for borrowers, but this is not necessarily a bad thing if you get extra liquidity,” said David Clark, chairman of the Wholesale Markets Brokers Association. Ultimately, though, the initiative is less about the convenience of individual corporates than filling the vacuum created by the slimming down of Europe’s banks. Focused firepower In today’s world of expensive capital and KYC requirements, banks have to be selective about the loans they offer. Most are focusing their fire power on their biggest clients – the same clients, on the whole, that have the necessary scale and recognition to issue bonds in the current market. The European Commission is therefore eager to find ways to make it easier for SMEs to access the capital markets. Europe has cultural, as well as legal and regulatory hurdles to overcome before its capital markets can truly flourish. This, in essence, is what the CMU is all about. According to the Commission’s website, it will allow the Commission to “explore ways of reducing fragmentation in financial markets, diversifying financing sources, strengthening cross-border capital flows and improving access to finance for businesses, particularly SMEs”. As such, CMU is a process – a journey, rather than a destination. And it is arguably one Europe has been on for some time. “We already have CMU to some extent, in effect regulations such as the Prospectus Directive, EMIR, MiFID, UCITS and Solvency II are its building blocks,” said David Shearer, a partner at Norton Rose Fulbright. “There may not be many headline-grabbing reforms left to do. What is likely needed are lots of smaller changes to the nitty gritty of how things work, but these can be tough to implement at the European level.” “In the short term, there is scope for quick wins in things like improving the securitisation market, prospectuses, private placements and creating a better understanding of infrastructure financing. The question is whether it will have the ambition to tackle harder subjects like harmonising solvency law and tax” Increasing intra-European harmonisation is a goal in itself. Some countries, such as France and the UK, have a relatively established DCM culture. “In France we see 40% of financing done in the capital markets, compared with a European average of 25%,” said Sebastien Palle, deputy head of public affairs at Societe Generale, responsible for drafting the bank’s response to the CMU consultation paper. “I think that is because of the universal bank model in France; banks do both lending and capital markets work and so can objectively advise their clients. Furthermore, French statistics show that capital mar

If anything underlines the growing stature of the Green bond market and cements its longevity beyond basic primary flows, it’s the move towards transparent standards, and the emergence of a more evolved ecosystem that includes dedicated funds and the proliferation of major investment commitments, plus the availability of analytical tools and services such as indices. The Green bond market reached two milestones in March this year that pushed the cause of transparency and a hardening towards consensus standards: the first anniversary of the Green Bond Principles (GBP) and the paper Green Bonds: Working Towards a Harmonized Framework for Impact Reporting, for projects to which Green bond proceeds have been allocated. The 2015 update to the GBP certainly articulated a clear direction of travel for the market that points towards ring-fencing of proceeds, creation of sub-accounts, moves towards more rigorous project selection and tangible impact reporting. Market participants continue to be nervous about setting standards that are so high that they stifle issuance but as they stand, the GBP are what one banker defined as “the universally acknowledged necessary and minimum conditions for defining a Green bond”. A more transparent framework will help silence cynics and sceptics who are still out there, and will engender growing support for Green bonds as a component of an active strategy to reach global climate-change mitigation targets. As for buyside patronage, news has come thick and fast. Mirova announced the launch of a global Green bond fund in June; KfW said in April it would start buying Green bonds in the second quarter with the aim of reaching a portfolio size of €1bn; in February Deutsche Bank said it would invest €1bn in a portfolio of high-quality liquid assets in Green bond format as part of its liquidity reserve investment. Deutsche’s plans echo Barclays’ announcement last September that it would invest a minimum of £1bn in Green bonds by November as part of its liquid assets buffer. Zurich Insurance, an early mover in this space, raised its investment target in Green bonds to US$2bn, while several other firms are putting the finishing touches to their criteria for Green bond investments. Increased buyside interest is certainly a shot in the arm for the market although it is putting increased pressure on the investment banks to create supply. The fact that this was somewhat subdued through the first half of 2015 is a hot topic of conversation. On the plus side, the Green bond market has seen issuance to-date across some 18 currencies in fixed and floating-rate, convertible, stock index-linked, securitised and project bond formats; structures targeted to retail as well as institutional interest; the full range of short and long-dated maturities and an increasingly global issuer base across multiple geographies and industry sectors. Analytical tools These developments speak to the increasing depth of this emerging market and throw into sharp relief the greater potential levels of activity that beckon. The arrival of benchmarking and screening tools, such as Green bond indices, is also vital because they will drive more productisation. This will allow a more heterogeneous set of players to find entry points into the market in a manner that suits multiple investing styles and builds towards multiple outcomes. The Barclays/MSCI Green bond index family that was launched in November 2014, for example, added an independent and objective overlay to offer investors greater comfort around the market. Evaluations are conducted along the four key dimensions: use and management of proceeds, project evaluation and reporting. Speaking to the productisation point, State Street Global Advisors launched its Global Green Bond Index Fund in May 2015, claiming it as the first UCITS-compliant mutual fund tracking the Barclays MSCI Green Bond Index. MSCI has also had various incoming enquiries about Green debt ETFs. “My take has alwa

“I’m here to tell you something my friend, you can eat and eat and eat, but nothing will ever fill that void.” So declared Brad Pitt on the perils of over-eating in his cameo as fat-buster Will in Friends – but the message may also ring true for bank execs and treasurers around the world. Since the near-catastrophic events of 2008 when the world teetered on the brink, banks have been forced to pile on the capital, hoping it would assuage regulators, only to be faced with another round of regulations. Some rules were dedicated to protecting entire economies from the failure of oversized lenders. Others merely imposed new layers of transparency, illuminating a once opaque industry but trimming profits at hard-up financial institutions. Either way, whatever new legislation was heaped upon their staggering frames, it was never quite enough. Enter TLAC The Basel-based Financial Stability Board’s new rules, first unveiled in November 2014 at the meeting of the G20 group of nations in Brisbane, propose a minimum total loss-absorbing capacity on 27 global systemically important banks, or G-Sibs. Each of the tagged institutions (for now the list excludes China’s largest banks), from Wells Fargo to HSBC and Mizuho to Credit Suisse, will need to hold more equity and convertible debt, the better to absorb losses in the event of future crises. The FSB’s message was clear: no bank deemed too big to fail would ever again be bailed out by the taxpayer; during future crises, the buck would have to stop at the front door of the bank’s HQ. TLAC remains a work in progress, despite the emergence of a more complete set of laws in February. It offers lenders and the wider financial industry only “a tentative set of rules”, said Jonathan Weinberger, head of capital markets engineering at Societe Generale. “We’re still waiting for more specificity to emerge. For now, the way to think of TLAC is that it is designed specifically to insulate taxpayers from the consequence of future bank failures. That is how it primarily differs from other new post-crisis bank regulations.” Banks, almost certainly, will be forced into (yet another) round of capital raising, notably in the form of Additional Tier 1 and Tier 2 debt. Lenders will also likely have to increase their Common Equity Tier 1 ratios, while topping up on long-term unsecured debt, all of which will be designed to be easily written down or converted into equity during moments of internal or existential crisis. But this is where it starts to get fiddly. Some bonds will be disqualified from the new rules, such as Tier 2 bonds with less than five years left to maturity. TLAC also goes way beyond the strictures of Basel III, under which banks will be required to have a minimum total capital ratio of 10.5% in place by 2019 or higher in some jurisdictions. Under the new rules, G-Sibs will need to have a buffer of between 16% and 20% of the bank’s entire risk-weighted assets in place, comprised mostly of a lender’s loan book. Me too No one regulator wants to be at the mercy of another. So it was that just 12 days after TLAC’s introduction, European legislators unveiled their own version. The European Banking Authority’s minimum requirement for own funds and eligible liabilities (MREL) offered the world more than just another unappetising acronym and a new set of financial rules by which to abide. It was also designed to make credit institutions and large investment firms more resilient, and to ensure they have sufficient loss-absorbing capacity to allow resolution instruments, including the bail-in tool, to be applied more effectively. The two standards are likely to be different beasts. One divergence will be timing. MREL will be introduced in 2016, though full compliance is likely to be phased in by January 2020. TLAC is unlikely to be imposed fully before 2019, in line with Basel III. Rules girding both remain ambiguous, and even a little messy. For now, said SG’s Weinberger, “everyone is de

It was the best of years, it was the worst of years. It was the age of constancy, it was the age of disorder. Since the European Central Bank announced the launch of its long-awaited €1.1trn quantitative easing programme in late January, the markets haven’t quite known what to do, swinging wildly first one way then the other like a punch-drunk boxer. At first, stimulus offered the market room to breathe and grow. QE was well-flagged and well-received. After its official launch in March, bond prices rose sharply. Yields, notably on German Bunds, fell to fresh historic lows, turning negative on some shorter tenored debt. Issuance rose in lockstep, with corporate debt sales totalling €176.9bn in the current year to May 26, up 31% on an annualised basis, according to Thomson Reuters data. Most corners of the market improved versus 2014, bar sovereign debt issuance, which was virtually flat on last year’s data over the same period. That constituted less of a surprise, given that stimulus was designed, said Charlie Diebel, head of rates strategy at Aviva Investors, “to make government bonds unattractive for investment, so money flows into equities and also into the provision of credit to the real economy”. True to form, yields remained grindingly low well into the fifth month of the year. On May 7, Spain sold €885m worth of five-year bonds with an average rate of return of ‒0.286%, the first time Madrid had printed medium-term debt with a negative interest rate since the onset of the eurozone debt crisis. Daily volumes in eurozone government bonds were around a third higher than normal in the first quarter of 2015, according to MarketAxess. Stimulus also successfully re-engaged investors with the concept of risk, diverting them “away from core government bonds and into riskier assets such as peripheral European government bonds and corporate bonds”, said David Zahn, head of European fixed income at Franklin Templeton Investments. In the year to May 26, the volume of corporate hybrid prints rose more than 50% year-on-year, reaching €13.14bn, according to Thomson Reuters. Search for yield Portfolio flows into developing market securities hit US$35bn in April, with most of the fresh capital being diverted towards Asia and equities, according to the Institute of International Finance. “The impetus behind lowering rates even more seems to be attracting foreign issuers into this market and forcing investors in Europe to go along the credit spectrum and look for things that provide higher yield,” said Peter Noble, a partner at Norton Rose Fulbright. “You’ve seen an acceleration in corporate hybrid issuance and high-yield debt issuance across Europe. With ultra-low rates, people will buy anything that offers a decent return.” Maturities stretched in lockstep with stimulus. Peripheral eurozone sovereigns found themselves issuing debt maturing in the late 2040s. The tale was the same told last year, when monetary stimulus and ultra-low rates set in motion a desperate hunt for yield. The only difference, it seemed, was the source of the stimulus, with Frankfurt replacing Washington. Indeed, it was hard to think of a more stunningly effective and simple riposte to those who believed the eurozone to be a permanently lamed duck. Stimulus has, said Aviva Investors’ Diebel, “had a profound effect in terms of yield compression at the front end of the curve. But equally the recent correction in prices, and the increase in term premia, highlight that there is a degree of growing belief that over time the QE policy will work and gradually reflate the economy.” Along the risk curve Marcus Svedberg, chief economist at emerging market investment manager East Capital, said the search for yield was “pushing investors further out on the risk curve. The fact that not only developed market sovereign bonds with short maturities but also longer maturities and emerging market sovereigns are being sold at negative rates, are good illustrations of this t

Regulatory change in 2014 involving a reclassification of Formosa bonds laid the foundation for an issuance boom in the product. This came alongside a drying up of the Dim Sum market and caused many to ponder whether the Taiwanese renminbi market was about to eclipse its better established Hong Kong neighbour’s. The jury is still out. In November 2013, Taiwan’s Financial Supervisory Committee (FSC) allowed Taiwanese and foreign banks to issue in renminbi using the Formosa bond market. This comprises foreign currency issuance in Taiwan’s domestic bond market, usually through listing on the GreTai exchange, and which is subject to domestic regulations and taxes. Mainland Chinese banks rushed to bring deals after the deregulation, accounting in late 2014 for 65% of total Formosa bond issuance. Further regulatory change in April last year lowered the funding cost for foreign issuers listing their bonds in Taiwan while the classification of Formosa bonds issued by offshore entities and cleared offshore spurred issuance. Bringing deals in the Formosa bond market is subject to local regulatory approval and local tax is payable on the issuance and this, together with the relatively poor liquidity of the market, explains why renminbi-denominated Formosa bonds historically have yielded less than Dim Sum bonds, although increasingly there is yield convergence. The regulatory approval for renminbi-denominated Formosa bond issuance resulted in a surge in investment by Taiwanese insurers in the product. And a regulatory change in April last year, with a consequent switch from low-yielding Taiwan government bonds, prompted a rise in local domestic government bond yields. Taiwan life insurers have foreign investments capped at 45% of their portfolio, hence the reclassification prompted a mass switch into Formosa bonds. And with long end yields around the 2% mark and most Taiwan insurers adopting a 4% hurdle rate, these companies are natural buyers of offshore fixed-income assets, and they are increasingly shopping around to achieve or exceed this hurdle. The freeing up of the local life insurance investor base has resulted in increased demand for offshore paper in dollars as well as renminbi. Still, this blossoming comes with a health warning for offshore banks hoping to grab wallet by selling down Formosa paper; if they are not licensed in Taiwan they face penalties from Taiwan’s FSC. Barclays’ Taipei branch was fined NT$12m (US$384,000) in December for selling offshore securities without a licence in Taiwan. The booming renminbi-denominated Formosa bond market has been music to the ears of DCM bankers who had been staring down into what appeared to be the demise of the Hong Kong Dim Sum market. Issuance in that market has slowed to a trickle this year as monetary easing by the mainland Chinese authorities reduced borrowing costs in the domestic markets and rendered Dim Sum issuance uncompetitive. Opening demand The vast pool of renminbi located onshore in Taiwan is the biggest outside mainland China and much of the funds sit with life insurance companies. As well as the opening up of demand from life insurance companies, issuance was driven by a rosy arbitrage scenario for issuers, particularly in renminbi, where post-swap savings from renminbi into dollars were irresistibly advantageous. Ironically this came about just as a spike in onshore renminbi deposit rates in Hong Kong suddenly made the Dim Sum market look profoundly unattractive. Three-year rates spiked up from around 2% to 4% earlier in the year and issuers were simply unwilling to fork out for the higher coupons demanded. “For a long time, the Dim Sum market was a one-way trade predicated upon the stability of the renminbi FX regime. With Hong Kong cast as the gateway to China, investors had the luxury of an attractive carry play,” said Andrew Stephen, head of Asian private placement and local currency at Deutsche Bank in Singapore. “Now that we’re seeing more v

If the Chinese proverb “rich is the man with no debts” is to be believed, then local authorities throughout the country have been growing steadily poorer from decades of fundraising through opaque local government financing vehicles (LGFVs). Concerns about spiralling debt among local and regional governments (LRGs) have mounted as the economy has slowed, sparking a revolution in transparency through regulatory changes aimed at encouraging a transition away from LGFVs and into municipal bonds. LRG debt is viewed by many analysts as a serious threat to the economy and recent interest-rate cuts by the People’s Bank of China have failed to lower borrowing costs for many lower-rated issuers, compounding concerns about default. For some time, experts have argued that the only long-term solution to local debt is the creation of an active municipal bond market, something that since 2012 the central bank has been exploring. “Continuous borrowing by local governments to fund infrastructure and other spending has led to the build-up of a substantial debt pile. This is estimated to be around US$2.5trn–$3trn. This municipal bond programme was designed as an attempt to make provincial governments more responsible for their borrowing. Whether it has succeeded in doing that, however, is another matter,” said Danae Kyriakopoulou, senior economist at the Centre for Economics and Business Research. Despite broad recognition that LRG debt in China is a problem, up-to-date figures about it are impossible to come by. The last Chinese national audit report in June 2013 put the combined debt of local governments at Rmb17.9trn (US$2.86trn), up 67% from the last audit in 2011. A year ago, Reuters cited estimates that local governments might owe up to US$4trn, 42% of China’s GDP, and an updated audit is expected this summer. Need for transparency Andre de Silva, head of global EM rates research at HSBC, said: “One of investors’ major concerns is that the structure of local government debt is so opaque. With the emergence of over 8,000 LGFVs, it has been difficult to grasp the magnitude and nature of the debt. Even the central government is finding it a challenge, as the National Audit Office discovered when it went through the books. Creating greater transparency is crucial.” As provincial governments start to suffer from a slowdown in growth and a sluggish property market, China’s leaders have grown nervous. In April, the Shenzhen-based Kaisa Group became the first Chinese property developer to default on its overseas debt, put at US$2.5bn. Nahed Ennasr, chief strategist at Fathom Consulting, said: “The problem posed by municipal debt is a symptom of a slowing economy and overcapacity. Our view is that China is experiencing a hard landing. They have just cut their benchmark rate and we have seen the first international default on the debt market, Kaisa – and we will see much more coming.” The LRG debt has grown despite restrictions banning local borrowing 20 years ago, largely because central government under-funded ambitious development plans, forcing provinces to push ahead with costly infrastructure projects bankrolled by risky, unregulated borrowing off-balance sheets through LGFVs using shadow-banking products and short-term loans. Crackdown Regulators launched a crackdown last year and in a series of steps empowered the 32 provincial authorities and some city-level governments to issue muni bonds. Investors have responded enthusiastically, with the Standard & Poor’s China provincial bond index gaining almost 10% in the past 12 months. In March this year, the government announced that it would allow LRGs to convert as much as Rmb1trn (US$160bn) of existing high-yielding debt into municipal bonds in a bid to cut debt-servicing costs, potentially reducing interest payments by as much as Rmb50bn a year. However, in April it was revealed that several LRGs have had to postpone bond auctions as banks – reluctant to be saddled with poor a

A favourite phrase of the great Chinese patriarch Deng Xiaoping encapsulating his approach to foreign policy was: “Hide your brilliance, and bide your time.” The underlying idea was that the rapidly growing Asian dragon needed to proceed in diplomatic affairs in a way that did not frighten the rest of the world, whose investment, technology and markets it needed. No better symbol exists of how this cautious approach has been superseded by the country’s paramount leader Xi Jinping than the creation of the Asian Infrastructure Investment Bank, which was announced in 2013 and is now taking form on paper. Jonathan Fenby, managing director of China research at emerging market research service Trusted Sources, said: “There has been a real sea change in foreign policy under Xi Jinping, who took power 2-1/2 years ago, which can be summed up in the phrase ‘We are going to show our brilliance, and our time has come’, and the AIIB is part of that. What this reflects is geopolitics being backed by geo-economics.” Geopolitical ambitions Borne out of frustration with a lack of reform at US-led multilateral financial institutions such as the World Bank, International Monetary Fund and Asian Development Bank, the AIIB now has 57 prospective founding members and is likely to have registered capital of at least US$100bn, against which it can borrow a multiple from capital markets. On paper, its aim is to fund infrastructure – with a key focus to finance China’s ambitious vision of a “New Silk Road” – but Fenby believes the creation of the bank cannot be divorced from Beijing’s broader geopolitical ambitions, using “strategic economic” tools backed by eye-watering reserves of US$4trn rather than the “strategic military” approach of the past. In particular, the creation of the AIIB responds to the desire both to export excess capacity at a time of slowing growth in China itself and to internationalise the renminbi. “China has invested heavily in infrastructure, so much that it now has a lot more buildings and structures than it can use – there are roads that lead nowhere and cities that no one is living in,” said Danae Kyriakopoulou, senior economist at the Centre for Economics and Business Research. “This means that returns to further investment domestically are not promising, and so China is looking abroad for higher returns and ways to keep its infrastructure industries in employment. This is an important motivation for creating the AIIB.” Meeting a need Yet Asia’s financing needs for infrastructure are well beyond the capacity of existing institutions. The ADB Institute estimated in 2010 that infrastructure needs in the region in order to sustain growth would amount to US$8trn up to 2020. The ADB, with registered capital of US$165bn, still finances less than 2% of Asia’s needs. Frederic Neumann, co-head of Asian economics research at HSBC, believes emerging Asia will need to invest more than US$11trn in infrastructure from now until 2030, with the majority required outside of China. He wrote in the Nikkei Asian Review: “The existing arrangements are not up to the scale of the challenge. Despite Asia’s success in driving growth, hundreds of millions of people still live near the poverty line. Demographic trends suggest the pressure on government budgets will only grow over time.” Nonetheless, behind the hype and high expectations surrounding the creation of the AIIB, it is clearly too soon to assess its prospects. Nahed Ennasr, chief strategist at Fathom Consulting, said: “It’s far too early and very difficult to judge if the AIIB will have any benefits for Asian countries. Our first conclusion is that China is trying to export its overcapacity and it is unclear if AIIB will have any sort of influence in the region.” Currency ambitions She agrees that its creation has to be seen alongside China’s broader ambitions for its currency, though it remains undecided which currency the AIIB will use – the US dollar or renminbi, or a mixt

The power of leverage has been known since the days of Ancient Greece. The mathematician Archimedes said some 2,200 years ago: “Give me a place to stand and with a lever I will move the whole world.” During the financial boom years of the three decades in the run-up to 2007, corporate executives and bankers took those words to heart, using a significant amount of borrowed money to finance the cost of multi-billion dollar acquisitions and giving birth to the concept of the leveraged buyout. But since the global financial crisis of 2008–09, regulators across the Western world, and particularly in the US, have become more wary of the ability of leverage to magnify risk as well as borrowers’ firepower. The fall in official US Federal Reserve interest rates to close to zero, combined with its quantitative easing programme, created vast swathes of cheap financing that has triggered a surge in leveraged lending to rival the pre-crash volumes. Triggering penalties In March 2013, the Fed and the Office of the Comptroller of the Currency separately published guidelines to govern the sorts of loans banks would be able to make to debt-laden companies, as they sought to prevent credit markets again overheating. In particular, the moves flagged up leverage of more than six times Ebitda as something that could trigger penalties. In the autumn of that year, the Fed used its annual stress-test scenarios for banks, including factors that would test a bank’s response to changes in economic conditions that might affect the performance of leveraged and other high-risk loans. Then in a “frequently asked questions” publication released in November 2014 it flagged up concerns over covenant-lite leveraged loans that had fewer restrictions on collateral, payment terms, and levels of income. Deal brake The actions appear to have worked to limit the growth in US leveraged loans, falling from US$292.6bn in the first quarter of 2014 to US$125.7bn, according to data from Thomson Reuters. US LBOs funded using those loans also eased from US$21.1bn to US$19.0bn over the same period. Jeff Norton, US banking partner at global law firm Linklaters, said that regulation was certainly “top of mind” for all participants in new deals. “People are slightly more mindful about the amount of leverage, the covenant approach and other things the regulators are concerned about, but there has yet to be a significant change in overall approach,” he said. The scale of leverage has been reduced. According to Thomson Reuters data, at the end of last year, the largest corporate leveraged buyout deals in the final quarter of 2014 carried debt of 6.54 times earnings, on average. This was down from 6.96 times in the third quarter, which was the highest level of holdings since they averaged above seven times during most of 2007. Other regulations are also acting as a brake on leveraged deals. Regulations such as the Volcker Rule, Dodd-Frank’s risk-retention rules, and Basel III capital requirements have dampened issuance in the leveraged finance market, with the prospects of compliance making arrangers and borrowers reluctant to bring new deals to market. Spotty calendar According to Standard & Poor’s Capital IQ Leveraged Commentary & Data, arrangers of transactions expect acquisition-driven loan volume to continue at the pace seen so far in 2015, with an emphasis on strategic deals. “As for leveraged buyouts, the calendar may be spottier, in part because of high stock-market valuations,” said Andrew Watt, a primary credit analyst at the ratings agency. While US leveraged loans may be declining as a source of financing, it has hardly brought deal-making to a halt. The deal momentum accelerated towards the end of the first quarter of 2015. Highlight deals included loans raised for the financing of the acquisitions of retailer Petsmart (US$4.3bn), Riverbed Technologies (£1.6bn) and packaging firm SIG Combibloc (US$1.2bn). But what each of these transactions had

Barely a month after Petrobras avoided a technical default by finally publishing its audited results, it stunned the market on June 2 with a more positive surprise – a US$2.5bn Century bond that attracted more than U$13bn in orders. The deal marks a dramatic comeback for the scandal-wracked company and confirmed a resounding return by Brazilian issuers. The country has been the primary driver behind the region’s seven-year hot streak in the bond markets but had retreated from the international markets following the Petrobras scandal, wreaking havoc on Latin American bond issuance. For the first time in several years, Latin America did not post record issuance in 2014, when supply dipped to US$196bn from US$199bn in 2013. That continued during the first quarter of 2015 when overall supply fell to US$39bn from US$55bn a year earlier, according to Thomson Reuters data. Scampering to the sidelines After accounting for more than a third of the region’s record supply for the last several years, Brazil’s borrowers scampered to the sidelines during the second half of 2014. The fallout from the corruption scandal was severe, closing access to credit markets for the country’s biggest issuers and also forcing a number of its supply-chain companies into bankruptcy. Coupled as it was with a slump in the price of oil and recession in Brazil, the country’s usually frequent issuers pulled in their horns and mothballed capital expenditure programmes. While market participants were stunned by the timing and reception of Petrobras’ return to the international bond markets, there were already early signs of a recovery in deal volumes during the second quarter. “There is a sense that the fog is lifting over Brazil and that supply may be returning,” said Chris Gilfond, co-head of Latin America capital markets origination at Citigroup, speaking before Petrobras hit the market. A flurry of recent supply supported that thesis. A fortnight after Petrobras published its accounts, cement company Votorantim Cimentos, which was unaffected by the Petrobras scandal, came to the euro market with a €500m offering. Rates volatility meant that markets were choppy. Getting it done “It got done, but it wasn’t a blowout,” said one source close to the deal. But given that it was the first international deal by a Brazilian company in eight months, “getting it done” was some achievement. Then BRF, the Brazilian foods group, announced a brace of firsts – it made its debut in the euro market and also printed the first Green bond by a Brazilian issuer with a €500m no-grow seven year trade. “There is a sense that the fog is lifting over Brazil and that supply may be returning” Meanwhile, Vale, the Brazilian mining company, secured a US$3bn five-year revolving credit facility for a term of five years, after seeing its free cashflow eroded by the falling price of iron-ore. Then on May 22, Banca Itau raised US$1bn. “Slower economic growth has allowed banks to fund internally and have less need for dollars, so the return of financial issuers is a positive sign,” said Gilfond. Brazil’s absence in the previous eight months had stoked pent-up demand for Latin America paper across the board and encouraged issuers in other countries in the region to step up. Breadth of issuance “While the gap from Brazil’s absence is large and it is felt, 2015 has been a fantastic year so far for other issuers,” said Katia Bouazza, head of Latin America capital financing at HSBC in New York. “The breadth of issuance has been diverse and vast.” With Russia off limits and Central and Eastern Europe out of favour, demand for well-known credits from the region has remained robust and borrowers have shown a preference for the euro markets, where yields have looked increasingly attractive on the back of the ECB’s quantitative easing initiative. Notable non-Brazilian issuance has come from sovereigns such as the Republic of Chile, which raised €1.39bn with record-breaking yields and cou