Keith Mullin, KM Capital Markets: But avoiding those pitfalls is not a trivial point if you lack full visibility going into a trade around how it might be received. In terms of how you assess what you need to do as intermediaries and how to position a deal to make sure it goes well, what are the additional factors that you need to take into account in this MiFID II world that we live in?
Mark Lewellen, Barclays: The point has already been made. Notwithstanding the tighter constraints we face due to regulation, we’ve just gone back to the normal way of doing transactions. The 2016, 2017 way of putting waves of transactions into the market, particularly last year, and essentially knowing they were going to go well, has changed.
There is a lot more focus on investor marketing, a lot more thought goes into roadshows and on credit positioning. Syndicate desks are having to work for their money and they’re having to think hard about timing and advise issuers in the right way. But that’s really healthy. Everything we’re talking about is really just moving back to normalisation.
Keith Mullin, KM Capital Markets: But it’s a more complicated world. Beyond the market changes we’re discussing, it’s a new world out there in as far as there’s much more scrutiny around the allocation process than there used to be. There’s far more scrutiny over the information dissemination process and what constitutes material non-public information, and the credit research world has potentially been turned upside down.
Mark Lewellen, Barclays: If I think about the internal processes around issuing a bond compared to how it was five years ago, yes it is more complicated. There is a lot more thought that needs to go into it. There’s a lot more thinking around information dissemination etc and we’re working under the constraints of MiFID II.
But again, I think that it is very positive. There was possibly some not great behaviour taking place. That has been stripped out. There is a lot of thought around allocation. There had been a lot of complaints from certain classes of investors who didn’t feel that they were being fairly treated in the allocation process. Now we have transparency around that. It is very helpful.
But in terms of the general way that we do transactions in terms of roadshows, marketing, timing around execution, that hasn’t really changed. What’s changed is the internal processes we need to follow to get things done in the right way.
Henrik Johnsson, Deutsche Bank: I think the market has actually gotten simpler rather than more complicated. The syndicate black art used to be trying to find investors you knew were long-term holders and maybe giving them preferential access. As activity on the secondary trading side has reduced, what’s happened is that more of these asset classes, maybe with EM and high-yield as outliers, are turning into market-beta asset classes where investors are taking the market risk.
We used to be able to intermediate much more collectively as banks because we had more inventory and could smooth out market volatility. We could selectively allocate people we felt were more long term. All those things are more difficult to do as a result of regulation. Investors are basically taking that risk more than we are at the moment. But that makes sense because they have the capital.
As we see more political volatility or spreads widening, the real test is going to be whether there are going to be effects. If there is a shock, what happens on the buyside? Do they suddenly get massive withdrawals because ETFs have daily liquidity? That’s more the risk than anything the banks are doing right now.
Frederic Zorzi, BNP Paribas: MiFID II is a non-subject for new issues. As Mark said, maybe we have to do more recording but that’s on the bank side; that’s internal organisation. On the external side, for investors, it’s business as usual. Has any issuer been impacted in terms of spread, in terms of volume, because of MiFID? No. Primary is different in that sense to secondary.
If anything, what it does is gives more transparency to the market, which is a good thing. And what it will do – and long term that’s the trend in the market – is find some kind of common practice. That’s not MiFID. MiFID has been the trigger but it’s more about the willingness to find common practice across asset classes and across markets.
This trend can only be positive for the bond market. More transparency will make investors more comfortable in their investment decisions. And the size of buyside balance sheets today is massive. That’s money that has gone from the banks, so yes, we rely on investors as partners to issuers.
The more transparent the market is, the more comfortable they will be and it will facilitate transactions. In that sense, regulation adds some internal strain to the banks; it makes life a bit more difficult and it sometimes slows down the process. But long term, it will help to unify, to standardise and globalise the primary market. That’s beneficial for all issuers.
Jean-Marc Mercier, HSBC: What’s interesting is that despite all the work done by the International Capital Market Association, by the FICC Market Standards Board and MiFID II, we’re still talking about the question of fair allocation.
What happens in the event a bank is undersubscribed? Do we have the capital to support and be long the trade or do we just pull it and there is no deal? The dynamics are going from one extreme to the other, of building a massive book on certain euro corporate trades in 10 minutes of bookbuilding to maybe some trades where we’re long. What happens then?
Mark Lewellen, Barclays: What is untested is secondary liquidity. Credit is an illiquid market in secondary. To buy a decent amount of bonds, an institutional investor really has no choice but to go primary. You can talk about the BlackRocks and the Pimcos and even if you start going down the chain, there are still significant names. But if you do get these significant outflows, where is that secondary liquidity going to come from?
There’s definitely room for technology to pick up on this in terms of disintermediation etc and some companies are looking at that. But we haven’t seen it advance yet.
Personally, I don’t think the near-term risk is that we get a large crisis-type sell-off in credit. But if it does happen and you do get these large institutional investors suffering significant outflows, it’s difficult to see where that back bid is going to come from because from a regulatory perspective it’s not going to be able to come from the banks.
Frederic Zorzi, BNP Paribas: Well, we saw what happened in 2008. It’ll be the same thing where you will have some irrational behaviour. The question is how long it will last. A lot of people say that one of the biggest risks to the market is cyber risk and cyber security. What happens if you have a big attack on two or three big banks or a big asset manager and we paralyse the market for a few days?
We haven’t even talked about geopolitical risk. What we’ve have seen since the start of the European crisis is that investors are not adequately pricing risk. And rightly so because they don’t know how to price it.
We can have a view on credit spreads and I’m not negative on that. They might go wider but on a historical basis they will still be attractive. But the next big move, I think, is going to come from a technical factor or from a geopolitical risk event that we won’t see. The question at that stage is who is going to step in? Who will fill the gap and for how long?
We saw what happened in 2009 when you had Single A corporates printing in euros at close to 10%. It was not rational and it didn’t last. But can we go there? I doubt it because everybody knows the history of 2008 but can we go back to 5%, 6% on something that is not predicted? Yes, though that’s not a central scenario today.
Jean-Marc Mercier, HSBC: We also had the [severe stress in] the high-yield market in 2015 and the Fed taper tantrum in 2013. But we’re talking here about Black Swans.
Keith Mullin, KM Capital Markets: I wanted to discuss where we are on Capital Markets Union. The hope among policymakers is that Europe evolves from a predominantly bank-driven market for SMEs into more of a mixed solution, with the bond market taking up a lot more of the heavy lifting.
In parallel with that, we’ve seen the European Commission create standardised private placements, harmonised covered bonds, STS securitisation, and European Secured Notes. There’s a lot of labelling going on.
Is the expectation that the direction of travel in terms of dealmaking and flow will be the one that the European Commission wants? It certainly plays into the hands of the bond market. How do you perceive developments as they come out of Brussels?
Frederic Zorzi, BNP Paribas: Standardisation is positive and the market needs it because it will facilitate flows of capital between investors and issuers. I’m really supportive as long as it gets done. Maybe you start with Europe but you do need to have global standards because it’s a global market. Forget about currency; it’s a global market.
Access to private capital for SMEs is a key challenge for Europe. It’s very important and banks should feel that. The way the market will evolve is not that banks won’t be needed; banks will evolve to better service clients. But on the basis that every institution has a fiduciary duty to its clients but also to its shareholders, and some capital markets business is not the most profitable, the challenge of banks as intermediaries is to be more efficient in the way we provide capital to our issuers. That’s where technology will definitely help.
Not next year but maybe in two years’ time, the way we do a deal for SMEs will be completely different to how it is done today. And we will bring a bigger pool of liquidity, which will act as a strong support for growth in Europe.
Mark Lewellen, Barclays: There’s some very good work happening around Capital Market Union. Brexit has got in the way and taken a lot of attention away from it but we need to understand how financial services will co-exist between the UK and Europe post-Brexit, what will happen with passporting and all these issues we’re all dealing with day in, day out. After all, the European Union is at risk of losing a significant part of its financial base and market.
We need to understand how that’s going to work through before some of the excellent moves Europe was making in terms of standardisation around private placements and mid-cap financing [will kick in].
Henrik Johnsson, Deutsche Bank: I think the ambitions should be higher. We’ve been talking about the size of the US market, that you can do US$40bn or more. But what we’re missing in Europe, among other things, is a common or harmonised insolvency regime
The problem in Europe is that there are so many vested interests holding those things back. Europe needs some leadership. To the extent that it’s worthwhile for borrowers to be able to borrow a lot of money in their home currency, which as a bank it’s not clear you want because you like cross-border and cross-currency flows, Europe needs to do a lot of work on transparency and the ease of raising capital. This seems to be going at a glacial pace.
If Europe wants to compete with the US or even with Asia … we were talking about that earlier, how you can do Reg S dollar Asia-to-Asia and Europe gets disintermediated …
Mark Lewellen, Barclays: We had a record year in our private placement business in Europe last year. But it was the Reg D market, it was driven by US investors. There’s UK and European investor participation but the bulk of demand is coming from US insurance companies that are really keen to buy these second and third-tier names.
Jean-Marc Mercier, HSBC: I’m an optimist on the CMU; it’s been the most exciting development in finance since the start of the EU. We need it to fund the economy. Things like the growth of the Schuldschein market, French insurers’ ability to buy loans, there is a lot going on but it takes a long time.
We’ll probably see CMU start to get to high-yield. This year, European issuer volume is around a third to half the size of US issuer volume. That’s not bad compared to where we were just five years ago. But we need time. Having the focus of our regulators, our authorities and politicians is immensely useful. It’s only now after 50-plus years of being together that we’re saying for example, “well, actually, for a Slovenian issuer it’s a bit tricky”. How come? If, for example, you’re down in Kentucky or wherever in the US, you can get funding. If you get a rating you’re done; it’s just a price discussion. We still have work to do but it’s quite encouraging that now there is a focus on the matter.
Keith Mullin, KM Capital Markets: You raised an interesting point. We have seen an increase in the proportion of unrated issuers looking to access the bond market. Are we going to see more unrated issuers? What are the challenges of coming to the bond market without a rating?
Frederic Zorzi, BNP Paribas: It’s a very good question. The answer is it will depend on the way investors raise money. Right now, most of the money is against benchmark. That means rated with maybe an average of 10% that you can allocate outside that. But a lot of CIOs I’ve spoken to recently are trying to raise money for total return and value-investing strategies.
This will be good for the market. If that happens, the answer is yes. If the money investors raise can be put to work based on different criteria, this market will continue. A rating doesn’t always make sense for a small company.
There have been developments around alternative sources of finance; French insurance companies recently starting to buy loans. In France, we’ve also seen asset managers getting together to invest in SMEs. These initiatives are positive. We do need them and they’re a good kick-start to the European project but they are very domestic. The next step is to have this money become pan-European.
Henrik Johnsson, Deutsche Bank: I hate to disagree with you but I think we’ve passed the peak in unrated. That was a bull-market trade and I don’t think investors are necessarily that keen. The reason why large-ish companies were doing unrated deals is that they didn’t want to pay for a rating or because they didn’t want the transparency.
Both are valid reasons not to want to get a rating. Benchmark investors are going to be a lot more cautious about unrated deals. The point that I agree with you on 100% is that there is a tier of smaller companies where a rating from the big rating agencies just doesn’t make sense because they are not big enough. Europe needs to find a solution. There’s a wealth of products trying to fill that gap, like Schuldschein or private direct lending, but not that many are efficient or Europe-wide. That’s where there’s going to be some big development.
Mark Lewellen, Barclays: We need a European version of the NAIC rating that we have in US private placements. I agree that unrated issuance does tend, unfortunately, to be a bull-market product, which is a shame. The evidence is that most of the large unrated issuers that we’ve seen over time have eventually got ratings because they’ve realised that’s the way to get the best possible pricing.
It would be great to see a slightly less onerous, short-form or short-cut type of rating that can be used as a benchmark without having to go through the full rating process with S&P and Moody’s.
Frederic Zorzi, BNP Paribas: OK it’s a bull-market product but by the same token issuers pay a premium for that. It’s not like free money is handed to them for not having a rating. Even in a bull market, it’s coming at a premium. That’s why some investors like them because at least they can do their own credit analysis. I don’t disagree with your argument but by the same token it’s not an arbitrage for issuers.
Henrik Johnsson, Deutsche Bank: No, but the cost is going up and in a more volatile market there is a more compelling reason to get the rating. It used to be relatively low cost and in some cases no cost.
Keith Mullin, KM Capital Markets: It’s very difficult to discuss debt capital markets today without mentioning sustainable, green and social. While we’ve seen a rise in issuance of green and other types of climate or social bonds since 2013, it still accounts for a very small percentage of bond market issuance. Banks now have platforms to develop sustainable finance and many are aligning their internal corporate and social responsibility work with their external client work.
But there are question marks, still, about lack of standardisation around what people consider to be green and it’s difficult to get proper impact measurement, certainly around social. While it’s easy to get behind the notion of sustainable finance, it’s just as easy to be cynical. What are your expectations about how this market grows this year, next year and the year after?
Are we going to get to the point where not doing a green issue will be the exception rather than rule? Investors are clearly focused on the sustainable economy but they are also focused on returns and they don’t want to contribute to sustainability at a cost to themselves.
Henrik Johnsson, Deutsche Bank: What you’ve said is valid. But since the second half of last year and earlier this year, green issues can actually get better pricing than standard issues. And then it just becomes very compelling. It used to be that people did it for PR purposes but you can now credibly say that a green issue attracts a lower price because there is a critical mass of dedicated investors that want green or sustainable. And that’s why I think that it’s going to continue to grow.
It’s never going to be the exception for things not to be green because you can’t shoehorn every possible issue into that straitjacket. But it’s going to be an exciting market and it’s going to continue to grow.
Jean-Marc Mercier, HSBC: The volumes we’ve seen are low. We still have a lot of issuer clients who have not yet even started to think about it. Whether it’s social, SDG or green, there’s a lot still to cover. Investor appetite is very clear.
We all want to do good and the financial appetite is there.
Climate risks have been extremely clearly laid out and we’re now talking about punitive RWAs for your brown balance sheet if you’re a bank. We should be very proud that the private sector has led the initiatives. After COP 21 we were all thinking ‘happy days’ but it’s been the non-government side that has been the powerful force to grow this market without any sort of public intervention. That is quite rare.
Frederic Zorzi, BNP Paribas: I hope we are past the cynical bit. Looking at the league table is the wrong way to look at this. The world woke up to sustainability a long time ago and it goes way beyond Green bonds. A lot of banks are working hard to make sure that private money can match sustainable projects.
Developments in this area won’t always make the front page and won’t always be in the league table but there’s a massive amount of work being done and the industry is changing. And the way investors approach this is changing; this trend is here to stay. Maybe I agree with you that issuing something that doesn’t fit green or social criteria will at some point be the anomaly.
Mark Lewellen, Barclays: We’ve seen pricing benefits in the bond market and we’re now seeing Green loans with margins linked to sustainability targets. I’d love to see the next development in the market being institutional investors being willing to provide some form of pricing benefit to clients who make those targets, because hitting those targets should increase credit quality.
The rating agencies have already said that they’re taking that into consideration so will an institutional investor pay? Will you have a situation where a coupon is linked to making sustainability targets? Maybe it’s a long way off but it would be lovely to see that kind of development.
Jean-Marc Mercier, HSBC: One of the major benefits, and maybe we’re not seeing the value yet, is investor engagement. If we all agree that the markets are going to be a bit more difficult, you want a very healthy relationship between investors and issuers.
If you are an issuer and you want to develop strong relationships with investors, then green and social is an amazing tool to convince investors that you are doing the right things in the right way. It’s a very strong tool to get better trust into your name in the markets. Financially, it makes huge sense for issuers.
Keith Mullin, KM Capital Markets: I want to ask each of you before we close to make a short closing statement in terms of your expectations for the rest of 2018.
Mark Lewellen, Barclays: I’m pretty optimistic. I think we’ve got off to a good start. Yes, volumes are marginally lower but we’re coming off a very good 2017. Global economies are running well and monetary policy is well flagged. I’m not a big believer that we’re going to see spikes in inflation this year. If we do that could derail things. I think it’s going to be a healthy year for supply and that there’s going to be enough for institutional investors to see.
Henrik Johnsson, Deutsche Bank: Something that we didn’t talk about is demographics. One of the things you sometimes heard from strategists coming into this year was some sort of shift from debt into equity. That happened to a certain extent, particularly, in the US but it’s been dwarfed by flows into Asia and from Asia into fixed income in the rest of the world. One of the underlying mega-themes is the ageing of Western economies and some Asian countries. That’s going to be a supportive factor for fixed income.
But as I said at the beginning, 2018 is not 2017; there is going to be more volatility. You need to be careful to issue and invest at the right time. But the underlying mega-trend is continued support for fixed income whether that’s in rates or credit.
Jean-Marc Mercier, HSBC: If we all agree markets are getting tougher, clients will need strong partners. Whether you are an investor client or an issuer client, you will want to have a long-term relationship, with sound advice, capital, ideas and the intelligence that we gather every day in our dealing rooms, in our advisory teams and from all of our staff.
And you will need experience. Some of the young guys have not seen tougher markets, didn’t experience 2008 or in many cases even 2013 or 2015. We will need experienced staff to navigate markets for both investor and issuer clients.
The other thing is China. China is opening up as the third-biggest bond market in the world. If you haven’t got your QFII or RQFII, don’t have access to the China Interbank Bond Market or haven’t done anything on Bond Connect, there is still time.
Frederic Zorzi, BNP Paribas: We should not forget where we have come from. We should be proud of what we have achieved in Europe in terms of the growth of the market. Maybe we can do only €13bn instead of US$40bn-plus in the US but it’s still amazing compared to what we were doing 20 years ago.
And looking at the US, the investment-grade corporate bond market did US$1.4trn last year. Who would have thought that was possible 10 years ago? We’ve come a long way. Markets are functioning; it’s challenging and regulation has made it more difficult but it’s important because it is essential that markets keep supporting the growth of the economy.
The market has become global. Emerging trends will be key, whether it’s sustainability, whether it’s standardisation, whether it’s digitisation, we need to work to stabilise this market and continue to make it a success.
We should look beyond a 10bp-15bp widening and look at what we can achieve. I remain positive for 2018. If we in the market are successful with this transformation we have a long future ahead of us.
Keith Mullin, KM Capital Markets: That is a perfect place to end. Thank you for your very insightful comments.
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