Tried and trusted

Britain has dominated business headlines around the globe this year, albeit mostly for the wrong reasons – its perpetually fumbled attempts to leave the European Union. But amid the political chaos, one market has quietly boomed: the sterling bond market. In particular, sovereigns, supranationals and agencies have flooded into sterling since the start of the year. “Sterling is off to a flying start and [showing] resilience this year,” said Jonathan Peberdy, head of syndicate at NatWest Markets. “Demand for sterling assets remains very strong and sterling is an attractive funding choice for international borrowers.” Issuance is up 60% year-on-year with around £23bn of paper sold up to mid-March, compared to £14bn in the same period last year, according to RBC Capital Markets. So, what has happened? First and foremost, there has been a shift to replace the discredited London Interbank Offered Rate (Libor) with the considerably more robust Sterling Overnight Index Average (Sonia). The move is being driven with the regulatory stick and the capital markets carrot. Last summer, UK financial regulators made it clear that Libor was on its way out and that the transition must complete by the end of 2021. At the time, Andrew Bailey, chief executive of financial regulatory body the Financial Conduct Authority, drew a line in the sand. “I hope it is already clear that the discontinuation of Libor should not be considered a remote probability ’black swan’ event. Firms should treat it is as something that will happen and which they must be prepared for,” he said. In actual fact, the transition has, to all intents and purposes, already happened. As Sean Taor, global head of public sector at RBC Capital Markets, noted, around £180m three-month Libor contracts a day are now traded, compared to £48bn a day for Sonia. He describes it as “a robust rate to benchmark against”. EIB blueprint What has definitely sweetened the transition was the deliberate move by the European Investment Bank to price a bond linked to Sonia last year via HSBC, NatWest Markets, RBC and TD Securities. On solid demand and a decent book, it printed £1bn June 2023s at Sonia plus 35bp. This was in line with initial price thoughts and offered a 3bp premium over EIB’s Libor curve to boot. “The choice of referencing the Sonia benchmark removes the need, for both issuers and investors, to consider any future changes to Libor for this bond,” said Bertrand de Mazieres, director general of finance at the EIB. A runaway success in more ways than one, it has become the blueprint for Sonia issuance, although it was not actually the first Sonia-linked bond ever. In fact, the EIB had priced a £300m Sonia deal back in 2010, but that was what Thomas Schroder, deputy head of division and managerial adviser in the capital markets department at the EIB, at the time called “a novelty”. One banker picks up the story. “When we did that deal in 2010, we learned that the plumbing was not in place. But by this time last year, the documentation was in place. After EIB did the first reformed Sonia deal last summer, issuance really picked up in the second half of the year,” he said. And Sonia issuance has continued into 2019. Of the £23bn SSA issuance that had been seen until mid-March, £6.5bn of that references Sonia, according to RBC Capital Markets. Not all about Sonia But that is not the sole reason for the upswing in issuance. If you look at this year’s SSA issuance in sterling and take out Sonia deals, it still stands at £16.5 – up 20% on last year. The reason quite simply is the basis swap. SSAs are sophisticated borrowers when it comes to pricing and have the flexibility in their funding programmes to issue in the most cost-effective markets. “Sterling is always hard to anticipate as a funding vehicle. But if deman

Venezuela’s parallel government, led by Juan Guaido, the president of the country’s National Assembly, must consider a long-term debt restructuring that does not penalise foreign bondholders in a draconian manner. Otherwise, a new administration could be mired in litigation and cut off from international capital markets for more than a decade, warn experts. The country is still nominally led by Nicolas Maduro, who took over the presidency in April 2013 upon the death of Hugo Chavez, but Guaido declared himself the interim president on January 23. His parallel administration has now been recognised by more than 50 countries. Until now, the country’s generals have backed Maduro but the appalling economic meltdown is having a dramatic impact on the army’s rank and file and their family members. A coup d’etat against Maduro is a possibility. Furthermore, the US government has tightened the sanctions screw on the Maduro regime. On February 1, the US Treasury limited the sale of Venezuelan sovereign bonds to non-US entities only, following a similar move on debt issued by state-owned oil firm PDVSA. Trading in the sovereign and PDVSA bonds has now ground to a halt. Other US sanctions have made it hard for countries that use the US banking system to purchase Venezuelan crude, which used to account for 95% of Venezuela’s exports. The Trump administration has also frozen Venezuela’s assets, including PDVSA’s US refining arm, Citgo Petroleum Corp, the country’s most important foreign asset. Almost all the Maduro government’s sources of hard currency have now been shut off.Restructuring planning There is speculation that the US president could order an invasion of Venezuela if Guaido is jailed or harmed. One way or another, most financial analysts now expect regime change within the next year, so the parallel administration must plan for a debt restructuring in case this happens. The country’s total debt load is around US$130bn, including sovereign and PDVSA debt. Nominal GDP stands at around US$75bn, giving a total debt-to-GDP ratio of 173%, according to Andean Capital Management, a New York-based hedge fund. This indicates that bondholders could face a hefty haircut north of 80% on Venezuela/PDVSA debt once a restructuring finally occurs. However, experts warn that a restructuring of this magnitude could lead to an avalanche of litigation by foreign investors and the sovereign/PDVSA could suffer Argentina’s fate, being cut off from international capital markets for 15 years. “The challenge is to establish a sustainable sovereign risk-free rate of return that incentivises existing creditors to remain invested in Venezuela, increase their investment in Venezuela and not hold up the reorganisation of the country’s liabilities in domestic and foreign courts,” said Daniel Osorio, chief executive officer at Andean Capital Management. “Few things will impede the normalisation of Venezuela’s economy like a long litigious process that will prevent the country from re-establishing its relationship with the international capital markets. On the flip side, existing creditors will have to afford Venezuela a critical commodity, time.” He says that a ‘patient capital bond’ structure could be the solution. It would allow the Guaido administration around 18 months to market it to creditors and prepare the issuance. It would roll up all of Venezuela and PDVSA’s liabilities into one long-dated bond. Its amortisation schedule would have a grace period for the first few years of its life, then amortisations would gradually increase in the intermediate years, and amortisation payments would decrease as it gets closer to maturity. Bondholders would face a haircut, but not at the top end of the range, and it could avoid the scenario of a new administration being bogged down in litigation for many years. This structure would enable a ne

The strength of the bond market in 2019 is masking the differences between peripheral credits and leading to some level of convergence. Greece, Italy, Spain and Portugal have all done deals in Q1, with all enjoying healthy order books. It is a market in which few expect the European Central Bank to raise rates, given tepid growth and inflation that is projected to remain below target for years to come. Slowing growth in the EU as a whole has boosted bond markets, raising expectations for supply as governments look to plug holes in their finances. True, it means debt levels will increase further, but investors want yield, and these credits are where they can find it. That calculation looks set to persist for the foreseeable future. While the peripherals share the characteristic of offering an attractive pick-up in yield, economically speaking the credits are very distinct. Luca Cazzulani, deputy head of fixed income strategy at UniCredit, said: “I am cautious about the term ‘peripherals’ for these credits because they are so different from each other. But as a group of issuers that offer a large spread, they all generate big demand right now.” “The peripherals are the most compelling play in Europe at the moment,” said Louis Gargour, founder and senior portfolio manager at LNG Capital. “Italy and Greece are the credits with the highest risk and, as a result, with the highest returns to investors, therefore an interesting opportunity exists for investors. ”If one believes that Italian political problems can be overcome, and that the ECB will keep smoothing over the cracks in Greece – which we do – these are good investment opportunities.” Looking at Greece specifically, this sentiment is understandable. Given the amount of time and money the EU has already invested in saving the country, it seems unthinkable that it would now let it default. Investors therefore regard Greek debt – along with the other peripherals – as having an implicit guarantee. This allows them to gloss over Greece’s still ominous fundamentals. Although things have been improving, Greece remains in a league of its own in terms of the scale of the challenges it faces, particularly its public debt-to-GDP ratio, which stands at 188.7 %, according to OECD data. Italy’s, by contrast, is 152.6%, while Spain’s is 114.7%. The market has been welcoming in both of Greece’s issues in 2019. First up was a five-year deal in January, raising €2.5bn from orders in excess of €10bn and pricing at the tighter end of the 3.60%–3.70% range set in guidance. This was followed up in March, when it came with its first 10-year deal in nearly as many years, raising €2.5bn with pricing at 3.90%, having generated orders of €11.8bn. These issues have been more about creating a curve and fixing relationships with the investor community than actually raising money. “Greece’s recent bond issuance shows excellent progress in ‘normal’, long-term market access,” said Lee Cumbes, head of public sector EMEA at Barclays. ”The sovereign didn’t really need the money, but the strategy is to develop the curve and rebuild broad investor confidence, to ensure everything is fully functioning in future as and when it is needed. This year’s deals are absolutely textbook steps towards creating a robust market.” The sovereign has a long way to go before it succeeds in that task. While there is a repo market in Greece, it is used more for financing than for covering short positions in the GGB market, unlike other established euro government bond markets. And while there are auctions for bills with tenors shorter than one year, there are none for bonds with maturities longer than one year. Closing in In terms of the sizes of their markets, Greece and Italy occupy the two extremes on the scale of peripheral credits. But in terms of

When Benin began the roadshow for its debut €500m bond in March, there was a familiar-looking disclosure tucked away in the prospectus that has been attracting increased scrutiny from investors. The country said it is planning to spend close to US$1bn on a new international airport that is expected to be funded by the Export-Import Bank of China. Such Chinese-funded infrastructure projects are accelerating in Africa, with Chinese loans to sub-Saharan African countries rising to more than US$10bn annually between 2012 and 2017, from less than US$1bn at the turn of the century, according to Moody’s. Last September, China pledged to invest a further US$60bn in Africa over three years. But as Africa’s debt levels have increased, so too have questions about China’s lending practices and what impact they are having on the capital markets landscape on the continent. “There are some countries with higher concentration risk with China than others, but it’s something that investors are becoming more and more concerned about when we do due-diligence trips or meetings with officials,” said Kevin Daly, a fund manager at Aberdeen Standard Investments. Part of the concern is that China’s loans are notoriously opaque. Often they are confidential, meaning there is little data on the size of the loans, the interest payments or when they are due to mature. “Full and timely information on debt service schedules are virtually non-existent in many of these countries, at least not on a very contemporaneous basis,” said Stuart Culverhouse, chief economist and global head of research at Exotix. “You might know what the position was two years ago; but when you really need it, when they are in problems, you don’t know.” That means debt metrics can jump with little warning. In Zambia, for instance, Daly said the country’s external liabilities were US$800m in 2018, but this year they will shoot up to about US$1.4bn, largely because some of its Chinese loans are starting to amortise. “Investors are having to become more forensic,” he said. “The key question is when do these loans start amortising. You also want to know what the loan proceeds are going towards and whether or not they are inflated, and then thirdly you need to know if they have any future commitments with China. You really have to push hard for this stuff.” Cameroon, for instance, has a number of undisbursed loans from China that, if drawn down, would likely make its debt unsustainable, Daly said. For now, such concerns are not denting appetite for the continent’s debt. African countries including Ivory Coast, Senegal and Kenya issued a record US$28bn of Eurobonds in 2018, about US$10bn more than was raised in 2017, according to Refinitiv data. So far this year, Ghana, Benin and Egypt have issued more than US$7bn of bonds between them. SSA bankers are bullish that this favourable climate for African sovereign bond issuance is set to continue, not least because the US Federal Reserve has signalled it is unlikely to raise interest rates this year. And while the availability of Chinese loans has probably taken some potential supply away from the bond market at the margins, most bankers view Chinese debt as complementary rather than a competitor they have to pitch against. “If there are multiple sources to raise money, does that change the number of bonds that are issued in the market?” said Lee Cumbes, head of public sector for Europe, Middle East and Africa at Barclays. ”The likely answer to that is going to be yes, but it’s not as simple as saying if you do one then you won’t do the other,” Yet as African sovereign borrowers pile Chinese loans on top of the roughly US$100bn of outstanding publicly issued bonds, problems could be being stored up for later were any of these countries to slide into financial difficulties. “Restructurings will

A monetary cycle that was supposed to have seen the Federal Reserve and European Central Bank back quickly away from their stimulative policies and move into full-blown tightening has been replaced by a rapidly hatched Plan B. Markets are struggling to figure it all out. Under the umbrella of a much gloomier growth outlook, Plan B is dovish. It is a stance induced by poor economic data, lower growth forecasts, US-China trade tensions and political strife, including the vexed question of Brexit. All factors that have on occasions led to disorderly and volatile markets. Spooked by economic, political and geopolitical headwinds, and by subsidiary fears that monetary authorities would fail to change direction and potentially make things worse, US stocks led global markets into a tailspin in December. Bouts of volatility built on unpredictability followed the March FOMC meeting, short-lived three-month T-bill to 10-year T-note inversion (signalling a recession to some) and the poor March Germany manufacturing PMI, which pushed 10-year Bunds into negative yield territory. The bottom line of the new monetary reality is the continuation of elements of stimulus fronted by lower rates for longer. The ECB’s summer 2019 rate hike was pushed to 2020. The hikes the Fed had been signalling and the market had been duly pricing in have been replaced by stasis, with a growing proportion of participants believing the next step could be a rate cut; a view supported by overnight index swaps. “The most dramatic development of the year to-date has not been on either trade policy or politics. Rather, it is the Fed’s full-throated embrace of a monetary stance more dovish than many market participants had been expecting,” head of macro research Ajay Rajadhyaksha and global macro strategist Michael Gavin co-wrote in Barclays’ Global Outlook published on March 28, right below a heading which read ‘Fed capitulation rocks markets’. The revised monetary policy stance has up-ended the much-vaunted process of asset price normalisation in the capital markets that was supposed to have accompanied expected policy normalisation. Years of central bank stimulus has demolished any vestige of proper price discovery. A risk-reward profile that has been heavily skewed to borrowers throughout the QE phase was supposed to have shifted towards investors as spreads found a new equilibrium. The shoe was decidedly on the borrower’s foot in the first quarter of 2019. Having the central bank as buyer of first resort in the bond market had led to artificially tight spreads and the formation of asset price bubbles. Anxiety around how the market would be weaned off central bank support without incurring some abrupt repricing disorder or cliff effect had started to replace anxiety around why stimulus was there in the first place (to boost growth via the extension of low-cost bank credit into the real economy).Turning point A key turning point in Europe was the September 2018 ECB meeting, which called an end to monthly net purchases under the Asset Purchase Programme by year-end, leaving only the reinvestment of principal from maturing securities (although, with securities holdings from the APP still above €2.5trn at the end of February 2019, the ECB’s presence will continue for some time). A key component of expected normalisation, parallel with the end of asset purchases and the beginning of rate tightening, was the run-off of TLTRO II borrowings, which had reached €740bn at their height and provided much-needed cover for banks, principally in Spain and Italy. In the way of best laid plans, the ECB’s March 1.1% projection for 2019 euro area growth, 60bp lower than its December forecast, was a reality check. The ECB pointed to unexpectedly sluggish real GDP growth in Q4 2018 and substantially weaker than previously expected activity in H1 2019. “The broad-based worsening of economic sentiment indicators ac

Descriptions of new Federal Reserve chairman Jerome Powell’s volte-face in policy at the end of January range from the euphemistic to the blunt. It has been termed a ‘pivot’, which perhaps comes under the heading of euphemism, but also, more bluntly, ‘U-turn’ and a ‘180 in four weeks’. It has also been wondered whether the Fed buckled under pressure from President Trump, who mused whether the Fed had ‘gone loco’ in hiking rates. But perhaps the misstep committed by Powell was not hiking the Fed Funds target rate to 2%–2.25% on September 26 and then again to 2.25%–2.50% in December (the highest since April 2008) but by indicating in interviews that the rate was a ‘long way’ from neutral. This suggested a lot more hikes were on their way in 2019, and it unnerved the market considerably. The S&P 500 lost almost US$2trn in October, and there was another vicious sell-off in December, culminating in the worst week for US stocks since 2009 and a 600-point drop on Christmas Eve. “Maybe it was a throwaway remark that the Fed is a long way from neutral, but it was the gong for the market to think that there will be many more hikes and the curve will invert. It was a rookie error; Janet [Yellen] had one and Ben [Bernanke] had one,” said a senior credit strategist at a US bank in New York. If the Fed chairman called it wrong in the third quarter of 2018, he was quick to redress his error. By the meeting at the end of January 2019, the mood had shifted significantly. Rates were put on hold and the Fed said it would be “patient” in determining any future rate shifts. On this occasion, Powell stressed that the data will dictate the future path of rates rather than a pre-determined strategy. The effect was instantaneous. The 10-year Treasury, which had been yielding 3.21% on November 8, in the middle of the rate hike panic, rallied to 2.55% at the beginning of February. “Did the Fed call it wrong? Yes, it got it wrong in reading the data, hiking rates and indicating it would go higher. The reversal of communication probably indicates that they think the policy action at the end of 2018 was a mistake and they’d like a do-over,” said Mark Cabana, head of US rates strategy at Bank of America in New York. Economic releases so far in 2019 have also not corroborated the impression that the economy is over-heating. The February retail sales data, for example, were particularly anaemic, coming in at minus 0.2% compared to market expectations of a 0.3% rise. Indeed, those onlookers sympathetic to the Fed’s about-turn say the data in the last quarter of 2018 indicated strength but so far in 2019 has indicated something else entirely. “They didn’t get it wrong in October 2018. The Fed is data-dependent. When they signalled rate hikes, the economic signals were stronger, but the economy evolves and so do expectations,” said Steven Zeng, a US rates strategist at Deutsche Bank in New York. There are other factors behind the fall in yields this year. As rates began falling, there was a surge of buying of 10-year Treasuries by mortgage portfolios. Mortgage portfolios are positively convex, meaning falling rates shorten the duration of their assets as mortgage pre-payment becomes more likely. These positions are offset by buying Treasuries and/or receiving fixed rate in the dollar swap market. Most business is normally conducted in the 10-year tenor. It is a trope of the US capital markets that a sudden collapse in rates is fuelled by mortgage portfolio buying – and this is what happened in the first quarter of this year. What gave perhaps an even bigger boost to Treasury prices was that the decision to switch to a hiking mode in the third quarter of 2018 was accompanied by a balance sheet runoff. The so-called portfolio balance channel – quantitative easing by another name – was announced by the

Having heaped losses on investors during a miserable fourth quarter of 2018, risk assets rallied as the new year got under way. The dramatic recovery came about because assets started to look cheap and investors were under-invested, although the biggest source of comfort came from Federal Reserve chairman Jay Powell, who called time on rate rises and even raised the prospect of loosening policy later in the year. Meanwhile, the European Central Bank also delivered a surprise on the upside, by appearing to postpone any rate rises of its own. The result was a risk-on dash to the market by investors, and SSA issuers obliged by grabbing the opportunity with both hands. The strong market conditions paved the way for a torrent of supply, with most sovereigns well ahead with their plans for the year and the buyside pouring cash into issues across the board. “We saw a fantastically successful first quarter with huge, high-quality order books as a procession of trades were snapped up by investors. Big-name sovereigns hit the market in size, while, as the market conditions continued into the second quarter, smaller agencies also enjoyed attention,” said one syndicate head. The resurgence in supply followed a textbook pattern. Lee Cumbes, head of public sector EMEA at Barclays, said: “The first stage was led by large sovereign issuers, then supranationals and bigger agencies, then, finally, the smaller issuers increasingly entered the fray as investors chased spreads lower. By the end of March, the fourth-quarter sell-off was beginning to look like a bad dream. We are roughly back to where we were last October in terms of spreads.” January kicked off with a mood of trepidation, particularly in the euro market, which received the most attention because it had suffered such a sharp drop in demand during the fourth quarter. Markets entered the new year full of apprehension that the end of QE was nigh and there were worries that the ECB, the world’s biggest euro buyer, was about to stop. In the US, the Fed was tightening and reducing its balance sheet, while the ECB ended its expanded sovereign purchases programme in December. Bullish buying While it is the investment community that ultimately facilitates issuance, it was the Kingdom of Belgium that grabbed the plaudits for taking the plunge on January 8 with a €6bn 10-year that attracted more than €28bn in orders. Ireland and Portugal tore out of the blocks the following day and, between them, these three trailblazers racked up €70bn of demand. Having reopened the market, Belgium then returned on January 29 to print a €5bn 30-year that raked in €27.5bn of orders. “That was a real game-changer. Investors were clearly happy to buy in the main benchmark maturity of 10 years, but the question was whether they would want to lock in rates at the long end. Belgium answered with a resounding ‘yes’,” said Cumbes. The initial success of Belgium, Ireland and Portugal was too good for Italy to resist and it jumped at the chance to banish concerns over its own financing capacity, as well as those about the health of the broader market, with its €10bn 16-year. Italy’s woes had begun to ease towards the end of the year with the approval of its budget. And when it garnered a near €40bn order book – its biggest ever – it became clear that any apprehension was misplaced. The sheer volume of cash pouring into deals showed that investors who had been on the sidelines since May last year were returning in force. Spreads widened at the end of 2018, and the subsequent repricing brought new accounts back into the market. But few had foreseen the speed with which they would return and the volumes of supply that they would support. “With spreads widening for SSA paper, on a mid-swap/asset swap spread basis, more bank treasury accounts are bidding for SSA paper,” said one syndicate head. Sovereigns

SSA issuers, particularly agencies, have been among the most prolific issuers in the sustainable development bond market. The idea was that issuers could demonstrate their commitment to issues that resonate with customers, investors and voters, while also funding on competitive terms. SDBs help public sector borrowers achieve their mandated political objectives, be that the promotion of renewable energy with Green bonds, cleaning up water resources with Blue bonds or increasing provision of affordable housing with Social bonds. Existing loans were repackaged and sold as bonds to investors-cum-philanthropists, who would also make a healthy return. The Green bond market was the first to really take off, and remains the biggest. KfW, which claims to provide one third of Germany’s Green loans, commenced its Green bond programme in 2014. The German lender issues on average €1bn-€3bn of Green bonds per year, with around €14.5bn outstanding across five currencies, mostly euros. It represents around 60% of the German market in Green bonds. The Nordics have also been huge supporters of Green bonds, with around 7% of the total cumulative Green bond issuance between 2007 and 2018, according to the Nordic Investment Bank. NIB has played a significant role in that: its first Green bond came in 2011, and by 2018 it had issued a total of €3.5bn in environmental bonds, with at least one issue every year in that period. Since 2014 NIB has issued benchmark deals – at least 500m in size, whether in euros or, on one occasion in 2014, US dollars. Its deals tend to be for seven to eight-year tenors, with one Swedish krona transaction coming as a five-year. Maturities tend to be determined by market conditions, said Jens Hellerup, head of funding and investor relations at NIB. “The dollar market provides good short-maturity deals and euros typically add more value in longer maturities.” Annual Green bond issuance has generally trended upwards, although it dipped in 2018 due to the distraction of its first Blue bond deal. NIB issued €920m of NIB Environmental Bonds in 2017, and €500m – a single bond – in 2018, though it expects issuance to resume its upward trajectory in 2019. The appeal of the Green bond market is clear. Petra Wehlert, head of capital markets at KfW, said: “The environmental/climate challenge is the biggest issue the world faces. But our focus on Green bonds is because that is where the liquidity is. We think by developing this market we are also supporting others, like the Blue bond and Social bond markets, which will grow as Green bonds grow.” For SSA borrowers in particular, the biggest motivation is a desire to develop the market, to lead by example, both in terms of the size and the structure of their issuance. KfW did not need to provide a second party opinion on the green assets, given investor trust in its expertise. “We decided to do so because we believe that should be best practise in investors’ interest. That is our role in the capital markets; we set the benchmark for smaller issuers to follow,” said Wehlert. “SSA issuers consider themselves as being leaders in market developments, including Green bonds. We can issue the requested volumes to get international attention and we can create the infrastructure for the market to grow,” she said. Leadership can take many forms. ICO, which was on the road with its inaugural Green bond in March, hosts events that bring together investors, banks, issuers, ratings agencies and others, to promote the concept of SDBs. But there is more than pure altruism at play here. Green bonds provide a price advantage for issuers of around 0bp-2bp on average. The latest offering from the European Investment Bank, which in April issued a €500m Climate Awareness Bond due November 2042, is fairly typical, pricing with at 1bp through mid-swaps, equivalent to 59.9bp over the July 2042 Bund