Year in numbers

When it comes to China, Donald Trump is not shy about taking credit. The US president’s self-proclaimed list of achievements even includes convincing Chinese President Xi Jinping not to send troops into Hong Kong to deal with months of anti-government protests, according to a rambling interview he gave to Fox News in November. As far-fetched as that may be, Hong Kong’s capital markets probably owe him some gratitude. The Stock Exchange of Hong Kong leapfrogged the New York Stock Exchange and Nasdaq to become the largest venue for new listings in 2019 following Alibaba Group’s HK$101bn (US$12.9bn) November offering, according to Refinitiv data. Trump cannot claim any direct influence on China’s biggest e-commerce group, but the timing of Alibaba’s float, against a backdrop of political unrest and volatile equity markets, points to rising concerns about the impact of the US-China trade dispute on global capital markets. “A lot of Chinese companies listed in the US are having to think more carefully about the potential risk of being caught in the crossfire of the trade dispute,” said one senior investment banker. “Having a secondary listing either in mainland China or in Hong Kong is a natural hedge against the worst-case scenario.” For Chinese companies, that worst-case scenario involves a loss of access to US capital markets. Three separate bills have been submitted to Congress that will force companies to delist from the US unless regulators agree to allow US oversight of their auditing process, a longstanding source of tension between Beijing and Washington. In November, lawmakers also introduced a bill to prevent a government pension fund from investing in Chinese stocks, while the US Department of Commerce in October placed eight companies on a trade blacklist, including several IPO candidates. “There’s a risk of the trade war spilling over into financial markets, although portfolio inflows from the US into China are still quite negligible and therefore the overall effect on its balance of payments would be low,” said Brad Setser, senior fellow for international economics at independent think-tank Council on Foreign Relations and former staff economist at the US Department of Treasury. “So far most of the discussions around financial decoupling have been kept separate from the trade negotiations but if the negotiations were to turn sour, or if there was a breakdown in China-US relations over Hong Kong, for example, that could change matters.” LISTING BAN Trump has made a new trade deal with China a centrepiece of his administration and can legitimately claim to have had a lasting impact on relations between the two superpowers. Calls for a reset of the trade balance now cross the political divide, and Chinese companies expect US policymakers to be far less accommodating – regardless of the result of presidential impeachment proceedings and the 2020 presidential election. So far, efforts to restrict China's access to US capital markets have come mostly from Congress, rather than Trump, with three bills submitted in the last two sessions (one of which has since expired) that would effectively ban Chinese companies from listing in the US and force those currently listed there to comply with tougher regulations or be delisted. The most notable of the three bills, the Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges Act, or the Equitable Act, was introduced in Congress in June by a bipartisan group of lawmakers led by Republican senator and one-time presidential candidate Marco Rubio. Ostensibly designed to improve transparency, the proposed law would block listings from foreign companies that fail to submit to US regulatory oversight of their auditing process. Companies already listed in the US would have three years to comply or face delisting. Although the bill’s only reference to China is th

There is a term in Japanese business circles for a market that has developed without the influence of external forces. Garapagosu-ka, which translates to Galapagosisation, takes its inspiration from the quirks of nature found only in the remote Galapagos islands, 1,000km off the coast of Ecuador. It is a fitting description for the yen bond market, which has retained its own unique characteristics even as the global markets have evolved to become faster and more efficient. This fondness for isolation, however, is slowly fading. After six years of monetary easing that has dragged government bond yields well below zero, Japanese investors are scouring the globe for higher returns. The vast yen bond market is gradually embracing international influences, too. Foreign issuers have introduced the pot system to the yen market, leading a shift away from the retention system that has been a characteristic of bookbuilding in Japan for as long as underwriting syndicates have existed. The pot, where the lead managers run a single order book, encourages transparency and promotes accountability, minimising the risk of rival underwriters competing with each other to sell their individual portions. Issuers argue the process delivers the best possible price for their debt, and it has been the dominant bookbuilding strategy in the global markets for 20 years. The first Samurai bond to use the pot system was a three-tranche financing for South Korea's Shinhan Bank in October 2017, when the issuer and its advisers were looking for greater efficiency amid worries about geopolitical risk in the Korean peninsula. The idea caught on surprisingly quickly, and all international yen issues in the following years have followed the pot system. However, the traditional retention system still lives on in Japan’s domestic market, where the big investors remain extremely secretive and bankers resist any calls to share information with their rivals. The pot system has gained some traction on hybrid bonds, as the characteristics of such fundraisings are similar to equity offerings, where large shareholders are made public. As such, it is easier to convince issuers and investors that the pot system is preferred. Some small green bonds have also been sold using the pot system, but it was not until May 2018 that the pot system was used for the first time on a major domestic straight bond – Fast Retailing’s ¥340bn four-tranche offering. FORMATS Japanese investors have also broadened their horizons in terms of issuance format, with the result that foreign issuers no longer need to spend the time and money to prepare local language documentation before selling bonds in Japan. The traditional Samurai format, where bonds are issued under the Japanese law and are included in the Nomura BPI, Japan's major bond index, is still the preferred choice for most Japanese money managers. Increasingly, however, the big savings banks, insurance funds and asset managers are accepting yen bonds issued off EMTN programmes and SEC-registered platforms, as they learned they would miss out on investment opportunities if they limit their options. The Bank of Japan's ultra-low rates and massive bond buying programme also squeezed local returns, sending investors into foreign currencies in search for yield, where EMTN programmes and SEC-registration are common. The first wave of euroyen and global yen issuance came in 2017, when global names such as Starbucks and Walmart tapped the yen market in search of cheap funding. The second push came in early 2019, as global banks rushed to sell yen bonds to raise funds for their total loss-absorbing capacity requirements. The first quarter of this year was also the final three months before the Japanese Financial Services Agency increased the risk-weighting on TLAC investments for some Japanese regional investors. TLAC issuers – by nature some of the world’s most sophisticated financial institutions – chose

When regulators decided that it was no longer tenable to have deals worth trillions of US dollars linked to Libor it was for good reason. There are, after all, virtually no underlying transactions in actual Libor. But in their rush to chart life after Libor regulators overlooked something vital: the new money market, risk-free benchmarks they are pushing do not possess some of the key characteristics of Libor that market practitioners have come to rely on. And if large, sophisticated issuers are selling bonds linked to new risk-free rates (RFRs) but in reality still reference them back to Libor, what chance is there that real end-users will embrace such comprehensive change in a hurry? Even asking the question signals how difficult a feat it will be for all the key players – banks, investors and corporate treasuries – to have in place fail-safe systems in time for Libor's planned cessation at the end 2021. Especially considering that regulated entities are facing fierce heat from their supervisors – not their clients – to get on with the move. “Our customers clearly don’t care. For them, it’s number six or seven on their list of priorities,” said a senior fixed-income banker at a major European bank. "The regulators want us to do it, but our customers don’t care. There’s a disconnect." And it’s not like Libor is fading away. US dollar Libor interest rate swaps stood at a mighty US$237trn at the end of the third quarter 2019, and up from US$199trn in the first quarter. It’s not only US dollars or interest rate swaps. Sterling Libor dominates the UK loan market and many new long-dated derivatives contracts continue to reference it. Analysis by the Bank of England at the end of September highlights that the total value of contracts referencing Libor cleared through LCH has also increased, to around £25trn in August 2019 from around £20trn in April 2018 (see graphic). DISCONNECT This disconnect is understandable considering the scale of the challenge of unpicking the Libor framework. Francois Jarrosson, a director in the debt advisory team at Rothschild advising corporate clients on derivatives and hedging strategies, said that treasurers cite several issues delaying their move off Libor. They require new systems for calculating RFRs and are waiting for the formal adoption of International Accounting Standards Board draft rules setting out how the transition should be accounted for. And at the moment it costs more to raise debt using a new RFRs than Libor while banks are not technically ready to provide corporates with capped hedges using the new rates. “Treasurers don’t want to be seen in the short term to be doing the wrong thing [by switching from a low Libor] even if it might be the right thing to do in the long term," Jarrosson said. GOOD SHAPE The difficulty lies in persuading an entire market to stop using a benchmark that is so useful and so pervasive that the exposure to it has continued to grow despite its near-assured obsolescence in a little over two years. One way is to attempt to recreate some of the existing ways of doing things. Further to the good progress made in primary bonds, the development of futures markets for SOFR, for instance, is in good shape. It is worth remembering that Eurodollar futures is where price discovery takes place for three-month Libor and how market participants price OTC instruments, interest rate swaps, and all the other instruments that are benchmarked at a spread to Libor, such as bonds, securitised products, and Treasury futures. And both CME and ICE have seen strong monthly growth in the 18 or so months since their respective SOFR futures contracts have been operating. Made to look and feel as familiar as possible to Eurodollar futures, their growth is important for the creation of an ecosystem similar to the existing one based on Eurodollars and replicating the swaps market's developmen

How best to organise and develop an institutional fixed-income market to finance real environmental change has become a vital and urgent topic for the finance industry. A key question is whether green bonds – where proceeds are ring-fenced with a defined use, and that comply with defined standards such as ICMA’s Green Bond Principles or the Climate Bonds Standard – are fit for purpose as an effective driver of substantive climate-change mitigation. Why? Because of the almost complete absence of environmental polluters in the green bond market – the very issuers that should be core to financing transition. There is a genuine – and potentially intractable – debate around how the fixed-income market should address the climate emergency. But the absence of environmental polluters may demonstrate that the green bond market has lost sight of its fundamental purpose. Certainly, the refusal of some market stakeholders to accept that brown companies even have a place in the green bond market – and that only certain use-of-proceeds financings can be considered true green bonds – may be counter-productively leading issuers to spurn the green bond market as an option. A question now being asked with increasing frequency is whether something other than bonds labelled under the Green Bond Principles is required – either as an addition or as a substitution. Other formats and ideas have emerged in 2019. From the creation of a parallel market to accelerate transition by companies in sectors such as oil and gas, metals and mining, chemicals, materials and transport, to an embryonic market for general purpose corporate bonds with environmental goals set at the corporate level rather than at the asset level. But does the emergence of these new market segments threaten green-labelled bonds? Mirko Gerhold, head of corporate solutions and origination at Commerzbank, doesn’t think so. “Transition and ESG-linked bonds are complementary to labelled use-of-proceeds green bonds,” he said. “The benefit of traditional green bonds, structured in line with the Green Bond Principles, is that investors know exactly what proceeds are being used for, and they get a lot of transparency by way of allocation and impact reporting.” NOT A PANACEA Still, he acknowledges that there are issuers and sectors where green-labelled bonds may not be the right instrument, where sustainability is not based on use of proceeds but on the sustainability of the company, or where the use of proceeds is not pure green but more focused on transition. “In these situations, transition or sustainability-linked bonds offer issuers alternative sustainable financing instruments and investors alternative sustainable investment opportunities. They can then decide what type of instrument best fits their ESG strategy,” Gerhold said. The experience of Spain’s Repsol set an unfortunate precedent in this broad debate. In May 2017, the company issued a €500m green bond with apparently reasonable emission-reduction projections, partially derived from efficiency improvements at its refineries (under a formal transition programme). The Climate Bonds Initiative (a standards setter and pro-green bond lobbyist) concluded the bond didn’t meet its criteria and, because most of the green bond index providers include a CBI thumbs-up as part of their approach to bond inclusion, Repsol was excluded from the indices. It was the first and last oil major to issue a green bond. When Italian natural gas infrastructure company Snam came to market for €500m in February this year with similar use-of-proceeds transaction to Repsol (including reductions in the environmental impact of existing activities), it gave the green bond market a swerve and issued under a self-created Climate Action Bond label instead. Management went to great lengths to create this one-off label to avoid calling it a green bond,

As another painful year for Europe’s banks draws to a close, the need for big bank consolidation has never been greater. For years, calls for consolidation as the answer to the woes of Europe’s hobbled banking sector have fallen on deaf ears. But in 2019 a broader consensus began to emerge that there is a pressing need for intra-bank mergers & acquisitions. Europe’s fragmented banking sector has been under pressure for almost a decade, and that ramped up a notch over summer when the European Central Bank cut rates, increasing the stress on banks already battling higher capital charges, disruptive new entrants in retail and larger US rivals sweeping all before them. Industry figures say consolidation is the way forward. Commerzbank and Deutsche Bank held merger talks, while Italy’s UniCredit engaged advisers to run the rule over Commerz. Politicians have made supportive noises, while banking CEOs have called for action, with UBS CEO Sergio Ermotti telling a conference in Zurich in November that the issue for Swiss and EU banks has changed: They are “no longer too big to fail, but rather too small to survive”, he said. Indeed, in its 2019 global banking report, McKinsey warned that many banks will not survive another downturn and that they should take steps now to avert another crisis. “Scale in banking, as in most industries, is generally correlated with stronger returns,” the report said. The head of European FIG at a US bank said: “There is much more willingness to contemplate crossborder mergers. The pressure is building.” But talk is cheap. For all the renewed noise about the need for consolidation, there has been precious little in the way of action. The head of FIG at one global bank said: “We’re super busy. In 2020 we expect to see global consolidation in the insurance industry, and plenty of deals in payments and fintech. The only sector we don’t expect activity is in big bank M&A.” One reason is that confidence is a crucial catalyst in M&A and after nearly a decade of cost-cutting and retrenchment European banking CEOs are drained of it. The region’s banks are trading at a discount to book value and shareholders, who are already sitting on big losses, are wary of any deal that leads to further dilution or results in them owning stock in a weaker lender. Jean Pierre Mustier, CEO of UniCredit, the bank seen as a consolidator, has poured water on the prospects for consolidation because such moves will require additional capital and that with bank shares trading at a discount, buybacks are more viable than dealmaking. “Europe needs bigger banks but I cannot see any M&A transactions at this stage,” Mustier told analysts following the bank’s third-quarter earnings on November 7. NO RISK APPETITE Instead, European banks stagger on, cutting costs to the bone while searching for growth. “In the current overwhelmingly challenging environment for European banks, the prospect of consolidation is undoubtedly being considered but it still ranks behind other items on the boardroom’s agenda,” said Stefanos Papapanagiotou, head of FIG for EMEA at UBS. And with banks still focused on cutting costs “uncertainty pushes decision-makers to be more introverted,” he said. Certainly, the current crop of banking CEOs, having emerged from the aftermath of the financial crisis, do not seem to have the risk appetite to pursue banking mergers, especially given the legacy of previous failed crossborder banking acquisitions, such as Royal Bank of Scotland’s ill-advised purchase of ABN AMRO in 2007, a deal from which RBS never recovered. Such failures remain burned in CEOs’ collective consciousness. “Bank executives [remember] the painful experiences of previously pursued large-scale, cross-border mergers among European banks, adding to their overall cautious approach,” said P