Riding to the rescue:
Covid-19 was the single greatest contributing factor to record-breaking SSAR supply in 2020, causing significant revisions to the funding plans of many issuers, none more so than the European Union. The outbreak of the pandemic and subsequent response saw the supranational leap from second-tier issuer to bond market colossus, smashing demand records along the way. The EU is IFR’s SSAR Issuer of the Year.
After raising just €400m in 2019, the EU originally planned to issue only a further €800m of bonds in 2020. But after the Covid-19 pandemic struck, it was suddenly catapulted from being a second-tier issuer to potentially one of the biggest in the world as the EU became the Continent’s main financing vehicle to lead the economic fight.
Rather than create a new intergovernmental structure like the EFSF or ESM as it did in the wake of the financial crisis and concomitant eurozone debt crisis, the EU looked to tackle the financial damage wrought by the pandemic by directly raising funds itself.
That meant that, almost overnight, the EU had to transform its thinking from running a multi-million euro funding programme to a multi-billion one, to effectively build a new curve and get investors onside, and to consider the far-reaching consequences of its borrowing for the broader bond market.
And all this while the pandemic continued to rage and working from home became the norm.
“It was the best of times; it was the worst of times. The pressures were nothing like I’d experienced in my nearly 30 years at the Commission,” said Gert Jan Koopman, European Commission director-general for budget.
The EU had learnt its lessons from the two previous crises. The fiscal response to Covid-19 had to be big, bold and coordinated.
“It was obvious that the real risks were a divergence of the union and the resurgence of the sovereign debt crisis in the absence of a common coordinated response,” said Koopman. “And that got on the agenda of the member states very early on.”
Johannes Hahn, the commissioner for budget and administration, acknowledged that the pandemic struck close to home. “The coronavirus pandemic affected all of us profoundly at both a personal and professional level. It has also changed the way of policymaking, especially the way to respond to this unprecedented crisis,” he said.
Policymakers developed two big programmes, both with huge implications for capital markets.
First, an up to €100bn “Support to mitigate Unemployment Risks in an Emergency”, or SURE, programme to support the labour market was proposed on April 2. Then in July came the announcement of a €750bn “Next Generation EU” recovery fund.
“With SURE and Next Generation EU, the EU will become one of the largest bond issuers in Europe and in the world, at par with the big sovereigns,” said Hahn.
“These bonds can become a reference asset for international investors looking for a Triple A rated euro-denominated asset and by doing so, strengthen the euro capital markets.”
Not easy being green
The programmes will also ensure that the EU will not only become a dominant player in the bond market but also, more specifically, in the ESG sector. A new social bond framework was created for SURE, while the EU earmarked 30% of the recovery fund for climate protection.
Issuing a third of the recovery fund – around €225bn – as green bonds would make the EU the biggest issuer globally and transform that sector.
After the Next Generation fund was announced, excitement quickly grew as to when the EU would undertake its first issuance. Its plan was to fund the SURE programme first and only then tackle the recovery fund.
But that still meant the EU would have to issue regularly and in size. Luckily, the EU could leverage its existing structures and techniques deployed in previous financial crises.
“That’s what we did and that’s why we could move very quickly,” said Koopman.
Given the scale of issuance, generating interest in its funding plans was never a problem.
A clear sign of that was in the number of participants on the investor calls, with 500–600 attendees compared with 100 or so previously.
Despite this, the first transaction under SURE in mid-October was still a tense undertaking.
The stakes could not have been higher: a poorly received transaction would have been a huge setback. The deal simply could not fail.
Instead, reception for the €17bn deal, comprising €10bn of 10-year and €7bn 20-year social bonds, was remarkable and demand passed €233bn. That was easily the biggest order book for any public bond offering in history.
“We knew there was latent demand for something that is a very safe asset but priced a little bit more attractively than the Bund, but I think it is fair to say that we were all taken aback just by the scale of the reaction, which was incredibly positive,” said Koopman.
Some did raise questions about the pricing strategy after both notes tightened by about 10bp in the first couple of days of trading.
Carefully does it
One of the challenges for the banks on the deal was how to position the EU. The institution is traded as a supranational, akin to the EIB or ESM.
But in theory the EU represents the biggest economy in the world, an amalgamation of 27 member states. In that sense, it could be argued it should trade close to the big EU sovereigns, even though these weren’t quite the jointly and severally liable Eurobonds that arch Europhiles have long dreamt of.
Throw in this being the first deal under the new programmes plus the scale of funding to come and the EU trod a careful line.
“You have to remember where we came from,” said Niall Bohan, director for asset, debt and financial risk management in the European Commission’s budget department. “We didn’t know what lay ahead. We were ambitious in terms of what volume we wanted. On pricing, we were using our own curve and France as reference point and to get to as close as France as possible. We did a lot of intelligence work beforehand.”*
Bohan says the strategy paid off. As the EU returned with two additional heavily oversubscribed SURE outings in 2020, its standing in the market has changed.
“We’re now seen as a proto-sovereign and no longer as a traditional SSA,” said Bohan. The main reference point is now the Bund market, not OATs.
“We’ll look to be more aggressive on pricing. We’re learning on every level but now have a good head of steam.”
The two further deals the EU did last year under its SURE programme raised an additional €22.5bn. That took the total funding to €39.5bn and went a long way towards financing the €90.3bn of loans approved so far under the programme by the European Council to 18 member states.
Building a curve
Apart from the continued level of interest in the deals, the key point is how quickly the EU has built a curve with issuance at five, 15 and 30-year tenors to go with the 10 and 20-year notes on the first SURE transaction.
The ESG element, too, was a notable achievement, with about 63% of the first deal going to ESG-oriented investors. “That wouldn’t have been possible without the social angle. We have a product that is inherently ESG,” said Bohan.
For the commissioner, the ESG element ties in with the overall success of the start of the EU’s journey.
“There is obviously a high demand forbonds that guarantee sustainable investments,” said Hahn. “The size and quality of the demand was a vote of confidence in the European Union as an issuer and as an important global player on the financial markets.”
* Corrected to give the right title.
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