The success of the UK’s Debt Management Office’s pandemic-induced fundraising quashed questions over its use of syndications
On March 5, the UK DMO wrapped up its funding programme for fiscal year 2020 with a £500m sukuk offering, ending a record-breaking year with an innovative flourish that will set the tone for the next 12 months.
That is because in 2021 the DMO is set to make its debut as a green bond issuer, with two syndications expected in the coming months as it looks to raise a total of £15bn and establish a green curve.
The UK DMO hired HSBC and JP Morgan as structuring advisers and they will help it put together a green Gilt framework by the end of June. The green programme will form part of £296bn of overall Gilt issuance planned by the UK in the 2021/22 financial year that began on April 1.
But as well as greater funding diversification, 2021 will also see the UK return to more familiar territory as it radically reduces its overall issuance target and returns to issuing index-linked bonds, a tool that was missing from its financing repertoire in 2020 after the UK government instigated a review of the instrument.
Jamie Stirling, global head of debt capital markets SSA at BNP Paribas, said: “For the UK, this year will feel more like business as usual with the return of linkers and moderately sized transactions. We expect to see a similar number of syndications to 2020/21 but of smaller size.”
The DMO’s 2021/22 target comes on the heels the record £485.5bn it raised in an unprecedented year in which the Covid-19 pandemic resulted in a massive ramping up of its borrowing needs, which more than doubled compared with £220bn in 2019/20.
The debt office effectively tore up its funding plan programme for £156bn when the country was plunged into national lockdown, and UK Chancellor unveiled a package of emergency stimulus measures, including the Bank of England's Asset Purchase Facility.
“We needed to be pragmatic and had to design a Gilt remit from the bottom up, with a viable operations calendar in mind,” said Sir Robert Stheeman, DMO chief executive. That included starting to hold two auctions a day on some days of the week, an approach that has been maintained.
“From the point of view of the [Gilt-edged market-makers] and investors, we thought they would prefer to be quite focused in their activities for specific periods during the week while also having sufficient space in which to digest the supply," said Stheeman.
It also broke new ground in terms of tenors as funding requirements grew. Traditionally, it had preserved syndicated issuance for the long and ultra-long end of the curve, but in 2020 it targeted the medium sector of the curve with debut 10 and 15-year issues. The inaugural 10-year, which printed in May 2020, was £12bn in size, a record for the UK DMO.
The decision to print an inaugural 10-year via syndication attracted an order book of £82bn – the biggest for a DMO syndication – and also scrutiny from the UK Treasury Select Committee, which questioned whether it was selling bonds too cheaply at syndications given the huge amount of demand, and also whether the fees paid to syndicate banks were in the best interests of the UK taxpayer.
With the pandemic forcing a radical revamp of funding, syndications enable borrowers to take out greater size than an auction, as was the case with the new 10-year.
“We wanted to establish a major liquid benchmark quickly. We could have raised a typical size of £3bn in a medium auction but a syndication enabled us to raise multiple times that amount in a single operation," said Stheeman.
Also he stressed the order books should not just be judged on size alone. “The overall size of the order book does not give a complete picture of underlying demand. The quality of the order book is more important.”
Fee levels are based on the size of the offering, and with the UK DMO printing the biggest syndications in its history, it was unsurprising that fee levels were elevated. Banks earned £18m on the £12bn 10-year, a record high that was matched in June 2020 when it printed a £9bn 30-year.
With syndications there is a trade-off between minimising the cost to the taxpayer and accepting a price that is attractive enough to encourage future investor participation. In a letter to the Treasury Committee, Stheeman explained the importance of syndications as a way of rewarding primary dealers for their support for the overall Gilt programme.
“Participation in the syndication programme (including fees paid) represents an important factor for primary dealers in their decision to support the programme more generally and to invest in their Gilt franchises,” he wrote.
With a vast amount of funding to be done very quickly to support the UK economy, syndications were seen as the right approach.
Asif Sherani, managing director, head of DCM Syndicate EMEA at HSBC, said: “DMOs all around the world have called on syndications as an effective channel to fund. When you want to get long duration and large volumes away, syndications have proved to be a highly efficient method of execution.”
Yet despite the scrutiny they attracted, syndications accounted for 12% of total UK DMO supply in 2021, down from 20% in 2019.
With the Covid situation still evolving and uncertainty around vaccines and variants, DMOs will have to continue retain flexibility in their funding plans throughout 2021, although they are unlikely to need as much elbow room
“The biggest problem now is that we have increased debt by a huge amount, so the question is how to make it sustainable. Is it short-term? If so, let it run off in bills or let it run off in short-dated debt. But equally, that kind of size can’t just be something that runs off in one or two years because it’s going to take a long time for GDP growth to bounce back and to make this debt more sustainable,” said one SSA banker.
Instead, it is about extending the duration of that debt. “The DMOs did such a good job to keep a level head and address those issues during the crisis that we don’t have a huge burden this year. Equally, DMOs are continuing the same strategy – they are extending debt where possible, taking advantage of the low-rate environment,” the banker said.
The UK DMO traditionally prints more longer-dated paper than its European peers. And it will further cement that reputation in 2021/22, when £134.9bn of the UK’s total Gilt issuance is planned to be in long-dated paper, defined as having a maturity of more than 15 years,. That amounts to 28% of total planned issuance and is up on both 2018/19 and 2019/20.
The planned £296bn of overall issuance is down significantly on last year’s record supply but is still greater than the previous record (£227bn) set in 2009/10. The initially unallocated portion of issuance in 2021/22, which comprises £28bn, includes future planned green issuance of at least £15bn. The unallocated portion can be used to top up syndications, auction sizes and to schedule Gilt tenders.
Funding conditions are different from where they were in the teeth of the pandemic, with 10-year yields having rallied in all major markets since the start of the year.
The rally in yields enabled the government to print a long-awaited five year sukuk transaction on March 25 – only its second since its £200m debut in 2014. The Treasury had signalled its intention to re-enter the sukuk market in 2019 but the Covid pandemic led to a delay as the focus was on issuance of Gilts in record amounts. In addition, sukuk investors had reservations about participation in issuance when shorter-dated yields were negative.
The sukuk issuance was about more than simply getting a certain amount of funds through the door, Sherani said:
“We had other strategic objectives, such as value for money for the taxpayer, distribution to sukuk investors and having the UK Islamic investor base on board as well. Because we had flexibility in timing, we were able to achieve those objectives without being pressed to raise financing during the peaks of the Covid crisis."
The £500m July 2026 trade, which employed the commonly used al-ijara structure, priced flat to the existing Gilt curve, underlining the value to the taxpayer, against an order book of around £600m. While this was in contrast to the £2.5bn of demand that poured into the inaugural £200m offering nearly seven years ago, it pointed to the quality of the book – while momentum investors piled into the debut in expectation of attractive pricing, they were less inclined to do so a second time, when there was a comparable price benchmark.
“We took our time and found the right window. As soon as the books had over £500m of high-quality demand, we closed the transaction,” said Sherani. HSBC acted as structuring adviser, and joint lead manager along with CIMB Investment Bank, Dubai Islamic Bank, Emirates NBD Capital and Standard Chartered.
DMOs in other European countries have followed the UK’s penchant for longer-dated debt in 2021, and it is important to note that although spreads have rallied, funding costs remain substantially lower than they were before the pandemic.
“Despite the amount of government debt that has already been issued, order books remain very robust and there has been little push-back from investors. This reflects the strong ongoing global demand for rates assets,” said Stirling.
After an unprecedented year, bankers agree that DMOs in general and the UK in particular have passed the test of a global pandemic with flying colours.
“The job done by the UK DMO has been fantastic as is reflected by the fact we’re coming out of the crisis with no question marks over their response in terms of sizes and duration. The UK has done this while still innovating through its sukuk bond and planned green programme,” said Sherani.
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