Sylvain de Forges, who created European inflation-linked government bonds during his time as chief executive of Agence France Trésor, is trying to do the same for the corporate market. The question now is, will other non-government borrowers follow suit?
Veolia Environnement, where de Forges is now director of financial operations, opened the books on its €600 million 10-year bond indexed to European inflation on June 6 and closed them two days later. The bond yields 1.79% plus European inflation, 65 basis points over the 10-year French treasury bond.
Of all corporates, utilities are natural inflation issuers. Globally, for example, wages account for about 40% of Veolia Environnement's charges. Its remuneration and the price revision clauses in its contracts reflect this indirect link to general price evolution. So it makes sense for the company to have part of its debt – about 4% after this deal, although the eventual proportion has yet to be decided – directly indexed to inflation.
The deal attracted final orders of €670 million, enough to increase it from €500 million. And, as de Forges points out, these orders were not speculative. They came from a limited number of investors that were happy with the credit, with the price, and with how they treat corporate linkers. Some have a credit portfolio and see this bond as credit plus inflation protection. Others will put it in a linker portfolio where it represents inflation plus credit spread.
But can the corporate linker market in Europe develop? Last month, the Euro Debt Market Association issued a report on eurozone inflation-linked products. It called the lack of corporate issuers "puzzling". Tight spreads and flat credit and breakeven curves, as seen in 2004, should have attracted credit investors to corporate index-linked bonds last year. The report said accounting issues were holding the market back, and it was not clear how an issuer's improved asset-liability management should be reflected in its rating.
More fundamental is the question of investor demand. While it was good to see Veolia Environnement get the market started, it is debatable whether June was the best time for a Baa1/BBB credit to come to the market. The company found enough demand to make a mid-sized deal feasible. But with breakevens in the eurozone at their lowest levels for a year, it makes little sense for investors that predict low growth and low inflation to buy linkers today.
"Given the rally in nominal markets,inflation bonds have not been recently the asset of choice," says Mark Parry, director of fixed income at Schroder Investment Management. "When breakevens narrow, conventional bonds outperform linkers." And while investors keep buying conventional bonds, breakevens could keep narrowing. "One question today is whether breakevens accurately reflect inflation expectations, or do they reflect the overwhelming demand for nominal interest rate products, which has created a large momentum trade which breakevens themselves lag," says Parry.
Investors don't look keen on linkers. They left the €1 billion 30-year BTPei auction on June 24 uncovered, with Italy selling around €845 million of the deal. Even in the more developed sterling market, demand has been limited. United Utilities issued £50 million ($91 million) in 30-year index-linked bonds back in 2002. "We would consider another such issue if we felt the price was right," says group treasurer Tom Fallon. "But there has been little investor appetite for such issues."
Another UK utility, Anglian Water, has swapped inflation-linked bonds back into fixed-rate in the past, suggesting a paucity of buyers.
And a lot of utilities are wrapped. Investors have to take a view on the quality of the monoline. This means forgoing the advantages they enjoy if they employ large teams of in-house credit analysts. They also end up hitting concentration limits on the insurer.
Add to this a general bearishness on credit, and a liquidity premium, and it is hard to see how the eurozone corporate linker market can grow significantly this year.