GERMANYA EUROMONEY SURVEY – June 1996DEUTSCHMARK EUROBONDSHistorical rootsIn the last few years the Deutschmark bond market has gained increasing importance as an attractive investment alternative to the US dollar bond market for many international investors. The Euro-Deutschmark bond market has steadily increased its market share over the years. The Deutschmark is now the second most important reserve currency. This process has not been only triggered by the secular trend of Deutschmark appreciation versus the major currencies but also due to a switch of the Bundesbank’s market regulation policy to an attitude which is much more investor-oriented than in earlier years. In the last 10 years, the Bundesbank has abolished many obstacles which had reduced the attractiveness of the Deutschmark-denominated Eurobond markets for foreign issuers and investors. In 1985 the Bundesbank allowed German-based subsidiaries of foreign banks to lead manage Eurodeutschmark bond issues and opened the market to more innovative debt instruments such as FRNs, zero-coupon and dual-currency bonds. Since 1989, the Bundesbank no longer requires lead managers to inform it ahead of a planned issue, paving the way for issues on a standby basis such as medium-term notes and commercial paper programmes. In 1992, the Bundesbank said it no longer requires Deutschmark bond issues to be governed by German law or to be listed on a German stock exchange. However, the lead manager of a Deutschmark issue must still be a bank domiciled in Germany. In the last 4 years (since the beginning of the 1992/93 bull market for Deutschmark bonds), the outstanding volume of the Deutschmark Eurobond market has surged and in fact nearly doubled. 1995 and 1996 has seen a very strong rise of the Deutschmark Eurobond market. Issuers Private and public banks have been the most active issuers in the Deutschmark Eurobond market in the last 15 months but sovereigns, supranational issuers, several European governments and other authorities are also important players in the market (see Table 1 and Chart 1). In comparison to those groups, international and private corporates play only a minor role in the Deutschmark Eurobond market. Non-German corporates tap the market when swap rates are attractive, but are reluctant to carry unhedged Deutschmark debt on their balance sheets due to the secular appreciation of the Deutschmark. In the early months of 1996 the market has seen long-term issues low-rated central government credits for the first time, namely the 10 and 15-year Eurobonds for the Republic of Argentina. Table 2 gives an overview on the top borrowers in the Euro-Dm bond market. Investors Traditionally, the Deutschmark Eurobond market has been a retail market but this situation has changed slightly in recent years. However, although no official statistics are available for this market segment, it is well known that retail investors in Germany, Switzerland and the Benelux countries still play an important role, mainly due to tax reasons. Instruments The range of debt instruments available in the Deutschmark sector is very large. Straight bonds are still the most widely used instrument in Eurobond financings, where fixed-rate issues have accounted for more than 50% of the market on a year-on-year basis. In the 1980s, bonds with warrants, either for equity or debt, made their appearance in the Deutschmark sector. At times, the issue volume in these instruments was very large, and recently the issuance of covered warrants without accompanying debt financing has replaced the traditional issuing method. Their share is currently around 30%. Though convertibles were also sometimes popular with the issuers and investors and substantial amounts of these instruments have been issued in the 1980s and early 1990s, their share has come down significantly. Floating-rate notes (FRNs) are capital market instruments with variable-rate coupons linked to money-market interest rates – most often Libor but increasingly Fibor. In 1994, there was a surge in the issuance of new Deutschmark FRNs, which were designed to satisfy investor needs. In 1995 and so far in 1996 their share is about 7 % (see also Chart 2). The introduction of money market funds in Germany in August 1994 created further demand for Deutschmarks and for Deutschmark FRN issues. FRNs can also be combined with a floor or a cap, providing the investor with some downside protection against sharp falls in money market rates (floor) or providing the investor with a higher spread over the base rate; thus compensating the investor for giving up the opportunity of strongly rising rates (cap). Apart from the usual syndicated bond offerings, MTN or CP programmes provide the issuer with more flexibility. Under an existing credit line, the issuer has the flexibility to draw new lines under an existing programme as and when necessary. Global bonds are a relatively new innovation to the Euro-Deutschmark bond market, with the first Deutschmark global bond launched by the World Bank under the lead management of Deutsche Bank and Salomon Brothers in 1993. Through intensive marketing with both foreign and domestic investors, a global bond issue helps raise the issuer’s profile. And by concentrating on a few big issues and active market-making, funding costs can be reduced. Underwriting and Syndication A few years ago it was customary in the Deutschmark bond market to launch an issue with large syndicates consisting of managing and sub-underwriting banks (selling groups) involving smaller banks with only limited regional placement capabilities. Increasing competition, declining management fees and the issuer’s desire to maintain an active market in an issue for a sustained period of time have considerably changed the traditional practice of bond issuance. Today, Eurobond issues are launched by small groups of banks, meeting certain requirements. The most important requirement is a strong international salesforce to ensure the necessary international placement capability. A lead manager should also have the ability to underwrite and successfully manage even large issues, a fact that is often demonstrated by a high ranking in the international league tables. For Deutschmark Euro and global bonds the corresponding figures are shown in Tabl e 3 with DMG as the leading bookrunner – benefiting from its triple-A rating and its widely recognized competence in Deutschmark instruments. A lead manager should also play a prominent role in secondary market activities -otherwise the issue could attract only a limited number of investors due to the perceived lack of liquidity. The ability to generate attractive swaps, often linked to the lead manager’s international credit rating, is also gaining importance. Pricing Increasing market volatility and intensive competition have lead the issuing banks and issuers to abandon the traditional syndication methods in favour of the so-called fixed price, re-offer system. The fixed price, re-offer system was designed to return profitability and syndicate discipline to the market, where cut-throat competition had become the norm. Under this system the lead manager would normally indicate the price as a spread relative to a certain benchmark. For a few hours the issuing banks would then offer their clients the issue at the fixed price. Once a sufficient amount of the issue has been placed the lead manager announces the final terms of the issue and declares the issue to be ‘free-to-trade’. Only then should normal primary market trading start. This procedure should ”theoretically’ prevent the issuing banks from underbidding each other by offering early discounts from the offer price, driving the price down and eroding management fees. Trading Generally issue sizes in the Eurobond market are smaller than in the domestic government bond market. Hence, an issue tends to become illiquid sooner. Therefore, it is important for the issuer as well as for the investor to find lead managers committed to making a market in the issue for a sustained time period. As an issue becomes more firmly placed with retail investors, liquidity generally decreases. For big issue sizes – Dm1bn or more – banks usually make an active market for one or two years. For liquid issues, the usual bid/offer spread is Dm0.05. Illiquid issues are quoted at a bid/offer spread of Dm0.25 or Dm0.50. For liquid issues the average trade ticket at Deutsche Morgan Grenfell would be between Dm10m-Dm25m, while the average trade ticket for less liquid issues is around Dm250,000-Dm1m. Clearing and form of bonds As a rule Euro-Deutschmark bonds are issued in bearer form, although some registered bonds exist. A certain percentage of bearer bonds are still physically deliverable, but the trend is toward book entry only. Retail clients, in particular, still have a pronounced preference for definitive bonds, and consequently issues targeted at retail clients still provide for definitive bonds. Bearer bonds can be settled via the Deutscher Kassenverein, Euroclear or Cedel. For Deutschmark global bonds settlement via DTC is also possible. Table 1: Issuers of Dm Eurobonds
Chart 2: Gross sales of Dm Eurobonds Source: Datasream Table 2: Top borrowers in the Eurobond market
Source: Datasream Table 3: Dm Euro and global bookrunners 1995
Deutsche Morgan Grenfell |
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