In European bond markets it’s almost time to put up or shut up. As Emu draws on apace, there’s increasing confidence about the emergence of a European bulge bracket. The US experience suggests it’s best to be part of that bracket on day one – it will get harder and harder to barge your way in later.
For those banks that have been throwing money at the bond business, it will soon be time to assess whether their investments have paid off. “At a senior level I get the impression that a lot of people are saying this is the year. If we don’t get it right we will have to re-evaluate,” says a senior European banker.
But it seems that secondary market bond trading no longer occupies the privileged position it once did. As Robert Morrice, managing director and co-head of fixed income at Barclays Capital, observes: “Origination, origination, origination has been the mantra and will continue to be so.”
Trading now tends to slipstream new-issue business – gone are the days when a house could run an active trading business without the accompanying primary market share. Paul Hearn, head of European capital markets at JP Morgan, sees this as a logical development. “The more deals you lead in the primary market, the better handle you have on what investors are up to, and on which investors own which issues,” he says.
The co-dependence of the two business areas marks today’s market off from the Eurobond business that grew up in the 1980s. “The leverage you gain from primary on secondary business is one of the biggest sea changes of the nineties,” suggests Shaun Wyles, head of Eurobond trading at Paribas.
But some see signs of redress, with the balance swinging back towards secondary trading. “Some borrowers are growing a little uncomfortable about the investment being made on the secondary side,” says Morrice at Barclays Capital. “There is a suggestion that there is not as much liquidity as there should be.”
Liquidity is not something traders can conjure out of thin air, and an apparent lack of it does not necessarily reveal a shortcoming on the part of intermediaries. “[Lack of liquidity] is not a concern that they [borrowers] should have,” argues Wyles. “If it is becoming the case, it is because of the clients themselves.” He points out that the switching in and out of bonds that characterized the market during the early 1990s is no longer present. Belgian, French and Dutch funds have become buy-and-hold investors with the result that liquidity has been drained from some areas of the market.
This is certainly true in credit markets, says Jan Pethick, co-head of global credit products at Dresdner Kleinwort Benson: “Institutions do not engage in secondary credit trading as they used to. They tend to stick to credit bets unless there is some flux in the market.”
But when such flux occurs, banks without a strong trading ability to back up their primary business will suffer, says Neil Neilinger, managing director, head of credit trading in Europe at Deutsche Morgan Grenfell. “Secondary trading has not lost its importance in any way, shape or form,” he says. “If you don’t have the capability when spreads start widening then you’ll find yourself out of the new-issue business.”
If Eurobond traders are worried about their lower profile, the reverse is true of their counterparts in government bond markets. They are wetting their lips at the prospect of an end to the fragmented European market and what they see as an increasingly important role for them within capital markets. “The development of a large, integrated and liquid government bond market is a precondition of a true corporate bond market developing,” argues Zoeb Sachee, managing director and head of European government bond trading at Salomon Smith Barney. There are, however, some obstacles, at least in the near term. Foremost is the likely battle over which country should be treated as the benchmark. “It is in a country’s interest to have some of its issues seen as benchmarks,” says Sachee. “That gives them an incentive to beat the next guy in line, and prevents them sitting down together to structure the market.”
Like many other houses, Salomon has restructured its government trading operations in the last year, with all European countries except Italy being traded out of London. Deutsche Bank has chosen Frankfurt as the centre of its euro-zone operations with satellites in Milan, Madrid and Paris, and other European governments being traded out of London. It is also positioning its government trading business closer to derivatives, with Saman Majd as global head of both groups.
Like its rivals, Paribas has centralized government trading, with London being the focus of operations, except for French and Italian business. There has also been a change in emphasis: “We’ve focused on achieving a higher turnover of trades,” says Robert Hawley, head of government bond trading. “We’ve brought in Bernie Ward in London to run market-making, and we’re doing a lot more customer business. We take the view that this is what drives the market and allows us to position ourselves to make money.”
At the top of the Eurobond traders’ poll there has been some jockeying for position but little major change, perhaps indicating that at least some of the members of the coming bulge bracket have already been decided – SBC (carrying UBS) and Deutsche Bank being first through the door.
The significant changes come further down, and it is the battle for the middle ground that is shaping up to be most bloody. Two banks that can be pleased with their performance during what can euphemistically be called “a restructuring year” are Barclays Capital and Dresdner Kleinwort Benson.
Barclays’ sale of its M&A and equity business appears to have had no impact on its bond-trading performance. “We’re consistently told that there is room for another European house at the top,” says Morrice.
Like other firms, Barclays Capital is working to get more out of fewer, but better, traders. “You need experience,” says Morrice. “You need to know you’re getting what you’re paying for.” Morrice lured Brendan Tynan, a 14-year Morgan Stanley veteran, to Barclays to oversee all sovereign risk Eurobond trading, and Guido Greim, also from Morgan Stanley, to head euro block trading.
But rivals call into question Barclays’ ability to move beyond its traditional sterling franchise. “Sterling and floaters are good, but where is the money in that?” asks a competitor.
According to Kensey Green, joint head of global syndicate at Commerzbank in London, that is exactly where the money may be when the single currency kicks off in 1999. “We have a strong belief that dollars and sterling will be of increasing interest to European investors. You have to be in the dollar market next year. Even though it was 30% of our business last year we have still made an effort to increase our profile there,” he says.
Commerzbank is another of those inhabiting the no-man’s land between the global and niche players. But Green says that it has a clear idea of where it wants to be: a European bank first and foremost. “In terms of ranking, that requires being in the 10 to 15 bracket or close to it,” he says.
Dresdner Bank could be seen as being in a similar position to its German rivals, although in terms of league table performance it appears to be one step ahead. “We have undergone a significant change in terms of both personnel and culture, introducing a more international feel to our business,” says Pethick. “Most of the additions we’ve made have been neither typical Dresdner nor Kleinwort Benson types.”
But Pethick is not about to get carried away by the bank’s improved performance in the poll. “We are comfortable that we have not lost ground in a difficult year,” he says. “We’re giving ourselves a B-plus. At least we’re back in the pack and not slipping behind.”
While European banks fight over the middle ground, US banks still tend to dominate the higher territory. The state of play in this transatlantic contest can perhaps be gleaned from Europe’s nascent asset-backed, high-yield markets, the latter included in our poll for the first time. In both areas, US banks are trying to leverage off years of experience in their domestic market, while European banks grow their operations from scratch.
Asset-backed securities is an area where continental banks are investing heavily, and despite the continued dominance of US borrowers the market remains open. “No-one, as yet, has got huge market share, nor is it extremely profitable as a fixed-income business,” says Alexander Justhan, head of asset-backed bonds at JP Morgan.
It is not a market renowned for liquidity, although Justhan says that this is improving. He ascribes JP Morgan’s improved performance in the poll to an increased emphasis on the secondary market. Its most liquid deal to date has been the $900 million, mortgage-backed issue for Puma Two. “We’ve seen regular and consistent flow just because everyone can trade it,” says Justhan. He suggests that secondary trading remains an area neglected by European banks.
Of these, Deutsche Bank has been building a large team although without having done much quality business to date. In contrast, UBS, which once led the Europeans, has fallen apart in the wake of the merger with SBC. There are rumours that its team may be resurfacing at CIBC.
If Europeans are making some tentative headway in the asset-backed market, they appear to be way behind in high yield. But appearances can be deceptive, suggests Pethick at Dresdner Kleinwort Benson.
“US banks are very concerned about their franchise in high yield, and the result is that they tend to rubbish European banks’ ability to run high-yield deals,” he says. “But US banks, like Europeans, are still in a building phase for solid high-yield placement in Europe. They only talk great distribution in Europe. Most of the paper still ends up with North American buyers.”
Neilinger at Deutsche Bank agrees. “If the question is: are Europeans lagging a bit? Then the answer is yes. But the US banks should be running because they just don’t have the relationships that continental banks have.”
Amid all the euro-induced excitement the Asian crisis seems just a distant memory. There may have been some reassessment of risk management but traders report no real change in the way they’re conducting business. As Neilinger says: “Markets are once again quite frothy in terms of spreads.”
That is no doubt acting as an incentive for investment banks still hoping to make the grade in Eurobonds, but as one syndicate head observes: “If you’re not making money hand over fist now, then you shouldn’t be around.” By next year the almost there houses may have turned into also-rans.
