Has the market in euro-denominated bonds been mostly hype?
Ayesha Shah, head of funding, European Bank for Reconstruction & Development: The only hype we see is in the name. There is no substantive difference between a euro-denominated and an Ecu deal. We issued an Ecu deal, with the same one-to-one redenomination clause as a euro-style deal, in July 1996. It’s a matter of semantics when “euro” became the term for deals with this clause, but probably the market judges it to be the beginning of 1997.
Mario Gonzalez, manager of financial resources, Telecom Argentina: This has been the first stage of the euro which has been used mostly by governments and supranationals to set benchmarks.
But we’ve also seen a certain appetite from investment banks to keep their position as leading underwriters in that market, which has meant that they will try and hurry you into the market. We don’t see that there is such a hurry. I think the urgency is being driven by investment bankers.
Adrian Coats, treasurer, Scottish Power: The idea has been half-heartedly pushed at us. But my perception has been that it’s been largely about hype and scene-setting.
Gareth Jones, chief executive, Abbey National Treasury Services: Capital markets are hyped places. There is a lot of reality about the euro.
Per Akerlind, treasurer, Svensk Eksport-kredit: It makes sense for governments to issue parallels and so on. But when it comes down to Ecu convertible into euro I don’t really see what is so fancy about it. If you believe there will be a one-for-one exchange then what’s the big deal? Nor do I see the big difference in issuing a French franc to euro deal. For me Emu domestic currencies and euro are all part of the same game.
Anders Osberg, treasurer, Volvo Finance Europe: To a certain degree it is about hype. But that is understandable. Investment banks are always looking for new ideas, always trying to lure investors. But the true market in euros will kick-off on the first of January 1999. Only then will we know what sort of benchmark issue we will really see under Emu.
Jerome Lienhard, corporate treasury manager, Toyota Motor Credit Corporation: I’m not as sceptical as a lot of people. The firms hyping themselves are probably those best positioned to be players in euros and so have a vested interest in getting things going.
Osberg: The banks need to come up with ideas, otherwise we won’t get a pre-market, and it is important to get a taste of the Emu market before it becomes reality. It is always hard for issuers to come up with ideas because they don’t really see what investors want.
Lienhard: The euro is going to be a big force, and in that sense it’s fairly easy to plan for it. But I’m not yet convinced that a true core investor following has yet developed for a corporate name issuing in euros. It will happen, it will have to happen, but actually seeing it occur is something we’re still waiting for. We’re trying to best evaluate when that group of investors will be willing to buy euros.
Martin Müller, head of international funding, Bankgesellschaft Berlin: One has to be aware of investors’ constraints. We’ve just had a French asset manager in the office. He pointed out that there are only a limited number of borrowers he follows, and with the advent of the euro the investor will have an even greater number to choose from. So if you’re not on that list of 20 or so names, it becomes increasingly difficult to get deals done.
How do you reach those investors. Is marketing the key?
Coats: We haven’t done a European roadshow, although going forward, some form of profile-raising event may be necessary. The equity side tends to be well hammered, but the poor old bond investors tend to miss out.
Jones: In the past it has been more of a name market, now it’s going to be more of a credit market. We hope that what we’ve done already is market our name rather than our pure credit story. We tend to perform somewhat better than our double-A rating.
Shah: The best way to prepare for Emu is to target issues carefully to the differing regional investor groups across Europe. Today, a plain-vanilla euro deal would not provide us with a cost of funds within our normal target levels.
Coats: We couldn’t see any value in it for us for the time being, especially as we are not a very big international borrower, nor do we have large European operations.
Akerlind: It is very much due to borrowing cost. If we issued a euro deal and swap spreads were where they are today, we would be funding at Libor plus.
Shah: And for us there’s no reason for levels to change. We’re talking about credit spread. Market forecasts are that the current after-swap sub-Libor levels will persist and the market does not expect a significant change for a triple-A supranational like us.
Anders, how did your French franc euro-fungible deal go?
Osberg: We issued it for flexibility reasons. We felt it was something we needed to do for our French investors. I don’t think that it really had a huge impact at the time, because it was a little bit too early. People were not really thinking about corporates borrowing in euros, it was all about supranationals. But corporates will need to follow the supranationals, or they will risk seeing spreads widen out considerably.
Lienhard: Quite frankly we’re yet to be convinced that there is a true, core investor base for a corporate issuer in euros.
Have banks been trying to convince you?
Lienhard: The argument has been that we’ve got to be ready. And we don’t disagree. A few months ago there were a couple of people pushing the idea, but it’s quietened down since. We have had a strong dialogue with intermediaries, and we’ve said: don’t come to us until you can convince us that there is a core buyer for us in euros.
Is the lack of swap market holding you back?
Lienhard: I think it’s safe to say that the swap market in euros doesn’t exist in any meaningful way enabling our targets to be met.
David Walker, director of liability management, General Motors Acceptance Corporation: For a long time you had to pay up significantly to make euro transactions a success. It was not something we were willing to do. We’ve never had a desire to be first into a certain market.
Mario, will a small Latin American borrower be able to issue in euros?
Gonzalez: Yes, we feel we can. The size of the issues we do is usually around $200 million, and for that size we don’t foresee any problem in going to the full euro market, especially as we’ve been very active in Italian lire over the last two years.
How will the euro affect your cost of funds?
Müller: The overall cost of funds is going to rise as previous arbitrage opportunities disappear. The euro market will develop along the lines of the US. Corporate borrowers will satisfy investors’ needs for higher yield and credit diversification and so higher rated issuers will find it more difficult to raise the same volume at attractive levels.
Lienhard: That will be a function of the euro, but also a function of fundamental changes in the way in which money is managed in Europe. Accumulation of retail money into professionally managed funds is already having an impact. Retail money is no longer managed at a branch level, and the euro has accelerated that process.
Walker: Yes, we’ve noticed the trend, and going forward it implies fewer arbitrage opportunities in the US, Aussie and Canadian dollars. But opportunities should still exist in newer currencies such as rand and drachma.
Müller: In order to still be acknowledged as a top quality borrower you need to offer something that occasional borrowers cannot live up to. This means maintaining a constructive dialogue and offering reliability as to the frequency of our issuance.
Lienhard: It is really a trade-off. In return we will get more transparency and the ability to have more liquid transactions.
Will the greater focus on credit after 1999 mean that you issue Eurobonds more frequently?
Gonzalez: The frequency of our borrowing is really related to funding needs.
Jones: If anything it will probably mean the reverse. The market may not be as attractive to us, especially if it becomes like the US market. We think it will probably be a half-way house, as it were.
Müller: The euro is in principle here already. There won’t be a complete and sudden change of investor behaviour between December 31 and January 1. I don’t see any liquidity problems, to the contrary, liquidity will increase.
The euro market will be dominated by superliquidity?
Walker: The connection between superliquidity and the euro is somewhat disjointed. Superliquidity was driven by lower borrowing activity from the US government, and by the fact that during the Asian crisis liquidity became everything to investors. So it’s not necessarily linked to the euro.
Müller: Yes, issues will continue to get larger, but that doesn’t mean that you should have one deal a year rather than coming to the market more frequently.
Lienhard: Even at the beginning of the year my reaction to superliquidity, and this may sound nostalgic, was that it was unfortunate that there was such an emphasis being placed on it. Because for very high quality, museum-piece corporate names there is no way that they’ll need such a level of funding. So if the market is moving more towards superliquidity, it excludes by definition some of the best names in the world.
Walker: I’m not sure that there’s always going to be a huge desire for superliquid issues.
Lienhard: It’s certainly far from clear that these super liquid deals are universally successful. Some have not traded well just on the fact of being superliquid, which is what the market was preaching at the start of the year. The most important thing remains getting the timing right. And if you’ve “only” got $7 billion to borrow each year, then each deal counts more.
Pity those with only $700 million to borrow.
Lienhard: Yes, it’s really tough. But these trends tend to swing like a pendulum, and I think it might be swinging back towards smaller size issues.
Walker: Other currencies will continue to offer niche opportunities, and as a market in euros develops we will see euro200 million ($222 million) issues as well as euro1 billion issues.
Osberg: Diversity will be key in the future. It’s not the case that we will have to depend on the euro. For instance, we have always got a lot of good funding from the Nordic region. While we can’t rely on that continuing in the future, we don’t want to disqualify Swedish kronor from our future plans, it could prove to be good diversity play.
Without currency diversity in Europe, will other markets become more attractive?
Akerlind: We’re definitely looking at other sectors, and putting a lot of effort into emerging markets. I think that there will be a lot of opportunities outside Emu.
Lienhard: We will look for opportunities needed to offset what we’re losing in funding cost advantage. I don’t think investors will automatically move to credit orientation. Until now they’ve always bought foreign currency for yield advantage – they won’t become credit analysts overnight.
Akerlind: I believe Swedish kronor will be important and a good diversification currency. With all the fuss over the euro, investors may not be paying much attention to diversification plays today, but they will in the future.
Osberg: If you think back a couple of months there was no one talking about Greek drachma. But now the market is unable to supply enough paper to meet the demand. We will see a similar process in other currencies. But structures will also provide investors with opportunities for more yield.
Will there be more complex structures?
Osberg: We do get a sense that competency has improved a lot of late. But that doesn’t mean that you necessarily get an absolutely fair price for a deal. The absolute fair value of a structure may be Libor minus 40 but there will be two people in the market who will do it for Libor minus 20. So one aspect is the evaluation you make, and the other is what you can get in the market.
Are you worried about overcrowding in the euro market, especially in early 1999?
Shah: No we are not in the least bit worried, nor will we be holding our breath hoping to be the first issuer at midnight plus five seconds on Monday January 4 1999.
Gonzalez: We’re not worried. If we were successful in the lira market we can be successful in the bigger euro market, especially as that market will be driven more by credit than by coupon size.
Walker: You will need to be flexible and quick to the market. But those borrowers who spend time with investors, laying out their strategy, will benefit.
Akerlind: It will be crowded as it always is at the beginning of a year. And if so, you have to come to the market at the right spread to the other issuers that you are normally compared with. But in that situation we don’t want to be forced into the market. And I don’t think you have to issue a big benchmark within the first three months.
Lienhard: Overcrowding is already happening in the Eurodollar market, and it will in euros. In Eurodollars, every time a window of opportunity opens half a dozen to 10 deals immediately hit the window. Half are a success, and you don’t see the other two or three that are crowded out altogether. The problem is that you want to be the first, but you don’t want to end up hitting the window before it opens.
You’re not sounding very positive.
Lienhard: On the contrary. I think that there will be tremendous opportunities for a borrower like us. Despite all the talk of a high-yield market in Europe, it remains some way off. There is an opportunity for ourselves, and a handful of others, to set the standard for corporate issues in euros. I can’t say we’ve got the recipe for that at the moment, but we want to develop it in the not-too-distant future.
Is that a position of advantage for US corporates?
Lienhard: I’m not sure quite how real Americans think Emu is. Being aware of it is one thing, putting in place an issuing strategy that enables you to be a standard is another, and requires detailed understanding of what’s going on. Americans can be pretty inward looking. They don’t really care about exchange rates and issuance is still dominated by dollars.
How will you select a bank to lead a euro-denominated issue?
Walker: With every transaction it’s a very difficult call. There are always several banks capable of executing the transaction. For our euro floater we had to ask: is it more of a euro deal than a floating rate note? Is the investor base totally different for the two? In the end we selected two global banks with complementary distribution strengths as the issue was as much a floater as it was a euro.
René Karsenti, director-general of finance, European Investment Bank: I think you may see more and more of a core group emerging, banks that play the role of market makers and specialists.
Osberg: With international markets the flow of capital will be even more intense than it is at the moment. Already we see that yankee issues have a tendency to come back to Europe. A new name will go to the yankee market and be well received. But after a year 30% of the issue may find its way back to Europe. Issuers need to watch this kind of thing, and accept that it will happen. It is safer to rely on a counterparty’s global presence, because then you can have a dialogue and know what’s happening.
Lienhard: It’s an interesting question. For us, initially at least, we will try and have respect for tradition. We would select a European bank to lead an issue, and a number of US banks have got mad when I’ve told them so. But I believe in development-sponsorship. This is going to be a European currency, and the core investors are going to be fundamentally nearer to European financial institutions. So initially I would lean towards those firms who have a major constituency in euros.
Jones: In our first euro denominated bond we used a joint banking team, Goldman Sachs and Paribas. Paribas was good at sniffing out the opportunities and Goldman had the muscularity.
Do you expect banks to provide pan-European distribution?
Karsenti: It depends. There are a number of large banks that have pan-European distribution at an institutional level, but not in retail markets. Only a few banks have a pan-European network at that level. That is where strategic alliances may have power, and is why banks with specialist geographical distribution will still be important.
Shah: Until a buyer of euros can invest without caring which listing exchange or tax regime the issuer or he himself falls under, then the idea of true pan-European distribution won’t exist. We don’t have a homogenous market in any way, and until the structural barriers are removed we won’t have pan-European distribution. Banks are probably saying it more out of hope than anything.
Gonzalez: We are driven by the demand for our paper in different markets. We always try to broaden our investor base, but we have to look at where the demand for our paper is coming from. It’s not so straightforward to always find new investors.
So will the same banks remain on top?
Müller: I know various banks that have a strong distribution capability, and those that have been able to place paper in France, Italy, Germany and the UK before now will obviously qualify. When you’re talking about pan-European distribution it is obviously important to have distribution in Portugal and other places, but only in relation to the size of the market. You’re not going to suddenly be placing a euro500 million deal solely in Portugal.
Osberg: But you have to be flexible. It depends on the angle presented by the bank. Smaller companies may want their distribution to be widespread in Europe. But if a Belgian bank came to me and said they wanted to target 75% of the issue at Belgian investors, then I would listen to them. The logic is changing. Instead of saying that there is a swap window in French francs or Belgian francs, it may be about targeting particular types of issues at investors in certain countries. The differences won’t disappear with a single currency: different investors will still have different demands.
Lienhard: European distribution remains very fragmented. It may be where the opportunity exists to differentiate yourself as an issuer: putting together a syndicate that really does get bonds distributed across Europe. That may take three or four issues, or it may come with issue one.
Do European banks have stronger distribution capabilities than US intermediaries?
Lienhard: The answer is yes. We like to combine a US bank’s risk management, underwriting and trading ability, with the true European distribution of a European house.
Karsenti: It is a unique chance for the Europeans. They are sitting on a distribution base that is on paper equal to what the US banks have in America. You can’t easily build distribution to small, retail investors.
Walker: I don’t believe that a euro trade reaches a totally new investor base. They are primarily the same investors who bought other bonds, but are simply opening up their portfolios to euros.
Are you concerned about the impact of euro-redenomination on your outstanding issues?
Akerlind: Why should I be? We will keep our bonds as they are. In 2002 local currencies will cease to exist, and until then there will be a relation between domestic currencies and the euro.
But won’t failure to redenominate damage liquidity?
Akerlind: Maybe to some extent, but compared to the big transactions we have that problem already, depending on whether a bond is held by institutions or retail investors.
Gonzalez: There are two straightforward situations. If your issue has an automatic redenomination clause at the investors’ option, as our latest issue had, then it is of no concern to us, because it is an option we have given investors. If there is no such clause then there is a set of rules for monetary union that we will abide by. In that case, investors will have known that was the case when they bought the issue.
Will the European bond market develop along the same lines as the US market, or will there be important differences?
Shah: No, not unless a true euro Eurobond market develops. While corporate and sovereign issuers can target their bonds to a faithful domestic audience by listing their bonds on the local stock exchange and writing the prospectus in their native language the euro market will be less homogenous than the US.
Osberg: A lot of people would like to make it simple, say that the European market will become just like the US. But we have a different culture of banking in Europe. For one thing, fee structure is different. In the US the top firms rule the market more intensively.
Walker: Transactions in the US are typically done using the pot system of allocation. In Europe it’s still driven by the lead managers. We did a pot transaction earlier in the year to try and get the co-lead managers more involved. While the deal was a success, not everyone received the concept warmly.
Will the pricing of lower-grade credits be inaccurate until the market reaches critical mass?
Akerlind: There is of course a risk, and the intermediaries have a big responsibility in pricing new corporate borrowers at the right spread and putting forth the right analysis to investors.
Lienhard: It takes time for investors to develop the credit research, and buying a high yield corporate is very different from buying a double-B rated sovereign. But many companies with strong single-A ratings or better have a lot of familiarity for investors, and when investors are looking for credit spread, that’s where the advantage will go.
Akerlind: But having a market that focuses on credit risk will also put more momentum behind the credit-derivatives market. Today there is simply a lack of reference bonds against which to price derivatives. The bid-offer on derivatives is very, very big. We could create a good portfolio of well diversified Scandinavian risk. In credit derivatives we have tried to get prices, but we find that banks in Scandinavia will put a much better price on a guarantee facility for the same credit risk than we can achieve in the credit derivatives market. The two just aren’t in line. So we’re not executing much.
Lienhard: One thing that the US market has is the existence of the US treasury as the benchmark issuer. Nothing really exists like that in Europe.
Karsenti: No, of course we won’t have a single government printing money. But all governments have announced that issuance features will be standardized. I think that we will have different benchmark issuers. The market will look at different time brackets and select the optimal issue. We want to be one of those benchmarks.
Lienhard: I think it’s more likely to be the euro swap curve that develops as the benchmark.
Karsenti: It’s one of the tools for ensuring the efficiency of the market, but I don’t think it will become the benchmark.
Lienhard: Maybe I’m arguing for what I hope happens. But if the swap curve is the benchmark, there will be the opportunity for high quality issuers to go through the benchmark, and well through it.
Shah: The swap curve is the benchmark used by the market anyway. It is not a risk free benchmark, but it is the trading benchmark. It’s a Libor curve and is therefore a curve for double A-ish rated banks. That means that triple-A rated borrowers should issue through it. It’s not a risk free curve but at least it’s a heterogeneous curve with specific maturities and therefore other credits can be priced off it.
Lienhard: Just as important an issue is the fact that there is no Securities and Exchange Commission in Europe. In the US the SEC provides an enormous amount of homogeneity to all parts of the market. It fosters credit diversity because of the stringent reporting requirements for all issuers. That makes it extremely easy for investors to evaluate credit. If such a body doesn’t exist in the future then Europe will be a less transparent market than the US. The SEC plays a huge role in the US, and that hasn’t yet been addressed in Europe.
Karsenti: It’s an interesting point. And it’s true to say that supervision in Europe remains fragmented. But there has been progress, and I wouldn’t say that there is nothing at all in place. There will be a lot more coordination and harmonization. Obviously it won’t be as perfect as the US, but then the US is the oldest monetary union in the world.
Will you be building a liquid yield curve in euros?
Jones: We will have a yield curve automatically with the bonds that we have out there. But will they all trade reasonably well? The smaller deals will be ignored. Investors will concentrate on bigger issues.
Akerlind: We’ve tried to do it in Swedish kronor, but the problem is size. That’s still there with euros. Does it make sense if the Eurobonds on the curve are euro100-400 million, which is our normal size? Is that the yield curve that investors are after? The Kingdom of Sweden will have several billion euros outstanding in every maturity on the curve. That makes sense.
