The UK’s $3 billion, five-year US dollar Eurobond issue showed what European sovereigns can learn from the UK and vice-versa when it comes to foreign-currency borrowing.
Announced on June 23, the UK deal was notable for its rarity, being the sovereign’s first dollar issue for seven years; its pricing, beating the cost of domestic funding by around 10 basis points and saving the UK taxpayer around £8 million; and the level of investor appetite. The deal was also outstanding for its pricing through the dollar curve, and for the speed of book building.
Citigroup, Deutsche Bank, Goldman Sachs and Morgan Stanley were lead managers and joint bookrunners for the issue.
The bottom line is that dollar funding was cheaper than funding in sterling through gilts at the end of June. So why aren’t all European sovereigns doing dollar deals?
Well, the UK deal was for a specific purpose. “The objective was the ongoing financing of the Bank of England’s asset liability management of foreign exchange reserves,” says Paul Tucker, who runs the bank’s foreign exchange market operations, including the UK’s foreign currency reserves. “So this was quite a different exercise from financing government borrowing. The gilt auction programme can easily deal with the scale of funding that the government needs. The government doesn’t need to diversify its sources of financing in order to cover its deficit.”
Of the European sovereigns, France and Germany are closest to the UK in market profile, but because they are members of the single currency the European Central Bank manages their foreign currency reserves.
“The UK did a service to other high-grade issuers because it highlighted the attractiveness of AAA diversification in the dollar markets. But the deal also underscores the uniqueness of the UK,” says Philip Brown, managing director and head of sovereign debt issuance at Citigroup’s corporate and investment bank. “It’s not the kind of deal that many other sovereigns could repeat.”
In France, which removed the legal barrier to issuing in foreign currency last year, Agency France Trésor is working with its primary dealers to create the necessary logistical support in IT, back-office skills and accounting to enable it to issue in dollars.
Germany’s Finanzagentur’s approach to the capital markets is increasingly commercial. But it’s ambitious to expect it to issue in non-euro currencies.
“The guys in the Finance Agency would like to do a dollar deal, but they can’t get political approval,” says a primary dealer. “Germany is core Europe, and it worries that a dollar deal would damage the integrity of the euro.”
Even those who doubt that political support for the euro constrains France and Germany acknowledge anxieties about the signal a non-domestic issue would send to investors. “It’s not seen as ‘unpatriotic’ to borrow in a currency other than euros. The euro is well established as one of the world’s three main currencies,” says Citigroup’s Brown. “But there is a great concern about the message signalled to the markets by such a move from those who have never issued in foreign currency.”
If Germany and France could get better deals with a UK-style approach to borrowing, the UK could learn from those smaller European countries that issue in dollars more often, either systematically, as in the case of Italy, or more opportunistically as Austria, Spain, Sweden and others do.
“If you accept that the UK can always borrow close to flat to US treasuries, then because dollar swap spreads are always wider than sterling swap spreads and euro swap spreads, it will always be cheaper to borrow in dollars,” says a fixed-income specialist. Other sovereigns tolerate swap exposure on counterparties to achieve cheaper funding. The Bank of England won’t say whether it swapped its June deal.
“The UK’s US dollar deal benefited tremendously from a scarcity value,” says James Garvey, head of sovereigns and supranationals at Goldman Sachs. “The power of the underlying brand is strong and the UK could issue more regularly and still maintain this position when compared to its peers.”
In the future, the changing shape of international investment in euro issues could reduce the need to tap the US investor base. Three years ago, Asian investors might have bought at most 10% of a euro deal. Now it can be up to 30% depending on maturity.
“Central Banks in the Middle East and South-East Asia are increasing the proportion of their reserves held in euros. If the investor base continues to diversify like that, you might not have to go to the dollar markets,” says Bill Northfield, co-head of the frequent borrowers group at Deutsche Bank.
