A burgeoning new sub-asset class in the sovereign debt markets will set the tone for European debt markets in 2011 after a tumultuous 2010. And it is acronym rich: the European Financial Stability Mechanism (EFSM), a European Union funding vehicle, kicked off proceedings in early January when it raised 5 billion from the sale of five-year bonds. The European Financial Stability Facility (EFSF) is set to follow with an inaugural 5 billion issue this month.
Amount the EFSF and EFSM hope to raise in 2011
Although the EFSM isnt a new issuer it has been selling debt for a few years to lend on to non-eurozone EU member states such as Hungary, Latvia and Romania it has been infrequent, with this years funding programme dwarfing its outstanding debt. Nonetheless, market participants have been paying more attention to the debut issue from the EFSF.
"A lot is riding on the EFSF, its a bit more challenging because its a new entity, and its overcollateralized to make sure its has a triple-A rating, so its a lot tougher to know how it will go," says Sean Taor, global head of public sector DCM and syndicate at RBC Capital Markets.
The EFSF will issue bonds with a five-year maturity on its debut and expects its second transaction will have a 10-year maturity, although it wont raise any longer-term debt because the average tenor of the Irish loans is only 7.5 years.
"The strategy is to issue a benchmark-size deal and then tap that from time to time," says Christophe Frankel, the EFSFs chief financial officer. "It is important to meet the demand at the right time." Frankel dismisses recent market speculation that the EFSF could use some of the funding to buy sovereign debt of Europes periphery, even if demand for the paper were strong.
"Buying euro sovereign debt is not part of the mission," Frankel tells Euromoney. "We have a clear view of what to expect for the first two quarters, and in theory its dependent on the market. In the meantime were mandated to fund Ireland and there is no possibility that we will prefund beyond the 17.7 billion we need for that."
The funding authority will issue in euros first and go to other markets, such as the US, only if such a broadening of the investor base is really needed. This is dependent on how much supply hits the market from other sovereigns and agencies.
Thats why the stakes are high, says Taor. "The EFSM and the EFSF are creating a new subsection of the market, and the early concern had been that this new supply might reprice the market in a bad way," he says. "The bottom line is that if it doesnt work, were back to square one."
"The strategy is to issue a benchmark-size deal and then tap that from time to time. It is important to meet the demand at the right time"
Investors have taken some time to understand the credit characteristics of the EFSF as an issuer. Its triple-A ratings are derived from its ability and willingness to honour claims on a timely basis, each bond will have an over-guarantee of 120% and an upfront cash reserve that is equal to the net present value of the margin of the EFSF loan and service fee. A cash buffer will also ensure a full triple-A cover of the liabilities. "The level of knowledge around that deal now is pretty high, probably higher than any other new issuer the market has ever seen," says RBCs Taor. "The EFSF spent a great deal of time explaining the structure, explaining the overcollateralization, the cash buffer, etc. I think this will fly."
The EFSM raised its five-year money at 12 basis points over the mid-swaps rate and Taor believes that the EFSF bonds wont be too far away from that level, as investors have got more comfortable with its characteristics. "Early indications had been for it to be 10bp plus wider than the EU, but I think demand is such, that it will come far closer and will be a blow-out transaction. Its got a lot more positives than people have been anticipating."
The deal was due to launch in the third week of January.
Also this issue:
Market leader: Tensions run high over sovereign debt haircuts
Against the tide: Its in the eurozones DNA
EU sovereign debt: Bondholders should bite restructuring bullet
Sovereign debt: Principles and practice