MTN debate: Coping with the crunch in private


Published on:

With the public markets all but closed, issuers have turned to private and structured products to fulfil their requirements. Those who have maintained the best relationships with their investors and dealers have proved best able to ride out the turmoil, printing deals at half their CDS levels or better. Infrequent borrowers and those who have taken cheap funding for granted are in for a shock.

Delegate biographies: Learn more about the panelists

Executive summary

• Liquidity has been surprisingly easily maintained by some issuers

• Private and structured products have been the best sources of funding

• Maintaining best relationships with investors and dealers is crucial in choppy markets

Nick Jacob, MTN editor, EuroWeek Can we start by looking in general terms at the main problems we’re facing? How have issuers in general reacted to the problem so far?

RS, SGCIB As dealers we wanted issuers to react as quickly as possible, because there was such a widening between secondary public market pricing and the targets for private placements. We’ve seen issuers who did adapt fairly quickly to the new situation: they realized that this is a new market environment but that they still need funding and they still need the structured MTN market to provide it. And we have seen that translating into their funding grids fairly quickly. At the other end of the spectrum we’ve seen issuers being a lot more opportunistic and waiting for a stabilization and a return to some sort of normality that never really happened. As a result we, as dealers, had to be a lot more choosy in terms of issuers, including issuers in the same rating categories, as some were still showing us pre-crisis levels while others had already shifted to much wider levels.

NJ, EuroWeek Jacques, at CBA you have changed your levels and you were fairly quick to do so.

JL, CBA Last year, yes. There was a slowdown in flow, but not particularly significant, probably not as much as other houses may have experienced, but nevertheless we’ve tried to stay ahead of the game and, to do that, we’ve felt it necessary to keep faith with our investors. Now they’re predominantly Asian – that’s probably why we’re still getting a flow – perhaps a little less sensitive to pricing, but nevertheless we were starting to see a fall-off in supply. There was an element of price discovery, particularly in November and December, because we didn’t really know what trades we were missing or, if we were missing them, why we were missing them. So there was a certain element of playing around with the numbers a bit, and then in December we changed our levels, and the reaction was very good, very positive, and that manifested itself in January with our busiest month ever in terms of number of trades.

NJ, EuroWeek And Andrea at UniCredit, was it a similar situation for you?

AL, UniCredit Yes. Being one of the largest banks in Europe, we have a large balance sheet to fund, so when we faced the new situation in August/September, we decided to move quickly, and we were one of the first Italian banks to adjust targets and to publish a grid which was substantially higher than the one for the previous six months. And the result was very good in terms of the volumes we were able to raise. We are continuing that strategy in 2008 and we have started putting a lot of focus on the MTN market because we cannot rely only on the expensive and extremely volatile public market. The effect of this change in strategy was that we attracted a lot of attention from new dealers and new investors and have established ourselves as a key MTN issuer whereas before we were more seen as an opportunistic player in the private placement and structured private placement business. We have made investments upgrading our front-office systems and we have recently reinforced our team.

NJ, EuroWeek How much are you raising now compared with before?

AL, UniCredit In the first two months of 2008 we have almost equalled our 2007 total in what overall is a shrinking market. So we have significantly increased our market share and so far we have done, I would say, more than a transaction per day, summing up to a total of €2 billion. The MTN market has really become a key instrument in ensuring effective diversification and a balanced funding mix for UniCredit

NJ, EuroWeek And Nathalie, how have things changed for you in terms of pricing, because you’re in a bit of a different position?

NM, CFF For us, there were three distinct phases of market development that we observed as a triple-A borrower. In the first semester of 2007, CFF issued a total volume of €12.5 billion, with €1.6 billion under private placement. If we compare this to the second semester after the beginning of the financial crisis, when CFF issued a volume of €11 billion with €2.6 billion under private placement, this demonstrates the strong quality and the recognition of our signature. The beginning of 2008 also looks to have similar trends for high demand on quality, with €2.4 billion during the first quarter.

As the leader in the French covered bond market, we can quickly adapt our funding strategy with more flexibility on our grid of funding and the capacity for investor restructuring. Liquidity has been there for us when we’ve accessed the market.

The €23.5 billion issued in 2007 and the total volume at the beginning of 2008 demonstrate the permanent flow of CFF issuance, especially in bad market conditions. Moreover, the new CFF German format offered to German investors met with very strong interest from insurance companies, with 22 trades and €548 million since last September.

NJ, EuroWeek And Wafi, Jacques talked about a process of price discovery, how have you gone about that process?

WS, Banesto For us there were two periods. The first period was the beginning of August until December. And the second period is January until now. We had executed a large portion of our funding in the first half of 2007 so, when the crisis started in late July and the beginning of August, and many issuers still needed large amounts of funding and thus had no choice but to adjust their levels to capture investors’ attention, we didn’t need to. We did not want to transmit the wrong message to the market that we were in need of cash. Investors were very credit-cautious and were examining issuers’ behaviour and we were well funded. We transmitted a message of calm to our investors and dealers. Nevertheless, towards the end of the year the spread difference between us and our peer group had become quite wide and we decided to enhance our levels slightly in order to be competitive, and to provide investors who demanded Banesto specifically with fair-value paper. This year, we’ve started extremely actively. Our January was nearly 60% up in comparison with last January. And as a double-A we are finding the market is pretty active for private placements and for structured products.

Price levels and liquidity

NJ, EuroWeek And how do you go about finding the right level?

WS, Banesto As a rule of thumb, structured levels are more stable than vanilla levels and are not very sensitive to CDS and secondary trading. They fluctuate within a certain range around vanilla pricing that depends on the issuers’ appetite for funding taking into account the complexity of trades of course. In normal market conditions structured levels have to be compared with vanilla but both vanilla and structured spreads have widened and it’s the vanilla that have gone out furthest.

NJ, EuroWeek Christoph, do you agree with that?

CC, HSH Nordbank In general, yes. We raised our levels fairly quickly and immediately circulated our adjusted euro and dollar funding grids to stay ahead of the curve. At the same time we were well funded as we refinanced the lion’s share of our refinancing for last year in the first half, including benchmark transactions in senior unsecured of €1.5 billion, lower tier II of €1.75 billion and two jumbo Pfandbrief transactions of €1 billion each.

Simon Brady, Euromoney I’m surprised to hear that liquidity has been so easily maintained given the news in general. Is there or is there not an interbank and more general liquidity squeeze?

AG, Commerzbank That depends on the borrower. This group are long-time users of these markets and they are flexible in terms of structure and pricing. But you have to remember the market is down by 50%. These borrowers have worked hard for the past few years and it’s paying off. Wafi mentioned private placement levels. It’s true, if you have to show the same level for structures as for vanilla, you might think, okay, let’s do vanilla only. But you can’t do vanilla at the levels he wants because the market is not there. If you try to do a three-year or four-year floater then you will find it hard to do at the levels these guys are showing, at least on the unsecured side. So structured is still open, while vanilla private placement is not closed but very difficult.

EM, Natixis If I may add something to Amaury, we have seen more business on the vanilla private placement side, but really private. For example, deals that are very tailored in terms of size and maturity and which are done outside the issuers’ standard funding grid. These deals offer both issuer and investors opportunities if they are prepared to be flexible. We used to do more than 80% of our business in structured products but since mid-last year, more than 50% of our issuance has been vanilla, all private placement, and in large size. This shows that investors, with no benchmark product to buy in the public market, will buy large, vanilla transactions in the private market as a replacement, but they do not want to add structure risk and credit risk to the liquidity risk they are taking with a private deal. Issuers who are unwilling to pay the price investors demand in the public markets, but who will pay in the private market, can still get deals done.

AG, Commerzbank Elsa is right. We’ve seen this increase in vanilla private placements, but the deals are different from what they used to be. They are all very short, or very long, or aimed at very specific investor bases. When Deutsche Bank comes with €4 billion, three years, vanilla, at plus 72, it scares everybody. Who wants to be an investor who buys a private placement from a double-A name at maybe plus 30 or 35, and the next day sees Deutsche is paying 72 in a public deal? So that means a segment of the market is dead, but there is still a lot of cash around and you can still do business. And for structures, the market is still very much there, maybe not in Europe, but in Asia, in the US, and some domestic markets.

NS, Baring AM Like Simon I was interested to hear that issuers have just adjusted their price levels and been able to access the market and maintain their market profile and that liquidity isn’t an issue. As an investor I get the impression that the liquidity problem is being faced more widely among second tier, tertiary tier banking institutions and among non-bank financial institutions, and that’s the kind of mechanism that gets the bad headlines and the news flow. So adjusting the target levels is an easy solution for a bank that has got constant access, a solid investor base and reliable repeat business, but it does scare the less regular issuers who might need this kind of financing.

JB, European Credit Management I too was amazed to hear about such easy access to liquidity in these markets when in the public markets it’s very hard to find a new issue to buy and it’s not easy to trade in the secondary markets. It seems to me that issuers here have changed tactics and are accessing small pockets of cash from people who know them well. On that basis there is certainly cash out there to be invested. I notice though that no one here has mentioned the kind of premiums they have had to pay!

SB, Euromoney On that point, are people going to the private markets because they don’t want to pay public market prices, or because they don’t want to be seen to pay them? And if pricing in the private markets is better by a long way then why should that be? Why should there be a 300bp difference for vanilla debt just on the basis of public/private? What does it say about investors?

RS, SGCIB There are two categories of issuers. Those who have historically been active in the structured MTN market, are now trying to maximize further the savings that this market can bring by either maximizing volumes through showing more flexibility (in terms of structures, minimum size, buyback, etc.) or by reducing the gap between their private placement levels and their potential public issue levels, or both. What is important to note is that the savings in absolute terms for each trade are much larger than before the crisis because whereas before the crisis active issuers could achieve 5bp to 10bp per year saving on a bullet trade, they can now, because the spreads are so wide in absolute terms, achieve a lot more. Now the second category of issuers is the one which has not been active so far and is seeing the above benefits in the structured MTN market and is therefore gearing up or has geared up to be able to print this type of trade. So in my view, the strategy is still very much, and perhaps even more, a strategy of lowering average funding cost. The number of trades done with very high discounts is in my view very limited and probably related to a specific investor taking a more aggressive view on a certain credit and/or trading on a product where the optional value is so high that the credit component is less of an issue.

EM, Natixis Issuers right now are not ready to be seen desperate for cash. That’s why they would rather do private placements, where they don’t pay the same levels as they would for public deals and there is no widespread communication of price. From the investors’ point of view, we see that they are keen to buy private placements at really good levels, considering that there is no public issuance. Investors are driving the market, and everybody is looking for confidential trades at nice spreads.

AG, Commerzbank At the moment, the right price is the price where you print and issuers are aware of it, at least most of them. CDS and secondary spreads are not as relevant as they used to be, especially for very volatile names. Borrowers look more and more at what their peers are doing, trying to assess what they have to show in order to print.

WS, Banesto The private market is currently a hot topic simply because the public market is closed. Access is not always guaranteed and spreads are very volatile. Investors may be sounded out two or three times before a deal is announced and still not have a clear price indication for new issues. Also, success is not always granted even at high spreads. Private placements are tailor-made for one or just a few investors. They are not always priced versus secondary market or CDS levels, which are theoretical in present market conditions. Instead they are priced based on the investors’ assessment and perception of the credit in question. There are no benchmark deals, no public deals, and issuers are forced to find alternative funding sources. On the other side, given the closure of public markets, private placements are one of the few options available for active investors. These forces balance out in pricing.

SB, Euromoney So how does price discovery work? How did Kaupthing get its price of 380bp over versus 700bp CDS. How are deals priced now?

EM, Natixis What we have seen so far is that the issuers are not willing to pay their CDS levels. A rule seems to be emerging that the real price is a little bit above half of CDS levels.

AG, Commerzbank
Kaupthing, who clearly view their CDS levels as ridiculous, proved to everybody that with the right investor connections you can print a trade well inside CDS. This is not possible for everybody and it is done on a very private basis. It is much easier to conduct a negotiation based on a close and historical relationship than to go public in a market where fear has overcome greed for quite some time now and where rational arguments are not heard any more.

WS, Banesto As I mentioned before, deals in the private placement market are currently being priced taking into account the mix of secondary trading (if any) or CDS and the investor’s own assessment and perception of the credit in question, plus paper availability.

NS, Baring AM
It remains, though, that the basic problem on price is that there haven’t been the issuance volumes that would either validate or invalidate secondary spreads.

SB, Euromoney
What happens if you’ve been out of the market for a while. Do you have no idea what price to come in at all?

NS, Baring AM Well, I think that’s particularly true for subordinated bank capital – Barclays priced 40, 50 basis points back from secondary spreads for example. Certainly if you are a debut or irregular issuer, you’re a mile away from knowing where the market is at the moment.

JB, European Credit Management
The distortion in the public markets is liquidations, particularly in the tier II sector of the bank capital markets, as CDOs and structured investment vehicles have hit triggers and had to sell assets – they were big buyers of tier II bank capital. That’s pushing things extraordinarily wide in that market whereas the private markets are unaffected.

AG, Commerzbank For very good issuers, people who have been working for years with dealers, with investors, these are good times, because even if it’s a smaller market, dealers will trust people that have been working with them for years on things like the secondary market and buy-backs, and on ease of execution. It’s a lesson for other issuers who can’t do deals at the moment because they hadn’t done their homework beforehand.

Credit sensitivity surge

RS, SGCIB One impact of all this has been that investors in the structured MTN market are now more credit sensitive, which is more profound than it sounds: investors who before were just saying "on the back of this structure I want any double-A issuer", are now differentiating significantly between issuers in the same rating category. And that’s something that I think is probably a structural change in the way investors are approaching this market.

AG, Commerzbank This is true. Particularly with regard to the secondary market, investors are realizing that what is increasingly the key driver of price change in their bonds is not the embedded structure, it’s the credit of the issuer. This is especially true with US investment bank issuers with CDS spreads at 200 or 300 and it implies that, for certain issuers, vanilla is the way to go and that for structured products very high quality issuers are needed.

EM, Natixis That’s why we have seen a flight to quality with double-A agencies which were not that present before.

JB, European Credit Management
This is a key theme. First, people are less trustful of ratings and they’re doing their own analysis. But I think it’s going to go a lot deeper than that and in a market structured like that it is much more difficult to do some of the things we’ve done in the past in terms of speed of issuance, volumes or structures. It will be a fundamental change, because people are not going to trust even the highest level of ratings without knowing the individual issuer. Know the person you’re dealing with on the other side is going to become a key watchword of everything done in the debt capital markets over the next few years.

WS, Banesto I agree with that and I would also add that commitment from issuers is absolutely key. Investors are doing more individual work on credit profile rather than merely asking for rating agencies reports. We at Banesto have noticed that and have accommodated our dealers and investors both with more general and more specific reports about our business – for example details of our mortgage portfolio. Furthermore we are reinforcing our commitment to the structured funding business by showing, as we have always shown, flexibility, speed of response to reverse enquiries, buy-backs and restructurings.

JL, CBA The impact on the ratings differential has been twofold. There are intermediaries who are bringing a lot of business to us because they used to issue a lot in their own name, and theirs is no longer an acceptable rating for their investors. And there are other houses that are clearly diverting all the funding enquiries to their own desks, because they need to raise their liabilities. So there seems a bit of a split from whom we’ve seen flows, particularly in the last eight to 10 weeks.

AL, UniCredit Based on our experience I think that investors’ attitudes have become more complex than in the past. A high rating is no longer insurance that the spread is going to be stable over the life of the instrument (which in the case of structured private placement can be extremely long). I think investors are now giving more importance to factors such as the nature of the business and the country of the issuer. I think that as an institution we are benefiting from being very well diversified in terms of business model and country risk exposure, since we are present in 23 different countries in Europe

AG, Commerzbank Exactly. Your treasury may be much more competitive than the rest of the market which makes things interesting internally for an MTN desk trying to push third party issuers with a lower rating and who is less flexible than your own issuing house at tighter spreads than you.

JL, CBA Well we deal with about 45 different intermediaries and some of them have disappeared without trace.

CC, HSH Nordbank
I think that investor marketing becomes even more important if we look at the rating agencies which have, rightly, lost a lot of their reputation. Nowadays you are no longer just a double-A or whatever, you are that specific issuer with your specific risk profile and also country profile. It’s more important than ever that people do really understand your risk profile and your business strategy.

AL, UniCredit We already see this. As I pointed out before, the investor approach is now more sophisticated and less rating oriented. It is now more common to see investors putting together a list of preferred names which typically includes names with different ratings, and the final judgement is made carefully considering the combination of credit quality and spread offered.

AG, Commerzbank The country and region also matter now even in the structured world. Regardless of your rating as an issuer, your country now has to be explained and is part of the credit decision. This is a new and recent development.

SB, Euromoney
Which countries?

AG, Commerzbank Iceland to start with, I think it can be very difficult [though two key Icelandic borrowers recently competed 2008 funding in the private market]. Southern Europe is difficult as are the UK and Ireland – but the trend is that investors are tending to retreat into their domestic markets where they feel they know the credits best. If they take structured risk, then they do not want additional credit risk.

NJ, EuroWeek How about Germany?

EM, Natixis It’s a difficult country and it’s difficult for investors but not in terms of pricing, it’s in terms of either you take a German issuer or you don’t .

Don’t forget that we’re in a structured market, right? So what they’re buying first is not the credit, they’re buying the structure. And as much as we were saying at the beginning that investors on this market are now looking at the credit a lot more than what they were doing, they still have a first layer of constraints and restrictions on certain group of issuers like for instance "I like this country, I don’t like this country" or "I like this rating and I don’t like this rating".

EM, Natixis So you don’t have to have a curve for German issuers or French issuers or Spanish issuers; they want this type of name or this country or not, considering their structures.

CC, HSH Nordbank
As someone representing a German bank, it is quite clear that it helps us if we differentiate ourselves by saying that although we are a German bank, 60% of our earnings are generated from cross-border business of our clients. Furthermore, HSH Nordbank is successfully operating in global industries such as shipping, aircraft, rail, logistics and energy and, thus, only in part dependent on the domestic economy in Germany. In addition, we are able to issue Pfandbriefe which have proven to be one of the most stable asset classes, having been almost unaffected during the market crisis.

RS, SGCIB Right now, demand is being much more driven by name recognition. Certainly, in Asia and the Middle East name recognition is the first criteria for most of the investors. That is a wake-up call for issuers to be more proactive in their communication to investors in this region. The investors are not closed to new names, but they need the credits to be explained, especially in this type of environment.

EM, Natixis I agree that issuers now have a lot of homework to do in terms of roadshows and in terms of explaining their credit, and to show their flexibility, guaranteeing buybacks and helping with restructuring. That is definitely what will make the difference now with the investors.

JB, European Credit Management
As an investor, I would second that. It is so important. We need to know the story and we need to keep hearing it so that we feel we have consistency and a rapport. And that will make a very big difference, whether it’s a public or private issue.

AG, Commerzbank
A key question is: who’s going to be there in three years’ time when I need to buy back?

Buy back or die

NJ, EuroWeek Leaving ratings to one side for a moment, we talked a little bit about pricing and how that’s had to change, we’ve also talked about the fact that there is a considerable amount of cash out there to invest in structured notes. What else do issuers need to be doing to access that funding?

AG, Commerzbank They need to be nicer to dealers! Relationship, price flexibility and trust are more important than ever. We are in an investors’ market and issuers will sometimes find they give away something they didn’t need to. It will happen because issuers have to react quickly, and for the past four years it didn’t. And this is not just price, it’s structure: Schuldscheine, retail notes, minimum denominations and so on.

NM, CFF Yes. One of our ways to provide flexibility to investors was to work with dealers to diversify in terms of format. One is the Namensschuldverschreibung – the registered version of Schuldscheine – and the other one is the flexibility for different underlyings. For us as a covered bond issuer, we have been able to add the capability to restructure.

CC, HSH Nordbank And from my point of view, the key is transparency, responsiveness, and flexibility (scope of structures, minimum deal size, non-call period), and also willingness, as we have said, to buy back paper. We for example have dedicated people in New York and Asia to overcome the time difference to cover reverse enquiry transactions, and this has made a difference.

NJ, EuroWeek Wafi also mentioned buy-backs. How important is that commitment from issuers?

RS, SGCIB It’s crucial. We are in an investors’ market now and most issuers have realized that it’s not simply an option any more – it’s almost compulsory if they want investors or dealers to focus on their names. So the trend we’ve seen is that from, probably, 30% to 40% of issuers committing to buy back their paper two or three years ago, today we are more talking about 80% or 90%. I think that is a structural result of the current market changes.

EM, Natixis And that’s not necessarily a bad thing for the issuer. Investors often ask for buy-back because of changes in portfolio management criteria, not because they don’t like the specific issuer, so they will tend to reinvest with the same issuer. But certainly when we talk to investors, and explain that such-and-such an issuer doesn’t do restructuring or buy-back, they quickly lose interest. And if an issuer refuses to participate in the restructuring of an outstanding issue, then I know those investors will never buy that issuer again. As everybody’s saying, it’s an investors’ world now.

RS, SGCIB Remember that we are not talking about free buy-backs, we’re talking about buy-backs with a cost of replacement charged by the issuer. So it’s not necessarily a free service that the issuer is giving. But at a time where the market is not that comfortable with credit, who is better placed than the issuer himself to hold or buy back his own paper?

Where to fund now

NJ, EuroWeek There has been a difference in liquidity in the public markets between the US and Europe in the first couple of months of the year, where the US public markets have been more active. Has this translated to the MTN market?

CC, HSH Nordbank The US market has shown that it was very liquid in the sense that there was always money to put to work, but not necessarily price-efficient from an issuer’s perspective.

AL, UniCredit
One US point: we have a 144A MTN programme, but you can’t use it as easily as the Euro-MTN, because of frequent updating needs due to reporting-related restrictions. As a consequence, we have used the US market only for public transactions so far. This, however, we are committed to follow up on a regular basis. The issuance window is now open between September until March the following year.

NJ, EuroWeek Jacques, you have had experience of the US too.

JL, CBA Yes. We experienced a significant fall-off in enquiries this year and perhaps the last two or three months of last year. The dealers tell us that the investors are looking at US agencies and domestic names.

NS, Baring AM
The problem in the US is that the geographical remoteness plus the 144A separation works against the trend towards being closer to investors. So I’m surprised you’d be talking about that as a viable route to diversifying funding at this particular juncture.

AG, Commerzbank
It depends which kind of programme. If you have a branch there, then it can make sense. And there is a huge market for equity-related securities into the private bank market which you can tap. We’re using third-party issuers at the moment, which is expensive, but a well-known European name in the US at the moment is more appealing to some investors.

WS, Banesto We have an EMTN programme with 144A language that allow US QIBs [qualified institutional buyers] to buy our name. We have not been actively marketing Banesto there as much as I would have liked to and are using the help of our dealers. We did manage, though, to print a significant amount of structured notes into the US. On the other hand, I agree with Amaury, solid European names are now more appealing to US investors than before. The market is very opportunistic: you have to look for windows of opportunity and try to jump into the market whenever there is an opportunity either for cost or for volume at reasonable cost.

NJ, EuroWeek Which other markets are attractive?

JL, CBA For us, the domestic Australian market is available, and the yen loan market has been given a boost by a recent tax treaty which makes routing funding to Sydney easier. We’ve also looked at Schuldscheine but we need dollar funding and there are European names pricing significantly wider than us whom investors prefer.

AG, Commerzbank Yes. The issue there is that the German banks have been paying up for funding in that market and they are attractive as domestic names. If you don’t pay at least 50bp or 60bp over Euribor, it’s going to be difficult to generate interest from the German insurance companies on the secured side.

NJ, EuroWeek I think it would be interesting to find out from each of the issuers – given their success in maintaining their funding channels – to explain which investors they have had most success in tapping. Jacques, obviously CBA is a great name in Asia and that’s where you do most of your business.

JL, CBA Certainly. We’ve asked our relationships to provide us the approximate location and the type of investor and we are very strong in Asia, but incredibly diversified in Asia, not only geographically but also drilling down to the various layers; from housewives in the uridashi market to educational authorities in samurais. One slight change we have noticed is that we’ve done more block trade private placements than historically we would have done – and that’s all reverse enquiry.

NJ, EuroWeek And Andrea? Where is UniCredit focused on in terms of its investor base for structured notes?

AL, UniCredit Concerning structured notes at the moment, our main core market is Europe, which we try to cover across all the products and documentation formats, including Schuldscheine and Namensschuldverschreibung. For structured products in Europe, we target mainly institutional investors, but our MTN programme allow us to issue in retail format abroad, and can easily be passported in different jurisdictions.

The US has recently also become a core market for us. We have started a regular issuance activity in the public market through our MTN programme and we are for example one of the main issuers of extendible notes.

We are also exploring the Asian market and we are currently able to issue domestically through our Hong Kong branch and a Hong Kong CD programme. In order to increase diversification, we are also looking at Australia, for example, and Canada.

SB, Euromoney What about the Middle East as a rich source of potential funding?

WS, Banesto It’s an interesting point, but quite a few of the Middle Eastern countries are considered tax havens under Spanish tax code and again withholding tax applies.

AG, Commerzbank
The other issue is competition. It’s hard for dealers to make money on structures in this part of the world.

EM, Natixis
And these investors have also been among the most credit sensitive. We’ve seen them switch out of issuers on the calls for credit reasons. This is unusual with the more traditional investors.

NJ, EuroWeek
Nathalie, what about for you in terms of geography of demand?

NM, CFF Well, last year, nearly 60% of our distribution of private placements was outside France. For private placements, the three main sources of demand are Japan, Germany, and the UK. Last year, 20% of our private placements were structured notes, and the rest plain vanilla, in euros, US dollar, Japanese yen, GBP and also some exotics. Our transactions are mainly long-dated – 10 years to 40 years. And in terms of structured transactions, we have seen less equity-linked and less inflation-linked, and mainly interest-rate-linked. Complexity of structure has declined too.

WS, Banesto For Banesto it’s different. We are much more active in equity-linked and other asset classes. Commodity-linked has been an active area this year, as well as FX, credit-linked and even fund-linked, with interest rate structures actually down in Europe.

NJ, EuroWeek
What’s driving these shifts in preferred underlyings?

WS, Banesto In the past, there was more distinction between different underlyings and the funding levels associated with them. You would look at interest rate as an underlying that you can slightly pay more than on equity. The same happens when you have principal protected and principal at risk: you would pay slightly less for non-principal protected in both cases because the more vanilla the product, the easier it is to book it into the system and to document.

EM, Natixis Also, equity-linked structures appeal largely to the private bank investors, and so any shift in their preferences will alter the balance of product in the market. Right now they will only accept certain double-A issuers and this restricts the market’s capacity to provide product.

High volatility opportunity?

SB, Euromoney What has the sudden shift to a high volatility regime done to structures and investor demand?

EM, Natixis In terms of volatility of interest rates, it depends on the currency. In US dollars we have seen sellers of vol via structured products. The buyers are more market-makers, as this will reimburse their premiums. In euros, we have seen market-makers buying vol which allows them to get back the premiums, and they are buying vol via structured products such as CMS and floored CMS structures.

AG, Commerzbank High volatility has always made it easier to create attractive structures and generate more margin for dealers in a well-functioning market. But it is a completely new world now, one most bankers did not imagine in their worst nightmares. Volatility in a market driven by fear and where liquidity is very thin is not helping the structured business overall. Depending on the investor base, the market is still reasonably active but investors tend to retreat to easier structures. That said, they are happy to look at new underlyings with sometimes a higher de-correlation to the current bearish equity market, for example.

WS, Banesto Demand for structured products has dropped significantly and one of the reasons is the credit spread volatility. Nevertheless some underlyings of the embedded bonds have become more attractive, with higher return due to equity market correction and higher correlation as per credit linked first-to-default baskets for instance.

SB, Euromoney Does the absolute level of interest rates drive flows into particular structures?

JL, CBA Well, if you go back to 2003 when absolute US interest rates were very low, a Hong Kong corporate would get half a percent on a three-month deposit and 6% or 7% on a capital-guaranteed structured product, which was a very interesting risk/reward ratio. As interest rates have risen, that risk/reward has been eroded. You’re still getting the same 6, 7% on a range accrual, but deposit rates are now higher and the risks in the range structure have risen sharply.

SB, Euromoney What does the table define as ‘highly structured’ these days?

RS, SGCIB There are two ways for a structure to be qualified as complex. Either the underlying itself is complex (such as a hedge fund basket), or the formula – the type of optionality embedded – is complex.

AG, Commerzbank
So "structured" means hybrids, credit-linked notes trading on sovereign names, that kind of thing.

NJ, EuroWeek
Opportunistic structures that package up the CDS/cash divergence?

EM, Natixis Exactly.

AG, Commerzbank
CDS are so wide, Libor is so volatile and countries’ spread relationship with Libor so out of line with historical levels that correlation trades involving baskets of sovereign names can offer fantastic coupons at the moment even when the basket is Italy, Spain, France, Germany, Austria. But we have seen that people have certainly shied away from structures containing exotic options. The innovation has been coming more from the underlyings than from the actual pay-off profile of the structures.

JL, CBA Just going back to more exotic structures, I don’t think the day goes by that we don’t get shown something new. So innovation hasn’t slowed down at all.

EM, Natixis
Remember that now issuers have new rules, like the IFRS, which means that they can’t trade and book any kind of structures.

At SocGen we used to create a lot of new products, complex and hybrids, to get leverage, especially because interest rates were low, and – for example – the Hong Kong corporate could go to the stock exchange in China and get double-digit returns. These structures contained multiple options and also very complex options. But it ended up with the issuer unable to value them, which is a problem under IFRS, SGCIB. Investors too can have accounting issues with complex products. This has reduced demand for products with complex options.

NS, Baring AM There is something else. I’m interested in managing money against rate risk, credit risk, currency risk, and I want to be able to decompose those areas and take each of them in the quantity I desire in as vanilla a form as possible. So having highly structured notes with mixed exposures doesn’t naturally appeal to me. For some people, multiplying up these risks through a single instrument in a digestible form does appeal, but that doesn’t speak for a wide cross-section of the investor base.

JB, European Credit Management From an investor standpoint, I generally agree with Nigel that simplicity is key, particularly after what we’ve gone through. However, there is a niche of investors who have a real hunger for yield and are still looking for double-digit returns. They are still willing to take complex option, underlying and structural risk.

NJ, EuroWeek That is all we have time for. Thank you.