The UK's EU referendum result may have surprised a lot of people. But far from the doom and gloom that some predicted would follow such a vote, HSBC reports it has been busy as the debt capital markets return to normal. Edward Russell-Walling reports.

HSBC team of the month

It may seem counterintuitive, but since the UK voted to leave the EU, sterling debt capital markets (DCM) have taken off. As issuance has ballooned, HSBC has been the most active manager.

In the first 10 weeks following the vote, HSBC was bookrunner on 19 sterling bonds (across all categories) worth £3.37bn ($4.92bn), according to Bloomberg, followed by Barclays on 12 issues worth £3.113bn. This was a welcome burst of activity compared with what had gone before.

In the months leading up to the referendum, sterling DCM had been particularly wary. Corporate issuance volumes for the year up to the vote date were about half the level of the same period in 2015, and activity from financial institutions groups (FIGs) was similarly subdued.

“There was a wait-and-see attitude,” says Jean-Marc Mercier, HSBC's global co-head of DCM. “Investors were cautious, so pricing was a bit wide in sterling, which was not interesting for issuers.”

Unexpected result

The result of the referendum, as is now known, was not what international financial markets were expecting. Even as the pound plummeted, what the effect on issuance would be was not immediately apparent.

“Some were in shock, and thought that nothing would happen for a long period,” says PJ Bye, HSBC’s global head of public sector syndicate. “But the sterling market is driven largely by the domestic investor base, for whom it doesn't matter if the pound depreciates.”

It took a few trading sessions for everyone to digest the result and there were, in the words of one banker, “a couple of rocky days”. As Mr Bye points out, at least some players were convinced that the market would take a long time to recover. But not everyone felt that way.

HSBC decided to test the waters. “We did a lot of work with investors globally to get a sense of their appetite following the news, and found that many were quite comfortable with it,” says Mr Mercier. About one-quarter were cautious; another quarter were really positive, noting that market conditions were good; and the remaining half were neutral but open for business. “That convinced a number of issuers to look at the market a week later,” adds Mr Mercier.

Exactly one week after the vote, two transactions demonstrated that there could be life after Brexit. Both featured HSBC as joint bookrunner.

The first was denominated in US dollars rather than sterling but came from a UK bank. This was Lloyds Banking Group's inaugural holdco issue, a $1bn five-year Securities and Exchange Commission-registered trade. Starting with initial price thoughts of Treasuries plus 225 basis points (bps), the no-grow deal attracted orders of more than $6bn and was printed in less than six hours at Treasuries plus 210bps.

The same day, British American Tobacco (BAT) reopened the sterling market with a five-year unsecured transaction, the first corporate sterling offering in more than a month. With initial price thoughts of gilts plus 150bps, the order book grew to £2.3bn, allowing the deal to be upsized to £500m and the re-offer spread tightened to gilts plus 130bps. That represented a new issue premium of zero – “a remarkable achievement, given recent events” as HSBC puts it.

Opportunities for arbitrage

Lloyds and BAT were issuing for strategic reasons, to demonstrate that they still had access to the market. Other issuers now lined up to take advantage of the arbitrage opportunity that would arise when – as was now widely anticipated – the Bank of England cut interest rates to ward off a Brexit-inspired recession.

Arbitrage-driven issuers included Germany's KfW (with a tap of an outstanding issue), Canadian Imperial Bank of Commerce and Wells Fargo. “Investors knew that the Bank of England would have to react with some form of stimulus package, and many of them wanted to get their hands on some quality sterling assets,” says Asif Sherani, a director in HSBC's public sector syndicate. "KfW, for example, is AAA rated but was still paying a spread over gilts."

Mr Bye explains the “massive liquidity” that manifested itself after the Brexit vote. “The Bank of England was likely to cut rates and do more quantitative easing [QE], so investors had to chase the market,” he says. “But they didn't know where the QE would fall. Would it be corporate? Sovereign, supranational and agency [SSA]? No one knew, and we benefited from that.”

One issuer that found a much more receptive market for its paper was high-profile UK infrastructure organisation Heathrow, which issued its first senior sterling bond for three years. A £1.25bn order book allowed the size of the 33-year deal to be increased from £250m to £400m, while the price was tightened from gilts plus 130bps area to 118bps over gilts.

The investor base for these sterling offerings was less domestic than usual. “While we saw the scale of orders increase, we also saw a more international market,” says James Cunniffe, HSBC's head of corporate and asset-backed securities syndicate. “European and Asian central banks were more interested in corporate sterling issues.”

Central banks' buying of sterling bonds had been very much on hold in the run up to the referendum, and they were now able to come back to market. "There is also a general correlation between currencies and the international buying of SSA paper, with a rebalancing of portfolios when currencies go down," adds Mr Bye.

Caution evaporates

If corporate and FIG activity had stalled before the vote, public sector issuance was up by more than one-third. “SSA issuers had been very cautious because of nervousness about Brexit and other European elections,” says Mr Bye. “With heavy front-end loading, they were already 70% funded by half-year, compared to a normal level of 60%.”

The UK Debt Management Office left a large gap in its normally smooth gilt operations calendar in the days before the referendum. Afterwards, it returned to market, reopening its 2065 index-linked gilt, with HSBC as joint lead and duration manager. With order books of £10.1bn, it raised £2.5bn against an expected £2bn, achieving a record low real yield of -1.3245%.

On August 4, the Bank of England duly obliged with a 25bps rate cut to 0.25%, and QE commitments to buy £10bn of corporate bonds and another £60bn of gilts. Sterling corporate bond yields fell to new lows. But with more stimuli expected before the end of the year, the sterling market continues to be buoyed up.

Non-UK issuers have also been taking advantage of these favourable conditions. One was BMW. With HSBC as joint bookrunner, it seized the opportunity to launch a six-year sterling bond, priced inside current euro levels at gilts plus 67bps. "Issuers such as BMW would not look at this market if they couldn't achieve the same pricing as their home currency," says Mr Mercier. "Normally, arbitrage trades are in small sizes, but these are very large because investors don't want to be left out."

Home advantage

For UK names, the demand allowed them to issue in bigger size, and more cheaply, than before. InterContinental Hotels, for example, priced a £350m 10-year bond with a 2.125% coupon. This was the lowest coupon ever achieved by the company in sterling, and compares with the 3.75% it paid last year for an earlier 10-year deal.

UK housing association Places for People issued its largest ever sterling bond despite a shorter maturity and a different format from the norm for such organisations. Its 10-year unsecured bond drew in orders of £1.3bn, allowing the size to be increased to £400m and the price to be tightened to gilts plus 225bps.

With high-grade issuers being generally already well funded, the technical backdrop for issuance remains strong. “Investors must position themselves to buy the right credits, so the fight for paper is real,” says Ulrik Ross, HSBC's global head of public sector and sustainable financing.

The prospect of Brexit may have helped sterling to define itself more clearly. “In the past, there was some convergence with the euro,” says Mr Mercier. “Now it has become clear that this is a different market, and that will deepen it. It's not Europe, so people will want to play there.”

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