Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Asia-PacificApril 6 2009

Europe looks East for investors

Asian central banks are still key customers for European issuers, even if their reserve growth is slowing. The move out of emerging market currencies and sterling is also giving a boost to euro-denominated issues. Writer Michael Marray
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Horst Seissinger, head of capital markets at KfW

Asian central bank reserves are no longer growing at the rapid pace that they were a few years ago, but Asian placement remains crucial to the success of offerings from AAA rated sovereigns, supranationals and agencies in Europe.

In the current risk-averse environment, Asian central banks have increased their focus on core European sovereigns such as Germany, France and the Netherlands, as well as top names such as European Investment Bank (EIB) and KfW. There is also growing Asian appetite for treasury bills, particularly from central banks that are having to defend their currencies, such as the Bank of Korea.

The spread differential between German Bunds and other European sovereign bonds has widened dramatically as a result of the flight to quality, with investors more concerned about capital preservation than capital return.

Rise of the Euro

The severe phase of the financial crisis that has gripped global markets since last September has also given momentum to the trend towards holding more euro-denominated assets. Euro-denominated issues have benefited from the shift out of currencies such as the Australian and New Zealand dollars and Asian emerging markets currencies, all of which had previously enjoyed strong central bank demand. Even sterling has suffered, with bankers reporting only moderate Asian demand for sterling paper.

Thus the financial crisis marks another step towards the emergence of the euro as a second global reserve currency. However, the outcome of a sizeable shift by countries such as China from dollar to euro assets would likely be a long-term upward run in the value of the euro. This would be bad news for the global competitiveness of European exports, which is one reason why EU officials and finance ministers do not talk up the growing reserve status of the euro.

And though Asian central banks are buying more euro paper, many European borrowers still rely upon their dollar programmes for their most sizeable placements into Asia. At the moment, the two to five-year segment of the curve is where most of the demand is.

"In the current difficult market environment there is clearly a strong investor focus on shorter maturities," says Horst Seissinger, head of capital markets at KfW. "In the dollar market, doing a 10-year deal might be something of a challenge, but for five years or shorter, as long as you have a good feel for pricing there is strong demand."

On January 7 this year, KfW launched a three-year dollar global bond. After the transaction was put on the screens at 8.30am, London time, the order book built to more than $3bn within an hour. The book was closed in the afternoon within a volume of more than $6bn, and with a re-offer at mid-swaps plus 30 basis points (bps), KfW was able to close a well-diversified deal that included important central bank accounts.

Asian investors took 29% of the paper, which is fairly typical for a KfW dollar benchmark deal at the shorter end of the curve. KfW has announced refinancing needs of about €75bn for 2009.

Like all well-established AAA issuers, KfW is facing additional competition from the large volume of government-guaranteed bank bonds being sold as a way for commercial banks to get access to funding.

"It is a fast-changing environment for AAA issuers, with additional sovereign supply coming, as well as government guaranteed bank bonds with different maturities depending on the jurisdiction," says Mr Seissinger. "In the sovereigns, supranationals and agencies sector, it helps to have a well-established track record like KfW, and our major competitive advantages are our unlimited direct guarantee, as well as the fact that we can offer investors a whole range of products in various maturities and currencies."

Lengthening tenors

Most government guarantees on bank bonds are set at a three-year maximum, though some go out to five, and more governments are looking at lengthening tenors. For example, under the Spanish programme covering senior unsecured debt, the term can range between three months and three years. However, there is a potential extension to five years in exceptional circumstances after consultation with the Bank of Spain. Issues guaranteed by the Financial Markets Stabilisation Fund in Germany can go out to three years, and the Dutch State Treasury Agency offers guarantees out to five years.

Some of this guaranteed bank paper is being placed in Asia. But whereas European fund managers have been quick to approve government guaranteed bonds as a new asset class, central banks tend to have a slower approval process. So with most programmes intended to only last until the end of 2009, most of the placement is within Europe.

There is currently an advantage to be had for any issuers that can issue beyond five years to avoid government guaranteed deals, but demand is weak.

Vying for investors

Guy Reid, managing director for frequent borrower coverage at UBS in London, says: "Government-guaranteed bank issues go out as far as three or five years depending on jurisdiction, so it would be better for well-established AAA issuers to avoid the added competition and do seven or 10-year offerings. But since there is not much demand further out along the yield curve, a lot of issuers are competing for the same investors in the three to five-year segment.

"Some central banks have been moving a bigger proportion of their reserves into much more liquid, shorter-dated products, so there has been a decrease in appetite for traditional sovereign/supranational paper and an increase in demand for treasury bills," he adds. "We have also seen a big increase in demand for euro commercial paper."

Nonetheless, when on January 12 the EIB launched a €3bn five-year euro area reference note (EARN), the maturity was specifically chosen to offer investors an alternative to the large short-dated supply, in particular the two and three-year government guaranteed bank deals. It was lead managed by UBS, Société Générale, HSBC and JPMorgan.

"The order book built up consistently throughout the day on Monday with an excellent quality of orders from real money investors, and about 200 participants in the transaction with no price sensitivity," says Zeina Bignier, deputy head of debt capital markets at Société Générale. "We decided to keep the book open overnight to market the deal in Japan, which was closed on Monday."

Price guidance was revised on Tuesday morning to mid-swaps plus 20bps, which represented a pick-up of 96.1bps over Bunds. The deal had 37% placement in Asia, with 60% going to Europe and 3% to the US.

Asian placement of 37% for a euro-denominated deal is on the high side, and though this included some Japanese accounts such as insurance companies and fund managers it was heavily taken up by central banks and other government institutions, who made up 39% of the book.

Another €2bn EARN from EIB launched in February had a 10-year tenor, and here Asian participation was much lower at 11%. This illustrates how Asian central banks prefer shorter maturities, whether buying agencies or sovereign bonds.

"At the moment there is a tendency for investors everywhere to buy at the short end of the curve, as those maturities have by definition a lower sensitivity to price volatility, and in this environment of low interest rates and yield we have seen increased demand for bills and for bonds with maturities up to five years," says Philippe Mills, chief executive of Agence France Trésor (AFT).

In recent years, Asian investors have steadily increased their investment in French sovereign debt, buying a net amount of €22.5bn worth of securities in 2006, €41.6bn in 2007 and €67.1bn in 2008. In fact , since 2006, Asian investors have, month by month, been net buyers of French government bonds, and are now AFT's second source of funding after Europe.

"There is a gradual trend among Asian central banks to increase their holdings in euro-denominated debt, and in the current crisis environment, Germany and France are favoured as core European holdings, with regular and predictable auctions and good liquidity," says Mr Mills. "Liquidity is especially important to investors in the context of flight to quality and strong demand for safe haven paper."

Bart van Dooren, head of funding at Bank Nederlandse Gemeenten (BNG), says: "Over the past few months there has been strong appetite for traditional AAA issuers, and though there is new competition from government-guaranteed bank issuance, not all investors have changed their policy to be able to invest in these guaranteed bank deals."

Strong demand

Demand has remained strong for BNG benchmark deals, which have a minimum size of €1bn or $1bn. During January and February, BNG completed €4.7bn worth of its estimated €13bn to €15bn worth of long-term funding requirements for 2009, and Asian central banks have continued to make up a sizeable part of the order books.

"We generally see more Asian demand for our dollar deals than our euro offerings, and a three-year $1bn deal in early January was two-thirds placed with Asian investors, mainly central banks," says Mr van Dooren.

Even for a top quality name such as BNG the increased tiering is evident. In the highly liquid markets of 2006 and early 2007, three-year BNG paper might have offered a pick-up of 10bps to 15bps against comparable EIB or KfW offerings. Today that would be more like 35bps to 45bps.

Similarly, sovereigns such as Belgium had very tight spreads versus Bunds, but that has widened out as conservative investors such as Asian central banks have moved more of their holdings into core European sovereigns such as Germany, France and the Netherlands. Germany in particular has enjoyed the liquidity premium as many central banks are concerned about having to defend their currencies and want to hold the most liquid paper possible in case of emergency. But in a difficult environment, even Germany has had problems bringing in investors, and its first bond auction of the year failed to attract enough bids to cover the €6bn auction.

Avoidable problem

The volatility on prices of less liquid European sovereign bonds has not helped to make them attractive. Some of this market turbulence is viewed as having been avoidable, since it was partially triggered by a series of negative rating actions taken by rating agency Standard & Poor's (S&P) back in January. S&P put countries including Spain, Portugal, Greece and Ireland on rating watch negative, and shortly afterwards downgraded Greece and Spain. At one point, the spread differential between Greek government bonds and German Bunds hit an all-time high of 300bps, and other countries suffered as market jitters set in.

Some market participants are clearly unhappy about the way in which the flow of information to the markets was managed. First, one by one, countries were put on rating watch for possible downgrade, making the market nervous about who might be next. And second, some announcements came in the middle of the European trading day, when they were likely to create maximum disruption.

"There has been a lot of price volatility in the European sovereign bond market this year, and we have seen the spread differential between our 10-year obligations linéaires and German Bunds move out as far as 130bps at one point before coming back in 85bps," says Jean Deboutte, director of strategy at the Belgian Debt Agency. Belgium is rated AA.

"Some of that volatility in January was a result of market reaction to rating agency announcements about sovereign downgrades, and various sovereigns being placed on rating watch," says Mr Deboutte. "The way in which these announcements were released sometimes generated panic in the middle of the trading day, and we hope that things can be better organised in the future.

"We have seen less interest from Asian central banks over the past 12 months, and we are selling more of our bonds to domestic European accounts," he adds.

For issuers in currencies such as sterling, the current environment is more difficult, partly because the UK is perceived as having severe economic problems because of its high exposure to financial services.

And even UK issuers that do issue in dollars have recently seen weaker demand for their paper out of Asia. In January, for example, UK rail company Network Rail was in the market with a three-year dollar deal, and this time only 5% went to Asia. A three-year dollar deal in the first quarter of 2008 had much higher Asian participation of 33%.

"Most of our issuance is long dated sterling inflation linked, which generally goes to the UK where pension funds and life insurers have inflation-linked liabilities and need inflation-linked assets," says Samantha Pitt, deputy group treasurer at Network Rail. "Most Asian interest in AAA product comes from central banks, who typically only have appetite up to about five years."

Despite the overall negative sentiment towards sterling, in mid-February, EIB launched a £1bn (€1.11bn) four-year fixed-rate transaction. This was priced at mid-swaps plus 30bps, offering investors an 81.2bps pick-up over UK treasuries. The deal was aimed mainly at UK accounts who bought 74% of the paper. But there was also a sizeable Asian bid, mainly from central banks, and Asian placement was 19%.

In general, Asian investors are not as dominant as they were back in 2005 or 2006. The run up in oil prices in 2007 and 2008 vastly increased liquidity in the Middle East and Russia, and Brazil also stepped up its purchases of European bonds.

The once-rapid growth of Asian central bank reserves has since slowed, and central banks actually saw their foreign currency reserves fall during 2008, for example, the Bank of Korea had to defend the value of the won. Korea's reserves stood at $201bn at the end of December, up $720m on the previous month after eight successive months of falling numbers. The main reason for the rise was the increase in the value of euro and other assets when stated in dollars.

AAA rated placement into European accounts has also increased as investors have pulled away from structured AAA credit such as covered bonds and moved their cash into simpler credits such as KfW or EIB, particularly since spreads versus Bunds have become richer. Issuers are seeing a lot of bank treasury departments, and other accounts that they haven't seen before, on their order books.

Region still crucial

While the days when Asian central banks might have taken 75% of a dollar-denominated deal are gone, many transactions from European sovereigns, supranationals and agencies still often find a third of the placement on a single deal goes into Asia. And with the long-term demand for euros versus dollars gradually increasing, the region remains of prime importance for European funding requirements.

The big increase in sovereign supply on the way – as governments put together economic stimulus packages – is clearly of concern to investors. But in a troubled environment where investors are putting safety first, AAA rated European issuers still expect to see heavy buying from Asian central banks.

EIB €3bn five-year euro area reference note, launched in Jan

 

Guy Reid, managing director for frequent borrower coverage at UBS in London

Guy Reid, managing director for frequent borrower coverage at UBS in London

Was this article helpful?

Thank you for your feedback!