Since the arrival of the euro, government debt management agencies have had to work hard to distinguish themselves from one another. They have had to come up with policies that make their issues more attractive than their neighbours'. Along with liquidity and transparency, marketing is now a buzzword among agencies that relied for many years on a captive domestic market.
According to Graham Bishop, an adviser on European financial affairs to Salmon Smith Barney who was once nicknamed "Mr Euro" for his positive view on the single currency, it is now a fairer market: "The Germans do not have the edge any more that the Bund gave them. And the captive domestic market has all but vanished, which I think is a good thing. All the agencies are now having to get out there and market to a worldwide audience."
The Germans may no longer dominate the market with the Bund but theirs is still the benchmark. However, they are having to work incredibly hard to retain their status because the French are rapidly catching up.
"I see no reason why French bonds cannot trade two to three basis points cheaper than Germany," says Caroline Turner, debt analyst at HSBC Investment bank. "They both have AAA status, similar liquidity and budget deficits, the only major difference is the developed futures market in Germany. But, if an investor is diversifying from the equity market into the bond market, more often than not they will go for the classic German 10-year bond."
French innovations To counteract this, the French, already in a strong position with their Obligation Assimilable du Trésor (OATs), French government bonds with a maturity of seven to 30 years, have been coming up with innovations that differentiate them from the Germans. One example is the euro-inflation linked bond (OATs), which is aimed at the euro-based investor that needs protection from inflation. France is the only country to issue this type of reference and plans to reveal a new longer-dated maturity in September.
The French are also working hard to develop their strips market, in which a bond is broken down into separate coupon and principle payments. According to a spokesman from Agency France Trésor (AFT): "Stripped bonds allow investors to improve their portfolio because of their greater sensitivity to interest rate movements. This offers them greater leverage than on a conventional OAT. Stripped securities also allow one to eliminate the interest rate risk linked to reinvestment of the coupons of a conventional security."
As France was the first sovereign issuer to authorise the stripping of its securities in 1991, it has become a benchmark for this type of product in the eurozone. It is now a relatively mature market that attracts keen interest from all over the world. In January 2001, outstanding OAT strips came to about E35bn, corresponding to 11% of outstanding strippable securities.
"The French strips market is by far the largest and most liquid in the eurozone," says a Paris-based dealer. "This gives them a real advantage over Germany, which the Germans will have to work hard to redress."
France has also issued a 15-year bond in the past year to address demand from the pension funds industry. Spain, Italy and Belgium have done the same. "France is really trying to challenge Germany's benchmark position by becoming more proactive and innovative," says Ms Turner. "And really the only thing that it is missing is the fully developed futures market. I think one day it will succeed in trading at the same level as Germany; I don't see why it won't. It really is the most transparent of all the agencies and basically that is what the market wants. Investors want to know what is going to happen as early as possible so they can take positions.
"The French tend to adhere to their targets. For example, the recent concerns over the increased financing needs was met via a E12bn extra BTF [T-bill] issuance, rather than exceeding their OAT/BTAN [up to five-year] expectations."
Germans retaliate
The Germans, though, are fighting back. The Bundesbank no longer issues bonds and this now falls under the remit of the Finanzagentur (finance agency), which was established in September 2000 to manage the state debt. "This is an obvious effort by the Germans to try to market themselves better," says a source. In 2002, the Finanzagentur plans to issue or reopen German government securities of E186bn. These will be split into 27% holding a short-term maturity, 43% with a medium-term maturity and 31% with a long-term maturity. It also plans to pay off German government securities of E167bn and to spend E43bn on interest payments. According to Ms Turner, the Germans react to any initiatives taken by the French. "They are trying to stop France taking the benchmark status," she says. "For example, Germany has increased the five-year Bobl to E18bn from E14bn last year and just E6bn in 2000. In addition, they have followed the AFT's lead in becoming more active in the swaps market and have recently modified legislation to give a mandate for E20bn swaps per year, a 100% increase."
According to a London-based European debt analyst, the distinction between the two is likely to remain blurred. "In terms of what is seen as benchmark, there are different sectors of the curve where France or Germany is perceived as better," he says. "So there is no clear-cut answer to which market is seen as the benchmark. And it is a fluid situation - I don't expect a clear-cut answer in the near future."
Smaller competitors
The smaller countries in the eurozone that will struggle to achieve the same levels of liquidity as France and Germany are turning to alternative issuance procedures, such as syndicating initial tranches. Also they are reducing the frequency of issues, while increasing the size of their scheduled auctions. Spain, for example, reduced the number of Bonos auctions to 83 in 2001, from 115 in 2000, while increasing the average allotted volume at each auction by 16%. In 2002, it began syndicating the first tranche of a new bond to place a minimum of E5bn, enabling the bond to be immediately EuroMTS tradeable.
Greece has been working hard to establish benchmark bonds with high liquidity to ensure increased tradeability and build up the size of its issues quickly, with more than 70% of issuance in 2002 accounted for by three syndications compared with just 16% in 2001. It has also been restructuring the debt to reduce exchange rate risk and improve the composition of its portfolio, reducing costs and increasing attractiveness to investors.
Following the successful launch of MTS-Espa-a, MTS-Portugal and MTS-Ireland, all the eurozone markets, with the exception of Austria and Greece, have their own MTS trading platforms. This greatly increases the liquidity of included bonds thereby improving global competitiveness and price transparency. Treasuries are relaunching websites, making information easier to obtain, and offering more detailed analysis to investors to further differentiate themselves from their competitors.
The Netherlands
According to a spokesman from the Dutch debt management agency, the Dutch State Treasury Agency (DSTA), "there has never been so much innovation in the European debt market". The DSTA manages a total volume of Dutch government long-term debt of E172bn. The average remaining maturity is 6.3 years and the average coupon rate is 5.8%. In 2001, the Dutch state issued E19.6bn of Dutch state loans (DSLs). A total of E13.6bn was issued in the newest 10-year DSL and the remaining E6bn by tapping two existing DSLs with a maturity of around three years.
The DSTA has appointed 13 primary dealers for 2002. Morgan Stanley is the newest addition to the group. These banks have the exclusive right to subscribe to DSL tap auctions and they also maintain a liquid secondary market. "The Netherlands has a very tidy bond market," says Ms Turner. "It has consolidated 96% of its bond portfolio into 16 DSL lines via exchanges and buy-back programmes."
Belgium
The Belgian government debt agency has embarked on a worldwide marketing policy. Jean-Luc Steylaers, deputy director, recently returned from a trip to Canada to sell his country's debt. "We have a very active marketing policy," he says. "We have to. If you go outside Europe, people have heard of Bunds or maybe OATs, they certainly do not know us."
Prior to the arrival of the euro, 90% of the Belgian government's debt was held domestically. Now the figure is closer to 50-50. The agency organises between 14 and 16 roadshows a year, of four to five days each. "We even do roadshows at home. We have not abandoned Belgium for the rest of the world," says Mr Steylaers.
"Our marketing policy is very simple," he says. "We simply explain to people that we can offer the same liquidity and transparency as the French and Germans but with a better spread. In addition, we are same quality. We are not AAA but AA+ and I don't think many of the rating agencies could identify the difference. In addition, we have the Belgian MTS platform."
Flight to quality
With the world stock markets in turmoil, government debt agencies have seen a flight to quality resulting in an increased demand for issues. "In terms of the yield curve, there is clearly a flight to quality," says Mr Steylaers. "Our 15-year bond, launched in May, reached a lot of investors we have not [reached] before and got a very good pricing. That would seem to indicate we are seeing more interest in the bond market."
A London-based analyst agrees. "There has been more demand. We are seeing, for example, insurance companies reducing exposure to equities and moving into bonds. European mutual funds have also seen a lot of growth this year as a result of the stock market crashes."
According to Hamish Watson, a senior member of the UK Debt Management Agency, there has also been a flight to sterling-denominated bonds. "We have seen short paper very much in demand recently," he says. "The natural conclusion is that at times of uncertainty, there is a tendency to go into bonds."
Another reason that there is more demand for eurozone government debt is that investors are seeing evidence of cost-cutting measures by most of the agencies. "Many of the countries in the eurozone are taking advantage of the low funding rates to buy back high-coupon, illiquid issues," says Ms Turner. "This will reduce funding costs while helping to move treasuries towards the objective of more balanced budgets."
Pressure for legislation
Some investors, however, feel the European Union must step in with legislation before the market becomes too independent. A paper published by the Centre for Economic Policy Research (CEPR), Dealer's Choice, calls for the European Commission to "promote co-operation and co-ordination of debt-issuing policies across European monetary union members". It recommends that a supranational institution should be set up to discourage big players from issuing similar maturities in a short space of time.
Such issuance causes significant supply pressure in one segment and can affect securities across the market, even those that are not issuing at that part of the curve. For example, sovereigns tend to issue new 10-year bonds at the beginning of the year and in January 2002, 65% of the fixed rate issuance (E43bn out of a total E67bn) was in the 10-year segment.
According to Ms Turner, it is not in the Treasuries' interests to concentrate supply. "From an issuer's standpoint, it is best to issue in the richest segments because it costs them less as the market is willing to pay more," she says. "Any legislation would be very hard to implement and would also be relatively undemocratic. Treasuries' issuance policies are generally driven by the government, which gives certain targets such as debt reduction, average life reduction and so forth. Also, Treasuries have to take into account the redemption profile and issuance policies, such as maintaining liquid benchmark curves to remain competitive and retain transparency."
The government debt market was already an established and sophisticated market prior to European monetary union (Emu). But the arrival of the euro seems to have pushed it up a level or two. The agencies are being forced to sell themselves in a way that they did not have to prior to Emu. The result has been an increase in products and scope that has made debt sexier than ever before. A Paris-based analyst says: "The agencies have really changed since Emu. They have increased transparency, predictability and investor relations. They have also streamlined issuance policy. If the world's equity markets continue to perform badly, there is no shortage of reliable and safe issues to soak up investors' money.
"I can only predict the eurozone debt markets going from strength to strength. The opening up of the region in terms of monetary policy has been the best thing that could have happened to them."
