Agence France Trésor has been a pioneer of European inflation-linked bonds. Natasha de Teran interviews chief executive Bertrand de Mazičres about the development of these debt instruments.

Bertrand de Mazičres, the newly-appointed chief executive of Agence France Trésor, faced an unenviable task when he took the post last December. The agency has a reputation as one of the most innovative and well-respected sovereign issuers, so in his new role, Mr de Mazičres has much to live up to.

His strong educational background at L’Ecole Nationale d’Administration and the Hautes Etudes Commerciales, his track-record at various government agencies and his most recent posting as secretary general of Conseil des Marchés Financiers all equip Mr de Mazičres admirably well for his new post. He is also a studied and strong supporter of inflation-linked funding.

That support is crucial: a considerable part of the agency’s reputation stems from its innovative inflation-linked bond issuance programme. Since the agency first introduced an inflation-linked bond in 1998, the French market has developed to become one of the most significant globally. The achievement is a notable one. Inflation-linked issuance accounts for just 7% of the outstanding French sovereign debt, compared with 25% of long-term government debt in the UK and Sweden. Moreover, France was the first inflation-linked issuer in the eurozone, where overall levels of such issuance are still low.

“From the very beginning the instruments were indeed well received by the market,” says Mr de Mazičres. “Since then, the aim of the Trésor, and subsequently Agence France Trésor, has been to apply the same policy that applies to all its other issuance programmes – that is to say its aim is for as predictable an approach as possible to issuance that is designed to ensure maximum liquidity – to this sector as well. Moreover, the importance of these instruments is growing: the European Central Bank, for instance, studies the forward rates of linkers as an integral part of its monitoring and monetary policy decision-making processes.”

Controversial issue

Sovereigns are the obvious source of inflation-linked supply as tax revenues rise with inflation. Even so, France’s decision to issue the first eurozone inflation-linked bonds was far from a predictable one – and was controversial at the time.

What some must have seen as a considerable risk has since paid off handsomely. Today, foreign investors hold about 42% of all France’s outstanding bonds and in the agency’s most recent linked issue, foreign investors took up to 60% of the issue. “That validates the Trésor’s original belief that these products would prove appealing to foreign investors and help to widen its investor base,” says Mr de Mazičres.

According to him, the Trésor’s original decision to begin what was then a pioneering programme was based on a detailed analysis that had been undertaken earlier. The analysis showed that there would be a growing investor need for such instruments for at least two reasons: asset liability management and portfolio diversification.

Good guesswork

The Trésor’s decision was also influenced in part by the arrival of the single currency. “The Trésor was aware it would benefit from pre-positioning France ahead of the arrival of the single currency and the eurozone-wide investor market. There was an element of guessing that an inflation-linked programme would be an optimal solution for all of these issues, since our analysis was purely theoretical, but it appears the correct decision was taken,” says Mr de Mazičres.

An additional fringe benefit from the programme is that the Trésor clearly established itself as a market leader. In the 18 months to September 2003, the inflation-linked bond market in the eurozone doubled to more than E50bn. And, as populations age and private sector pension provisions grow, demand for eurozone inflation protection is expected to start developing towards that seen in the UK and Sweden. Barclays Capital estimates that the market for inflation-linked bonds could triple to almost E1000bn by the end of 2010.

In spite of the compelling case for eurozone countries to issue linkers, to date only Greece and Italy have followed France’s lead and they remain far behind. Mr de Mazičres says that the slow start can perhaps be explained by the political debate that must necessarily precede a decision to issue inflation-linked products.

Political persuasion

At the time that France first issued, many eurozone countries – including France – had recently experienced high inflation and there was a struggle to establish the European monetary union area as an inflation-controlled zone. For a state to issue inflation-protected assets at such a time could have been interpreted by some as a mixed signal – or worse. The Trésor therefore had to face the associated political debate and make its case to the central bank and to parliament. Nonetheless, it was given the go-ahead. “Ultimately, France’s decision to go ahead with the programme was based on an analysis that was more investor-orientated than economic policy-orientated,” says Mr de Mazičres.

Since the success of Italy’s first issue, a five-year E7bn linked issue in September last year, the likelihood of a wider eurozone inflation-linked market has become stronger. Moreover, given the southern European countries’ extensive funding needs, Italy could quickly become the largest issuer in Europe.

Welcoming competitors

Even so, Mr de Mazičres is unperturbed. He says that the agency welcomes the entry of countries like Italy and Greece, even though they are its competitors, because it makes the market wider. It also helps to develop these products into an asset class of their own, which helps to ensure there will a sustainable appetite for them. With the kind of confidence that only the truly comfortable can muster, Mr de Mazičres says: “Competition is a good thing for us because it forces us to listen to the market and to be prepared to meet market expectations. It also keeps our primary dealers on their toes and ensures that they give us the best service they can.”

Mr de Mazičres says he would not be unhappy if more agencies and local corporates began to issue linked paper either. But before that happens, he may face an even more formidable competitor: Germany has said it is considering issuing in 2004.

“I don’t know what would happen if Germany came into the inflation-linked market,” says Mr de Mazičres. “Much would depend on how and when. But overall, it would be a positive development for the market, even though we would have to be even more market-friendly and astute than we are already.”

Apart from the impact that the Trésor may eventually have on other sovereigns’ issuance programmes, it has already influenced strongly the development of a derivatives market.

France’s lead in the market has, to a certain extent, allowed the Trésor to influence the structure of the market.

Dariush Mirfendereski, head of inflation-linked bonds and derivatives for UK and Europe at UBS, says: “By being the first eurozone issuer of inflation-indexed bonds, the Trésor was able to define which indices it wanted to use. The decision to use the ex-tobacco index, which is now commonly used by non-French eurozone sovereign issuers such as Italy and Greece, was related to French laws forbidding linkage to tobacco prices. Although a combination of inflation swaps linked to the eurozone HICP (all items) and the HICP (ex-tobacco) had been trading several months prior to the 2001 issue of the OATei 2012, the standard then became the Trésor-favoured ex-tobacco index. Once Italy decided to join the club of inflation-linked bond issuers and chose the same HICP ex-tobacco index, no doubt was left about the index that future eurozone sovereign issuers would use: the one picked by the French.”

Since France’s debut in 1998, the eurozone inflation swap market has developed to become the most active in the world. That France can have had that impact in such short a time is extraordinary. In a recent investor poll conducted by Barclays Capital, 75% of respondents said that they were either already using inflation-linked derivatives or planned to in the next 12-24 months.

The Trésor does not use inflation-linked derivatives itself. “We are not surprised by the development of the inflation swap market – rather we welcome it. It is another signal that the market is now fully developed and, indeed, another argument for us to go on issuing inflation-linked bonds. But at present we do not use it,” says Mr de Mazičres.

Agence anomaly

It is surprising that the agency does not use inflation-linked derivatives, especially given that it is known for its cutting-edge behaviour. And it has been engaged in an extensive swap-based buy-back programme to shorten the duration of its outstanding debt. Mr de Mazičres says of the anomaly: “At the moment, our swap programme has been suspended but in any event I doubt we would use inflation-linked swaps in it much. Given that inflation-linked bonds only account for a small share of our outstanding bonds and that our target of a global 10% share will be met through primary issuance, they are obviously not our primary targets in our buy-back programme.”

Mr de Mazičres plays down the Trésor’s reputation for innovation. He is keen to stress that the agency’s policy is dictated by sound financial sense rather than by an arrogant need to stand at the cutting edge. “Inflation-linked bonds have played and continue to play a serious role in our objective to get minimum funding costs because they expand demand. Our aim is to be transparent and innovative, but innovative in a low-risk manner,” he says.

“We are not trying to be innovative for the sake of it or for vanity but in order to meet our obligations. Our legal mandate is to manage debt and France’s treasury at a minimum cost to the taxpayer and with maximum safety. We are innovative only within that framework.”


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