The European Union has not traditionally been a big borrower. In the past several years before 2020, it consistently raised well under €10bn a year. But the coronavirus pandemic has changed all that.
In 2020, the EU raised a whopping €39.5bn for its Support to Mitigate Unemployment Risks in an Emergency (SURE) funding programme alone, which provides loans to EU member states to address sudden increases in public expenditure and help protect jobs.
That amount was raised through two vast dual-tranche transactions and a third deal, all in a period of just over a month, between October and November. All of the EU’s SURE funding is being conducted through syndicated social bonds.
“The EU did a fantastic job and had truly unparalleled success,” says Lee Cumbes, head of public sector EMEA at Barclays in London. “If you go back just a few months prior to the first transaction, the EU had relatively small amounts outstanding in the bond market, with limited liquidity and no clear precedent for this sort of issuance programme. So, to issue tens of billions in such a short space of time is incredibly impressive.”
The EU will round off its SURE funding — which could be as much as €100bn in total — in the first half of 2021 before kicking off an even bigger programme for its €750bn Next GenerationEU (NGEU) recovery fund. That could result in the EU raising over €170bn in 2021 alone by some estimates.
Communication the key
The first few deals of the EU’s SURE funding programme in 2020 were blowouts by all measures. The order books were world beaters, the new issue premiums were tiny despite the huge deal sizes and the secondary performance was incredible. So what helped drive the success?
“One element which was crucial was the communication strategy,” says a funding manager for the EU in Luxembourg. “We organised two global investor calls where we explained the key factors of the SURE programme and how we intended to implement the issuance plan.”
Cumbes at Barclays says: “The EU did a great job preparing the market with the two global investor calls and the use of online presentations.”
He continues: “There were questions over the approach, with some people asking for more direct access, but simply look at the enormously successful end results as a measure of the strategy. Investors had what they needed and everything was released at the same time to all participants in order to make it fair.”
The EU is aiming to build on its relationship with investors in 2021, as it boosts the size of its funding team.
“In the past months, we have worked to strengthen and increase our funding team and will continue to do so in the coming months, in the run-up to [the NGEU programme],” says the EU funding manager. “Next year we aim to build a deeper relationship with the investor community, including by adopting a more personalised approach, when applicable. The bigger team will make it easier for us to achieve that.”
There were also supportive technical factors that helped drive the EU’s success.
“One was that the EU was issuing into a market with net cash inflows,” says Cumbes. “Many governments had funded heavily before the summer to manage against any worst-case scenarios, which were often not reached. Therefore, in a number of markets, supply had dipped when the EU came, at the same time ECB stimulus remained very strong. So it was an incredibly powerful environment for a borrower of EU’s prestige to enter into with a high quality, liquid product, ideally suited to a lot of that excess demand.”
Competing supply
But the backdrop will not be as supportive for the EU in 2021, especially in the first part of the year when every borrower will be keen to press on with its new funding programmes.
“Of course that’s something to be taken into account especially in the first quarter,” says the EU funding manager. “We will implement a strategy that would allow us to achieve maximum efficiency, for example by continuing to proceed with bigger transactions.”
“Their first trade of 2021 will be another test depending on the size that they will looking for but we believe that this early success has highlighted the strong investor support for large, liquid EU benchmarks,” says Jamie Stirling, global head of sovereign, supranational and agency debt capital markets at BNP Paribas in London.
It will not just be fierce competing supply that the EU will have to contend with in 2021. The EU will also be navigating an even bigger borrowing programme as it adds up to an extra €750bn for the NGEU recovery fund.
The EU aims to begin the funding for its NGEU recovery fund at around the end of the second quarter or at the start of the third quarter of 2021, as soon as it completes its SURE programme.
The European Commission has said the borrowing for the NGEU recovery fund will be completed by the end of 2026, with 30% of the funding coming through the issuance of green bonds.
With the bigger programme of NGEU, the EU is also expected to expand its funding toolkit with the use of auctions and other products.
“If you look at the amount of issuance involved, it is more or less on par with the bigger sovereigns of the EU,” says the EU funding manager. “So it’s quite logical to say that in terms of the funding tools and methods of issuance, we should be on par with them. Sovereigns have a variety of funding tools at their disposal and we intend to follow that path.”
Andrea Iannelli, investment director at Fidelity International in London, expects the EU to raise at least an additional €100bn in 2021 taking into account the borrowing for the NGEU recovery fund.
“We may see some cheapening and bigger new issue concessions but that’s normal and expected,” says Iannelli, adding that the sustainable tags of the EU’s issuance would help drive the demand.
Supranational or sovereign?
With the volume of issuance that the EU is expected to raise over the coming years and if it broadens its funding toolkit, there is the question of whether the EU will therefore be aligned more like a sovereign than a supranational borrower.
“The EU is still perceived as a non-sovereign SSA,” says Klaus-Peter Eitel, head of public sector at Commerzbank in Frankfurt.“What remains to be seen is whether the current perception of EU can be sustained or whether the EU will gradually gravitate to become a sovereign issuer and will therefore need to be compared to a different set of peers.”
“Clearly from a volume perspective they already can be compared to a sovereign issuer,” says Eitel. “Yet for now their funding is for a dedicated purpose and it’s backed by extra guarantees and budget contributions of individual member states with a finite timeline. Whether the EU will finally get the envisaged authority to collect its own taxes — a key element for any sovereign — and how far Europe proceeds towards debt mutualisation are key questions yet to be answered in that respect.”
Stirling says: “In terms of how you classify the issuer, it’s almost in its own asset class — a supra/sovereign hybrid. It offers more spread than Germany yet now trades through or flat to France across the majority of the curve.”
Could the EU eventually rival the Bund as a liquid safe asset for the eurozone?
“I’m not sure,” says Ianelli. “We’ll have to wait and see. The depth of the Bund market is unparalleled in Europe. The amounts coming from the SURE and recovery fund programmes will be substantial but it’s still not going to be as big as the Bund market to rival it. Also, the most liquid benchmark bonds tend to have futures markets associated with them.”
Distortion ahead?
A potential impact of the EU’s huge issuance programme is that it could lead to a distortion to the broader SSA bond market.
“With the sheer amount of volume the EU will have to raise the premium it needs to pay over its SSA peers should drag other SSAs wider,” says Eitel. “And in theory, we should see a more pronounced impact in longer tenors given the average duration of the SURE funding is 15 years, thus substantially longer than any other SSAs duration.
“However, in practice we are not seeing this for now. So whether EU fair value will remain where it is with no impact on other SSAs will be subject to the political process mentioned before but equally important it’ll be subject to ECB purchases that effectively can dictate pricings.”
Cumbes at Barclays is confident the market can take it.
“Given the size of the programme, the market has been extremely resilient with little to no distortion,” he says.
“Just look at the yields of existing high quality bonds and you can see that there is huge demand for safe assets. As such, there is great capacity out there for future issuance.” GC
