Some have suggested that changing global political dynamics mean that the dollar is losing its position atop the international hierarchy. Whether or not this is the case, the fact is that the majority of the world’s debt is dollar denominated and that this gives it a unique importance.
But that does not necessarily translate to stable and efficient capital markets. 2020’s unique cocktail of volatility and disruption showed that, when the chips are down, the euro market was able to provide a more stable and reliable source of funding for the SSA market. As a result, the proportion of SSA syndications that took place in euros this year is over 50% for the first time since 2004, according to Dealogic. By contrast, dollar syndications raised less than 20% of the total for the first time since 2012.
“Traditionally, the euro market has always been more challenging than the dollar market when it comes to execution,” says Stuart McGregor, head of European SSA DCM at RBC Capital Markets. “The dollar market was easier to read, and you got more surprises in euros. That wasn’t the case this year.”
Dollars disrupted
In March, when the virus first made its presence felt in Europe, market participants looked to the SSA market to be the first to venture back into the turbulent conditions and signal to others that capital markets were open for business.
For many dollar issuers, borrowing in fixed rate and swapping the proceeds to floating rate is standard practice, but the pandemic caused such a scramble for dollar paper that the swap market was too volatile to access.
International Finance Corporation seemed an ideal name to buck the trend and re-open the dollar market, establishing a price point for others to work from. Its top credit quality and relative scarcity makes it one of the darlings of the SSA dollar buyers. A three year dollar social bond from such a popular borrower is as close to a sure thing as one can get in the primary capital markets.
Demand was no problem: more than $3.4bn of orders meant the deal was comfortably oversubscribed. Then swap spreads widened rapidly. Concerned the deal was coming too cheap, the leads rapidly sliced 4bp from the spread. Flora Chao, IFC’s head of funding said at the time: “A 4bp tightening isn’t normal, but this is not a normal market.”
But even before the deal was priced, swap spreads tightened once more and the pick-up to Treasuries that the issuer was offering collapsed from over 16bp to an eye-wateringly tight 4.4bp.
Neither the leads, nor the issuer could be blamed for such unprecedented gyrations in swap spreads. Even a move more restrained than the panicked 4bp tightening would have left investors looking at a painfully low Treasury spread, but that was scant consolation to investors when the bond was bid at 20bp over Treasuries later that week.
“It experienced a lot of swap spread volatility during the execution and immediately afterwards,” says Jamie Stirling, head of public sector DCM at BNP Paribas. “Dollars has traditionally been the safe haven, but there was such poor secondary liquidity and intra-day swap spread volatility back in March, that the euro market became the market of reference.”
Fearful of being burned, it was almost three weeks before one of IFC’s peers ventured to follow in its footsteps. And when it did, it opted to price versus the US Treasury curve rather than against swaps, seeking to avoid the sort of gyrations that affected the IFC’s deal.
Of course, the dollar market got back on track. The Federal Reserve and the US Treasury pumped liquidity into the system and eventually the market stabilised and a more normal market could resume for dollar borrowers.
For euro borrowers looking across the Atlantic, the threats were compounded. With lockdowns destroying revenues all over the world, borrowers were scrambling for dollars with which they could meet their obligations. While superficially, this would favour issuers borrowing in dollars and swapping the proceeds back to euros, the volatility was too fierce for most to venture into the market.
Even when the concerns about swaps liquidity began to fade, shifts in the yield changed the sorts of investors who were willing to participate in the dollar market. While higher yields entice some investors, central banks — one of the staple investor bases — were spooked by the increased risk and cut allocations to the sector.
“The dollar market had become very reliant on ALM accounts and central banks,” says Stirling. “With widening spreads, the official sector was less confident to invest. But the aggressive swap spread volatility and lack of secondary liquidity meant that the ALM community were also unable to play in typical size due to the large intra-day moves and inability to place orders on switch basis.”
Euros press advantage
By contrast, the re-opening of the euro market went far more smoothly, although issuers were still forced to pay up for the privilege. The German state of North Rhine Westphalia managed a smooth €1.3bn tap of an April 2023 line in mid-March, which performed in the secondary market, demonstrating that the market was still capable of providing issuers with funding in spite of the volatility. Axel Bendiek, NRW’s head of funding, remarked that “the SSA market was where funding activities should recommence”.
Olivier Vion, head of SSA debt capital markets origination and syndication at Société Générale says: “The fact is that execution has simply been easier in euros than dollars this year.”
The reason for this is hardly a mystery. The launch of the ECB’s pandemic emergency purchase programme was announced the day before Land NRW’s deal. “It’s just taken away many of the concerns around execution in euros,” says McGregor. “It’s the biggest buyer in the secondary market and it provides a great opportunity for arbitrage.”
Perhaps the clearest example of the way the ECB has reduced execution risk for SSA primary markets comes from the German Länder. Their penchant for fully underwritten deals has allowed them to come to the market at prices too aggressive for investors to stomach. Much of the deals have ended up on leads’ books, and shortly thereafter with the ECB.
“We’re seeing these deals that are undersubscribed tighten in the secondary market after a week or so because of the ECB’s buying pressure,” says McGregor. “The ECB’s actions are clearly helping to support these levels with their buying in the secondary market.”
Market participants will certainly hope that 2021 does not contain the same levels of volatility and market disruption as we have suffered in 2020. But this year may have taught issuers a lesson that will not soon be forgotten: in times of trouble, the global scramble to hold dollars in times of trouble can create volatility and make the primary dollar market an unforgiving place.
“Back in 2008, dollars was the currency that initially offered issuance opportunities despite the backdrop of severe volatility, but in 2020, euros actually provided a deeper, more transparent primary market,” says Stirling.
Duration drives euro appeal
With the pandemic forcing central banks into action, rising rates have rarely seemed further away. As a result, many of the sector’s most substantial borrowers are focusing on lengthening the duration of their debts.
Since the dollar market is only reliable out to around the five year mark, many issuers will be relying on the euro market more heavily than they have in the past.
World Bank is one such borrower. Andrea Dore, head of funding, says duration is a key focus for its new funding programme. As a result, the $80bn equivalent World Bank has raised as of November 20 in 2020, around €14bn has been in euros. For World Bank to rely on the euro market for 17.75% of its annual funding is a remarkable development.
From 2009 to 2019, euros provided an average of 6.1% of World Bank’s annual funding programme.
But the dollar market will remain an unavoidable necessity in the programme of every issuer of a certain size. While many issuers are lengthening the tenors they’re looking for, that doesn’t suit everyone’s book.
“For sovereigns, they’re happy to term out debt, but for agencies who are lending the money on, not everyone wants 30 and 50 year loans, as they prefer to fund shorter,” says Vion. GC
