Participants in the roundtable were:
Hartmut Buscher, director, public sector and frequent borrowers, Commerzbank, Frankfurt
Frank Czichowski, senior vice president, treasurer, KfW, Frankfurt
Tammo Diemer, managing director, Finanzagentur, Frankfurt
Rainer Guntermann, director, senior strategist, Commerzbank, Frankfurt
Sudip Roy, vice president, portfolio management fixed income, Deutsche Asset & Wealth Management (DeAWM), Frankfurt
Frank Scheidig, managing director, global head, senior executive banking, DZ BANK, Frankfurt
Phil Moore, moderator, GlobalCapital
Global Capital: Let’s start by looking at the German economy. With economic growth accelerating and inflation subdued, the outlook appears to be benign. But what are the risks?
Rainer Guntermann, Commerzbank: We agree that the outlook is benign. We’re forecasting growth of 2% this year and next, with inflation at between 1.5% and 2%. This implies that in the eurozone context Germany will do better than most or all of the other member states. We think that in aggregate a growth rate of only about 1% is feasible for the eurozone in the current environment.
On the positive side we also see a broadening of growth, with investment and consumption both improving compared to previous years, which is supported by the tailwinds of the low interest rate environment.
But there are also some clouds on the horizon in the form of external as well as some home-made risks. For example, upward pressure on wages, partly due to the minimum wage reform, may weigh on investment decisions going forward.
Then of course we can’t ignore the global risks arising from developments in emerging markets. We’re cautious on China where we see more downside risks than consensus at the moment.
Global Capital: It is 11 years to the day since Gerhard Schröder’s speech paving the way for the Hartz Reforms which are credited with enhancing German competitiveness. But with pressures rising for wage increases, is there a risk that some of this competitiveness will be eroded, and that German inflation will rise sharply?
Sudip Roy, DeAWM: Inflation isn’t such a big topic within Germany. The general outlook across the eurozone is towards lower inflation. So there may be a temptation for the ECB to respond by cutting rates because of the pan-European inflation outlook.
We seldom hear the ECB talking about inflation within individual countries. We all agree that inflation in Germany is higher than it is in the peripheral countries. But a deflationary trend in southern Europe is actually something that is welcome, not only by the German public but also by economists – because what we’re all hoping for is a lowering of unit labour costs and a more competitive scenario in southern Europe.
Global Capital: But is potential pressure on labour costs in Germany a concern?
Frank Czichowski, KfW: When you target an inflation rate within a currency area, then by necessity there will be differences from country to country. If you have lower inflation or even a reduction in wages in certain areas, you by definition have higher inflation in others. I don’t think this is a concern as long as the overall rate does not get out of hand. But nothing is pointing in this direction at the moment. Quite the opposite. In terms of inflation, we’re probably a little bit below what everybody would like to see at this point.
We need to talk about inflation in a euro area context rather than in a German context. It is pretty obvious that if we want to make adjustments in the eurozone overall there must be different paths of development in different parts of the eurozone. We’re working towards a rebalancing in the eurozone, which means that relative pricing will have to adjust, which may mean there is a little more wage inflation in one part of the area than in another.
Global Capital: So you would echo the view that the outlook for the economy is benign?
Czichowski, KfW: As far as the growth and inflation parameters are concerned, yes.
A relatively positive momentum is coming out of the US. Within Europe, I think we all agree that we will see an improvement both across the eurozone and in Germany in 2014 compared with 2013, and the outlook for 2015 is also positive. All this is benign, but there are external risks out there which may reduce economic activity in the eurozone. This is perhaps the biggest concern we all have at the moment.
But the eurozone’s institutional framework and its monetary and fiscal policy have all made big progress over the last couple of years. As a consequence we are enjoying relatively positive momentum.
Roy, DeAWM: Inflation is a secondary policy variable. Growth in the US is solid and positive. It is also picking up in Europe. The interest rate outlook would normally be related to the growth outlook. But the discussion about deflation is causing the opposite effect. Given the growth outlook you might argue that there is a case for slightly higher interest rates. But the monthly inflation report creates some tension because it can reinforce the growth and interest rate outlook or it can do the opposite. So while you might expect eurozone interest rates to be linked to US monetary policy, the inflationary outlook can be a stronger influence on policy actions.
Tammo Diemer, Finanzagentur: Unit labour costs in Germany are still very low compared to those in other EU member states. Other countries are improving, but the German economy is still very competitive and demand for German products is high throughout the world. Therefore the overall environment from a capital market perspective remains very positive.
Czichowski, KfW: I think the biggest challenge we face in Germany is comparatively low levels of gross and net investment which is also reflected in a relatively high current account surplus. This is probably something that over the long term we need to address both in the public and private sectors.
Frank Scheidig, DZ Bank: If you look at Germany in isolation from the other members of the eurozone, I’m a little more bullish.
If you talk to the Mittelstand companies that are the backbone of the German economy, their order books are already looking far better than they did at the end of last year, and they had a very good first quarter.
On the private front, high net worth individuals have increased their investment in real estate, although we are still a long way from seeing a bubble in the market.
All this leads me to believe that we will see a growth rate above 2% this year, with private consumption picking up. But I also expect slightly higher inflation as a result. If at the same time you take into account that Germans don’t like investing in equities, which in my opinion is not a positive factor, I believe that we’ll see much higher spending figures than are projected by most of the forecasting institutes.
Global Capital: The fact that Germans don’t like investing in equities is good news for the people around this table, isn’t it?
Scheidig, DZ BANK: You could turn the question round and say that in 20 years from now people who were investing for their pensions may look back and wish they had invested in equities. But the German mentality in general remains risk averse. We have the same problem with start-up companies in Germany. On the one hand we have a real economy that is one of the strongest in the world, but on the other the willingness of the financial industry to support venture capital is low, which is why this is still left to institutions like KfW and other development banks. We don’t have a broad venture capital culture and support for start-ups is in short supply. Technological innovation tends to be financed in the US or elsewhere rather than in Germany.
Global Capital: Is Germany’s rising current account surplus anything to worry about?
Hartmut Buscher, Commerzbank: It’s not negative. It’s symptomatic of a very specific strength of the German economy, which is exports. But it’s not something we want to be too dependent on.
Czichowski, KfW: In my opinion the issue of a current account surplus should not be looked at in the context of one single year. It’s driven by very high competitiveness, a relatively high savings rate and low domestic investment. There is also a demographic driver in Germany, which is related to the high savings rate.
You can’t run a current account surplus forever. The current account surplus is probably something that needs to be analysed to see whether there are imbalances evolving over the long term, which need to be addressed.
Global Capital: Let’s move on to look at the funding programmes of the borrowers around the table. Tammo, starting with the Bund market, how would you describe the evolution of the Finanzagentur’s funding strategy in 2013?
Diemer, Finanzagentur: For the Bund, 2013 was a very successful year from a capital market perspective. Our bank partners in the auction group worked very effectively and supported each of our auctions in a very reliable fashion.
In 2014 we have continued with the same funding strategy, although the total refinancing volume is lower than it was last year. In 2013 we had €257bn of new issues whereas in 2014 this will fall to roughly €217bn. We have reduced our short term activities in our six and 12 month Bubill transactions, although we have slightly increased our issuance activities in the inflation-linked segment.
Our long-term two, five, 10 and 30 year issuance volumes will be pretty stable this year, with an emphasis on the 10 year maturity and a slight decrease in the two and five year sectors.
We are planning 71 auctions in 2014 and another slight difference this year is that we have already announced the precise dates, volumes and instruments for the full year whereas in the past we just had a forward calendar for the next quarter.
The reduction in our refinancing volume is the result of two things: first, since 2009 we have slightly increased the outstanding average maturity of our debt year-by-year. Second, our budget has also shown a reduction, and in 2014 the government is only planning for €6.5bn of new deficit funding, which compares with €22.1bn in 2013.
Global Capital: KfW also saw a notable reduction in its financing requirement in 2014, didn’t it?
Czichowski, KfW: We did indeed. In general terms it is probably true that 2013 was a very good year for issuers as well as investors. Spreads only headed in one direction, as a result of which demand for debt securities remained very substantial and new issues all went relatively well.
We started the year with an assumption that we would raise €70bn to €75bn. As a consequence of an increase in pre-payments in our loan business we ended the year with an issuance volume of €65bn which therefore represented a reduction in our funding programme.
About 50% of this total was raised in euros. There were still relatively good refinancing opportunities achievable in a range of other currencies such as US and Australian dollars, both of which offered attractive levels when proceeds were swapped back into euros.
One important theme of 2013 was the continuous quest from the investor’s side for highly liquid product. We catered to this demand by issuing several large and liquid benchmarks of €3bn to 5bn or $3bn to $5bn. These accounted for about 60% of our total funding in 2013, which was a record for us. Non-benchmark issues and private placements accounted for the remaining 40%, so the quest for liquidity among banks, central banks and asset managers has increased significantly.
This year we expect our requirement to be between €65bn and €70bn. The big difference for us won’t be a change in strategy because we will still look to issue in a mix of benchmarks, non-benchmarks and private placements. The biggest change for us will probably be in the currency mix. The favourable funding conditions we saw in non-euro currencies as a consequence of the basis swap has partly disappeared or in certain cases even reversed. We now often see better funding opportunities in euros compared with funding in other currencies on a hedged basis. As a result we will probably end up with a higher euro share in our overall funding than in previous years.
Another trend we’ve observed in 2014 so far is a continued tightening of spreads. Everything has been moving tighter and tighter and it will be interesting to see how far this can go before any cracks start to appear. You get the feeling that certain securities may be a little bit too expensive now.
Global Capital: Frank used the word ‘cracks’ but are tensions starting to emerge at the auction level? There was some negative comment in the press about demand at the 30 year auction in February.
Diemer, Finanzagentur: I think it’s important to bear in mind that federal government bonds play a role as the benchmark for the eurozone and are therefore not just regarded as a high quality investment. They also play other roles. For many investors they are regarded as a cash surrogate in the second most important reserve currency in the world, or they are used as an instrument for hedging interest rate risk. Therefore the majority of our investors view German government bonds as a rates instrument rather than as a yield product.
In the case of our first 30 year bond auction of 2013 in February which you mentioned, from the perspective of the Federal Republic this was a successful exercise. It was a €3bn issue which was slightly uncovered. The amount we issued was in line with the range that was originally planned. Not only did we price the issue in line with the secondary market. We also did not allocate the full non-competitive bids in this auction. That indicates that the intention of the issuer was not to issue the full €3bn, but a smaller amount, which we achieved successfully.
As with all our issues, some bonds were held back for placement in the secondary market after the auction.
Buscher, Commerzbank: It’s also fair to point out that just a few days later the average yield following the escalation of tension in Ukraine had fallen to about 2.43% compared with 2.53% at the auction. Since then it hasn’t risen back above 2.53%, which demonstrates the strength of demand for the product in the secondary market.
Czichowski, KfW: I would agree that it is important to look at this demand not in a 10 minute snapshot but from a much longer-term perspective.
Scheidig, DZ BANK: Given the uncertainty over the geopolitical situation, I think we can expect a lot of volatility in the next few weeks and months. But over the medium and long term if you look at the precedent of Japan, yields are now at a level where some strong performance can still be expected.
Global Capital: I guess the point that Tammo was making is that in the market for Bunds the word ‘yield’ is a misnomer.
Diemer, Finanzagentur: Exactly. Plus the fact that our new issuance activity is directly linked to the secondary market. In other words, the supply-demand price discovery process is determined on an everyday basis in the secondary market. Our auctions are a direct reflection of this process.
Global Capital: So the price is, by definition, right?
Diemer, Finanzagentur: Yes.
Scheidig, DZ BANK: You should also not forget that the central banks of the European member countries which are an important part of the investor base for the Bund as well as for KfW are unable to buy in the primary phase. They have cash that they need to invest and they do so in the secondary market.
Buscher, Commerzbank: I do believe this question as to whether yields are too low for investors is reflected in a number of other ways. If you look at the relative performance of Bund spreads versus other public sector issuers and corporate bonds there has been a consolidation over the last two or three years.
To the extent that regulations or internal guidelines allow, investors will try to buy higher yielding assets. But benchmark yields are where they are because of investor demand at these levels.
Roy, DeAWM: At the beginning of the year the whole investor community had made up its mind that 10 year Bund yields would reach 2% or 2.25% by year end, with US rates at about 100bp or 120bp over Bund yields. So people have been waiting for Bund yields to show this 2% figure.
But what we’re now seeing bears out exactly what Tammo said, which is that Bunds serve a much wider range of purposes. Bund investors don’t really use it as a yield surrogate. In a risk-off scenario they use it as a hedge investment, and in derivatives transactions for collateral purposes, because there is a lack of alternative, very solid triple-A paper. Even those other securities with a close to similarly high rating, such as Dutch and Austrian government bonds, are not close to Bunds in terms of liquidity or size.
You can do all sorts of studies on GDP growth and idiosyncratic features such as the Dutch real estate market or the bad bank problem in Austria which ought to impact government yields in such highly rated economies elsewhere in the euro zone. None of this really helps very much because all these securities trade in a very close range to Bunds.
So Bunds are still a rates play. What is observable for investors like us is that investors are buying aggressively into Spanish and Italian debt and we’re seeing spread compression almost on a daily basis between Germany and those peripheral countries.
Hopefully this spread differential between the core and the periphery won’t disappear altogether, because then we’d have a similar situation to pre 2007 and 2008 when markets in the eurozone become a pure duration and rates play. That would make it very hard for all investors to generate a decent yield and to generate any attractive investment performance.
Scheidig, DZ BANK: I have the feeling that major investors don’t trust the trend they’re seeing. Instead of switching into US investments — be it US Treasuries or something similar — euro-based investors are holding back at the moment. They still want confirmation of what people were saying 18 months or two years ago, which was that elements such as fracking were going to enhance US competitiveness and accelerate US economic growth.
US figures have been good. That is true. But not as good as were being forecast some months ago. In spite of uncertainties about the Russian situation, this is making people feel more comfortable with the euro than with the dollar at the moment.
Guntermann, Commerzbank: I agree. But I would re-emphasise that monetary policy plays a crucial role in all this. The ECB has indicated that interest rates are likely to stay low for longer and could even fall further from here. We don’t share this expectation, but there are clearly risks which could push rates lower.
The ECB has also made it clear in its last meeting that it is able and willing to drive a wedge between US and euro rate dynamics. The ECB is focusing now on economic slack, which is relatively new. The message now is that the ECB is willing to keep rates low even if there are signals of an economic recovery in the US or globally. The message is therefore that even if there are rate hikes in the US, the ECB does not necessarily have to follow suit.
This will keep interest rates low for core issuers such as the German sovereign and lead to further spread compression, given the continued hunt for yield. I wouldn’t be surprised to see long-term peripheral yields falling to record lows. We’re already very close to those levels.
Czichowski, KfW: I think we’ve already reached a record low for combined euro issuance. If you were to create a synthetic euro-bond we would now be at something like 2.5%.
Buscher, Commerzbank: We’re still seeing convergence in bond yields in the public sector. But interestingly, the convergence is mainly downwards towards Bunds and the other more expensive issues, rather than a convergence upwards towards the cheaper peripheral sovereign issues, which could also have been a possibility.
Maybe the biggest risk is that if inflation expectations pick up again, the required inflation risk premium would push nominal yields higher – although this is not something we expect to see any time soon.
Roy, DeAWM: All of a sudden we’ve seen 10 year treasuries versus 10 year Bunds showing a spread differential of 130bp. Traditionally your models would tell you that something closer to 100bp would be more appropriate. But at 130bp, as Frank said, this raises the question of why investors aren’t buying dollars, because if you can get 1% more there than you can in Bunds, you have to ask yourself who is still buying core euro rates.
The answer might be Asian investors and central banks. But why the dollar is not attracting more investors is a bit of a puzzle. Imbalances are piling up, with the euro-dollar rate now going in the direction of 1.40, and the rate differential of 10 year treasuries to Bunds standing at 130bp. This implies that if there is a reassessment of inflation expectations, and higher yield differentials as a consequence, there could be a very fast reversal of investment flows, just as there was last summer between mid-May and the end of June.
Global Capital: Sudip mentioned Asian investors. It’s notable that KfW saw a huge placement into Asia last year. Was this driven by Abenomics or did the demand come from non-Japan Asia? What feedback are you getting from Asian investors today?
Czichowski, KfW: In our case the demand was not a result of Abenomics. We have not seen big shifts in Japanese demand. What we have seen is strengthening demand from very big institutions, especially central banks. It’s a very simple story.
Private banks and high net worth individuals in the region look for completely different assets. We don’t fall within their sphere of interest.
Scheidig, DZ BANK: The important point about central bank demand is not that their relative allocations to various asset classes or currencies are changing, but that their reserves in absolute terms are increasing. At the same time, total supply from issuers like the Bund and KfW is not rising. Next year supply from the German government may even fall.
That means that central banks which have to invest their reserves have very few options. They’re not like a PIMCO which can pick and choose on the basis of relative value. If they have a percentage of their growing reserves in euros, these central banks don’t have much alternative to the Bund or KfW.
Czichowski, KfW: This development has been particularly pronounced in our dollar programme, which accounted for a record 39% of our total issuance in 2013. There were two important factors that drove this. The first was that because of the basis swap market, issuers like us were able to pay yields that were relatively high compared to US issuers.
The other factor was that prior to 2008 there was a high supply of dollar-denominated issues by European SSA borrowers. The financial crisis slowed this down considerably. Immediately after the height of the crisis, there was only a limited number of issuers that were able to issue in dollars targeted either at the US or Asia. These issuers were beneficiaries of the strength of dollar demand from Asia.
Today, things have normalised. More issuers are able to issue in dollars again, spreads are getting tighter and the basis swap market no longer gives us such an attractive cost advantage. So I expect our dollar issuance to decline somewhat, and as a consequence the Asian share of our overall investor base will also probably decline a little because dollars account for a large share of their currency reserves.
Scheidig, DZ BANK: The bulk of Asian central banks’ euro allocations are most likely to go to the Bund, because there is no instrument with comparable liquidity in the euro area.
Czichowski, KfW: Asian central banks are a very important part of our investor base, but they are not dominant. One of the most significant developments we’re seeing at the moment is the need for very liquid instruments for bank balance sheets, for collateral purposes. This is creating structural demand for top-rated securities.
We see this in our euro issuance, where more than 50% of our benchmarks are bought by banks which need the paper in order to fulfil their liquidity coverage ratio requirements.
Scheidig, DZ BANK: If you look at the savings and co-operative banks sector, with hundreds of smaller and medium-sized banks spread all over Germany, they were traditionally able to invest in a wide range of bank names. In other words, their appetite for bank credit was very strong.
Now, as more and more of these banks’ bonds are reaching maturity, they have to shift their exposure towards liquid, high-end securities. That means they are shifting into Länder, Rentenbank, KfW and Bunds.
Global Capital: Everything we’ve heard so far suggests that yields have further to fall, doesn’t it?
Buscher, Commerzbank: Everything we’ve heard describes the ongoing need for this asset class. It at least describes that we are likely to see a further consolidation in levels between different issuers from the segment. How far this process can go, and if this will result in lower absolute yields, is a question I’ll leave to Rainer.
Guntermann, Commerzbank: I go back to the macro discussion. There is still a case for arguing that yields may fall slightly further. Some macro developments spilling over from the US, however, may suggest we are close to the bottom.
In terms of inflation, there may be some slippage over the next few months. But after that we would expect to see some stabilisation which would help to build a floor into the overall yield environment.
Our expectation is therefore for moderately higher yields towards year end. We believe that it will be difficult for Europe to remain immune to the adverse impact of rising US rates. So although the ECB will try to put a wedge between the dynamics of the two curves, we think Bund yields will be closer to 2% by the end of the year.
Czichowski, KfW: One thing I find fascinating is that if you look at economists’ analysis, they tend to be good at projecting economic development. They are usually quite accurate in terms of variables like GDP growth.
When it comes to yields, in 95% of cases they seem to make over-estimates. The question is: why? It seems to me that their respective forecasts are based on an analysis of historical patterns.
We’ve discussed some of the structural factors that determine yields, such as demand for certain types of instrument. But maybe we under-estimate the impact of demographics, which are creating bigger pools of money, which in turn chase certain assets.
We need to be very careful about saying that this time things are different. But there may be a need for a shift in expectations as far as real yields are concerned. It may no longer be possible to achieve a real yield of 2%.
Roy, DeAWM: Some economists say that 3% is the new 5%. There is a discussion in the US arguing that yields should reflect the price of capital. The price of capital is dependent on investment and savings flows, demographics, inflation expectations and growth potential.
The scenario we’re facing in the post-recession period is that it is taking very long for yields to rise back towards 3%. Maybe, as Rainer said, we’ll see 2% by the end of 2014. But 2% is what we were already seeing at the end of June last year, when people were saying that Bund yields would go to 2.5% and US Treasuries to 3.75%. Now we’re back to saying 2% by year end would be nice.
Perhaps there is less need in an information-driven economy for capital to be deployed, which may be one reason why the price of capital has fallen so far. Also, with a lot of capital flowing out of Asia, where social security systems are less developed than they are in Europe or the US, yields will also be compressed further.
So maybe economists are right to say that in a post-recession world 3% is the new 5%. We’re not there yet, because central banks are buying us time. But as Frank said, it may not be possible to return to the old yield environment within the next three to five years.
Scheidig, DZ BANK: I agree with a point that was made earlier, which is that when markets turn, they do so very quickly. Portfolio managers in particular, many of which have a lot of new money to invest, will change their focus very fast if expectations for rates change.
Let’s assume – hopefully – that the Ukrainian situation does not escalate. If that is the case, a turnaround in market sentiment could come very quickly, perhaps in early summer.
Global Capital: Let’s return to the nuts and bolts of the borrowers’ funding programmes. Is anything new or different happening in the Bund’s inflation-linked issuance policy?
Diemer, Finanzagentur: The inflation-linked segment is a very important refinancing instrument for the Bund. As I already mentioned, our total issuance volume is increasing compared to 2013.
As a benchmark issuer, our objective is to offer inflation-linked bonds alongside fixed rate instruments. But also, inflation-linked products play an important role in our strategic management of our debt portfolio. They add value to the balance between current and foreseeable future interest expenses.
We started issuing inflation-linked securities in 2006 on a very opportunistic basis. Since then we have developed a much more strategic approach to the market. We have not reached the same amount of precision in our forecasts for issuance activities as we have in the rest of our funding programme, but over the last year we have committed ourselves to auction at least €1bn each month, except in August and December. This year we have indicated that these auctions will take place on the second Tuesday of each month, so already we have established a fairly precise and strategic calendar of issuance.
Global Capital: Do you remain committed to issuing inflation-linked securities up to a limit of 5% of your total outstanding debt?
Diemer, Finanzagentur: It will increase slightly, in line with the overall rise in our issuance this year, but there will be no dramatic increase in issuance volumes.
Czichowski, KfW: We have issued inflation-linked securities. But we are in a completely different position to the Bund in the sense that we have to manage a balance sheet and we have no exposure to inflation on the asset side. So we don’t need exposure on the liability side for hedging purposes.
The swap market for inflation is rather thin anyway. There was a time when everybody wanted to receive rather than pay inflation, which made the market very lopsided.
We’ve done a couple of small private placements and we did one public transaction many years ago. But it’s not an instrument with sufficient liquidity to bring us an interesting funding opportunity for the time being.
Structurally I still can’t see who in the market would want to pay rather than receive inflation at the moment. I can see plenty of investors wanting to receive inflation, but it’s hard to see who the natural payer would be.
It’s also a challenging market because inflation comes in so many different forms. Individuals and institutions are exposed to very specific kinds of inflation, which may be skewed towards a certain region or basket. So long-term I don’t see the case for the development of a big linker market outside the government sector where there is so to speak a natural income stream linked to inflation. For banks and SSA borrowers outside the sovereigns I don’t see the case for issuance in significant amounts.
Roy, DeAWM: Inflation was a topic two or three years ago. At the time, as Frank said, everybody was interested in receiving inflation. This is no longer the case.
Global Capital: So who are the major buyers of German inflation-linked bonds?
Diemer, Finanzagentur: The main investors in our inflation-linked bonds are pension funds and life insurance companies which need to receive inflation for asset-liability management purposes.
Global Capital: What are the implications of this for liquidity in the secondary market?
Diemer, Finanzagentur: Our observation is that overall liquidity in the inflation-linked segment is stable. It is increasing slightly, but not compared with the rest of the market.
Within this segment there are flows towards the highest quality issuers, such as the Bund, since inflation-linked investors are highly dependent on being repaid the full amount on a timely basis. So creditworthiness aspects play an increasingly important role in this segment of the market.
Czichowski, KfW: Inflation-linked bonds can also be a very expensive product for issuers to hedge.
Buscher, Commerzbank: Back in 2009 and 2010, from a DCM perspective it was clear that there was demand for this product. But as Frank pointed out, as long as the hedging options are so expensive, it is difficult to create supply as there is only a very limited number of issuers who can use this market on an outright basis.
Global Capital: Has there been any change in the Finanzagentur’s strategy in non-euro currencies in general, and more particularly in its attitude towards the dollar market?
Diemer, Finanzagentur: No. We continue to look at the dollar market on a purely opportunistic basis. If we can achieve cheaper funding using a dollar instrument then this is something that would be interesting to us. We analyse the opportunities in the dollar market on a regular basis and in 2013 we came to the conclusion that there was no window open for us to issue at a competitive level. Given cross-currency basis swap spreads today, and given US Treasury yields compared to Bund yields we see a similar picture in 2014 as we did in the previous year.
Czichowski, KfW: We have a more strategic approach to the dollar market because we do have a lending business in dollars. We want to ensure that we have access to the dollar market both in the short and long term.
We used the dollar market quite actively over the last couple of years to refinance our euro book because it provided us with good value. That is still the case but no longer to the extent seen in the past. There will still be dollar issuance from KfW but — as things stand currently — in somewhat lower volumes.
Global Capital: Core euros and dollars accounted for 87% of your funding last year. Is that an unusually highly concentrated share for KfW? Did it reflect lower demand for currencies like sterling, Swiss francs and so on?
Chichowski, KfW: To turn the question around, the 13% we issued outside these two currencies is still a significant amount in absolute terms, given the total size of KfW’s funding programme. In relative terms, for us the amount we issued in other currencies was not very large. Nevertheless, in the kangaroo market for example we were the biggest issuer last year.
But the euro is our home currency and the dollar is the largest capital market in the world, so for the time being we will continue to fund the bulk of our needs in these currencies. We diversify as much as we can, and we are continually looking at other opportunities, but I wouldn’t expect the share of non-core currencies to reach more than 20% of our total issuance in the foreseeable future.
Global Capital: You’ve just passed a landmark in the Uridashi market, haven’t you?
Czichowski, KfW: We recently printed our 200th Uridashi issue which is quite an achievement. The Japanese capital market is important for us because it was the first international capital market we entered, back in 1985. We’ve been present there ever since. Volumes are good and Japan gives us a loyal and consistent investor base.
Global Capital: What about the RMB market? We’ve just seen Daimler-Benz sell its first RMB-denominated bond, so links between Germany and the Chinese capital market continue to develop.
Scheidig, DZ BANK: Over the medium and long term I’m very positive about the evolution of the RMB market. It’s already the world’s second most important currency for trade finance, and I believe it will become one of the top three reserve currencies within the next five to seven years. I also believe that Frankfurt will develop into an increasingly important RMB offshore hub within the eurozone.
Roy, DeAWM: It is very interesting that in the last few weeks we have seen rising volatility in the RMB, which suggests it is no longer regarded as a one-way street, or as a currency that is guaranteed to appreciate by 2% or 3% each year.
Global Capital: That’s healthy, isn’t it? It’s rather like the recent corporate bond default from China because it shows a genuine market is developing.
Czichowski, KfW: Just as we were arguing when we were talking about the inflation-linked segment, a market can only develop if there are two different opinions expressed. I agree that in the long term the RMB market will become increasingly important, and that Frankfurt will play a role in its growth.
Diemer, Finanzagentur: We follow developments in this market and I share Frank’s view that it has exciting long-term potential. But it plays no role in our funding strategy.
Global Capital: Another theme that came across very strongly in KfW’s preview of its funding programme for 2014 was sustainability. What role do you see SRI playing in KfW’s future funding strategy?
Czichowski, KfW: It’s a theme which is clearly gaining a lot of momentum. We’re seeing more and more investors adding sustainability criteria to their investment strategies. We’re also seeing dedicated portfolios being built up in this area.
The growing importance of the theme is evidenced by the large number of signatories to the Principles for Responsible Investment (PRI). We think the trend towards building sustainable equity and fixed income portfolios is here to stay.
This is something we take very seriously at KfW. We were one of the early signatories to the PRI. In Germany we co-chair the PRI’s fixed income group with a view to developing new projects in this market, and we recently hosted a German conference on PRI. It sits very neatly within our overall mandate given that we are a long-term development bank.
So we give a lot of thought to how we can address these challenges not just in our lending business but also in the management of our funding programme.
Global Capital: But conceptually can a development bank like KfW issue something called a Green or sustainable bond? Wouldn’t that by definition imply that your other issuance is brown or black or whatever?
Czichowski, KfW: For the time being we haven’t issued a Green bond. We put a lot of emphasis on improving the social governance credentials of KfW as a whole.
One of the reasons why we haven’t issued a Green or themed bond is that we’re not so sure that we should be dividing up our assets into the good, the bad and the ugly, or creating an explicit link between bond issuance and individual assets.
Additionally, our bonds have certain characteristics which investors value very highly – such as liquidity. If we were to issue themed bonds where the proceeds are targeted for specific purposes we would have to make them smaller and therefore lose some of their liquidity benefits.
We’re not saying we have no intention of ever issuing so-called themed bonds, and it’s a market we will watch closely.
Scheidig, DZ BANK: I share Frank’s views on this. But I think it’s also worth extending the discussion to infrastructure funding. Demand for infrastructure finance is high, even in developed countries like Germany where we need to address problems of waste disposal and sewerage, rebuild bridges and direct more investment into renewable energy. Perhaps these are projects that could be supported by themed bonds rather than Green bonds. There is room for more bonds of this kind because infrastructure can’t all be financed by the government.
Roy, DeAWM: The thematic bonds we’ve seen from issuers such as World Bank and IFC aren’t small, but as Frank said, nor are they super liquid. Most of our investors would probably say that they like the idea of financing, say, sewerage systems in Peru. But why not then buy a regular liquid bond from the World Bank which could then distribute the money to the appropriate causes?
Buscher, Commerzbank: I’m of the opinion that the SRI ratings of individual issuers will become increasingly important. Investors that want to observe certain SRI criteria won’t necessarily want to compromise on other criteria such as liquidity and market pricing. Given that SRI and corporate governance criteria are becoming much more prominent on a broader scale, I think they will eventually become a kind of prerequisite.
Czichowski, KfW: What I find very interesting about this SRI phenomenon is that the process is different to what we see in the market for conventional bonds. For example, the biggest difference between SRI and conventional ratings is that it is normally the issuer that solicits conventional ratings, whereas in the SRI space it is the investor which asks an agency to rate the holdings within its portfolio.
In other words, this is the first step towards engagement by the investor in the process. The second step, which will be very important, will come when the investor says he likes the issuer’s name but has reservations about some of its activities. Rather than saying I will or won’t invest, the investor may then choose to engage in a dialogue with the issuer, so it becomes an ongoing, interactive engagement between the issuer and the investor.
Global Capital: Are German institutional or retail investors any more demanding when it comes to SRI observance than investors in other countries? After all, Germany has always had a very strong Green political lobby.
Czichowski, KfW: Not really. I think it is the Scandinavians rather than the Germans who have been at the forefront of this movement. But the dialogue between issuers and investors is becoming more intense in Germany, which is a positive trend.
