As a changing of the guard took place at the UK Debt Management Office last week, amid its latest Gilt syndication, the issuer and its dealers and investors were able to assess whether changes it made to how it interacts with them were bearing fruit.
Longstanding head of dealing Martin Duffell, who joined the DMO the year it was founded in 1998, is to retire, with last Tuesday’s deal his last syndication, as GlobalCapital first reported. In his stead, the DMO has appointed two experienced people to fill his role and lead the DMO’s Gilts desk. They will continue applying the new approach the DMO is using to gathering market feedback ahead of issuing.
Duffell’s last deal passed typically smoothly, with the tap of the 4% October 2063s priced at the tight end of the guidance thanks to an order book of over £59.3bn.
The DMO has a big net financing requirement this fiscal year of £242.8bn, which includes £237.8bn of Gilt sales of which £27bn will be sold via syndication.
The DMO is widely praised for its deal execution expertise, as well as its proximity to its market. Never was that tested more than in almost a year ago when the issuer brought to market a syndication that took place on the same day that the Bank of England was compelled into emergency Gilt buying, following the turmoil generated by the then government's notorious mini budget. The DMO passed that examination by pricing the £4.5bn tap of its 1.5% 2052 Green Gilt on possibly the most volatile day in that particular market in living memory.
Bond markets may not have endured the chaos of the Gilt market a year ago but times have still been turbulent, especially when compared to the era of low rates and central bank intervention that preceded it. There was chaos in March as first Silicon Valley Bank went under, sparking a banking crisis that culminated in the rescue of Credit Suisse by UBS. More recently, a sell-off in US Treasuries as a result of greater than expected US borrowing combined with concerns over debt sustainability in an era of rising rates troubled market participants.
The yield on 10 year Gilts peaked in July to the highest level since the 2008 financial crisis, and 30 year Gilts suffered their largest one-day price decline since last autumn’s chaos unfolded. Against this backdrop the DMO has changed the way it conducts new issues.
Robert Stheeman, the DMO's chief executive, says that stable issuance conditions are “not something we can take for granted anymore” given the movements in global yields since January.
“The bigger picture in 2023 is that we certainly can’t avoid the fact that we have been in a global fixed income bear market for 21 months,” he says. “There are rising rates and yields as a result of global monetary policy decisions and inflation expectations."
While the increase in global yields at the start of summer has been sweeping, Stheeman said some of the moves had been reversed, but that a “fundamental debate” regarding expectations around whether we’ve reached peak rates was a “key dynamic” in the market.
Naturally, that has brought greater focus on to what sovereign debt issuers are selling into the market. “Until about a year or so ago Gilt auctions tended to be a non-event, and syndications were a bit more interesting," says Howard Cunningham, fixed income portfolio manager at Newton Investment Management. “Now we are paying more attention to the auction calendar and the size of syndicated deals, as these occurrences now have the potential to be more market-moving than in the quantitative easing days.[The recent] announcement by the Bank of England that it would slow the pace of Gilt sales raised a few questions, even if the Bank sought to downplay its significance.”
Time for change
Against this backdrop, Stheeman and sources elsewhere in the market have confirmed that the DMO has evolved its approach to syndicated bond deals, including encouraging “much more granular feedback” on investor demand and on price sensitivity than it has historically.
“The process has changed quite significantly,” says a source at a second, UK-based fund manager. “Three or four syndications ago we would talk to the duration manager and the people on the book and provide a rough estimate of where we thought pricing was and what our demand would be in terms of rough numbers.
“It was loose and not connected to what we would get in terms of allocations. But on the last two inflation-linked Gilt syndications we have been asked to provide our interest should it come out at a particular price.”
According to the fund manager, real money investors who provide “good information” in the days leading up to the syndication, will receive a better allocation, of which he says there are three levels, and that it’s “worth our while” to provide the information the DMO now wants.
However, there are drawbacks. “As an active investor,” he continues, “it prohibits you somewhat. The pricing on [September 5] came a bit cheaper than we expected, for example, which might have inclined us to put a bigger order in, but we’re also less inclined to do that because it might harm our allocations.”
The fund manager explains that while the new method produces more granular information for the DMO, it can “tie investors in a little more than you might wish”.
The fund manager says that while he undertakes similar conversations with other sovereign, supranational and agency borrowers, they were not yet quite at the level of detail as those with the DMO.
Sources tell GlobalCapital that the new approach reflects the state that markets are in since the end of widespread quantitative easing.
The same fund manager says: “This is a market where there’s no safety behind [the DMO] and it makes sense that they’re going to be a lot more sensitive to people buying the Gilts.
“In the last 12 months the Gilt market has not been particularly stable so these measures make sense — we’ve seen the market move on very little information. But it’s about finding that sweet spot for investors and issuers.”
The DMO is not the only large issuer in the SSA market to have increased its communication with investors this year. GlobalCapital is aware of two other large issuers, including one sovereign, which have striven to put in more investor work this year as a result of increased market volatility and shorter issuance windows.
Communication with the market has sharpened and investor relations activities have reverted to levels seen before the era of QE and low rates. Indeed, higher rates have attracted more real money investors to the SSA market, making communication even more important.
Evolutionary
Another Gilt market source stresses that the difference in the DMO's approach was not quite “game changing”, however, nor was it an indication that the sovereign had “totally reshuffled the cards and transacts deals completely differently now”.
“I think in the past the issue has been that it’s a bit of a game of cat and mouse,” he says. “The DMO goes to [the Gilt-Edged Market Makers (GEMMs) - the UK's primary dealer group] and the lead management group after they’ve been appointed and asks for feedback, which is delivered as part of the pitch process.
“One can have some pretty direct conversations with people and like with all things, a lot of the big investors don’t want to give too much away because they effectively want to give themselves as much pricing leverage as possible.”
The source explains that the aim of the DMO's latest approach is to secure “more accurate feedback” rather than granularity, around the “true size and price-sensitivity of orders”.
“Maybe there’s a move or will be a move to reward some of that feedback in terms of the way things are allocated,” he says.
GlobalCapital understands lead managers present a draft allocation, divvying up the order book according to what they think the true value of each investor order is, and applying an order fill rate they believe is fair to all investor types, and ask the issuer to approve it. “A lot of [investors] are very proactive in terms of nipping and tucking within that draft allocation,” one source says.
“It appears the DMO is now trying to suggest through the various GEMMs in the pitching process, and to the final joint lead managers, that a little more precision around feedback might on balance lead to a slightly better allocation,” adds the source.
Feedback from investors ahead of pricing is important for any issuer trying to size a bond issue as close to demand as possible. "They aim to do it with as little disruption to investors as possible because their time is precious," says one capital markets lawyer.
"If enough relevant investors [offer feedback on pricing] then it can be very useful and it's the kind of thing one would want to incentivise for the benefit of the transaction, and thus providing an uplift on allocation seems reasonable."
According to the DMO, allocation decisions fall within the lead managers' remit. "We have always understood that allocation decisions are — for good reason — the responsibility of the lead managers who face their clients directly," says Stheeman. "Yet we also understand that the more granularity offered by investors to the leads in the run-up [to] and during the syndication process about their pricing sensitivity, the easier it is for the leads to make an informed pricing recommendation to us as the issuer. If that results in the best outcome for the taxpayer then such an approach is one that we wholeheartedly endorse."
Indeed, a Gilt market source says that the rationale for the approach was down to government scrutiny over whether the pricing was fair for the taxpayer.
GlobalCapital understands there have historically been discussions around whether the DMO should abandon its 0.25bp-1bp pricing range, and opt for area-based price guidance, like the rest of its peers in the market, particularly with rates having risen so quickly of late. But one Gilt market source believes the traditional tactic has its merits. “Investors like it because they always know it will price at the narrow end which is why the tactics are shaped by the tactics the DMO adopts when it comes to pricing,” they say.
An SSA banker in London says that the core principle is to retrieve as much clarity from investors as early as possible to ensure smooth execution. “I think a successful syndication to a lot of these big DMOs is when it passes under the radar,” he says. “We have to provide them colour to provide a degree of comfort and it’s crucial to back up what you’re recommending.
“The fun in this job is that you might deal with investors who, for one reason or another, don’t always want to give away their hand. That’s the trade off in any kind of market.”
Gilt syndications are unique, the banker adds, in that they are set up to ensure quick execution. Indeed, this is one of the ways of “adapting to life post-QE”, he says, noting that it will soon be an approach adopted in the new issues market in euros.
“The job of the duration manager is stressful in that their function is to manage risk and I think it comes from a good place: it’s an attempt to avoid nasty surprises on the day,” he says. “A lot of UK fund managers are dispersed in terms of portfolios and may not know what their move is until the day. The risk is, they may get penalised for being slightly less efficient. That’s the quid pro quo.
“My personal view is that it’s a good motivator for investors. They are very well-prepared for when the bond comes so it seems only fair to provide a little more information," he continues. “The team at the DMO are award winning and there’s a reason for that. They’ve done a pretty impressive job over the years in building a very strong process. The diligence and the process is solid and that comes through in their deals.”
A lead manager on the DMO’s latest syndication highlights that investors in this market value clarity. “The overall communication definitely helps the trade,” he says.
