There is growing disgruntlement among emerging market bond investors that syndicates are starting with initial price guidance too wide to be a useful indication of where a deal will be priced. But this not entirely the fault of the sell-side which relies on honest assessments from investors about the price at which they will buy.
In recent weeks, as the EM primary market has grown busier than it has been for years, investors have said that there were deals — typically from issuers with few outstanding bonds — that they would not participate in.
This was not because they didn't like the particular credit or region the issuer was from but because of the amount of work they would have to do to determine fair value number on the day of pricing.
Investors had made an assumption that the issuer would attempt to tighten pricing by 50bp-100bp from initial price thoughts (IPTs) — as they had on a number of deals this year — which would make the bonds too rich for them.
The ploy from the sell-side in starting so wide is to capture early attention and build momentum in the order book. That may still be working in the case of the more frequent borrowers where the relative value analysis is quick and efficient to do.
But for issuers where there is more price discovery to be done, it is proving to be too much like hard work. Investors have blamed banks for pulling a bait and switch on them too many times.
But investors need to consider the role they play in the process. When a syndicate releases initial guidance for a bond, it is typically — especially for a debut issuer — at a level pin-pointed after weeks or even months of soft sounding the market about the deal, and often after at least a few days of meetings with investors on a formal roadshow.
Ideally, that work gives the sell-side an idea of where the bonds will clear. A syndicate does not put just any number out there and hope it will stick. If it did, it would start even wider — why start 50bp back of fair value when you could offer 200bp?
A decent starting point is 25bp-50bp back of fair value, depending on the strength of the market. If pricing moves by bigger amounts during syndication, then perhaps the syndicate did get pricing wrong and leave too much on the table, or perhaps it was being sneaky and trying to lure buyers in with a prospect it had no plan on delivering. But they can only work with the information they have before they open books. The less they know, the more cautious they will be.
EM syndicate bankers have freely admitted their surprise over the last few weeks as deals have flown off the shelves at prices far below their and issuers’ expectations. They had no idea that, when push came to shove, investors would buy some deals at levels so tight.
This tells the market two things. The first is that those on the sell-side are not mind readers. The second is that they are not being given good enough information buy investors, who after all are the real drivers of pricing.
As individuals, investors may feel there is an advantage to being coy with their feedback. But collectively, it is working against them as they, in the words of one debt capital markets banker, “add a premium for this, and then a little more for that, to cover all possible risks”.
A syndicate is bound to take them at their word to avoid having a deal fail. So it is no surprise when those overcautious estimates feed through into fanciful starting prices.
There are two ways then out of this bad habit that will result in far sharper, more certain pricing from the outset. The first is that syndicates could be punchier in their assumptions of where an investor will buy versus where they say they will buy — there is clear evidence now that investors are not being open.
But the possibility of pulling a deal for an issuer or having to widen guidance looms so large that this simply isn’t going to happen.
The other option, that fixes the problem, is that investors have to be more courageous, precise and more honest earlier in the process about where they care about specific issuers.
It may go against investors’ instincts to lay it all out there — part of their job is, after all, to be extract as much from an issuers as is possible. But they need to recognise that if they want to be offered a wider variety of issuance then they need to provide real, thoughtful pricing feedback.
It may look like a classic free rider problem — why should I show you my hand when no one else does and yet we all get the same bond at the same price? But in reality, those investors that engage fully with those selling a deal will be in a more powerful position with sellers when they can stand by their pricing. And if every investor does it, then the problem of wayward IPTs vanishes altogether anyway.
Without sharper price feedback, syndicates are flying blind. If investors want the bait and switch on pricing to stop, they need to stop pretending they have the appetite of birds rather than the hungry hippos they are.