The European Stability Mechanism will begin its capital markets career in earnest in October with its first benchmark syndication.
BNP Paribas, Citi, Deutsche Bank, Goldman Sachs and Société Générale are arranging the ESM’s investor marketing over August and September ahead its first deal.
The borrower has around €9bn to raise this year for Cyprus’s bail-out and to refinance debt taken on in relation to the support of the Spanish banking system. The European Financial Stability Facility, which as of July cannot take on new programmes, will continue to refinance the debt it has taken on to support Ireland, Portugal and Greece.
The ESM looks set to have timed its debut well to avoid competing supply in euros — it has the last three months of the year practically to itself to raise the €9bn required this year, as the other major euro funders are ahead of their schedules.
The EFSF had around €8.5bn left to raise at the beginning of September, after frontloading its €58bn funding target. The European Investment Bank was 88% done of a €65bn total and KfW had completed over 70% of a €65bn-€70bn target.
Although waiting until after September to launch means the ESM could fall victim to any volatility in the fall-out to the German elections on September 22, euro markets have proved themselves resilient to political shocks so far this year and the supranational should be assured of being able to find €9bn even in volatile markets.
Tight pricing
The most likely first deal for the ESM is a five year, targeting a full €5bn with another €4bn for its second deal to round off funding for the year. However, a 10 year is an outside option to offer up some yield for investors.
The ESM should price flat to or inside the EFSF from the off as it has a simpler guarantee structure and is a permanent mechanism.
“We know that we will expand the number of investors able to buy the ESM over the EFSF,” says Christophe Frankel, deputy managing director and chief financial officer of the mechanism and deputy chief executive and CFO of the facility. “We know a limited number that are either reluctant to or can’t buy EFSF because of its guarantee structure — a few central banks and a few standard investors. There aren’t that many, but in the end it should make a difference as to how the ESM prices versus the EFSF.”
Another comparable for both supranationals is France. If the levels remain stable ahead of October the ESM should easily be able to print a five year inside the EFSF but offering a healthy premium to France — and include a nice new issuer premium to boot.
OATs were trading at about mid-swaps minus 9bp in five years at the end of August, while EFSF paper was trading at about 5bp over.
“We will have to offer a new issuer premium for the ESM to get the wider investor base interested in buying,” says Frankel. “Some investors may hold off from buying at first. For one thing, the issuer’s curve won’t be as liquid as the EFSF’s. This means that for the first few transactions there might be a certain spread. That should change in time as the ESM becomes more liquid. We asked banks to provide us with their views. They felt that even with a premium the ESM should price at the same level or tighter than the EFSF. That difference might be limited or marginal.”
Some market participants have fretted that coming after nearly €50bn of EFSF issuance this year, the ESM might suffer from investor fatigue. Frankel disagrees: “I don’t expect the ESM to be troubled by hitting investor limits to the EFSF when it begins issuing. The EFSF is a large issuer, but it doesn’t have much outstanding compared to other large and frequent issuers. Even if you add the ESM, investors consider that a different type of risk.”
And the ESM will not — at least not at first — be a funding juggernaut.
The ESM’s expected funding requirement for next year is €17bn, while the EFSF is expected to have €34.5bn to raise — so combined the issuers will have less to raise than the EFSF alone this year.
The ESM will fund in much the same way as the EFSF does, targeting similar deal sizes of €3bn-€5bn for a standard benchmark. As it is run by the same funding team, it can schedule issuance with the EFSF in a co-ordinated way.
The EFSF/ESM funding team will publish a newsletter at the end of September detailing issuance windows for either an ESM or EFSF issue for the fourth quarter. The funding team will decide closer to the window which borrower to use the window for.