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Asian investors looking at European bond markets
European banks’ bonds offer investors attractive yields to comply with new capital requirements
Bayani S Cruz 19 Mar 2015

 Asian institutional and private bank investors are paying closer attention to the regulatory and subordinated capital structures from European bond issuers as they seek opportunities to make money in the latter’s markets. Anecdotal evidence shows the level of scrutiny that Asian investors now have of European issuers has dramatically improved such that familiarization talks on the European bond markets are no sometimes longer necessary.


“Just recently, we have an issuer coming to Asia and we had some investors turning down our invitation for meetings. It’s not because investors are not interested but they were already familiar enough with that issuer. Interestingly, it was an issuer coming from a peripheral country. About 18 months ago, this would have been an issuer most Asian investors would not want to touch at all,” according to Yves Jacob, head of debt capital markets, Asia-Pacific, Societe Generale.


Part of Jacob’s responsibilities as an intermediary is to help European issuers access the Asian markets as well as support Asian issuers access the European and US bond markets.


The growing interest in European fixed income assets among Asian investors is understandable at this time as it is fuelled by a combination of factors including:


• Changes in banking regulations, hence the increased interest in regulatory capital structures intended to build stronger financial institutions and issuers;
• An interest rate environment that is strongly supportive of rate compression over time, thanks to the European Central Bank’s (ECB) quantitative easing (QE) programme that ensures better bond yields in the long-term;
• Positive long-term fundamentals for the European economy helped by a high level of liquidity not only in Europe but in the global economy as well.
On the regulatory capital structures of bond issuers, the Financial Stability Board (FSB), an international body that monitors and makes recommendations on the global financial system, has issued a framework for building the loss-absorbing capacity of 29 institutions that were identified as global systemically important banks, also known as G-SIBs, by the G-20. These banks, many of whom had to undergo taxpayer-financed bailouts by their respective governments during the global financial crisis because they were “too big to fail”, will be subject to additional capital requirements to ensure they can survive future crises without any bailouts.
The banks will have to raise massive amounts of additional capital to meet the new capital requirements. This means these institutions will have to issue more bonds to sell to investors, in the form of senior or subordinated debt.


Subordinated debt has a higher yield compared to senior debt because in the event of the issuer’s bankruptcy, investors holding senior debt must be paid first before holders of subordinated debt. Bankruptcy, however, is not an issue for the G-SIBs since by their nature, they are deemed “too big to fail”.


These banks, mostly European, are expected to offer investors attractive yields for their bonds to comply with the new capital requirements, thus providing lucrative investment opportunities for Asian investors.
“The big story is really the increase in prominence of the regulatory capital structures and subordinated capital structures. I think this is really where the Asian investors both on the institutional side and the private bank side are focused. This is actually going to lead to more bond issuances and more product development, more interesting types of variance on some of these subordinated structures. That is something that is of huge interest to Asian investors,” says Mustaq Kapasi, head of Asia, International Capital Markets Association (ICMA).


This interest in senior and subordinated euro bonds is reflected in the investment strategy of Seatown Holdings, an asset management subsidiary of the Singapore government-owned investment company Temasek Holdings, which has a credit portfolio heavily biased towards European issuers because it sees a lot of value in that asset class.


According to Seatown’s portfolio manager Archana Parekh, while most high yield European bond issuances are interesting, on a standalone basis, one issue may be more interesting than others. “The thematic trade that we like out of Europe is really around bank capital. The reason is there’s a lot of capital raising coming in. Banks are getting de-risked and the rate environment is strongly supportive of rate compression over time. Globally, we don’t really see a cheaper set of alternatives than these bonds,” Parekh says, citing as an example the gap between Bank of China (BOC) and Societe Generale (SocGen) bonds.


On October 15 2014, the BOC placed US$6.5 billion in bonds with a 6.75% coupon, priced at 100% to yield 6.75%. During the same period, SocGen bonds were trading at 8.75%.


Although they are not yet that common, the prospects for such opportunities are anticipated to persist in the next three to five years when seen in the context of the slow and gradual recovery of the global economy that tends to favour bonds more than equities.


“The slow but steady recovery may not favour equities as much as it does subordinated credit. It probably favours super high credit well like SSAs (supranational/sovereign/agency and provincial sector) but yield pick up is in the subordinated part of the capital structure. I think that would probably be the biggest insight there,” Parekh observes.


The expected slow and steady growth of the European economy in the next three to five years is attributed, among other factors, to the current ECB policy geared towards QE. This means pumping massive amounts of cash into the financial system with the hope that it will generate more business activities and perk up the regional economy.


On January 22 2015, ECB president Mario Draghi announced a QE programme that will inject e1.1 trillion in the European economy until September 2016. This indicates the central bank will buy as much as e60 billion monthly worth of bonds until 2016.


The ECB will buy bonds issued by Euro area central governments, agencies and European institutions in the secondary market against central bank money, which the institutions that sold the securities can use to buy other assets and extend credit to the real economy. In both cases, these contribute to an easing of financial conditions, according to the ECB announcement.


The QE is expected to provide a positive impact on the bond markets in general because at the very least, it should keep the prevailing low interest rates from falling further.


“The QE is overall very supportive of the fixed income market. Maybe in some investors’ minds, it’s overly supportive. So we are in a situation where there is, globally not only in Europe, very high liquidity. In 2014, bond demand may have exceeded the supply by some US$500 billion and 2015 doesn’t look very much different and it’s not yet taking into account any possible QE,” says Eila Krevi, head of capital markets, European Investment Bank (EIB).


But although the QE is supportive of the interest rate environment, it remains to be seen how far it can help in terms of addressing the current challenge facing the fixed income sector – the very low yield. At present, most of the sovereign bonds in Europe have negative yield while corporate and bank bonds have very low yield.


“We are in a strange situation. Most of the core governments in Europe have negative yields up to two years, some even up to five years. And even the higher yielding names whether you look at SSAs, banks, corporates, their yields are all very low. Pension funds are hard pressed to find the yields they need for their investments. So it’s overall supportive, but there are quite a few challenges there as well,” Krevi remarks.


For the SSA sector, US dollar-denominated bonds instead of euro-denominated bonds are providing good opportunities for investors because of the strengthening US currency.


“From the Asian investors’ point of view, we have very good support in the SSA sector whether it’s the EIB, or KfW (the German reconstruction bank). There’s a heavy currency bias. We sell a lot of our dollar issuances into Asia because that is really the currency that sells the best in this part of the world,” Krevi says.


European corporates that don’t normally issue bonds in US dollar also offer Asian investors opportunities in the form of multi-currency bond issuance programmes.


“In terms of Asian investors and what they look for, there are two categories of investors that we come across in this space. One is a force to be reckoned which is the Asian private banks and the other is institutional investors like us,” Krevi says.

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