Reciprocal relationships

01 Sep 2014 | Richard Kemmish


Our friends at the Cover are introducing some new functionality to their deal database. What really caught my eye was a function to map the web of reciprocity that is the covered bond market based on who is on whose deals. This is always going to be a topic in a market where most of the lead managers are also issuers.

Counter-intuitively the reverse also applies, not in the sense that small retail focussed banks have the potential to be capital market powerhouses, but in the sense that they can always pretend to be a real lead manager. That strategy has the potential to cut their total underwriting bill by at least a third (if they are one of three lead managers they just pay 1/3rd of the total underwriting bill to themselves) or all the way to zero, if they play the reciprocity game well.

To play the reciprocity game well they need to have some credibility as an investment bank – Santander is unlikely to appoint a small regional savings bank on a benchmark deal - and/or appoint investment banks that have their own treasurers on a short lead and have total power to dictate the composition of their syndicate.

The degree to which the issuer’s syndicate pretends to be an equal partner varies. I have been on calls when they insist on driving the whole process (so annoying), on others where they freely admit to being there just to make up the numbers (hardly less annoying) and on every shade of grey in between. For me, the optimal approach would be ‘you know more about the market than me so you can run the show but I do have some marginal investors and know my issuer well, so let me help you’.

Why the differences in approach? Part of it is the distance between the issuer and the lead manager. If ‘syndicate’ is part of the treasury and funding team then they can afford to take a back seat. In other cases the distance is further. One investment bank I knew was the main shareholder of a major issuer. That meant they were in practice on every deal, but also that they had to work hard to justify that role. As the treasurer of the issuer liked to point out about the investment bank, ‘I’m not married to them’.

To the extent that reciprocity influences the choice of the best bank for the job it is potentially a bad thing. If I were an investor I might take issue with the inclusion of a bank that is obviously not going to make a market in secondary. If it is one of three banks on the top line, the market making lead managers become an effective duopoly. What about the inclusion of banks that add no new investors but take down some of the primary allocation in order to support the deal? I’ve seen plenty of cases where they have then dumped residual positions in the broker market.

Perhaps the covered bond market isn’t that badly behaved, particularly when you compare our syndicate structures to those of some recent investment bank contingent capital trades. But the web of reciprocity does create some risks. Investors, aren’t you concerned?


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