Why you should issue in foreign currency

05 May 2016 | Richard Kemmish

In my previous two posts I argued that there are many reasons for a debut covered bond issuer to come to the local currency market first. But like the fox and the hedgehog in the fable (the fox knows many things, the hedgehog knows one big thing) there is one overwhelming argument for a debut euro denominated deal: price.
The covered bond purchase programme is only a part of the story – absolute rates are important too – but one way or another it is very clear that prices in general and risk premia in particular are massively distorted in the current market by technical factors. Covered bonds are over-priced, ‘higher risk’ or higher duration covered bonds, are even more over-priced. It’s a great time to issue.

Looking at it from a different perspective, ultra-low policy rates could be an inevitable feature of the  demographic profile of old Europe (and Japan) – rather than just a temporary response to a cyclical down-turn. If this is the case then a flow of investment funds from old world to new world is needed by the investors just as much as it is by the issues. The current price distortions will facilitate this by forcing investors into EM in the search for yield. But I digress. 
In a rational capital market of course prices should equalise, a large buyer – the ECB - in euros should distort prices everywhere via the mechanism of relative value and swap spreads. To some extent this is true in the dollar market – a public sector issuer whose euro denominated bonds are eligible for the ECB’s purchase programme recently told me that this fact hadn’t reduced his planned dollar issuance at all – the relative improvement in the basis swap offset the fact that euro spreads were so attractive.
But whilst this might apply to the dollar basis swap, and might explain for example DBS’s debut covered bond coming in dollars rather than euro (apparently the prices were near identical), it does not apply to currencies with less liquid basis swaps such as those in all of the new covered bond jurisdictions.

There are of course other variables – the signal effect of access to euro funding cannot be underestimated, particularly as we celebrate Vakifbank’s wonderful recent transaction.

Are there benefits from a systemic point of view in foreign funding?

It is foreign investment in the sort of country that usually goes to great lengths to encourage that. But this should be balanced by regulation to ensure that the cheap term funds provided to the banking system go to productive uses. Beware the Spanish experience: €400bn of funding in the early years of the century, mainly from German investors mainly in the form of covered bonds, channelled into the housing market. And we know what happened there. 

And of course the local government debt management office might be grateful that they will have less competition for their funding plans.

In short: arguments on both sides. Looking forward to hearing the debate at the inaugural Euromoney/ECBC/EBRD CEE Covered Bond Forum in London on 10 May.

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