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German feedback

05 May 2015
Richard Kemmish

Rates rather than credit were the major talking point at the recent Euromoney Germany conference. With Germany as the epicentre of the negative rates discussion, and with covered bond yields heading ever closer to negative I thought it might be helpful to collect some of the comments that I heard on the topic. Some of them you’ll have heard before, but hopefully some are new.

Disclaimer: I don’t agree with all of them.

‘Negative coupons are impossible, even on floating rate notes when the reference rate turns negative’.
At the date of the conference 3 month Euribor had just fixed at a negative rate for the first time ever. If you own a bond that paid 3 month Euribor flat this would in theory suggest that you would have to write a cheque to the issuer for the first time. (Of course some floating rate bonds, particularly structured notes pay a euribor minus coupon and have already reached this problem but numerically the euribor flat notes are a larger problem). The two reasons why negative coupons are impossible are that paying agents just aren’t set up to be able to collect money from investors and, from a legal perspective, the terms in the prospectus which should require a reverse coupon flow are probably unenforceable.

‘An issuer might pay less than par to account for the coupons that should have been negative’.
Arguably this could trigger cost default clauses but any thoughts from lawyers and/or rating agencies on this would be much appreciated.

‘Bank notes could carry a negative yield’.
We all think that zero is a lower band because of the bank note alternative (give or take a few vault expenses and management fees).  I recently mentioned the idea of a bank note backed ETF (zero return...guaranteed!). It was suggested that bank notes could need to be endorsed each year to remain legal tender, with the endorsement costing, for example, 1 cent per euro. Alternatively a 2016 euro note could cost 1.01 euros of old euro notes which would soon stop being legal tender. Not sure I agree that this is viable but it is an intriguing prospect.

‘Higher credit issuers will be forced to issue more in foreign currencies and/or ultra long dated maturities’.
Putting aside the negative coupon discussion, many issuers think that it is in practice impossible for them to issue at a negative yield, therefore they would prefer to issue at a positive yield in another currency and swap back, with the swap basis – in particular to dollars – providing an all-in negative cost of funding.

‘A tax ruling will be needed to determine with negative interest payments are income’.
I would have thought that would be a given but I’m no tax lawyer. I’m equally ignorant of the accounting treatment but I was reliably informed that the prospect is creating some interesting accounting policy and systems issuers.

My quote collection isn’t exhausted (but I’m hitting my self imposed 500 word limit), so I’ll continue with this topic in the next post in a couple of days.

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