ESM expands into dollar market

Mitigating liquidity risk through investor diversification

This autumn, the European Stability Mechanism turned five years old. This coincided with another important feat, when the ESM raised $3bn with its debut bond issuance in the dollar market.

The ESM may be a young institution, but it is already a mature capital market player. Together with its temporary predecessor, the European Financial Stability Facility, it is one of the largest issuers of euro-denominated bonds. The EFSF/ESM have more than €250bn in bonds and bills outstanding. That is a striking figure for an organisation employing only 170 people.

In its short existence, the EFSF/ESM have accomplished some humbling achievements: the largest order book among sovereign, supranational and agency issuers; the first benchmark-sized deal with a negative yield; and the first ultra-long benchmark-sized deal. In April, the ESM raised €8bn on a deal with an order book of €21.6bn.

But issuing in euros exposes the mechanism to risks. If the euro market ebbs, the ESM would lose its only source of funding. While taxpayers back the ESM’s credit, it does not use any taxpayer money to disburse assistance loans. All of its money must come from the capital market. As the lender of last resort for euro area sovereigns, the mechanism has no back-up.

The ESM began to address this funding liquidity risk in 2016. Its aim was to spread risk over the two deepest capital markets – dollars and euros. The goal was to launch the first dollar deal around the fifth anniversary of the ESM in October of this year.

This would diversify the investor base, and capture cost efficiencies where possible. It was decided to swap all the proceeds back into euros, as it is the only currency the ESM uses to disburse loans to countries. Legally, it can issue in other currencies, but technically and operationally the mechanism is far from ready to do so.

The inaugural dollar deal, on 24 October, was an outstanding success. There were more than 130 investors and over $7bn interest involved the trade, with a significant number of new names. As the ESM had announced that it would not raise the intended volume, it sold no more than $3bn of this five-year bond.

The timing could not have been better. Over the course of 2017, investor appetite for Europe has surged. With the US and UK facing political challenges, Europe has emerged as a safe haven. The economy is expanding sturdily, and many non-European investors are interested in increasing their exposure to the region. The ESM offers a unique exposure, as it is the only blended euro area credit available – now also in dollars.

The ESM is now present in the two strongest global currencies. More importantly, it has achieved exceptional investor diversification. The euro will remain the mechanism’s main issuance currency while it continues to develop a strategic presence in the dollar market. The ESM is aiming to build up a curve with maturities of two, three and five years, and plans to go to market at least once or twice per year. Seeing so many new arrivals enter its books is a great confirmation of the success of the ESM, and of the euro area as a whole.

Kalin Anev Janse is Secretary General of the European Stability Mechanism.

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