How are capital markets handling the corona crisis? Against the backdrop of extraordinary measures bringing forth considerable new government borrowing and gigantic volumes of central bank bond buying, OMFIF spoke to two sovereign-backed agency issuers in the market with Covid-19 related transactions. The European Investment Bank, a key component of the plan agreed on 9 April by the Eurogroup, and the Council of Europe Development Bank, raised €1bn each last week with slightly negatively yielding bonds that met record-breaking demand. Nevertheless, will the issuance glut render the sovereign, supra-sovereign and agency market disorderly? What will happen to ratings and therefore pricing? How do capital markets work from home? And will corona bonds crowd out sustainability bonds, or are they the same?
OMFIF Chief Executive Officer John Orchard discusses these themes with Eila Kreivi, director and head of the capital markets department at the EIB, and Rolf Wenzel, governor of the CEB, together with Frank Scheidig and Marcus Pratsch of DZ Bank, a bookrunner on both bonds.
John Orchard: Welcome to this inaugural OMFIF roundtable on the capital markets response to the corona crisis. Sovereign, supra-sovereign and agency borrowers have an enormous amount of work to do to fund the programmes that have already been announced, let alone what may still come.
The current crisis is likely to be visible in these markets for some time yet, as we see the consequences of big changes to debt-to-GDP ratios among sovereign borrowers, balance sheet changes at agency banks and ratings downgrades working in one direction, and the massively expanded quantitative easing measures recently announced by central banks working in the other.
Today we have with us two European SSA borrowers freshly in the market with new bonds related to the alleviation of the corona crisis, the EIB and the CEB. And we also have one of their bookrunners, DZ Bank of Germany, to talk about taking these transactions to a busy market, and indeed working from home.
Eila Kreivi, director and head of the capital markets department, joined the EIB in 1995, having been at the Union Bank of Finland and Société Générale. Eila has been heavily involved in the sustainable finance arena, including chairing the Executive Committee of the Green Bond Principles between 2015-18 and representing the EIB as a member of the European Commission’s Technical Expert Group on Sustainable Finance. We’ll come back to this theme shortly.
Eila, what would be your one sentence description of what the EIB is and does?
Eila Kreivi: We are about real economy investment, largely in Europe, but also 10% elsewhere. Our bread and butter is large infrastructure projects, energy and transport, but also small- and medium-sized entreprise financing.
JO: We also have with us Rolf Wenzel, since 2011 Governor of the CEB, now in his second term. Before that he was head of the financial market policy department of Germany’s finance ministry and he helped represent Germany at the International Monetary Fund, G7/G8, G20, and the Organisation for Economic Co-operation and Development. Rolf, CEB is less well-known than EIB but has an interesting and relevant role – please tell us what that is?
Rolf Wenzel: We help our members finance social infrastructure investment, which at the current juncture is supporting, in particular, SMEs and the health sector.
JO: Joining us, too, is Frank Scheidig, global head of senior executive banking at DZ Bank. He’s also a member of the board of the British Chamber of Commerce in Germany and is deputy chairman of OMFIF’s Advisory Board. Since 2019 he belongs to the sustainable finance advisory council of the German government. With him is Marcus Pratsch, who has more than 15 years of experience in sustainable finance, including bringing numerous ESG issues to market. He is head of sustainable finance at DZ Bank, following 10 years as head of sustainable investment research.
Governor Wenzel, please tell me about your bond. What was the reason for the issuance of what is happening with the proceeds?
RW: We’ve seen very strong demand from our members to help finance expenditure in the health and SME sectors, both heavily hit by the Covid-19 crisis. We are well-financed, in fact, but for the last couple of years around this time we have issued what we call a social inclusion bond, and we thought, following market developments last week it would be a good window of opportunity to issue. When we went to the market with, I think, a very attractive price for investors we got a huge response and ultimately managed to raise €1bn. The issue was heavily oversubscribed: we were very transparent about how we will use the proceeds, namely to lend to our members for financing medical expenditure like investment in hospitals, and to SMEs, both sectors, as I said, that are key at the current juncture of the economic downturn we are seeing already in some European countries.
JO: Eila, tell us about your bond for the EIB.
EK: Our bond was also issued within an existing framework of Sustainability Awareness Bonds, which is a product targeting proceeds to particular sectors: water, with health and education added last autumn. The pandemic has affected the health sector first and foremost of course, but it is also impacting the whole of society. What we did with this one is extend the scope of eligibility. Up to now, within the health sector, the product targeted mainly access to universal health care. We decided to expand the use to just about anything related to the coronavirus crisis. This could be equipment, the conversion of buildings to hospital use or mobile units, supplies or consumables, staff costs, vehicles, emergency maintenance, just basically anything that helps with this pandemic. Issuers were keen to do anything which would help the economy, and investors also showed that they wanted to participate. The demand was huge, as you have seen.
JO: It was the same size – a €1bn benchmark bond?
EK: Yes, we kept it at €1bn ‘no grow’ from the beginning but it was more than seven times oversubscribed, which is probably the record for us for this this kind of instrument.
RW: If I may, I would like to point out that despite the very difficult circumstances, we are all working very well. I think that is the message to investors and issuers, current and new. What is paying off is our huge investment in information technology; people are transacting from mobile phones, iPads and notebooks. We are fully functional. There are only four or five people at the bank, running IT. Everyone else is at home, but it works well.
JO: So did you not really recognise any difference in the processes for originating and distributing these bonds compared to when you’re in the office?
Marcus Pratsch: From an everyday perspective, we can see that investment banking and debt capital market business are running very well, even from home.
JO: Frank, tell me about how the syndicate was composed in these circumstances.
Frank Scheidig: Well our syndicate staff were definitely in the office. But as Marcus and Governor Wenzel mentioned, we invested years ago in our IT infrastructure, which has worked very well during this crisis. The work between distribution, syndicate and the other DCM people was very harmonised. And it went extremely well with these two very prestigious issuers.
JO: What were market conditions like? We heard that these bonds were heavily oversubscribed. It seems that even with the low yields these days there is very heavy demand for these issuers and transactions.
FS: Yes. Don’t forget the sector, sustainability, whether it is a green bond or similarly social-themed bond, under the umbrella of Covid-19 and its related issues, as you just heard from the two borrowers. I think the response was extraordinary; deals very well received from very credible issuers. That’s why the book was more or less five times oversubscribed in the case of the CEB bond and eight times for the EIB one. The books were very, very well received in Europe particularly. And here you should mention Germany, with lots of smaller granular orders. We had more than 150 just in the one issue and 120-130 in the other one, so very broadly received. I think Eila and Governor Wenzel sensibly chose strong European banks, including us in Germany, with very strong networks in the main investor bases like bank treasuries.
JO: Eila, did you have particular investor groups or geographies in mind when you launched this transaction?
EK: Not really, we don’t limit our sustainability deal participants, anybody who wants to join is welcome. Of course, when you have a seven-times oversubscribed book, you would normally favour allocations to those who you know are very long-term holders, particularly with this kind of product. Then there is the currency, that’s really first and foremost the defining factor. So we had a lot in Europe, but we did take almost 20% in America and Asia, and then another 10% in UK, which is not bad for a euro deal. Asset managers were the largest group, which is normal for this kind of product. We knew they, and asset owners, would want to buy this, but bank treasuries also like this kind of product nowadays. Central banks a bit less, because although this is a €1bn benchmark sustainability bond, it’s still not the €3bn-€5bn benchmark these kinds of accounts tend to favour.
JO: Governor Wenzel, did you have particular targets in mind, investor or geography-wise?
RW: I could repeat what Eila just said, we have no particular region or investor type in mind, we try to approach all capital market sectors and regions. But we had strong demand in German-speaking countries, even stronger demand from the UK, and from France. Our headquarters are in Paris, so it’s perhaps natural that we are more the focus of French institutions. We have a lot of hold-to-maturity investors, including central banks, but also interest from bank treasuries this time around. We had a huge diversification in terms of type of investors, but also geography, which, at a time when you can’t go out on roadshows is a very good result.
JO: The SSA market is expecting, presumably, to have an enormous schedule of new issuance as governments and agencies start to borrow more. Are you concerned that this will make issuance harder as the market becomes more crowded?
EK: ‘Concerned’ is maybe not the right word. There has been such a huge amount of liquidity in the market in the past several years that absorption capacity is, I think, still going to be quite high. Central banks are certainly putting in huge efforts which will support the market. I think it will impact the spread in terms of relative pricing, but I don’t know yet to what extent. But given that governments will be borrowing much more than I expected, it will unavoidably have an impact on all of our spreads. But all of us are on-lenders, we don’t take the funds ourselves and we don’t take funds in fixed rate. What is important for us is that we can still efficiently deliver to our clients – that whatever we achieve is still sufficiently attractive to the people that we on-lend to. It’s something that we have to keep an eye on. The underlying benchmark will be getting a bit wider in general, I think. I’m more concerned about something different this time – the real economy.
JO: Governor Wenzel, do you expect the market to become crowded to the extent that it becomes considerably more difficult to issue?
RW: Firstly, we are well ahead of our funding plans for 2020. We were lucky, before the crisis we had already reached 60% of our funding plans for 2020. Now we are close to 80% after last week’s issuance, so we can wait and monitor the developments in the markets very carefully. What worries me a little bit is the reaction from rating agencies. We will see, I guess, a greater diversification of ratings among European countries and I’m not sure what that means in terms of funding rates and spread developments, or downgrades, which we’ve already seen. On the other hand, we have fixed 80% of our annual borrowing and can be quite relaxed, we have stronger demand, that is clear, which we responded to with last week’s Covid 19 response social inclusion bond. We would also like to see how the discussion at the European level develops regarding the European Stability Mechanism, the European Investment Bank, and perhaps some kind of corona bond or corona financing mechanism. We will monitor that very carefully. But it’s too early to make a forecast of how it will develop over the coming weeks and months.
JO: The CEB rating is a function of the composite guarantees of the member countries, so you would expect those ratings to come under pressure in places?
RW: Well, the rating agencies have already asked questions, I understand, and when you look at the fiscal policy measures, which themselves are very welcome to stabilise markets and to inject confidence, it also can mean that rating agencies will have to revise some of the ratings. In the end it will all depend on whether we have what they call a ‘V’-shaped recession, meaning we will come out of the situation very quickly and see economic growth again in the second half of 2020, or we have a longer period into the third of fourth quarter where some of the major European economies are affected by the Covid-19-related recession.
JO: Eila, presumably the EIB is not unduly concerned about rating pressure for itself or its bond issues?
EK: Well, in an idiosyncratic manner, no, I’m not worried. We have some cushion in the ratings in all main indicators. Speaking for a moment off the top of my head, if you imagine that all governments are to borrow immensely more, maybe in a few years we don’t have any AAA government left. Then it is very difficult to see that any international financial institutions would remain AAA. But that is a different kind of scenario, then it’s just a question of scale, with the normal distribution from high rating to low, so where do you put the line?
JO: At the same time, if there is any rating deterioration, presumably the ‘risk off’ atmosphere will mean that demand will be moving in the direction of SSAs is anyway. Marcus, I want to see whether you thought there is a risk of the SSA market becoming overcrowded?
MP: In the last few years we have anyway seen growth in the sustainable arena, beyond pure green bonds to other types of social and sustainability bonds. The current situation shows – as do these two issuers – that social and sustainability bonds are great vehicles to fight the coronavirus outbreak and mitigate the economic and social impact. Public capital is not nearly enough, we also need private capital to complement it, so the time has come for social corona bonds or sustainability SDG corona bonds, or however you want to call them. From my perspective this needn’t only apply to supranational institutions, we also have other actors in the market who could issue those kinds of bonds.
EK: The social aspect is becoming much clearer. Take corporates, for example. If they behave badly towards their stakeholders, beyond their shareholders, such as their employees and clients, they start see this in their reputational risk assessment. Investors see, for example, that they fired people during the crisis so maybe they wouldn’t want to buy their shares or bonds anymore. I’m not saying that this is happening from zero to 100 immediately. But it’s becoming clearly a much more important consideration.
JO: Marcus, we’ve talked about these two borrowers issuing via the theme of sustainability or ESG. Tell me how you expect that theme to develop in the markets in the near term. Some people thought it may take a backseat and it seems to be doing the reverse.
MP: Well, actually, what we can see in the current crisis is that coronavirus is affecting all four dimensions of our EESG model. We have the economic dimension, we’ve talked about the related economic downturn. Also the environmental dimension is affected, because there is a risk of stepping back efforts to tackle environmental issues. We have the social dimensions such as health, education, and the employment challenges related to corona. And then also the governance dimension. This is reflected in the challenges linked to different sustainable development goals. There are the economic challenges, for example, relating to goal eight, the environmental challenges of goal 13, climate action, the social challenges related to goal three, for example, health and wellbeing, but also the governance challenges related to goal 17, on partnerships. I think this now shows us this is a very good time for sustainability and ESG which will be needed, let’s say, to rebuild our world after the corona crisis.
RW: What Marcus just said is absolutely right. We should not forget ESG and the issues related to climate. We will come out of this Covid-19 crisis, but we have to be prepared – with our policies and with the messages to investors – to stick to the principles that we have agreed upon. I appreciated the flexibility from the International Capital Market Association to include Covid-related investments in these social bond principles. That was a very positive move. But as this market segment grows, which it certainly will, you also need to be very transparent on how proceeds of these bonds are used – this is what investors expect from us. We have to be very clear with the principles. Again: transparency is very important.
JO: Frank, we’ve heard that the CEB and EIB are issuing these corona bonds essentially in the context of their ESG issuing structures. Which other SSA issuers could benefit from social corona bonds?
FS: Well the whole asset class would benefit. So far, social bonds have lived in the shade of green bonds, but all of them fit under the umbrella of ‘SDG-compliant’, with respect to the 17 sustainable development goals from the United Nations which Marcus just mentioned. Having said that, given the current situation around coronavirus, and its massive extension of government debt, even sovereigns themselves are under pressure in terms of speed. So they, alongside promotional banks like CEB, EIB, International Finance Corporation and others, look directly to issue these ‘theme’ bonds related to areas like medical healthcare support, and for SMEs; in Europe, but also Asia Pacific, as well as in the Americas. There is very strong demand in particular from developing countries. I would predict we should definitely see more of these social bonds from sovereign issuers.
JO: Do you think that the green bond market might be pushed to the side as a result of the current Covid-19 crisis?
FS: Well, we will see that the green market will be a little less prominent from the media perspective because we are all focusing more on the social side, particularly if it is corona-related. But that doesn’t mean that we will turn our back on action in the world; the development has to go forward. Talking internally with Marcus but also with global investors, real quality ones such as pension funds, asset managers, central banks, particularly those also running pension money, they all expect to carry on their SPG investments also on the green side, because this is a long-term issue. And rightly so, if we don’t take care of our environment we will have many more problems in the future – many more people will die than from Covid-19, for example, if we don’t get that right, not to mention the multi-billion dollar price of the environmental damages, if we don’t continue what we started years ago.
JO: In other words, we think that these bonds and this issue are related in investors’ minds and should continue to enjoy a good reception because of that.
FS: Let me finish with one sentence: we should definitely continue focusing on what I’ve just mentioned regarding SDG bonds in general. The two themes, green and social, will be the dominant ones among the 17 sustainable development goals for financing through capital markets.
JO. Thank you, Frank, and to each of you for talking to us today. Congratulations on these heavily oversubscribed bonds, providing proceeds for an extremely important cause. I wish you luck with your future issues and well done to DZ Bank and its partners for getting these bonds away working from home in difficult circumstances.
Listen to the podcast: