Liquidity is more important than ever, but for public sector agency and sub-sovereign issuers – particularly those with annual funding requirements of around €10bn and under – this is challenging. Because these borrowers have smaller funding programmes, they have fewer opportunities to refresh their curve and issue new lines.
Ways in which smaller agency and sub-sovereign issuers can ensure their bonds are liquid were discussed in detail at the inaugural European agency and sub-sovereign forum, hosted by OMFIF’s Sovereign Debt Institute in Paris. The event brought together a group of leading agency and sub-sovereign issuers in Europe, along with investors, banks, policy-makers and other market participants for an in-depth discussion on issues affecting this part of the public sector bond market.
The importance of offering investors a meaningful new issue premium on primary market transactions was brought up by a few borrowers as a way of boosting liquidity in the secondary market. ‘It’s a long-term thing, it’s not just a one-off,’ said a funding official at a European agency. ‘Investors are supporting you in the transaction so support them back. Leave something on the table so that the bonds will actually perform in the market. They can sell them and make a little bit of profit almost there and then but, in the future, you don’t know what’s going to happen with the market.’
It is about developing a long-term relationship with investors. This is arguably even more crucial for smaller borrowers who rely on their network of investors to keep coming back to their bonds – thereby ensuring their bonds are liquid – particularly in times of crisis and volatile markets when issuers lean on buyers of their bonds. In a survey of the attendees at the forum, 60% said banks are not doing enough to help issuers maintain liquidity in their bonds.
This view was shared by another funding official who advised issuers to not be ‘greedy’ when they have big order books to avoid tightening the spread further. ‘You must stick to the commitment made during or before a transaction. That’s what we have done over many years,’ he said. ‘Sometimes the banks are surprised that we don’t tighten further but we say we have a commitment and we have discussed this and it pays off over time. We have experienced that in many crises.’
‘I’m paid for liquidity, not for price,’ he added. ‘That’s what many people forget. My board wants me to get €1bn-€2bn when there is an emergency. I don’t want to stand up and say I’m not going to do the trade because it might be a basis point too expensive.’
Some of the biggest portfolio managers in Europe were also part of the discussion. ‘Normally when you have a huge programme, you are more liquid,’ said a portfolio manager. ‘But with a small issuer, there is always this question of: where is the liquidity? I can buy in the primary market but afterwards, if I want to sell, how can I do that and at what price? When I want to buy in the secondary market, sometimes it’s not possible.’
Offering a bigger new issue premium over larger borrowers in the primary market is a liquidity premium smaller issuers have to pay to ensure their bonds are liquid, which issuers at the OMFIF forum said they were happy to pay. Investors need quick and easy access to buy and sell bonds in crises and times of urgent liquidity needs. Having a diverse network of investors is crucial in allowing this.
Another borrower said they have been rewarding banks that boost the liquidity of their bonds in the secondary market. ‘After every issuance, we don’t just sit tight and accept that our bonds are less liquid,’ said the funding head. ‘What we have been doing for quite a number of years is try to engage banks and let them know that their work doesn’t end with the primary market.’
‘We don’t only take into the account the job that they are doing in placing the bonds in the primary market,’ added the funding official. ‘We also take into account the secondary market.’ The funding official said these considerations help form their shortlist of banks for selection on mandates for syndicated benchmark transactions.
Other borrowers are looking to develop similar strategies on secondary market activities for banks. One borrower said they were ‘just starting’ the process. ‘We are getting reports on the secondary market transactions that banks are doing in our lines just to get an overview of how much each of our dealer banks is contributing to the liquidity in our outstanding bonds.’
Burhan Khadbai is Head of Content at the Sovereign Debt Institute at OMFIF.