Retail government bonds have become a hot commodity in Europe. Its sudden appeal is in response to rising yields driven by higher interest rates and less appealing options being offered to savers by banks. While a number of European sovereign debt management offices are ramping up sales of retail debt as a result, others are more sceptical of the nature of the demand for these products. Particularly, the potential refinancing risks they could cause.
The European retail government bond market was discussed in detail at the OMFIF Sovereign Debt Institute’s second annual European sovereign, supranational and agency forum on 19 September in Luxembourg. This exclusive in-person event brought together leading European public sector borrowers, investors, banks and other market participants for a day of engaging discussions on the key issues facing this market.
Italy, Portugal and Belgium have all been shifting more of their funding to retail investors, with Belgium earlier this month raising a record €21.9bn in a retail bond transaction. This is not just a trend in western Europe. Hungary is leading the way in central and eastern Europe with a sophisticated and well-established retail bond programme, offering the largest proportion of its funding to retail investors of any country across the continent at just over 20%.
A few years ago, retail interest in government debt was nowhere near where it is now. Many years of low interest rates pushed households and individual savers to stow their cash elsewhere. ‘Things have changed over the last couple of years and I have to say people have been quite reactive to the large increase in interest rates,’ said the head of a large western European DMO at the OMFIF forum. ‘What we have seen is a very large participation of retail investors in our T-bills market and our short-term market.’
DMOs that offer specific products to retail investors say it is a win-win. Investors receive a more competitive offering to save their money compared to high street banks, while sovereigns open up an avenue for diversification and a broadening of their investor base. Not only does this encourage more households and individuals to save and invest in their local economy, the increasing use of retail bonds are also a way for sovereigns to close the gap left by the European Central Bank as a big player in the purchase of government bonds.
The head of a CEE DMO said a retail government bond programme was a ‘policy matter’. The programme served to create a structure encouraging people to save, while also acting as a ‘funding tool’ to finance the budget with the direct involvement of retail investors. He added that their use of retail investors also ‘gives us leverage on institutional investors’ due to a lower reliance on them for their funding.
However, not all European DMOs are convinced on the need to have a specific retail government bond strategy. The head of another CEE DMO stressed the importance of ‘the need to have a stable investor base’, adding that it was ‘hard’ to identify whether a retail investor base was stable in the medium to long term.
This view was shared by a senior official at a western European DMO. ‘We have some concerns about launching a specific product for retail investors because we don’t know if that demand is structural or if it’s opportunistic,’ said the official, adding that if the demand was opportunistic, it could markedly increase refinancing risks.
‘That’s the question, if that demand is structural or not,’ said the official. ‘If this segment is going to stay for longer and if they really want to buy our products, we can issue a specific product for them.’
Understanding the nature of this demand is one of the biggest hurdles in the wider adoption of the retail government bond market in Europe. In a poll of the attendees at the forum, there was a 50-50 split when asked if it was difficult to determine whether retail bond demand is opportunistic or long-term.
There are also concerns about the costs involved for issuing retail bonds. One argument is that issuing retail bonds is a cost-efficient strategy by DMOs. It is reasoned that these bonds are issued at the short end of the curve and without fees attached to them like syndications. However, some sovereigns are actually paying up to offer a competitive rate for retail investors, which muddies the central role of sovereign debt managers in delivering the lowest cost to taxpayers’ money.
‘Out of policy, we decided to pay up,’ said the head of a European DMO. ‘We decided that in order for us to be in this market, we have to pay up over and above the threshold curve.’
Speaking of Belgium’s recent record-sized one-year retail bond transaction, one DMO official at the OMFIF forum labelled it as ‘a monetary policy operation to remove liquidity from the banking sector’ and into sovereigns. He added that there were better ways to incentivise banks to pass on higher interest rates to savers but as a DMO, their focus is to simply finance budget deficits and bond redemptions.
Burhan Khadbai is Head of Content of the Sovereign Debt Institute at OMFIF.