International demand for European safe assets a ‘zero-sum game’

European triple-A public sector bond market saturated with similar ambitions

Interest in European sovereign, supranational and agency bonds from international investors has noticeably risen. While this is enhancing the safe asset status of bonds in the continent, it is also causing fierce competition among the upper echelon of issuers.

Developing the euro as a safe asset formed a key topic of discussion at the European SSA forum hosted by OMFIF’s Sovereign Debt Institute in Luxembourg. This exclusive event brought together leading European sovereign debt management offices and issuers, along with banks, investors and other market participants to discuss the key issues facing this market.

‘The reality is that we have seen an influx in euro interest,’ said a head of debt syndicate at the OMFIF forum. ‘There is probably a larger percentage [of bonds] going into Asia and the Middle East, so there’s an internationalisation of the euro, which is positive.’

In addition to increased interest from international investors for euro-denominated bonds, there has also been increased issuance by international borrowers in the euro market.

‘We’re seeing a lot more international issuers coming to the euro market,’ said the head of debt syndicate. ‘That’s another side of the debate when you talk about the currency as a safe haven. China, Hong Kong, Korean issuers and many others out of Asia have been coming to the euro market over dollars or complementing their dollar issuance with euros.’

Up until now, international demand has proved to be fairly thin for European SSA issuers. For example, from the respondents to the European Union’s recent inaugural investor survey, only 6.2% were from outside of Europe. However, the recent increased interest from international investors is a huge boon for European public sector issuers in diversifying their investor base, thereby improving demand and liquidity.

A senior official at a leading European SSA issuer said 90% of its investor base was formed of European accounts but said it was focused on increasing its diversification from investors across the world. ‘Every issuer wants as broad an investor base as possible,’ said the official. ‘We want to expand our investor base more broadly. That is an ambition but it takes work.’

The key hurdle to this is that there are a lot of top-rated European issuers with a similar ambition. ‘It’s a crowded space with a lot of European governments, agencies and SSAs competing for overseas investors trying to sell themselves and it’s potentially a zero-sum game so we have to put our best foot forward and that’s what we’re doing.’

A senior market participant noted the vast number of safe and liquid assets from top-rated issuers in Europe. ‘We have the likes of the Netherlands, Luxembourg and Germany, the European Stability Mechanism, European Financial Stability Facility, European Union, European Investment Bank and European Bank for Reconstruction and Development rated at triple-A,’ he said. ‘However, one thing that makes things even more complicated is that, aside from these institutions, we have triple-A rated sub-sovereigns and the likes of KfW that are also safe and liquid assets, being fully backed by the government.’

There are varying definitions of what a safe asset is. Essentially it is about liquidity and accessibility: ‘A safe asset is an asset that I can buy and hold,’ said a senior official. ‘I find it extremely interesting, because you never read that anywhere in the usual literature.’

Another official echoed this definition but elaborated further. ‘A safe asset is characterised by a strong rating and high liquidity conditions. I think that it is as simple as that. A safe asset can also serve as a benchmark for pricing other securities or act as a safe haven, in case of market turmoil.’

There also seem to be issues in comprehension. The various acronyms of European supranationals and agencies complicate things further when funding teams are presenting themselves to international investors. It is difficult for investors to distinguish between these issuers, particularly when they are all top-rated safe assets that are funding similar goals. The arrival of the EU and its Next Generation EU programme has only muddied the waters further, although it has also brought greater interest in European bonds.

While it stands to be a tough job for issuers selling multiple safe assets, it’s clear that the fragmentation of the European capital markets is here to stay.

Burhan Khadbai is Head of Content of the Sovereign Debt Institute at OMFIF.

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