The public sector bond market is always developing. Its position as the biggest segment of the wider debt capital markets means it must, and should, always evolve. 2023 marked the return of liquidity in the European government bond markets to levels from before the Covid-19 pandemic. However, this is not the case for smaller issuers as liquidity is still front and centre of borrowers’ concerns as we have learnt through the various meetings held by OMFIF’s Sovereign Debt Institute last year.
There are a number of other interesting developments that will shape the discourse of the public sector bond market in 2024, such as plans by multilateral development banks to issue hybrid capital, the European Union’s journey to sovereign status, efforts to make bond markets more efficient and emerging market debt restructuring talks. Here is a round-up of 10 themes to look out for this year.
- Boosting liquidity to remain a key priority
Given that achieving liquidity for issuers is arguably the most important objective beside cost-efficiency, boosting liquidity will always be a priority. But there are innovative ways being discussed to boost liquidity, which have also been explored at meetings by the SDI. This includes adding incentives by sovereign debt management offices, allocating a bigger proportion to fast money accounts, overhauling the leverage ratio of banks, and most interestingly, adding non-banks as primary dealers. In a poll of attendees at the SDI’s European sovereign, supranational and agency forum last year, 70% said allowing non-banks to act as primary dealers was a good idea to boost liquidity in the market.
- Primary dealership mode under scrutiny (again)
Stresses on the primary dealership are not new but reviewing and adding incentives are now more important than ever to keep this model sustainable. In the SDI’s 2023 Public sector debt outlook survey, 45% of issuers from across the world said they were looking to provide more incentives to their dealers. This is particularly important for smaller banks who do not have capacity to keep up with obligations and compete with larger ones.
- Smaller issuers to look for ways of improving price discovery
The price discovery process became increasingly challenging for smaller public sector borrowers in 2023 with a wide divergence in calculations for fair value due to a lack of liquidity. This means issuers will need to spend more time working with banks to find solutions to this, such as increasing the use of taps of outstanding lines and issuing those taps directly into trading books and using reference points from liquid issuers such as the EU and KfW.
- MDBs will issue the first hybrid bonds via the capital markets
There has been the growing talk of multilateral development banks issuing hybrid debt to boost their lending firepower while protecting their triple-A credit ratings. The African Development Bank has been preparing the first such deal in the capital markets for the past few months and has received a lot of interest from investors. But the sticking point has been the price for the transaction. What is the right price for a subordinated bond by a top-rated MDB? Expect MDBs to negotiate a level that works for both them and investors with the first transaction in 2024.
- Greenium may narrow further but no longer a priority
The so-called ‘greenium’ – the premium achieved by issuers for selling green bonds – fell in 2023 and is expected to narrow further in 2024 to around the same levels as conventional bonds in some cases. The EU’s green issuance will largely dictate the greenium in the SSA market given the amount it issues in this format. But the falling greenium should not be too much of a concern given that it is no longer being considered a key priority for issuers.
- EU will make further steps towards sovereign status
The EU wants to be unanimously accepted as a ‘sovereign’ borrower and it is continuously making progress towards achieving that status. Last year, the EU reached several milestones such as introducing quoting commitments for its primary dealers to boost secondary market liquidity and being classified under the same haircut category as government bonds. This year, the EU will make further steps such as establishing a repo facility for its dealers to get access to EU securities on a temporary basis in case of scarcity. Meanwhile, plans for a futures market will heat up as liquidity continues to improve for the EU’s bonds.
- Efforts to improve market infrastructure will gather pace…
Progress is expected in the efforts to enhance bond market efficiency such as automating and standardisation documentation. Workflow processes were highlighted as the biggest inefficiency in the bond issuance process, according to SDI’s inaugural bond market infrastructure survey. Meanwhile, standardising legal documents and order book processes were highlighted as the ways to most improve efficiencies in pre-trade processes.
- …But digital bonds will continue to take a backseat
In spite of this, digital bonds will not take off into the mainstream due to the lack of a common standard in both the technology  and the structure of these deals. Moreover, the focus of market participants is set on improving efficiencies with the current technology rather than new technology. This is evident with the results of the SDI’s market infrastructure survey, where only 29% of respondents said they were looking to adopt distributed ledger technology and/or blockchain in debt issuance.
- Will retail government bonds continue to play an important role?
Last year, retail bonds became an important tool in the funding programmes of European government debt management offices. The issuance of these bonds served as a way to take advantage of rising yields driven by higher interest rates and less appealing options being offered to savers by banks. Belgium issued the biggest ever retail government bond in Europe with a €21.9bn one-year transaction before bringing other products with longer tenors. However, Belgium will reduce the amount it issues via retail this year while a number of other DMOs remain unconvinced on the need to have a specific retail bond strategy.
- EM debt restructuring will remain a complex affair
Debt restructuring is never an easy task and 2023 Â was no exception with the number of delays and setbacks in Zambia. The G20 framework has been frequently cited as the cause for the stretched negotiations which does not inspire hope for other emerging market nations this year. There were, however, some positive news with debt-for-nature-swaps as Ecuador sealed the largest such transaction to date with a number of new features to the structure of this product.
Burhan Khadbai is Head of Content of the Sovereign Debt Institute at OMFIF.