Borrowers are increasingly giving preferential treatment to investors who submit their orders early during syndicated transactions. But this incentive requires a careful balancing act between rewarding loyalty and tackling the longstanding issue of inflated demand.
Managing orders and allocation strategies was a key topic of discussion at the Sovereign Debt Institute’s 2024 Public sector debt summit in Paris. This flagship event brought together sovereign, supranational and agency borrowers in Europe alongside investors and intermediaries for conversations on the most pressing concerns in the market.
Speaking at the summit, a funding official at one of the biggest SSA borrowers said it had recently begun giving preferential treatment during syndicated transactions. This means that, if an investor submits an order early during the book building process and before the final the terms of the deal have been set, they will receive a bigger share of the order in the final allocation.
The funding official said that the issuer, like many others in the SSA market, already employs a similar process for rewarding investors for its green bonds, but it has now rolled this out to all types of investors for its conventional bonds, including fast money accounts and hedge funds.
A funding official at another SSA borrower said it also ‘slightly’ rewards investors that come in early, but that it was difficult due to the importance of remaining loyal to the core investor base. ‘There are some big central banks that expect to be protected who come relatively late to the party,’ she said. The funding official added that rewarding investors for coming in early works better for larger benchmarks where the deal size can be increased, rather than deal sizes that are fixed from the outset.
Figure 1. Net increase expected across all allocation types
Source: OMFIF Public sector debt outlook 2024 survey
The other big problem for borrowers is the issue of inflated demand. If issuers are going to give preferential treatment to investors who submit their orders early, more accounts will submit inflated orders in the hope they will be allocated more of the deal. It becomes a vicious cycle.
Heavily inflated order books are a longstanding issue in the SSA bond market, particularly since the onset of quantitative easing. Not only is it illegal to inflate orders under the European Market Abuse Regulation, it also creates a headache for issuers in analysing real demand and therefore the price discovery process. An inflated order book also gives off the impression to other investors that the deal will tighten due to an abundance of demand, when in reality the issuer may not want to tighten the deal or may not be able to if demand is indeed artificial.
Of course, issuers can and should communicate with investors through their leads during the syndication about being sensible with orders and discouraging inflated bids. This is the responsibility of both issuers and banks. But it is difficult to completely overcome the issue as there is no mechanism to prevent investors submitting inflated orders. Providing incentives for submitting orders early will not help the matter.
Figure 2. Borrowers expect a bigger allocation to Asia Pacific and Middle East
Source: OMFIF Public sector debt outlook 2024 survey
However, that is not to say rewarding investor loyalty and adding incentives is not important, particularly as the SSA market finds itself in a new and increasingly uncertain market environment. As a result, borrowers are worried about demand in 2024. Just under 90% of public sector borrowers responding to OMFIF’s Public sector debt outlook survey highlighted reduced demand from investors as one of their top three funding concerns in 2024.
Some level of withdrawal from central banks in particular is expected due to quantitative tightening, meaning other investor classes will have to step up. But there is good news on that front, with borrowers expecting a net increase in allocation across all other major investor types, particularly hedge funds, according to the survey (Figure 1). Issuers also expect a bigger net increase in the allocation to Asia Pacific and the Middle East (Figure 2).
Burhan Khadbai is Head of Content, Sovereign Debt Institute, OMFIF.
