01 Mar 2005, Credit magazine, Credit
When you ask seven investment banks – without offering fees – to investigate the market’s appetite for a 50-year government bond and then offer those same banks lead-manager positions on any issue that materialises from their search, it is not difficult to work out what their response will be.
In fact, when Agence France Trésor (AFT) asked Barclays Capital, BNP Paribas, CSFB, Deutsche Bank, HSBC CCF, CDC Ixis and JPMorgan to do precisely that on the second Monday in February, it took those banks just five days to report back to AFT’s chief executive officer, Bertrand de Mazières, that the market was indeed hungry.
Within a week the dealers’ conclusions had been relayed back to investors at simultaneous presentations in London and Paris and just five days later AFT had successfully priced and launched a e6 billion deal that stretched out to 2055 with a 4% coupon. The whole process was over in 13 working days.
But while it was always in the interests of the four leads (Barclays, BNP Paribas, Deutsche and HSBC CCF) and the three senior co-leads (CSFB, CDC Ixis and JPMorgan) to get the deal done, it never seemed likely that AFT would have much trouble bringing the longest ever G7 government bond to the market.
Wholesale changes to pension solvency requirements across Europe, which stipulate that pension funds must mark their liabilities to market instead of using fixed-rate calculations, have begun to push investors into longer-dated bonds and away from shorter notes, putting downward pressure on 30-year yields. Indeed, analysts in the Netherlands, where investors will have to shift to fair-value accounting from January of next year, believe that as much as €150 billion will flow into 30-year paper over the next two years with funds even cutting into their equity holdings to make way for fixed-income products.
“Dutch pension funds should be big buyers of duration in 2005 on regulatory factors,” says Harvinder Sian, analyst at ABN Amro. “Investors will want to hedge the risk in their long-term liabilities to avoid the most onerous regulation elements and we expect around €120 billion to €150 billion in 30-year buying.”
In fact, Credit’s own investigation of 10 pension funds in the UK, Sweden, Finland, Denmark and Switzerland as to the appetite for AFT’s 50-year note, which was carried out at the same time as the investment banks’ own study, found that the French note had a great deal of backing from the pension fund community.
“We think it is quite smart of the French Treasury to consider a long bond. Pension funds need to match their liabilities and there is ample demand from the sector for such a deal,” says Jussi Laitinen, chief investment officer at the e14.7 billion Finnish pension insurance fund, Ilmarinen.
Ole Petter Langeland, head of fixed income at the e17.3 billion Swedish government buffer fund AP2, agrees: “There is a large need for duration among long-term investors and this deal will definitely help a lot of them to achieve that.” Timo Viherkentta, deputy CEO at the €14 billion Local Government Pensions Institution in Helsinki, adds: “An ultra-long bond would definitely attract interest from pension funds and insurance companies, which are subject to strict solvency requirements. For those investors, a reduction in the present value of their liabilities would even out the loss in the value of the bonds if and when interest rates rise in the future.”
But fund managers were not without their concerns and some feel the current low interest rate environment could put off many potential buyers. “The French government must be confident that investors are unconcerned about being around when the note matures,” says a UK-based fund accountant at a county council pension fund. “Unless the interest return is attractive, why lock your money away for such a long time? I much prefer equities.”
Although Laitinen at Ilmarinen anticipates demand for the deal, he has no immediate interest in it. “Finnish legislators are not considering marking pension liabilities to market – at least not yet. So in the short run we probably will not be too interested in actively building up positions at these historically low interest rate levels,” he says.
Consequently, the results communicated by AFT at its presentation in London’s Grocers’ Hall on February 18 showed that, while 35% of the 400 responding investors – which were whittled down from an original study of 550 – said they had potential interest in the 50-year Treasury bond (OAT), 34% had absolutely no interest in the deal at all.
This does not trouble Benoît Coeuré, deputy CEO at AFT, however. He is confident that this group was only put off because of procedural issues. “Presumably some funds had no need for our deal because the duration of their liabilities is much shorter than 50 years,” he tells Credit. “But possibly there were others prevented from buying the bond because of procedural constraints. A few investors said that they would have to seek the advice of their investment committees before they could buy this deal and that they did not have the internal systems already in place for a 50-year note. This timing issue made it impossible for them to participate.”
Citigroup was also unable to participate. The absence of the US bank as either lead or co-lead was one of the most interesting aspects of AFT’s issue. Just four days before AFT held its presentations in London and Paris, it had published its own performance league tables, ranking managers on their activity in the primary and secondary markets as well as on their commercial relationship with the issuer. Citigroup came sixth in that overall table behind BNP Paribas, Deutsche Bank, HSBC CCF, Barclays Capital and SG CIB and also failed to finish in AFT’s top three for primary and secondary performance alone. Surprisingly CDC Ixis, which came one place behind Citigroup in the overall table, and CSFB, which failed to appear at all in AFT’s top nine, were both chosen ahead of the US dealer as co-leads.
Coeuré assures Credit that there was nothing sinister behind Citigroup’s exclusion. “We have 21 primary dealers and we selected seven that were the most active at the long end as well as globally. There is always a certain set of guidelines we use when we choose managers for a particular deal and Citigroup did not fit those guidelines on this occasion – there is no other message behind that,” he says.
But the message from investors is clear: demand is strong for 50-year paper. The UK’s debt management office has already undertaken a formal consultation process with investors about the possibility of issuing its own conventional index-linked and annuity-type 50-year gilts and AFT has also said that it is looking into the possibility of issuing an additional 50-year inflation-linked note to bolster its existing series of inflation-linked notes: OATi. At the same time, Germany and Italy are believed to be planning a move in this area.
In fact, many fund managers say they will not get involved in the 50-year sector before other government issuers get involved first. “The duration and yield trade-off is not great when you move from 30 to 50 years,” says one investor. “But when you look at this deal in the wider picture, and if it is followed by a German and Italian note, then the sector would become very liquid and very difficult to ignore – even for investors not following asset and liability matching rules.”
Laurence Mutkin, head of fixed-income strategy at Threadneedle Asset Management, does not think that investors will have to wait long. France issued the first 30-year note in 1989 and the first eurozone inflation-linked note in 2001. “This has become the first 50-year issue and where France leads others always follow,” he says.
Rule changes for pension funds
By the start of next year, pension fund investors in the Netherlands will be forced to calculate their liabilities at fair-market values instead of the 4% fixed rate they currently adhere to. The move, which comes as part of the Dutch government’s new pension funding rules, the Financieel Toetsingskader (FTK), will increase the volatility of each fund’s liabilities and push them into holding more long-dated bonds.
At the same time, the Swedish financial authorities are also discussing the possibility of pension funds and insurance companies moving to a fair-value system of accounting and away from their current 3.5% fixed-rated usage.
Both these changes come in the wake of the Danish switch to fair values in 2001, which resulted in a massive sell-off in stocks that saw some schemes reducing their average exposure to foreign equities from 35% to 10% and increasing their allocation to bonds from 54% to 73%.