Delays to derivative contract changes thwart Italy's dollar bond plans

Fri Jan 24, 2014 10:35am EST

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* Changes to collateral swap agreements on hold

* High swap charges likely to nullify arbitrage opportunities

By John Geddie and Christopher Whittall

LONDON, Jan 24 (IFR) - Italy's plans to return to the dollar market after a near four-year hiatus are being hampered by delays to crucial changes to its derivatives contracts, jeopardising its chances of broadening its international investor base.

The country announced at the end of last year that it would look to sell its first benchmark dollar issue since 2010 as it tackles a EUR470bn gross issuance programme in 2014.

However, its chances were greatly diminished after the government failed to present a crucial legal change to parliament on schedule at the end of last year [ID: nL5N0ID448].

The changes, penned by Italian lawmakers in October, would have allowed Italy to post collateral against derivatives contracts, helping reduce the credit exposure of bank counterparties and thereby improving all-in swap costs [ID: nL5N0ID448].

"In order to justify issuance in another currency, Italy needs to make a cost saving to its euro curve after the swap," a banker at one of Italy's primary dealers told IFR.

Bankers say their charges for executing swaps with asymmetrical collateral agreements would be significant. They are already wallowing under the country's notoriously large uncollateralised swaps portfolio - estimated by some dealers as being in the region of EUR40bn.

"There may be some arbitrage opportunities later in 2014, but if the margin is eaten up in derivative charges then it will make no sense," said the banker.

A spokesperson for the Tesoro told IFR: " was not the most appropriate occasion for such a specific measure: there could have been the risk to not be adequately analysed nor understood."

"The new regulation will likely be submitted in a more targeted measure, unifying it with other similar ones by subject."

As well as a blow to the banks, the delays could stifle Italy's chances of capitalising on renewed interest from international investors in its debt.

Currently around 61% of Italy's bonds are held domestically, with around 9% held at the European Central Bank and 30% overseas, based on the latest figures from the Bank of Italy.

Distribution snapshots from recent syndicated transactions show that the overseas placement of Italian debt is heavily concentrated in Europe.

The delays also mean that the market could be moving away from Italy. Since Spain launched a USD2bn five-year in February 2013 after a three-and-a-half-year absence, the benefit of swapping from US dollars to euros has reduced by around 15bp, from 25bp to around 10bp, before additional swap costs and collateral charges.

The two previous dollar deals from the Republic of Italy allowed it to save as much as 23bp versus its euro funding.

This is not to say that Italy can't stage a comeback without the changes, however.

"I want to say it is an impossibility, because clearly we want them to change, but I cannot completely rule it out," said a senior public sector origination banker at another of Italy's primary dealers.

Spain only has one-way collateral agreements, but was able to sell the dollar deal because one domestic bank offered to do the swap, bankers close to that transaction say. (Reporting by John Geddie and Christopher Whittall, editing by Helene Durande and Julian Baker)

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