* Narrowing EUR/USD basis swap starts to appeal
* Euro arbitrage reappears after two-year hiatus
* Debt ceiling resolution may close issuance window
By John Geddie
LONDON, Oct 15 (IFR) - Supranational issuers that have
shunned the euro market for over two years may be on the cusp of
making a return as funding costs in the single currency start to
become appealing again.
Global development banks which hold US dollars as their
reserve currency, such as the World Bank, are keeping a close
eye on increasingly favourable cross-currency swap costs that
could once again provide attractive arbitrage opportunities.
"If there is real demand from investors, real money
investors as opposed to bank balance sheet or collateral driven
demand, then we would certainly consider it," said George
Richardson, head of capital markets at the World Bank.
From the introduction of the euro in 1999, the World Bank
and its private sector arm, the International Finance
Corporation, were regular issuers of private placement and
targeted floating-rate bonds in euros. The World Bank even
issued two benchmarks over the period, a EUR1.5bn three-year in
2007, and a EUR3bn 10-year transaction in 2009.
Other supranationals, too, like the Inter-American
Development Bank and the Asian Development Bank also took
advantage of funding opportunities in euro markets.
However, in the middle of 2011, this issuance was stopped in
its tracks, as European banks struggling to fund their dollar
assets flooded the swap market, forcing up the cost of swapping
euros into US dollars.
These costs peaked at the end of 2011, but as global markets
have rebalanced, and European banks have found it easier to fund
in dollars, the basis swap has become steadily more favourable.
This has been particularly evident in shorter maturities in
recent months, which has prompted a number of bank originators
to pitch the World Bank to issue a new two-year euro benchmark,
said market sources.
Since June, the two-year euro/dollar basis swap has halved,
and at minus 15bp is now at levels not seen since early 2011.
US corporate issuers such as McDonald's and Microsoft have
already taken advantage of the decreasing cost of swapping euro
bonds back into dollars, diversifying and deepening their global
Supranationals, however, have proved harder to persuade.
Not only do they need to be assured that a euro issue would
at very least match their all-in dollar funding so their lending
costs are not affected, but they also have to be sure the bonds
would be properly placed.
"If the funding costs work, we would aim to do at least one
euro-denominated benchmark a year," said Richardson at the World
This trend has already led some European borrowers which
found more attractive funding levels in dollars to return to
their home currency.
Council of Europe, for instance, which has favoured US
dollar issuance in recent years, issued its first euro bond
since 2011 on Tuesday.
Sources close to that deal said that, in theory, and without
taking into account undisclosed costs and fees, the euro issue
comfortably beat the price on an equivalent dollar deal.
"I think we are going to see a lot more issuance in euros if
the basis swap continues to be favourable," said Kerr Finlayson,
head of SSA syndicate at RBC Capital Markets, a lead manager on
the Council of Europe transaction.
"Not only from non-eurozone issuers coming back to euro
markets, but also eurozone issuers who don't see the value in
the dollar arbitrage anymore."
This is good news for investors as well as issuers, and even
a sign that stability is returning to the fragile currency bloc.
"Apart from the obvious diversity that these issuers would
bring to the market, it could also be a way of benchmarking
existing issuers and creating arbitrage opportunities," said
Marie-Anne Allier, head of Euro Aggregate Fixed Income at French
asset manager Amundi.
"It is interesting that the euro is seen as a "stable"
currency or, let's say, as a credible currency for issuers that
have access to the dollar market. This is a good sign for the
entire eurozone and should give more confidence to investors
when it comes to investing in the euro."
While the main driver of movements in the basis swap is
European banks' reliance on the market, there are other factors
at work which could put recent trends into reverse over the
The risk of US default, in particular, and underlying
currency movements have been cited as also driving the more
favourable euro basis swap of late.
However, with most analysts predicting some last minute
compromise around the debt ceiling before Thursday's deadline,
the current window for issuance could be slammed shut.
"If we get some compromise on the debt ceiling, and the risk
tone around the US improves, we could see the euro/dollar basis
swap go deeper into negative territory again," said Asif
Sherani, public sector syndicate at HSBC.