5 Min Read
* 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 investor pool.
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 Bank.
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 short-term.
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.