World Bank could lead supranational revival in euro bond market

Reuters

* 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 haveshunned the euro market for over two years may be on the cusp ofmaking a return as funding costs in the single currency start tobecome appealing again.

Global development banks which hold US dollars as theirreserve currency, such as the World Bank, are keeping a closeeye on increasingly favourable cross-currency swap costs thatcould once again provide attractive arbitrage opportunities.

"If there is real demand from investors, real moneyinvestors as opposed to bank balance sheet or collateral drivendemand, then we would certainly consider it," said GeorgeRichardson, head of capital markets at the World Bank.

From the introduction of the euro in 1999, the World Bankand its private sector arm, the International FinanceCorporation, were regular issuers of private placement andtargeted floating-rate bonds in euros. The World Bank evenissued two benchmarks over the period, a EUR1.5bn three-year in2007, and a EUR3bn 10-year transaction in 2009.

Other supranationals, too, like the Inter-AmericanDevelopment Bank and the Asian Development Bank also tookadvantage of funding opportunities in euro markets.

However, in the middle of 2011, this issuance was stopped inits tracks, as European banks struggling to fund their dollarassets flooded the swap market, forcing up the cost of swappingeuros into US dollars.

These costs peaked at the end of 2011, but as global marketshave rebalanced, and European banks have found it easier to fundin dollars, the basis swap has become steadily more favourable.

This has been particularly evident in shorter maturities inrecent months, which has prompted a number of bank originatorsto 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 havealready taken advantage of the decreasing cost of swapping eurobonds back into dollars, diversifying and deepening their globalinvestor pool.

Supranationals, however, have proved harder to persuade.

Not only do they need to be assured that a euro issue wouldat very least match their all-in dollar funding so their lendingcosts are not affected, but they also have to be sure the bondswould be properly placed.

"If the funding costs work, we would aim to do at least oneeuro-denominated benchmark a year," said Richardson at the WorldBank.

COMING HOME

This trend has already led some European borrowers whichfound more attractive funding levels in dollars to return totheir home currency.

Council of Europe, for instance, which has favoured USdollar issuance in recent years, issued its first euro bondsince 2011 on Tuesday.

Sources close to that deal said that, in theory, and withouttaking into account undisclosed costs and fees, the euro issuecomfortably beat the price on an equivalent dollar deal.

"I think we are going to see a lot more issuance in euros ifthe basis swap continues to be favourable," said Kerr Finlayson,head of SSA syndicate at RBC Capital Markets, a lead manager onthe Council of Europe transaction.

"Not only from non-eurozone issuers coming back to euromarkets, but also eurozone issuers who don't see the value inthe dollar arbitrage anymore."

This is good news for investors as well as issuers, and evena sign that stability is returning to the fragile currency bloc.

"Apart from the obvious diversity that these issuers wouldbring to the market, it could also be a way of benchmarkingexisting issuers and creating arbitrage opportunities," saidMarie-Anne Allier, head of Euro Aggregate Fixed Income at Frenchasset manager Amundi.

"It is interesting that the euro is seen as a "stable"currency or, let's say, as a credible currency for issuers thathave access to the dollar market. This is a good sign for theentire eurozone and should give more confidence to investorswhen it comes to investing in the euro."

SHORT WINDOW?

While the main driver of movements in the basis swap isEuropean banks' reliance on the market, there are other factorsat work which could put recent trends into reverse over theshort-term.

The risk of US default, in particular, and underlyingcurrency movements have been cited as also driving the morefavourable euro basis swap of late.

However, with most analysts predicting some last minutecompromise 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 risktone around the US improves, we could see the euro/dollar basisswap go deeper into negative territory again," said Asif Sherani, public sector syndicate at HSBC.

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