KangaNews DCM Summit duration webinar
The development of long-dated liquidity is a massive agenda item for the Australian debt market, as sovereign issuance soars and yield at the front end stays anchored. Local and global market participants shared views on how duration has evolved internationally and what might be in store for Australia, at a November KangaNews Debt Capital Markets Summit 2020 webinar.
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Issuance at long and even ultra-long tenor is of course nothing new globally, and even the traditionally mid-curve-focused Australian dollar market has increasingly ventured out along the curve in recent years – led by the sovereign, but also with deepening footprints from semi-government and credit issuers.
The Australian Office of Financial Management (AOFM) extended its nominal curve to 20 years in 2013 and to 30 years in 2016. But its long-dated issuance ramped up in 2020 along with its overall programme. It issued nearly A$24 billion (US$17.7 billion) of 20-year and longer bonds in 2020 to mid-December, compared with just A$2.4 billion the previous year.
The year also saw notable semi-government issuance at the long end and the local corporate market consolidating the availability of 10-year liquidity for investment-grade credits.
This clearly matches a global trend. Alex Anderson, head of US syndicate at TD Securities in New York, described 2020 as “a year unlike any other” thanks to the impact of COVID-19, including “quite astounding” consequences for duration. In part this was a result of the nature of the stress the unfolding crisis placed on markets.
“The immediate impact of the pandemic, back in March, was on the very short end – money-market instruments – and the front end remained almost entirely inaccessible even as the market started to thaw later in March,” Anderson explained. “There was almost no demand for new issues at five years and shorter, whether for highly-rated issuers, high-yield, asset-backed or anything else.”
The theme lingered long after the immediate shock of COVID-19, however. Indeed, Australian semi-government issuers returned to the market in the time-honoured fashion of seeking liquidity at short tenor. The growth in long-dated issuance is a trend with deeper foundations than a market crisis.
The primary driver is the actions of governments and central banks to stimulate struggling economies with ultra-low rates and QE programmes that include direct funding to sovereign- and private-sector borrowers. This has the dual effect of encouraging borrowers to lock in low rates for as long a term as they are comfortable with and forcing investors to look for yield including by pushing out duration.
“There is a huge push-and-pull dynamic across the rates market that is creating real distortions not only within yield curves but across them,” said Laura Ryan, head of research at Ardea Investment Management in Sydney.
For much of 2020, the Reserve Bank of Australia (RBA) focused its market intervention on controlling yield at three-year tenor while leaving the rest of the curve to float within the bounds of acceptable market function. This provided a further near-term impetus for investors to go long.
Ryan explained: “The RBA has pinned the three-year part of the yield curve while the AOFM has been issuing a record volume of sovereign bonds. This level of issuance is pushing yield up beyond the anchored point, which is why the Australian yield curve has been, hands down, the steepest across the globe. This has presented a lot of relative-value opportunities for us.”
Other jurisdictions have drivers of their own, though. In Europe, the creep of negative yield has continued to move the tenor at which investors can get a positive return from high-grade issuers. For instance, Andrea Dore, Washington-based head of funding at World Bank, said the supranational’s euro deals hit zero yield at around seven-year tenor in late 2019 but by mid-2020 it had to issue 15-year bonds to achieve the same level. By early November that point had extended to 20 years.
On the other hand, investors say it is not as simple as a blanket requirement for positive return. Ryan explained, for instance, that Ardea buys on a relative-value basis and therefore outright rates are not a primary driver.
Andre Severino, global head of fixed income at Nikko Asset Management in London, added: “Negative yield at the front end of the curve certainly contributes to the hunt for yield and therefore the demand for duration. But we don’t buy duration blindly – we consider factors like our view on interest-rate direction and try to position to maximise return. The lack of inflation in forecasts and the expectation of muted growth, as well as ongoing QE, all support a long-dated bid. Investors are willing to add duration because they believe the ECB [European Central Bank] is, and will be, there.”
There is no magic formula that triggers long-dated evolution beyond the combined weight of low rates and policymaker intervention squashing the short end. Anderson told webinar delegates that exactly the same phenomena have been playing out in the US through 2020.
“We have seen a tremendous shift in the composition of the US primary market,” he said. “Duration has been the name of the game, and issuers have been encouraged by low interest rates to go longer and lock in low-cost, long-dated funding. The search for yield and spread has forced even the investors we were used to seeing gravitate toward shorter tenor to extend along the curve to pick up extra yield.”
The availability of low fixed-rate funding at long tenor is naturally a positive factor for issuers and many are more than happy to access it. “Investors’ search for duration is a welcome situation for World Bank,” Dore confirmed. “We have been focused on extending the duration of our portfolio for the past three years, purely from an ALM perspective – we want to reduce the concentration of refinancing while pushing out funding maturity to be a better match with the duration of our loans.”
For World Bank in 2020, this included issuing two 10-year US dollar transactions for a combined US$7 billion. The larger of the two, at US$4 billion, is the issuer’s biggest ever in the currency having historically leant more on the euro market for duration.
In euros, World Bank’s long-dated issuance included a €2 billion (US$2.4 billion) 30-year benchmark in October that Dore said illustrates the evolution of the long end. Specifically, she explained, the book for this deal featured a degree of diversity akin to what the issuer would historically have expected to see for 10-year euro issuance.
The euro market was also the venue for Treasury Corporation of Victoria (TCV) and other Australian state issuers to dip toes in the water of long-dated issuance. TCV printed €150 million of 2050 maturity bonds in April 2020 and Paul Kelly, the treasury corporation’s Melbourne-based senior risk manager, revealed that once investors became aware of TCV’s willingness to issue long-dated euros there was strong follow-on demand.
It has since added €200 million to this line as well as issuing A$960 million across several 2050 syndications and taps filling various gaps in its domestic curve from the late 2030s to late 2040s.
Kelly said: “The availability of long-dated demand is fantastic for Victoria and the other states. It allows us to align the funding profile somewhat more with the assets on the state's balance sheet. We are a big borrower for infrastructure and have a significant volume of long-term assets.”
Issuer capacity and willingness to keep fulfilling long-dated demand is not infinite, however – even for high-grade issuers outside the sovereign sector. Most have portfolio-based funding approaches rather than match-funding loans, which makes tenor extension a valuable goal – to an extent.
Dore said: “Our senior management would like us to fund as far out as we possibly can! Our portfolio obviously contains some long-dated assets. In particular, IDA [International Development Association] loans are much longer – they can be 30- or 40-year fixed-rate facilities. IDA is now an active issuer and its appetite for duration is therefore even longer than that of World Bank.”
Overall, though, World Bank is not looking materially to shift its funding strategy to much longer duration. Dore continued: “When we fund, we also do so for liquidity – so we will still issue in the short part of the curve despite our overall goal to extend the duration of the portfolio. Plenty of investors still have demand at the five-year point and the size of our funding programme means it makes sense to provide issuance to meet that demand.”
It is a similar story for European Investment Bank (EIB). Eila Kreivi, EIB’s Luxembourg-based director and head of capital markets, told webinar delegates the supranational’s average loan duration – and thus its natural preference for funding-portfolio duration – is actually somewhat longer than those of its peer group. But, at seven years, it is still not likely to prompt a flood of very long-dated supply.
“It is very attractive for governments to borrow for 20 or 30 years with a negative interest rate, but we have very little need beyond about 15-20 years,” Kreivi commented. “We have capacity to do one 15-year benchmark every year and perhaps €1-2 billion total in ultra-long dates – though these will not be benchmark transactions. The LIBOR curve also tends to be quite steep so we would be paying up for long-dated funding that we don’t really need.”
Subsovereign issuers – in Australia and globally – have the same type of constraint. Petra Wehlert, first vice president and head of capital markets at KfW Bankengruppe in Frankfurt, echoes Kreivi’s view that the sovereign sector is likely to be the most natural source of substantial volume at the long end.
She explained: “We definitely see investor demand moving further out along the curve in this interest-rate environment and we have also moved out to meet them. While for us it is more a case of going from five to 10 years than going to 20 years and beyond, there is no doubt very long-dated issuance is now a normal part of the market and will become more so with the EU’s new funding programme.”
There are technical challenges, too – especially for cross-currency issuance at the long end, and even for the highest-grade issuers. Dore revealed that World Bank has received reverse enquiry out to 100-year tenor and is exploring opportunities at 40 years, but also that swap liquidity is challenging for ultra-long dates. Kreivi said benchmark-volume issuance is hard to support in the swap market even at 30 years.
“Realistically, the supply of 15-year-plus debt is not endless – we are not going to change the way we approach the market,” Kelly concluded. “What long-dated issuance gives us is protection against future interest-rate rises for a lot longer.”
LIQUIDITY AND OPPORTUNITIES
Perhaps the biggest question for Australia is whether there will be enough supply to support the development of liquidity at longer tenor. Market participants tend to agree that, historically, Australian dollar liquidity drops off much beyond the 10-year government bond futures contract basket. AOFM issuance out to 30 years has helped but there is still much less liquidity in the 20-year futures contract, for instance.
Kelly believes things have improved already. “I have thought since at least early 2019 that we were pretty close to having a liquid curve out to 12 years in Australia and that extension to 15 years was not impossible,” he suggested. “I think we have probably reached that point now. I think it’s possible that Australian semi-government issuers could have a liquid curve out to 20 years, and though we are not there yet we are all starting to have a lot of long-dated bonds outstanding.”
The evolution of liquidity in global markets may not be a path Australia naturally follows, given the larger and more diverse nature of the investor bases in global core currencies. For instance, Anderson said while the US market has developed strong liquidity across the curve this is helped by the presence of disparate investor groups at different tenor points.
In fact, some of the longer dates are among the most active in the US. Anderson commented: “The deepest pool is 10 years, because there is money at this tenor from almost the full gamut of investors: pension funds, insurance, hedge funds and others. The 30-year tenor is probably the next most liquid, and actually we are seeing growth in liquidity at 20 years.”
Ryan added: “Long-end liquidity depends where you are and on market conditions. Liquidity dried up during the worst of the COVID-19 crisis, of course – but this was the case in all sectors. We are now back to more normal conditions, though there is definitely less liquidity at the long end. It is all relative, though: while the long-dated high-grade market is less liquid than the short end, it is still much more liquid than credit.”
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