WHEADON Markets have been very choppy, particularly in the past few months – but this is not a uniquely Australian story. Liquidity may not be what it was 12 months ago but it has not deteriorated to a point where we are concerned about getting our programmes funded.

Looking forward, elevated and persistent volatility could mean we face a more constrained set of choices in how the funding task is achieved. To date, though, the Australian government bond market has actually fared quite well. While we always try to be attuned to any stresses that may be present in the market and the impact of our activities on it, the Australian Office of Financial Management (AOFM) has by and large been able to issue in a relatively normal manner even with the wild swings of recent months.

With every chance volatility could persist for a while, it helps that budget outcomes are tracking considerably better than forecast when the federal budget was released in March. We are about A$25 billion (US$17.4 billion) ahead to the end of May alone on published figures. This means we enter the new fiscal year with a good head start on the 2022/23 programme.

There remains some uncertainty in the new fiscal year, though. The government has made clear its intention to create several new funds, which could increase our funding task – we have no information yet about what this will look like and how it will affect our funding task in FY23 and beyond. We await the October budget for clarity on this and the rest of the government’s fiscal agenda.

CHANDLER We had not syndicated since February and our issuance slowed into the end of the financial year, which occurred while the market backdrop became more challenged. We always try to have as light a touch as possible on the market when we issue and we took the view that a syndication of one of our fixed-rate lines, which would traditionally be a go-to to start the financial year, was not going to be the optimal trade for our clients or our investors at the time.

Given we run mismatches, we have the flexibility to issue in FRN format from time to time depending on the market backdrop. We thought the floater was the best option and had noted TCV’s successful trade a few weeks earlier.

It remains our expectation that fixed-rate benchmarks will continue to take the bulk of our issuance throughout FY23. But the FRN is a good option to have when the outright market is volatile, as participants tend to dial back their activities.

With FRNs, we are issuing a zero-duration instrument that takes away some of the noise and complements our overall issuance strategy quite nicely. It allows us to continue our funding activities even in a more challenged market backdrop.

KELLY The year so far has been a tale of two quarters. In Q1, we noted solid support from bank balance sheets andfrom Japanese real-money accounts, which saw us quite active through reverse enquiry and tenders. Then the end of the Japanese financial year seemed to coincide with an increase in volatility, sharply rising rates, and tighter semi and swap spreads. It stands to reason that the three big investor sectors were less engaged.

We thought it was time to be a little bit inventive and do something different, so we brought the dual-tranche FRN trade. To some degree, FRNs provide a safety outlet when market conditions are less favourable.

The main reason we launched the FRN in June was that we expected liquidity conditions to continue to deteriorate and judged it would be difficult to get a sizeable, fixed-rate deal away in the back end of the curve. But despite these headwinds we still printed more than A$6 billion in June, including A$4.4 billion of FRNs.

FAJARDO The latter part of Q2 was challenging in the fixed-rate market, with semi-government spreads to bonds at the widest level since July 2020. These wider spreads might now look attractive to investors, though – and we are seeing increased interest in semis at these levels.

QTC went into Q2 having already completed around 90 per cent of its borrowing programme and we had syndicated all our new maturities: a new benchmark, a new FRN and a new green bond. In the late part of Q1 and early Q2 we started to see reverse-enquiry interest, first in fixed and then in floating, and we comfortably completed our borrowing programme through reverse enquiry in Q2.

About two-thirds of the funding we have completed this year has been through syndication and tender, but these took place prior to Q2. In addition, the Queensland government released its budget in June – which gave us another reason not to issue during that period. This was fortunate given the market volatility.

KELLY We will continue to do a mix of syndication, tender and reverse enquiry, and it is a matter of choosing the right delivery method at the right time to give us the outcome we want.

We have done 35 per cent of our issuance this year through syndication, up from 30 per cent in 2021. Another 40 per cent is through reverse enquiry, down from 50 per cent. The remaining 25 per cent is in tenders, up from 20 per cent. The lesson we learned, particularly in 2020, was that when markets be flexible.

Whether we use syndication, tender or reverse enquiry, we are essentially choosing what we think will provide the government with the best volume outcome at the appropriate price.

CHANDLER We do not go into any year with a plan to issue a target amount across the three formats. Depending on investor demand and market conditions, overlaid with our clients’ needs, it is a matter of taking the most effective issuance option at a point in time.

We always aim for a very light touch on our curve and we are keen to avoid forcing trades into the market. During the period into the first half of Q2 this calendar year, we responded to reverse enquiry as there were pockets of demand that had deep pools to tap into.

FAJARDO QTC carries high levels of liquidity, which allows us to be absent from the market for a time during periods of volatility when we consider issuance to be counterproductive for us and for investor objectives.

Our decision to do reverse enquiry was not because we could not have achieved a syndicated deal in fixed-rate format if we had needed to go to market. The alternative to syndication at that time – reverse enquiry – was available in good volume. Had this not been available to us and we needed to fund, we likely would have had to go out with a tender or a syndicated tap.

CINQUINA Having flexibility in format, tenor and approach is the most important attribute needed in markets, particularly in these challenging circumstances. But semi-government access in Q2 has been quite good despite the volatility we have seen. In addition to the two large FRN trades from TCV and TCorp, there has been upwards of A$20 billion of issuance from the semis in tenders and reverse enquiry.

Our programme is reasonably small in comparison with our peers’ programmes, which gives us more flexibility in choosing when we come to market. At the moment – given our strong liquidity position and small client need – we could stand out of term markets for a number of months, at least in the sense of large syndicated trades.

Our approach to markets will remain mostly unchanged, through reverse enquiry, tenders and syndications. There will be at least two syndications this year, one in floating-rate format and a fixed-rate issue to fill part of the gap in our curve between the 2031 and the 2034. That syndication will likely be in thesecond half of FY23 and may take the form of a labelled issue.

At the moment, spreads to Australian Commonwealth government bonds (ACGBs) are looking very attractive but we are not seeing the participation we would like from domestic and offshore real money. It would be good to see more central bank policy clarity, which might help align markets with central bank expectations. This would support market stability.

KENNEDY The comment about having a light touch is really quite important. As issuers, when we come to market we are not just doing what we need for our own purposes – we are also guardians of market health. We take this seriously. We need to know that we can come back to the market and we do not want to be either diluting or polluting everyone else’s space, so we must be careful about how we access markets.

When I look at it specifically from a SAFA perspective over the coming 12 months, we do not have a lot to raise – about A$6.6 billion of long-term debt. Our total outstanding at the end of FY23 is only going to be A$30 billion, though, so proportionally the task is quite significant. We must be careful about how we put this extra supply into our curve.

The amount of outstanding debt we have in the market will increase significantly – by about a third. Being aware of what techniques are available, what liquidity conditions look like at any point in time and what the pressure points are for all investor sectors is important.

Offshore investors are also participants in the market, so having an awareness of what is going to be important to investors across all jurisdictions and types at any point is what will allow us to deliver the best outcomes, not just for the state but for the whole sector.

WHEADON Our next syndicated trade will be a new 2034 line, to be issued in the December quarter. This gives us a broad window to bring the trade and it is a part of our normal pattern, which would see us introduce up to two maturities each year that are a little longer than the 10-year basket when introduced.

Before pulling the trigger, a period of relative calm in markets and a data-light execution window is generally preferred. The reality is we rarely have the luxury of executing in ideal conditions, which means we always have to be a little flexible around timing, size and pricing, and be prepared to adjust expectations accordingly.

When we launched the November 2033 line back in April, we had a very large, diverse orderbook and it was a very high quality trade at a good price. In fact, throughout the last few months of relative turmoil in markets, I have been reassured by the continuing willingness of investors to engage with Australian government securities and we have been able to issue relatively normally throughout. This is a fortunate position for us to be in and we do not take it for granted.

To echo the point made earlier about capacity to stand out of markets – the AOFM is no different, by virtue of a conservative approach to cash management. The AOFM has the capacity to stand out of the market for quite a while if required, should there ever be unprecedented upheaval.

KELLY One difference between the states and the AOFM on the lending side that adds an additional layer to our funding decisions is that semi-governments have a large number of borrowing clients. In Victoria, the larger ones have their own debt management and risk management policies.

Not only are we weighing up buy-side demand and liquidity conditions, but often we do so knowing we have a particular lending or risk outcome we must achieve for our clients. This may mean we need to do a transaction at a less favourable time or in a less favourable bond line than the market would prefer.

KELLY I don’t think so. It is not unusual for real-money investors to sit out during a period of rapidly rising rates and high volatility. They want confidence of a turn before investing heavily, but with long-end semi-governments already having rallied by about 50 basis points we may have seen that point.

I think wider semi-government bond spreads should also be attractive sooner rather than later. Balance sheets have been progressively participating as well. They might not hit swap targets on every trade they do, but they have been averaging into the market in a reasonably common-sense way.

HARVEY Having some stability in rates is important and should start to generate more interest from offshore and domestic clients as markets find more reliable levels. Generally, when we see extreme volatility it is a difficult environment in which to change investment decisions, so I expect investors will remain reasonably cautious.

KELLY We have to get further through the cash rate cycle to take the variability out of markets and for the end game to become clearer. Once this happens there should be less volatility – this may be the turning point, and it may not be far away.

WHEADON We have not observed a significant structural change in our offshore investor base. Proportionately, holdings of ACGBs have continued to fall although it is worth noting that their share of the free float – excluding RBA [Reserve Bank of Australia] – holdings has actually risen fairly sharply. In dollar terms holdings have plateaued, perhaps fallen a little bit.

The data tell us Japanese investors were big net buyers of Australian dollar debt securities in 2020, modest net sellers in 2021 and net buyers again over the first four months of 2022.

It will be interesting to see how the rest of the year plays out given Japanese investors’ known aversion to volatility.

There have also been some fairly material changes in the price relativities between JGBs [Japanese government bonds] and other currencies. Some ebb and flow in activity is completely normal, but I think the overall Japanese investor story remains a positive one.

MCCOLOUGH No. This question links back to the concept I was discussing earlier about the regime shift. The yen is at a 25-year low and Japanese investors are now finding higher yield and a steeper curve in their home market.

We can make the case that, with everything else being equal, this may change their behaviour – that it is part of the regime shift we are talking about. But do I think this is such a large shift that it fundamentally changes the global search for yield and where Australia sits on a reward for risk spectrum? No, I don’t think so.

I think levels, spreads and differentiation between markets are going to get factored in to a greater extent. I do not think the yield enhancement trade shifts because we are getting a repricing right now. Japanese investors do not like volatile markets and uncertain conditions such as we are experiencing. This is not new.

We are at the upper end of a 25-year range for Australian dollar-yen, so of course we should expect selling by unhedged investors. From a hedged investor’s point of view, which is now the majority of Japanese investors, Australia’s yield advantage relative to JGBs has collapsed recently. It is also a logical, rational response from that investor base.

I do not think we need to extrapolate it into a dramatic changing of their focus. We need to understand that their motivating factors might be shifting, but not so much that it is going to have a dramatic impact on the pricing of semi-government or other Australian debt.

KELLY We were in Japan two weeks ago and we left feeling positive about the ongoing commitment to the Australian market. Investors are happy with the credit and liquidity story along the benchmark curves and should keep adding to their semi-government positions when conditions are favourable. Structurally, I am more than comfortable. We are not in a fundamental shift here, just a part of the cycle adjustment.

HARVEY There have been relative-value headwinds for semi-government bonds and this has been a major consideration for offshore investors. The move seems to have played out somewhat and we are experiencing more engagement from offshore clients. But we are possibly early in the repricing of global risk so I expect offshore investors will remain tentative.

CHANDLER There are some shifts going on, as there always are through the cycle. Investor cohorts can be dominant or not at any point in time. Pockets of investors are reducing but there are also pockets that are adding or engaged to add. We have had good flows into our bonds in the past two months and enquiry across all major investor groups and geographies.

The Japanese piece is interesting insofar as it relates to semi-governments. From what we have been hearing, it did not seem there were too many obstacles to dealers taking on inventory then recycling the stock back into other investor types. The Australian market has broadened and deepened over the past 5-10 years and if there have been reweightings or divestments it has not been a particularly disruptive market event.

Sure, spreads may have been a little heavy for a short period of time. But we are not concerned that the changing offshore investor mix is going to inhibit our ability to execute our programme.

If we look at our syndications through to late FY21, we had very elevated offshore participations in those books. One of our books was 45 per cent placed offshore. Over the last 10 years, a more natural offshore level in our primary books has been somewhere between 15 and 20 per cent.

Sometimes we can get a little caught up in what Japanese investors are doing with their portfolios and whether they see better value in other markets – we have seen a lot of these dynamics at play recently, but also over the years.

We think we will continue to see offshore demand going forward and we base this on what we are hearing and seeing in turnover and flows. Are we going to see more than 40 per cent of primary books going to foreign investors? Maybe not. Maybe it will mean-revert to more normal levels. But, from our perspective, we do not believe this means we will need to be overly reliant on any one investor type or geography.

CINQUINA Aside from currency considerations, market volatility clearly affects offshore investors as much as it does domestic accounts when it comes to making decisions about investing in Australian dollar products.

From this perspective, we see it as cyclical. Our bonds probably do not work as well for a Japanese hedged investor in current circumstances due to currency relativities, so they look for other opportunities.

Given recent volatility, it is not surprising to see investors predominantly staying within their core markets. This will change as market stability returns. However, we are still experiencing interest in semis from the Asian region, from the official sector and, to some extent, from the Japanese market in smaller volumes.

According to our travelling group in Europe, there are new investors considering Australian semis in the not-too-distant future. There are still opportunities out there to further diversify investor bases and we are finding investors keen to re-engage on a face-to-face basis.

We generally expect offshore participation to be somewhere in the 20-25 per cent range. I would expect it to be at the lower end of this range at the moment, but not too dissimilar to where it has been historically.

FAJARDO Diversification of our investor base has always been important to QTC. We recognise that investors at different times through the cycle will be affected by various drivers, such as currency, the Australian-US dollar spread or outright rates. We aim to provide a liquid curve for investors to transact and it is important to have flexibility in our issuance – whether it is benchmarks, FRNs or green bonds.

There might be a particular region that has not been as active for a while, but we can withstand this by tapping into different types of investors or different regions.

For example, we saw an active Japanese investor base prior to year end – it was an important source of reverse enquiry. That demand might not be there now but, as we have seen with recent TCV and TCorp transactions we are able to tap into a different investor base with the FRN product. Market stability will be key to re-engage on- and offshore investors.

WHEADON To emphasise the point on investor drivers, it was not that long ago that we had 4 per cent handles across much of the government bond curve and spreads to US bonds up around 80-90 basis points. Despite the market whipsawing everywhere, we had a cohort of mainly offshore investors that was happy to look through that and focus on value.

We saw this primarily in our ultra-long bonds, which are typically less liquid and less frequently issued. The bottom line is they reached attractive levels and numerous buyers came out of the woodwork – and they kept on buying even as the curve subsequently rallied and flattened. The frequency with which we have tendered the 2051 line in recent months reflects this.

FAJARDO The idea of stickier demand was in our thinking last year when QTC did its syndicated transaction. When we began gauging investor demand, it seemed that green bonds would attract the widest group of investors. The transaction had offshore investor participation of more than 40 per cent.

A part of QTC’s green-bond strategy is to highlight to investors what the state is doing in respect to the ‘E’ in the ESG [environmental, social and governance] space. We have expanded our green-bond programme compared with when we first established our asset pool and went to market in 2017.

Our first green bond was A$750 million and last year’s transaction was A$3 billion with a A$4.3 billion orderbook. It was a successful deal. The feedback we get from investors is that they want to add GSS-labelled deals to their portfolios. From QTC’s perspective, we are focused on adding further assets in the pool to diversify our portfolio further.

When we started looking at the product we were concerned with size, as investors want liquidity. We now have A$7 billion of issuance and an eligible pool of about A$14.8 billion, so there is capacity to issue and we understand investors would like us to diversify the pool. We see a potential pipeline of assets with a commitment by the government on renewable targets.

However, it is not purely about QTC’s green-bond programme but also understanding the more holistic view on what the state is doing, what the pathway to the targets is and where the data can be found.

This is where investors are. They want to know the data they are reviewing is accurate and up to date. In this regard, Queensland Treasury released the Queensland sustainability report in late 2021, which gives investors information on the state’s ESG commitments and outcomes.

CHANDLER I am not sure GSS issuance will necessarily be easier to do. It comes down to what we need and what the market looks like at any point in time. If it lends itself to doing a new GSS line, we can respond.

Our programme is not a general corporate purposes programme, therefore our issuance is constrained by the availability of the assets we have in our pool. If the market was to remain tough for a period, we may not be able to roll from new ESG line into new ESG line and therefore we must carefully think about how we deploy the programme.

We have a number of interesting green and social projects in various stages of being approved that will ultimately end up being incorporated into the pool. This will support ongoing issuance.

During this calendar year, we pivoted toward using reverse enquiry off the programme to add liquidity to bonds as investor feedback indicated desire for more opportunities to buy our lines. How we ultimately determine the format is a function of the composition of assets in our pool.

While we have issued a new line each year for the past four years, going forward we will use reverse enquiry and tender formats – though we do not always expect to be able to tap these lines – complemented with new lines as required.

Earlier this year we did a sustainability bond, capturing the ‘E’ and the ‘S’ components of ESG, which resonated well with investors. A few years ago there were more buyers of green over sustainability or social bonds, however this dynamic has changed materially. When we executed our new issue in February, we asked about the breadth and depth of the buyer base for the three labels and it was confirmed that there was no discernible preference for any one format.

KELLY GSS bonds could provide opportunities in difficult markets. This is why last year we developed a sustainability-bond framework, which gives us the flexibility to issue green, social, sustainable or a mix of all three. We have gone down a different ESG path than some of our peers by choosing to establish a 2035 benchmark bond rather than a number of smaller lines.

One important ESG project the state is working on is developing a TCFD [Task Force on Climate-Related Financial Disclosures] style disclosure to map its pathway to net-zero emissions and to build resilience to the impacts of climate change.

CINQUINA We released an information pack in November 2021 outlining the state’s ESG credentials, which was followed up with a post-budget update this year. There has been a significant amount of work going on in the background on what a sustainable bond framework looks like for Western Australia and WATC, with a view potentially to come to market with an issue during FY23.

We will be looking to fill some of the gap between our current 2031 and 2034 bonds, and it is certainly possible this will include a labelled issue. We do not have the scale of debt outstanding or new-money requirements to support multiple labelled maturities across our curve without cannibalising liquidity in our benchmark bond issues. It therefore makes more sense for us to consider a benchmark-type labelled issue like TCV’s approach with its 2035.

KENNEDY SAFA’s approach is a big job, but it is not a significantly larger workload than what others are already doing – it is just on a different scale. Everyone issuing green bonds is already doing the assessments, second- and third-party opinions, certifications, validations and the reporting that goes with it. We are just choosing to do it on a much larger scale, that is across the whole of state activities rather than a select group of assets or programmes.

As a smaller state, however, it is more achievable. We are going down the path of seeking to certify almost everything the state does. A lot of what the government takes on is going to meet ESG expectations by definition of what governments are mandated to do, but there will always be a little piece that does not.

We want to ensure we have the broadest and most concise alignment we possibly can. The biggest step we have seen recently that has helped validate our journey is the UN Sustainable Development Goals [SDG] impact standards, which identify that issuers will have to justify everything they do, not just be comfortable with the labelling of some of what they are doing or have done.

I don’t have a problem with the way the green and sustainable finance industry has developed – it has been important for awareness and development. But the responsibility sits with the issuer.

For a corporate borrower, this is quite easy to define because they have a single purpose. For government, it is hard – government is spread widely in the services it delivers. It is multipurpose and multifaceted in the way it provides support from different agencies and departments.

How we fit this bond issuer framework for SAFA, as defined by the UN SDG impact standards, is the difficult part of the interpretation piece. But everyone will need to address this as it is really about the endgame. The start of the journey was a green bond, the end game is being sustainable or viewed as a sustainable issuer across the programme and everything a government does.

This is the challenging part, because we are the central borrowing authority and not the policy makers and do not control the agenda. How do we influence the process, across government, in embedding the principles we believe need to be at the forefront of everything the government does?

KENNEDY We have recently managed to make some significant progress. The new state government, elected in March 2022, endorsed SAFA’s proposal for a governance framework that would sit across the agencies to embed sustainability in policy decisions. This will help us provide advice to agencies on how they deliver on the climate change action plan and the other pieces of work that will go with it in identifying risk.

This means we are not going to do a green bond – we will have a sustainable-bond framework that sits over our whole issuance programme. The plan is to deliver the framework this financial year, especially now we have a state government that can provide direction and a seat on a cabinet subcommittee that reports into cabinet.

The deputy premier is also the minister for climate, and on 30 May the South Australian government declared a climate emergency. It is thinking about this seriously and developing policy to address the situation – with SAFA now providing guidance.

After all, we have the most at stake. If the state doesn’t succeed, we are not going to deliver on our sustainable-bond framework and may not be able to access markets. We may have investors divest from South Australia [SA] if we cannot prove our credentials as a sustainable state. If we cannot fund, the government cannot deliver its essential programmes.

KENNEDY Very good question. It is a critical part of our intentions and ultimately a deliverable. Each agency will make reporting part of its deliverables because all agencies will be reporting, starting with SAFA, their financial statements in line with the TCFD framework.

Some of these agencies might also need to report in line with the TNFD [Taskforce on Nature-related Financial Disclosures] framework when we finish scoping it out. Impact reporting is an important part of the delivery of this governance structure, as outlined in the UN SDG impact standards.

WHEADON It is still relatively early days with the new government and we have nothing new to share on this front. There is obviously a lot of interest in what the Commonwealth might do in this space and some investors are perhaps a little more optimistic now with the change in government. But it is still a policy call for the government to make.