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Capital Markets Weekly: Emerging market sovereigns enjoy deal rush

24 January 2020 Brian Lawson

Following Monday's US holiday, Saudi Arabia, Chile, Colombia, Philippines and Romania all issued on 21 January, following Ecuador and Paraguay late last week: the largest order book was for a USD5 billion Pemex 11 and 30-year package, which attracted USD25 billion on the same day.

Emerging markets

Saudi Arabia sold seven, 12 and 35-year dollar debt with initial guidance of 110, 135 and 180 basis points over US Treasuries respectively.

  • It went on to price USD5 billion in total, of which USD2.75 billion were in the long-dated tranche, priced at 3.84%.
  • The two shorter tranches, of USD1.25 billion for seven years and USD1 billion for 12, were each priced 25 basis points inside guidance.
  • The package gained total interest of some USD20 billion.

There have been four Latin American sovereign deals in the last week, along with a highly successful USD5 billion sale by Pemex.

Ecuador issued the first sovereign-level Social bond to fund social housing.

  • It placed a USD400 million 15-year issue at 7.25%: the offering enjoys a USD300 million partial guarantee from InterAmerican Development Bank, with CAF also involved in its preparation.
  • Proceeds will be used to offer over 24000 housing loans at a 4.99% preferential rate to first-time buyers under the country's "Casa Para Todos (A Home for Everybody)" scheme.
  • The program also enjoys USD68 million of Ecuadorian government funds and over USD70 million from CAF.

On 15 January Paraguay sold a USD450 million tap of its 5.4% 2050 notes.

  • The new tranche was priced at 115.388% to yield 4.5%, versus guidance of 4.7%.
  • Demand reached USD3.5 billion.

On 21 January, following the US holiday, three major Latin American deals were completed, spanning Euros and dollars:

Chile tapped its 0.83% 2031 Euro-issue and arranged a new 20-year Euro-denominated Green deal:

  • It sold EUR1.96 billion in total.
  • It placed EUR1.27 billion of 2040 debt at 1.299%, 80 basis points over mid-swaps.
  • It also raised EUR694 million by tapping its 2031 issue at 0.695%, with an issue price of 101.477% to yield 0.695%, 50 basis points over mid-swaps.
  • The deal reportedly was twice-covered.

Colombia also sold a two-tranche deal:

  • It placed USD1.35 billion of ten-year debt at 135 basis points over US Treasuries and tapped its 2049 issue with USD300 million at a 173 basis-point spread.

Pemex issued USD5 billion split between 2031 and 2060 maturities.

  • The deal gained at least USD25 billion in demand.
  • The 2031 notes were sold at 5.95%, 417 basis points over US Treasuries, while the longer tranche was priced at 6.95%, a 471 basis-point margin.
  • Pemex flagged the improvement in its pricing levels since its last issuance: in September it paid 6.85% and 7.7% for 10 and 30-year debt.

On the same day, the Philippines completed three and nine-year Euro-denominated issuance.

  • It placed a total of EUR1.2 billion, split equally.
  • The three-year tranche was priced with an unprecedented zero coupon, to yield 0.1%.
  • The nine-year bond was priced with a 0.75% coupon and was described as priced through the country's outstanding yield curve.
  • Peak demand reached EUR5.5 billion according to National Treasurer Rosalia de Leon.
  • Philippines has obtained approvals to issue up to USD3.7 billion internationally in 2020 and is considering dollar issuance this quarter.

Indonesia's Bank Tabungan Negara gained over USD3.6 billion in demand for a Basel III compliant Tier 2 subordinated bond, its international debut and the first such instrument from the country.

  • The five- year deal was priced at 4.2%, 260 basis points over US Treasuries, versus initial guidance of 285-310 basis points.

Romania also participated in the sovereign "rush" on 21 January, raising EUR3 billion of 12 and 20-year debt.

  • Total demand reached EUR12 billion.
  • The two tranches were priced at 2.04% and 3.41%, representing 180 and 285 basis point margins over mid-swaps respectively.
  • It plans to raise some EUR6 billion internationally this year within a total gross government financing requirement of RON86.9 billion (USD20 billion).

ESG

In addition to the Ecuador issue described above, this week's key ESG development was a statement to the Financial Times by Sir Robert Stheeman, Head of the UK's Debt Management Office, that he was not in favor of issuing Green UK sovereign debt:

  • His main concern is that this could cost more than conventional issuance: he flagged that the UK reduces its issuance costs by building up "benchmarks of GBP20-30 billion size" to maximize their liquidity.
  • He warned that smaller Green deals would "fragment that process", with the resulting risk that the market is "not necessarily willing to pay a liquidity premium for those smaller bonds".
  • Stheeman suggested that the cost of arranging Green issuance would be "marginal", although it would require legislative action as the UK lacks a legal framework to assign specific fiscal receipts to individual projects.
  • Lastly, he suggested that the choice ultimately was political, noting that if ministers decided to issue such instruments the DMO would follow such guidance and "make a success" of it.

Our take

This week's emerging market calendar is clearly impressive, particularly given the positive reception for six sizeable state and state-backed deals on the same day. The Pemex transaction further reinforces the favorable trend for Mexican debt. Overall, the heavy deal flow continues to reflect seasonal factors, although next week's supply is likely to abate given the Chinese New Year.

Overall, as indicated by encouraging levels of corporate issuance in early 2020, and moves by Germany, Spain and Italy towards Green bond sales, we expect ESG financing to expand in 2020. This reflects both growing political focus on climate change and expanded market interest in ESG securities.

Nevertheless, there are constraints for such expansion. The UK DMO's statements reflect a common problem for sovereign borrowers considering Green debt.

On a like-for-like basis, Green instruments should enjoy a price advantage versus conventional bonds, because of the incremental demand from ESG-oriented investors. This tighter pricing thus should offset the greater cost of issue preparation, given the need to establish and certify a Green program.

The problem, however, lies in that available Green projects may be of smaller volume than the size normally achieved for benchmark government issuance. Reduced deal sizes for Green issuance risks investors seeking an illiquidity premium, threatening overall cost increases for the borrower.

Different borrowers are considering distinct solutions:

  • Concentrating Green debt sales on a single or limited number of issues to make these more liquid - as undertaken by France and others.
  • Germany's plans to undertake parallel sales of Green and conventional debt, with otherwise identical characteristics (although the two tranches would be of half the size otherwise available).
  • Denmark's proposal to issue conventional debt with a tradeable detachable green certificate for eligible projects. For Denmark, the problem is acute, as it has small public-sector funding needs overall, increasing illiquidity risks if it splits issuance.

Despite UK resistance, given the heightened global political focus on environmental issues we expect there to be growing momentum to use such funding. For larger borrowers such as Spain and Italy, aggregating Green projects to provide an issue size comparable with other syndicated benchmarks would seem the most obvious solution for liquidity problems. This is harder for Germany, which seeks use of its bonds as the market benchmark across the full yield curve. Very distinct problems apply for Denmark, which risks losing liquidity if it divides limited-scale issuance between Green and conventional bond sales.

Despite this focus on Green bonds - the "environmental gold standard" because of its defined regime and "no-harm" characteristics, we have flagged that the net environmental benefit of a financing is a key indicator of its environmental benefit. Wider use of ESG bonds that involve moving from "brown" to "less brown" economic activity is thus likely, with such issuance at times issuance having greater benefit in reducing more-heavily polluting activities.

Posted 24 January 2020 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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