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Greek CDS is back with a bang – International Financing Review

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Trading volumes in Greek credit-default swaps, the derivatives contracts politicians once accused of fuelling the eurozone crisis, have surged to levels not seen since the country’s historic debt restructuring.
Greece has become the second most traded European sovereign CDS this year behind Italy, according to Citigroup analysis of DTCC data, with US$259m changing hands on average each week in 2019.
This time, though, analysts say the sharp uptick does not reflect concerns over the local economy. Instead, it is most likely linked to bank trading desks using CDS to hedge their exposure to Greece stemming from derivatives contracts used by the country’s debt office to manage the sensitivity of Greece’s debt to interest-rate moves.
This year’s plunge in market interest rates, with euro swaps plumbing record lows, may have left Greece sitting on paper losses on some of those interest-rate swaps. That, in turn, could have encouraged banks on the other side of those swaps to use CDS to hedge their increased exposure to the country.
“It is likely that hedging needs have picked up across the year – allowing CDS trading volumes to boom,” Citigroup credit strategists wrote in a report last week.
Buying of CDS protection “anecdotally … seems to have largely been driven by bank CVA desks,” they added, referring to the desks that manage banks’ counterparty risk from derivatives trades.
Default protection costs on Greek debt have tumbled this year thanks to improving fundamentals and loose monetary policy in the eurozone. Five-year Greek CDS have narrowed from 468bp at the end of last year to 155bp on Thursday, according to IHS Markit.
That has coincided with a sharp increase in CDS trading volumes. Greece can account for as much as 10% of the volumes in the European sovereign CDS market at times, Citigroup said, with up to US$700m trading in some weeks.
Even during the sovereign crisis, Greece never consistently accounted for much more than 5% of total trading, although overall market volumes were far higher back then.
The only European country with higher CDS volumes is Italy, with a whopping US$1.3bn trading on average each week. Italy not only has the largest amount of government debt in Europe, it also has used derivatives to hedge risks such as interest-rate moves. That activity encourages banks on the other side of those trades to use CDS to manage their exposures to the country.
Greece controversially used derivatives in the early part of this century to help reduce its debt load – a move that came back to haunt the country years later when concerns over its colossal debt pile sparked the eurozone crisis.
There is nothing to suggest Greece has put on similar trades this time.
But Greece’s Public Debt Management Agency has said in public presentations that it has used a number of measures, including derivatives, to significantly reduce the amount of its debt linked to floating interest rates.
The vast majority of Greek debt is held by official institutions like the IMF and the EU, which often lend at floating rates of interest.
In 2016, 70% of Greece’s debt was linked to floating interest rates, according to a PDMA presentation. That portion had shrunk to just 9% in the first quarter of this year.
It is very difficult to know the terms of any derivatives deals Greece struck with investment banks given such trades occur in private markets. But PDMA presentations suggest a decent chunk of those swaps were executed over the course of 2018, when market interest rates were higher.
For instance, the five-year euro swap rate fluctuated between about 0.4% and 0.1% in 2018. It then fell steeply this year to a record low of less than -0.6% in August, before rebounding slightly.
That decline means the PDMA could be facing paper losses on any derivatives trades struck in 2018 that swapped floating interest rates for fixed rates.
The PDMA did not respond to repeated requests for comment.
Greek CDS volumes have picked up as 2019 has worn on and swap rates have decreased, with a spike over the summer period when rates bottomed out.
The Citigroup strategists also noted that Greece has issued several new bonds this year. Again, it is difficult to know whether there were swaps accompanying the bonds, but there has tended to be a pick-up in CDS trading after the new debt sales, they said.
“Since the start of 2018 it is quite possible that bank exposure to Greece has actually risen, in turn requiring increased aggregate need to hedge with CDS,” the Citigroup strategists wrote.
European sovereign CDS 2019 most-traded names
The New York Stock Exchange is proposing a rule change that would allow capital raisings alongside increasingly popular direct listings, throwing out a fresh challenge to the traditional US IPO model. Egged on by Silicon Valley venture capital firms that view the traditional IPO as inefficient and subject to mispricing, the NYSE is now seeking Securities and Exchange Commission approval for an amendment to its Listed Company Manual. Under the proposal a company would be able to sell newly issued shares directly into the exchange’s open auction on the first day of trading, thereby permitting what the NYSE is calling a “primary direct floor listing”. Music streaming service Spotify Technology and workplace collaboration software provider Slack Technologies have already departed from the traditional IPO playbook in recent years by undertaking direct listings on the NYSE with no capital raised and no lock-ups on existing shareholders. JUDGEMENT In a traditional IPO, underwriters typically build a book of institutional demand for primary and/or secondary shares and then use their judgement to determine a final price versus a marketed range. This, in theory, allows a company (via its bankers) to select the long-term committed investors it wishes to have as shareholders, while potentially also allocating some faster money to smooth the passage to market. But this is not possible with a direct listing where capital is raised at the open auction. “It is an open question whether issuers will be able to achieve the desired pricing and distribution of shares in a way comparable to that done in a traditional underwritten IPO,” , law firm Davis Polk & Wardwell wrote in a client memo. SEEKING APPROVAL Goldman Sachs, an adviser on the Slack and Spotify direct listings, has separately been working on what it has dubbed “direct listing 2.0” where direct listings could incorporate primary shares, a concurrent convertible offering or concurrent direct share programme, or even followed up by a so-called “dribble-out” of stock. Another key player pushing for the evolution of direct listings is the Stanford University law professor and former SEC commissioner Joseph Grundfest, who reportedly helped organise an earlier meeting between the SEC and other interested parties. Still, it remains unclear whether the SEC will ultimately embrace the proposed changes. “There are a bunch of people having discussions with the SEC to allow for primary raises with direct listings and so far [the SEC] is hearing them out. But it hasn’t committed to doing anything,” one senior ECM banker said. “It’s early innings but we have a very trusted way for companies to raise capital and they may want to keep that separate from the direct listing process.” The SEC, which has regulatory oversight of the NYSE, is soliciting comments on the rule change, but securities lawyers said the proposal may yet need to go through several iterations. “With something like this, I suspect it’s going to take a while,” said Anna Pinedo, a partner at law firm Mayer Brown. Nasdaq said it has had extensive conversations about direct listings with a primary raising with potential issuers, advisers and the SEC. “However, based on these conversations, we do not believe that the proposed rule change filed by the NYSE fully considers the complexity of the issue,” the exchange said in a statement. UNICORN HUNTING The exchanges are looking to arrest the long-term decline in public listings that has in part resulted from the explosion in private capital markets and given rise to the “unicorn” phenomenon. As part of its proposal, the NYSE is also trying to make it easier for private companies to go public via a direct listing by delaying the requirement to have 400 round lot (100 shares) holders from the time of listing to 90 trading days after the listing date. The proposal would require a company to sell at least US$250m of securities in the opening auction to ensure the primary direct floor listing
Westpac Banking Corp offered to refund retail investors in a recent share placement and said its chief executive had resigned, as it unveiled a raft of remedial actions to quell outrage over a massive money-laundering scandal. Westpac has offered to refund retail investors who signed up to a A$500m share purchase plan, launched earlier this month alongside a A$2bn overnight institutional placement, in an apparent attempt to prevent a class-action lawsuit. Law firm Phi Finney McDonald has already said it was in discussions with investors. Australia’s oldest bank and second-largest lender said Brian Hartzer would step down as CEO. Current chief financial officer Peter King is taking over as acting CEO while the search is on for a permanent successor. Current chief operating officer Gary Thursby will act as CFO in King’s stead. In addition, chairman Lindsay Maxsted will retire in the first half of next year. Ewen Crouch, who chairs Westpac’s risk and compliance committee, will not seek re-election at next month’s annual general meeting. Westpac’s share price continued its downward trajectory last week and closed at A$24.52 on Friday. It is now down 8% since Austrac filed its lawsuit on November 20, alleging the bank breached AML and counter-terrorism financing rules on millions of occasions. “We understand the gravity of the issues presented by Austrac and reiterate our deep sorrow for failings by Westpac,” Maxsted said. “We are determined to urgently fix these issues and lift our standards to ensure our anti-money laundering and other financial crime processes are industry-leading.” Austrac is seeking fines of up to A$21m for each of 23 million breaches, leaving the bank, theoretically, facing a cumulative penalty in the trillions of dollars. Most analysts expect a fine of around A$1bn, which would still exceed the A$700m paid last year by CBA for nearly 54,000 breaches of AML/CTF rules, a record fine for a bank in Australia. COSTS MOUNT Although Westpac said it had self-reported a large number of breaches of AML/CTF rules in an investor presentation at the time of the share placement, as well as in its last two annual reports, some investors may object that it failed to convey the gravity – and potential cost – of the cases. Institutional investors who bought new shares at A$25.32 on November 4 are now looking at a loss, but retail investors already have some downside protection: the retail portion will price at a 2% discount to the five-day volume weighted average price on December 2, with a cap of A$25.32. Several regulators, including the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and the Reserve Bank of New Zealand, also said they were investigating Westpac. APRA forced CBA to set aside an additional A$1bn in capital following its money-laundering scandal. Analysts also queried the A$80m (US$54.1m) Westpac has earmarked for improving its controls. UBS analyst Jonathan Mott said the cost would likely come in at “several hundred million dollars”. “OUTRAGE AND MISDEEDS” Westpac is also scrapping or reducing bonuses for the full executive team, carrying out an independent review into its anti-money laundering and counter-terrorism financing controls, and has pledged up to A$34m over six years to various community organisations that fight child exploitation. That is in response to specific allegations in Austrac’s lawsuit that it failed to carry out appropriate due diligence about potential child exploitation risks on customers sending money to South-East Asia and in particular to the Philippines. “Politicians of all persuasions are expressing outrage; a swathe of regulators are investigating and the media bulges with stories of Westpac misdeeds,” said Jefferies analyst Brian Johnson. “The Westpac brand has been damaged.” Hartzer’s resignation followed a massive public backlash from investors, shareholders and politicians, including Prime Ministe
Profitability across European banks dipped to 7% on average and prospects for an improvement remain bleak amid low interest rates and the threat of higher impairments, the region’s banking watchdog said. The European Banking Authority said return on equity for 131 banks across 27 countries averaged 7% in the 12 months to the end of June, down from 7.2% a year earlier. “There are hardly any clear catalysts for an improvement in bank profitability that appear on the horizon. It tends to be rather the other way round,” the EBA said on Friday. “Even though low rates might be supportive when it is about the costs of market-based funding and new lending volumes, they still pose pressure on banks’ NIMs [net interest margins],” it said in its annual report on risks in the industry. RoE has improved from an average of 3.5% in December 2014, but the data show most banks are still struggling to get returns above their cost of equity. The EBA said less than 60% of banks said their RoE was above their cost of equity. The truth is likely to be far lower than that – bankers estimate cost of equity is broadly 8%-10%. “UNATTRACTIVE PROSPECTS” The watchdog said the “unattractive profitability prospects” are reflected by market valuations: only 28% of listed EU banks trade at a price-to-book value above 1, compared with 81% of US banks. It is a worry for regulators, as well as banks. Low profitability limits capacity to generate capital and to fund loan growth, or pay dividends, or absorb loan losses if there is a downturn in economic conditions. The EBA said banks point to potential cost cuts as the main area to improve profitability. “However, over the past few years banks have struggled to adapt the evolution of their operating expenses to the fall in net operating income,” it said. The EBA released the report alongside a detailed “transparency exercise” of bank data. Operating expenses grew by 1.5% in the year to the end of June, higher than a 1.1% rise in net operating income in the period. The increase in expenses was driven mainly by a 2.5% rise in staff costs, which account for about 54% of expenses. CAPITAL UP, NPLs DOWN The overall soundness of the EU banking system improved in the past year, however, and capital ratios and asset quality continued to nudge higher, the EBA report showed. The EBA’s sample of 131 banks included 17 in Germany, 12 in Spain, 11 in Italy, 11 in France and six each in the UK, the Netherlands, Sweden and Luxembourg. The common equity Tier 1 ratio at the end of June averaged 14.4% across the banks on a fully loaded basis, up from 14.3% a year earlier. The EBA said banks with the lowest capital ratios had improved by the largest amount. The ratio of non-performing loans to assets decreased to 3% from 3.6% a year earlier, continuing a long-term trend. Asset volumes across Europe increased by 3% in the past year, which the EBA said confirmed the end of the deleveraging trend. But it warned that could pose challenges. Banks have significantly increased their lending portfolios in riskier areas, such as loans to consumers, commercial real estate and small and medium-sized firms. It said banks indicated they plan to keep increasing these exposures. “Banks’ focus on rather riskier segments shows their search for yield in an environment of low interest rates and shrinking margins,” the EBA said.
China National Chemical Corp is looking to raise up to US$10bn for its agrochemicals business before listing the unit in the Chinese A-share market, according to people close to the deal. The agrochemicals unit of the state-owned chemical giant, also known as ChemChina, is expected to include Swiss pesticides and seeds producer Syngenta, Shenzhen-listed global crop protection company Adama and other agrochemicals assets. ChemChina is working with Chinese and international advisors to raise funds in the renminbi market through a private placement and aims to complete the deal in the first half of 2020, according to the people. The company is expected to begin working on an A-share IPO for the agrochemicals unit next year after wrapping up the private financing, said the people, adding that it is hard to estimate the size of the IPO as it depends on regulatory approval and market conditions. The assets to be listed are yet to be finalised and are subject to change. Given the scale of ChemChina’s assets, a public listing is likely to be the biggest ever from the chemical industry, surpassing Petronas Chemicals Group’s US$4.8bn IPO in 2010. An A-share listing would give Chinese investors an opportunity to own a global business and could also appeal to international fund managers, who are increasingly looking for direct exposure to the domestic Chinese market. For ChemChina, a domestic market IPO offers a potentially higher valuation – as illustrated by the wide discounts on Hong Kong-listed Chinese shares. It would also leave the door open for an international listing in the future, possibly at the Syngenta level. ChemChina acquired Switzerland-headquartered Syngenta for US$43bn in 2017, cancelling its Zurich and New York listings. Speculation around a relisting has swirled ever since, but there has been little clarity on where or when that might happen. Erik Fyrwald, Syngenta chief executive officer, said in a media interview in October that the company planned to list in 2.5 years. In early November, Frank Ning Gao Ning, chairman of ChemChina and Sinochem Group, said the company was working on plans to list Syngenta on the Shanghai stock exchange. China has been working on a merger of the two chemicals giants for years. A spin-off of the agrochemicals business will help ChemChina lower a debt burden that has ballooned through years of acquisitions, mostly with the Syngenta purchase. Rating agency Fitch, which rates ChemChina A– on account of its central government ownership, estimates the company’s debt at roughly 11 times trailing 12-month Ebitda at the end of June, with interest payments over the previous 12 months equal to 2.3 times its earnings. ChemChina has Rmb83.4bn (US$11.9bn) of debt maturing next year, according to public filings. ChemChina did not respond to emails seeking comment.
Investors in emerging markets sovereign debt are having to confront the potential contradictions in the market’s new favourite fad: environmental, social and governance investments. Protests have been seen in Chile, Ecuador, Lebanon and other states. Most have stemmed from proposed tax hikes – including for environmental reasons – that disproportionately affect the poor. That throws into question whether lumping ESG together in one measure is useful for an EM sovereign debt fund, since a policy seen as environmentally beneficial may spark social unrest. “Social criteria have so far played second fiddle to environmental considerations,” said Christian Nolting, global chief investment officer at Deutsche Bank’s wealth management division. “Things need to change.” An investment banker said there had so far not been “enough thought about how to integrate S into the financial industry – far less than the E and G. It is more problematic and difficult.” Many investors have been wrong-footed by the ongoing demonstrations in Chile. These saw thousands take to the streets of Santiago in October to protest against public transport fare hikes and inadequate social welfare provision. Chile had been acclaimed as a country that had carried out balanced public sector reforms and was embarking on an ambitious programme of environmental measures too. That was topped off in June when it became the first country in the Americas to issue a green bond, raising US$2.5bn-equivalent through a dual tranche of US dollars and euros, ahead of hosting the COP25 UN climate conference in December. But four months later, the conference has been moved to Spain as Chile said the protests would prevent it from staging the event. The Chilean peso has weakened by nearly a fifth against the US dollar since mid-October. “We didn’t see that coming in Chile,” said Sergio Trigo Paz, head of emerging markets fixed income at fund manager BlackRock. “The country is very solid and was deleveraging but then social unrest has come along. We will need to manage this social winter in the months ahead.” BlackRock launched an emerging markets ESG fixed-income fund, managed by Trigo Paz, last year. This was benchmarked against an index measuring ESG credentials created by JP Morgan. The index overlays ESG criteria across JP Morgan’s EM indices, such as the EMBI. Those credits accorded better ESG scores are given greater weighting in the indices than those with poorer ESG scores. The latter see their weighting reduced or are even excluded. Green bonds are also over-weighted. ONE MEASURE Critically ESG is considered in the round, as one measure, rather than three individual criteria. However, the recent social protests, some of which have happened, as in Chile, in countries taking steps to meet environmental goals, raise the question of whether it is useful to measure ESG in such an integrated way. Some emerging market investors are already taking a more case-by-case approach and looking at the social issues separately rather than lumping ESG together. “Country ESG analysis is not a black box that spits out unequivocal answers,” said Mary-Therese Barton, head of emerging debt at Pictet Asset Management. “Investors have largely struggled to join the dots across countries’ E,S and G characteristics, particularly in fixed-income markets.” Pictet launched a sustainable emerging debt fund in September, based on the JP Morgan ESG EMBI too, but with a remit for Barton’s team to take a more activist approach by looking at social conditions on the ground. “It’s not enough to stick to the usual repertoire of meetings with government officials and senior business people, of being bussed from smart hotel to air-conditioned office and back again,” she said. Dutch fund manager Robeco is also taking a more in-depth approach to ESG. “On sovereign debt we give mo
M&A banker Francesco Bertocchini has joined Nomura as managing director for Italy, based in Milan. He reports to Stefano Giudici, head of investment banking for Italy. Bertocchini joined from UBI Banca where he was head of M&A. Before that he was a director at Rothschild specialising in consumer goods, retail, leisure and healthcare, as well as private equity transactions. Citigroup has promoted Akin Dawodu to head its business across Sub-Saharan Africa, expanding his reach across 32 countries. Dawodu has been Citi’s country head in Nigeria for four years and expanded his role in January to oversee West and Central Africa. He will continue as head of Nigeria until a successor is appointed. Dawodu joined Citi in Nigeria in 2000 as an FX dealer and became country treasurer, chief operating officer and public sector head. Dawodu will report to Atiq Rehman, head of Citi’s EMEA emerging markets cluster. MUFG Bank has appointed Marilyn Gan as head of origination for Asia-Pacific aviation finance. Gan reports to Masayuki Fujiki, head of the Asian Investment banking division. She is based in Singapore. It follows MUFG’s purchase of the aviation finance business of DVB Bank, where Gan has worked since 2006, most recently as APAC head of aviation finance. Danske Bank has hired Frans Woelders from Royal Bank of Scotland as its new chief operating officer and member of the executive management team. Woelders will join Danske on June 1 at the latest. He was head chief digital officer for personal banking at RBS. He previously worked with Danske’s new chief executive Chris Vogelzang at ABN Amro. Citigroup has hired HSBC’s global co-head of real estate, Kara Wang. Wang is due to start in January as co-head of real estate investment banking for Asia alongside Jonathan Quek. Based in Hong Kong, she will primarily cover property developers across Greater China. Formerly with Bank of America, Wang was appointed co-head of HSBC’s real estate globally last year. Citi has also poached Dayday Zhou, a director from the same team at HSBC. HSBC has hired Eddie Wong as director in its Asia-Pacific loan syndications team. He will primarily focus on syndication of event-driven loans, including corporate and leveraged acquisitions. Based in Hong Kong, he reports to Ashish Sharma, head of loan syndications for Asia-Pacific. Wong was most recently director in ING Bank’s loan syndications team in Hong Kong. He left the Dutch lender in September. He previously worked for Credit Suisse and ANZ. US alternative credit asset manager CIFC has added two more hires to the European team it started building last year. Anders Samuelsen, who joined from Muzinich, and Aidan Reynolds, from Murano Connect, will work with European managing director Josh Hughes in the investor services team. CIFC poached Apollo’s Dan Robinson as CIO for Europe last year. It sold its debut European leveraged loan CLO in July, and has launched a UCITS structured credit fund with AUM standing at US$100m. Morgan Stanley hired Ruchika Sethi to lead its nine support centres worldwide. Sethi joined from insurer AIG, where she was global deputy chief operating officer and chief transformation officer for general insurance. Sethi will oversee centres in places such as Bangalore and Budapest which house staff tasked with back office and some business functions related to technology, legal and compliance and operations, among others. Loan market veteran Eric Chan has joined First Abu Dhabi Bank as head of North Asia corporate finance. He is responsible for originating loans and bonds from Greater China and South Korea. Chan is based in Hong Kong. Citigroup’s vice-chairman for Asia-Pacific banking and capital markets Pramit Jhaveri is retiring after more than three decades with the bank. Jhaveri spent 32 years at Citi, including as head of India. Debt restructuring and investment banking advisory firm TRS Advisors has hired distressed debt investor Sara Tirschwell as a consultant. TRS
Italy’s Intesa Sanpaolo has become the first bank to issue a sustainable bond dedicated to creating a more circular economy, as the intensifying focus on ESG from investors and policymakers continues to gather momentum. The €750m five-year senior preferred bond gathered a book of more than €3.5bn and priced marginally inside the bank’s traditional bonds, perhaps showing that investors are ready to put a value – a “greenium” – on sustainability and support the idea of a circular economy. “Investors were willing to give up some yield to be involved in this trade. This is a strong message for Europe and the world,” said Alessandro Lolli, Intesa’s head of group treasury and finance. The concept of the circular economy has been pioneered by Derbyshire-born international yachtswoman Ellen MacArthur’s foundation, which partnered with Intesa in 2015 and renewed its commitment for another three years this January. The circular economy aims to redefine growth by using the principles of reducing, reusing and recycling to minimise the consumption of resources and keep production to a minimum. “The transaction … is an important step in developing the circular economy,” said Stefano Del Punta, Intesa’s chief financial officer. The five-year bullet was priced at 100bp over mid-swaps, having been announced with initial price thoughts of 120bp-125bp. The coupon is 0.75%. “We managed to issue the bond at 2bp below the secondary market,” said Lolli. “With a circular deal, you’re taking a risk as a first mover; in this case, we have confirmation that we’re on the right track and path.” NO STRANGER Intesa is no stranger to ESG. The bank issued a €500m unsecured senior green bond in 2017 to support loans for environmental sustainability, renewable energy and energy efficiency, and in June 2019 funded 75 projects which, it says, prevented 350,000 tonnes of CO2 emissions. That was followed by Intesa’s 2018-21 business plan, which prioritised sustainable profitability and aimed to make the bank a world-leading model in social and cultural responsibility. In 2018, Intesa launched a new lab in Milan dedicated to the circular economy and a €5bn credit facility for SMEs and corporates. The new bond supports loans granted through the €5bn fund that meet criteria drawn up by Intesa’s Innovation Centre and the Ellen MacArthur Foundation. Companies that meet one of five criteria, including production designed to support renewable or recycling processes, are given a loans at a 30bp-50bp discount on the margin that would otherwise have been charged by Intesa. Around 60 loans have been funded so far, totalling €600m, including a €200m loan for Thames Water and a facility for engineering firm Maire Tecnimont. The deal has a second-party opinion on its ESG credentials from ISS and the loans will also be externally verified for their inclusion against the criteria. Intesa will provide details of the facilities, use of proceeds and environmental impact in its annual report. POSITIVE MESSAGE Investors liked the fact that Intesa was dedicating money to the companies that it was lending to through the discount, which was cited as a reason for the bond’s large order book. The bond had a pan-European book, headed by investors from the UK and Ireland. “In the end, investors are taking Italian credit risk. When you look at the geographic split of investors, the majority was not Italy but core Europe and the UK. This, in my opinion, is a strong and positive message for Intesa and our country,” said Lolli. Banca IMI and Credit Agricole acted as green structuring advisers and joint bookrunners. ING and Societe Generale were joint bookrunners. While it was labour intensive to set up the platform and develop the expertise to issue the bond and educate investors on the circular economy, the process proved worthwhile for Intesa, as well as financially rewarding
Barbados’s creditors have given their formal backing to the restructuring of the Caribbean island’s US dollar bonds, creating a new class of sovereign debt which will give automatic relief from payments for two years if it’s hit by a hurricane over the lifetime of the bonds. In October holders of the US$677m of notes agreed to the deal terms, which sees those bonds, with maturities up to 2035, swapped for a new US$500m 2029 note with a lower interest rate of 6.5%. That gives them a haircut of 26.3% and the risk the notes could be extended if a natural disaster strikes. A source close to the creditors, which consisted of hedge funds Eaton Vance, Greylock, Teachers Advisors and Guyana Bank for Trade and Industry Limited, said there had been some pushback against the hurricane clauses being included. “Why do this? It might be easier to take out insurance against such an outcome,” said the source. Swiss Re and other major insurers offer such protection for an annual premium. The official sector, led by the World Bank, has also tried to develop such products. CATASTROPHE INSURANCE Last week the Philippines took advantage of this as the World Bank issued two tranches of catastrophe-linked bonds amounting to US$225m of protection that will pay out to the country should it be hit by an earthquake or cyclone in the next three years (see Bonds section). Sovereigns have been encouraged to take out such protection by ratings agencies too. “One way to mitigate the economic and ratings implications of natural disasters is catastrophe insurance,” said S&P in a note, saying that would prevent a two-notch downgrade if disaster struck. LESS EXPENSIVE Barbados’s solution is seen as less expensive. Under its terms, the bonds will simply be extended by two years if a sufficiently strong hurricane batters the island. Any interest will be suspended too and capitalised. “The clauses are in the creditors’ interest,” said a source close to the government. “In the wake of such a disaster the bonds just can’t get paid. So instead of having to restructure them again it makes sense just to suspend interest and extend maturities for two years. That’s better than a default.” He envisaged such clauses being increasingly inserted into new issues. “They could be linked to the price of oil or another commodity, which if it fell might cause an exogenous shock to a country’s economy,” he said. Last year Barbados also restructured around Bds$12bn (US$6bn) of domestic debt. Together that means significant debt relief has been achieved since prime minister Mia Mottley took office in May 2018, saying it would suspend payments on its debts. “We look forward to a new era of close cooperation and to eventually restoring our credit rating to the investment grade level achieved before the Barbados Labour Party last left office,” she said.
The International Capital Market Association is picking up the fight against EU mandatory buy-in proposals again, saying it could have “significant negative impacts” for high-yield bond market liquidity. The right to buy in is already a common contract term, but under proposals from the European Securities and Markets Authority it will become mandatory. But that change could have a dramatic impact on prices and liquidity, banking lobby group ICMA said. So-called buy-ins allows the injured party in a failed securities or repo transaction to require its counterparty to make good by sourcing the security on the open market. The new mandatory buy-in regime, due to be introduced in 2020 under the EU Central Securities Depositories Regulation, could cause bid-ask spreads of all bond sub-classes to more than double, ICMA said in a study published last week. The effects would be worse for illiquid investment-grade credit and high-yield. It is ICMA’s second impact study after publishing one in 2015. This time around, 44 market participants gave their views on the mandatory buy-in proposals. “The regulation will destroy the market forcing much more volatile conditions and long-only trading desks,” one sellsider said. All 16 sell-side respondents, and 12 of the 16 buyside respondents said mandatory buy-ins would be bad for bond market efficiency. “The only division of opinion is as to how bad,” said the report. A buysider, who said liquidity was already challenging, said the regulation would likely mean banks would not short bonds. “This would have a devastating impact on market liquidity,” he said. “TOO CHEAP TO FAIL” That was by not a unanimous opinion, however. One high-yield trader said he would welcome any initiative with the aim to improve the settlement dispute. “In a zero-bound rates environment it is simply too cheap to fail,” he said. “There is a risk of counterparts taking the view ‘I’ll just fail until someone tries to buy me in’ which comes at a cost to the whole system.” But it is not just the cost of unsettled trades to the investors not receiving the bonds that is the issue; they can also cause a problem when investors want to vote on corporate actions in a timely fashion. “Another issue to consider is the ability to vote on corporate actions in a timely fashion, which impacts implementation of corporate restructurings,” said the high-yield trader. “A market with better settlement discipline will engender more trust.” Under ESMA’s new rules, securities depositories must implement a penalty mechanism for fails, required to be heavy enough to serve as an effective deterrent.
French luxury goods firm LVMH is lining up around US$17bn-equivalent of loans to back its recommended US$16.2bn acquisition of US jewellery maker Tiffany, providing a welcome tonic as well as a touch of glamour to the European loan market after a disappointing year in which blockbuster M&A lending opportunities remained rare. The loans, which will initially fund the acquisition, comprise a US$8.5bn bridge loan, a US$5.75bn commercial paper back-up line and a €2.5bn revolving credit facility. The acquisition financing is expected to be refinanced in the bond markets with short, mid- and long-term debt. “Despite the wider external factors that have impacted the loan market this year, lending conditions are about as good as they ever have been,” a senior banker said. “There is quite a lot of volume sitting in the pipeline, including a number of bridge-to-bonds.” Despite its size, the transaction is expected to have a limited impact on LVMH’s leverage. LVMH was rated by Moody’s for the first time in July giving the luxury brand an A1 rating, a rating that was affirmed on Thursday. “LVMH’s A1 issuer rating reflects its leading position in the luxury goods market, its business and geographic diversity and very strong portfolio of brands,” says Vincent Gusdorf, senior credit officer and lead analyst for LVMH at Moody’s. “It also factors in the group’s strong cash-flow generation and relatively low reported debt, although its off-balance sheet commitments, mainly capitalised operating leases, are substantial.” LVMH and Tiffany said they expected to close the deal in mid-2020. Tiffany said in a statement its board of directors recommended that shareholders approve the transaction. BANK SUPPORT LVMH is being advised by Citigroup and JP Morgan on the acquisition, with both banks expected to take lead roles on the financing. LVMH can also expect strong support from its wider bank group. The company increased its total undrawn credit lines to €5.9bn in 2019, agreeing a €2bn five-year revolving credit facility in April as the company completed its US$3.2bn acquisition of luxury hotel group Belmond. That self-arranged financing was provided by BBVA, Banco Santander, Bank of America, Barclays, BNP Paribas, Citigroup, Commerzbank, Credit Agricole CIB, CM-CIC, Deutsche Bank, HSBC, ING, Intesa Sanpaolo, JP Morgan, MUFG, Mizuho, NatWest, Natixis, Societe Generale, Standard Chartered and UniCredit. That facility is in addition to an existing core syndicated RCF that was amended and extended in 2018, increasing the facility size to €2.5bn from €2bn previously and refreshing the maturity by five years. LVMH tapped the loan market for a jumbo acquisition financing in 2017, arranging €9bn of loans to back its €12bn acquisition of Christian Dior Couture. That financing included a €5bn 18-month bridge loan to bond market with a six-month extension option, and an around €3.5bn five-year term loan. There was also a €500m five-year RCF for general corporate purposes. The bridge loan was refinanced in May 2017 through a €4.5bn bond issue and in June 2017 and through a £400m bond issue, which was subsequently converted into euros.
Deutsche Bank has sold assets with a notional value of about US$50bn tied to emerging market debt to Goldman Sachs as part of the German bank’s attempt to shrink, people familiar with the matter said. Deutsche has sold several portfolios of unwanted assets and is keen to sell more to reduce the size and complexity of its balance sheet under a turnaround plan kicked off in July by chief executive Christian Sewing. Goldman previously bought a book of Asian equity derivatives assets auctioned off by Deutsche as part of Sewing’s turnaround plan. The recently sold EM debt assets were previously housed in Deutsche Bank’s wind-down unit, known as its capital release unit. The CRU initially had €281bn of leverage exposure, which had reduced by €104bn to €177bn at the end of the third quarter. That equates to a €16bn reduction in risk-weighted assets to €56bn. Deutsche is aiming to get CRU’s leverage exposure below €119bn by the end of the year, or €52bn in RWAs.
China is planning a Stock Connect scheme with Germany, building on a similar trading link between Shanghai and London which was launched in June. Chen Han, co-CEO of China Europe International Exchange, said at a recent conference in Frankfurt the exchange was working on setting up the trading link. “With mutual depositary receipt listings on the exchanges in Shanghai and Frankfurt by German and Chinese companies, we strive to establish an ever closer connection between our capital markets and real economies. The feedback from high-profile corporate issuers is emboldening,” he said. CEINEX is a joint venture between the Shanghai Stock Exchange, Deutsche Boerse (which operates the Frankfurt Stock Exchange) and the China Financial Futures Exchange. Launched in 2015 and headquartered in Frankfurt, it is a trading venue for investment products related to China and the renminbi in the international markets. LONDON MODEL The proposed Shanghai-Frankfurt Connect would be closely modelled on the recently launched trading link between the SSE and the London Stock Exchange, one source aware of the plans said. Under that scheme, companies listed on the LSE can issue China depositary receipts on the SSE, while SSE-listed companies issue global depositary receipts on the LSE. Huatai Securities was the first issuer under that scheme with a US$1.69bn sale of GDRs in June that drew a stronger response from UK investors than expected. The GDRs are fungible with Huatai’s domestic A-shares after a 120-day lock-up period, but around half of the issue remains traded in London, according to one source close to the deal. Chinese energy developer SDIC Power has also received approval to issue GDRs and is expected to open books in early December on a deal that could raise about US$700m–$800m. There have been no CDR issuers so far under the London Connect framework, although HSBC previously said it was looking at it. That was before relations with Beijing became strained over the bank’s cooperation with the US investigation into Huawei. AUTOS IN GEAR The trading link will ape Shanghai-London Connect as closely as possible, the source familiar with Shanghai-Frankfurt Connect said, including on technical details such as the lock-up period and settlement cycle. But there will be some divergence, particularly on information disclosure, given regulatory differences between the UK and Germany. “Why should China have a different system for different markets?” the source said. “It makes things much more straightforward for Chinese investors going outbound if the rules are the same everywhere, to the extent that it is possible.” Chinese state media reported German auto companies, in particular BMW and Mercedes-Benz, would be probable candidates for CDR listings, while Chinese manufacturing companies are most likely to issue GDRs. The source said the exchanges were currently talking to about 40 or 50 issuers from a variety of different sectors, including consumer goods and finance, not just manufacturing. CEINEX has also piloted D-shares, similar to Hong Kong-listed H-shares, as a means for Chinese companies to list in Frankfurt. That experiment, however, has produced little excitement. Chinese home appliance giant Qingdao Haier raised €278.25m (US$306.46m) in October 2018 in the first D-share sale, the only such listing to date.
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