1. What are countries doing differently?
The typical method in Europe for raising funds is via an auction — think Sotheby’s — whereby a country sells an amount of debt at a given time on a given day. Like at an art auction, investors make bids and prices fluctuate according to demand. Far less common is the private placement, in which debt management offices sell directly to investors, often for more obscure issues such as a 100-year Irish bond. The other way is via syndication, which involves appointing a group of banks to underwrite a sale. Syndications have largely been used to introduce new or ultra-long bonds to the market and have become a popular choice for funding coronavirus recovery plans. They cost a nation more but are guaranteed to raise the cash.
After a country’s Treasury works out its borrowing needs, its debt management office plans how to fund it — usually through a mix of auctions and syndications. The latter involves finding a set of banks who will take responsibility for securing investors and who agree to purchase any unsold securities. There is a premium to pay for the luxury of knowing the full stash will move. A recent Italian syndication racked up more than 100 billion euros ($113 billion) of orders, mainly because the bonds were offered with yields nearly 10 basis points more than those in the market. The process is a highly profitable one for banks, assuming they manage to sell everything.
3. Why are countries doing this?
Europe is facing unprecedented borrowing needs. Bond sales across the 19-nation euro area are set to total around 1.2 trillion euros this year, according to Bloomberg Intelligence, up from around 870 billion euros in 2019. And with countries still easing their way out of lockdown, governments can’t afford to come up short in providing the desperately needed support to businesses and citizens. Conventional auctions can be unreliable, potentially failing to sell all the bonds on offer, hence the demand for syndications. JPMorgan Chase & Co. estimates they account for around 30% of this year’s government debt issuance, a third more than usual for the time of year.
4. Can investors digest all the extra borrowing?
For now it seems like they can, and then some. Sales across the region have attracted record demand, largely thanks to the European Central Bank. While the institution cannot buy bonds straight from a Treasury, its growing presence in the secondary market means that investors know they can always offload securities. At its June meeting, the ECB increased its pandemic purchase program to 1.35 trillion euros. This doesn’t guarantee syndications will continue to be meet with strong demand, of course. A second wave of the coronavirus pandemic, for example, might make such sales more challenging for indebted nations such as Italy.
5. How does this compare with the rest of the world?
Syndications are often used by companies to sell bonds, as well as by emerging-market nations, regional governments and development funds. But the world’s biggest seller of bonds — the U.S. — doesn’t offer them at all. While the U.S. Treasury has considered syndications, citing the success of other countries, concerns have been raised over the possible appearance of playing favorites with particular banks and to disrupting the predictability of market supply. What’s more, there hasn’t really been a need: The status of Treasuries as the world’s largest and most liquid government bond market has underpinned demand, including from foreign investors.
6. Are there wider implications for the bond market?
Right now, the syndication process is working. Even on a day when the U.K., Spain, Ireland and Greece all conducted such sales, investors laid down nearly $300 billion of offers, showing that fixed-income demand is remaining robust for the time being. There may be longer-term risks to how the market functions, with central banks mopping up so much of the supply. Japan’s central bank has been devouring bonds to such an extent that there have been days when not a single bond traded on the open market. If Europe went the same way, a bigger proportion of the day-to-day work for rates desks may be conducting profitable syndications, rather than actually buying and selling securities. The danger is liquidity could all but dry up.