LONDON (Reuters) - As Britain inches towards Brexit, the market for top-rated sterling bonds has had its busiest start to the year on record, driven by UK banks’ clamour for super-safe triple-A rated debt in order to meet stringent new safeguards imposed by regulators.
Sales of public sector issued securities are up 55 percent year-to-date, according to data from Dealogic, with British banks under instructions to up their buffers of easy-to-sell assets to weather any post-Brexit crises.
One of the drivers for the surge in issuance, mostly by governments, quasi-sovereigns or international development banks, is lenders’ need to hold enough high-quality liquid asset (HQLA) to withstand a 100-day market stress scenario, instead of 30-day long crash, as regulators had previously demanded.
The Bank of England has asked some lenders to triple holdings of top-rated securities which can easily be sold at short notice, according to an FT report, in the event of a chaotic British departure from the European Union. The BoE declined comment.
Such public sector borrowers, collectively bucketed as SSAs, have sold £11.1 billion in sterling bonds this year, versus £7.2 billion in the same year-ago period and over half the total £21.6 billion raised in the whole of 2018, Dealogic data shows.
At the forefront is German development agency KfW which has already sold £4.5 billion sterling of bonds this year, more than the previous three years worth of issuance combined.
“The main reason for the issuance is demand is incredibly strong, predominately from UK bank treasuries, because of the uptick in HQLA assets and the attractive spreads SSAs have come at,” said Mark Byrne, a syndicate official at TD Securities.
KfW has completed seven deals in the sterling market this year, noting not only a pick up in demand from bank treasuries, but also an increase in the size of orders and the number of investors.
Around 50 percent of orders for KfW’s most recent deals have come from UK Bank Treasuries, an increase on last year, the agency said. Its most recent deal was a £250 million tap of its £1.3 billion, 1.25 percent December 2023s, priced at 35 basis points over the September 2023 British government bond.
The European Investment Bank and Asian Development Bank, both ranked triple-A, have also sold sterling bonds this year. ADB raised £1.2 billion with two bonds, while the European Investment Bank has raised just under £2.75 billion, Dealogic says.
“The sterling market has gained importance for us,” said Petra Wehlert, head of capital markets at KfW. “It is extraordinary that we have been able to issue over £4.5 billion this year when we have the UK in the news every day with the Brexit discussion.”
Bonds issued by highly-rated European agencies count towards a bank’s stock of HQLA, with sterling bonds in particular demand because they match the primary denomination of liabilities on a UK bank’s balance sheet.
“It is something the (BOE) have been pushing to ensure financial institutions are able to withstand any kind of shock or stress in the market and it makes perfect sense for them to do that,” said a treasury funding official at a UK bank, who has been buying the sterling debt.
Brexit concerns had actually deterred investors and issuers from the sterling market towards the end of 2018, leading yield spreads over gilts to widen sharply. But demand for sterling bonds surged at the end of January, bankers said.
The triple-A sterling boom has benefited both sides. With demand pumped up by banks, borrowers are finding themselves able to raise debt even more cheaply than last year.
KfW for instance, has just raised £250m four-year cash at a yield of 1.167 percent — versus the 1.496 percent it paid to raise £200 million last October. Both deals were a tap of the same 2023 bond.
The lack of supply in the last quarter of 2018 helped improve the sterling-euro basis swap, meaning it is cheaper in some cases to issue in sterling and swap back to euros.
“All of our funding came at a funding advantage versus our euro curve,” said Piet Jürging, senior manager in the funding team at KfW.
For bond buyers, meanwhile, KfW sterling bonds offer an alluring yield pick-up over British and German government bonds.
“The currency looks cheap if you believe there is a deal, and at these yields, they are offering something versus bunds,” said Lee Cumbes, who manages public sector debt sales at Barclays.
It is unclear how much more issuance is needed to meet British banks’ needs — UK banks stress-tested by the BOE last year were found to have a trillion pounds of liquid assets, more than quadruple the amount during the 2008 financial crisis. But other factors may underpin sterling bond markets.
For one, the BOE plans to continue its asset purchase programme. Second, gilt supply is dwindling — British finance minister Philip Hammond’s recent Spring Statement flagged that net gilt sales this fiscal year would be the smallest since 2002/2003.
Reporting by Virginia Furness; additional reporting by Abhinav Ramnarayan; editing by Sujata Rao and Jon Boyle