In parallel with the discussions around the European Union becoming a sovereign status issuer, there is another debate on whether EU bonds will become a pricing reference and benchmark for the rest of the continent. This comes as part of the EU’s objective to become a safe and liquid asset for the European capital markets.
‘The question for me is: are they a spread product or do they become a reference product?’ said Neil Murray, chief investment officer, fixed income at Abu Dhabi Investment Authority, speaking at OMFIF’s EU bonds summit in Dubai. ‘Do they become the reference product for Europe in the same way the US Treasury market is the reference point for the US, rather than one or two states which may be in a better fiscal position than the US government?’
At present, EU bonds are, without a doubt, a spread product, with investors buying these bonds on a relative value basis versus their peers. EU bonds offer a way for investors to diversify their portfolios and triple-A assets with a decent pick-up to the likes of German Bunds – the main pricing reference and benchmark for Europe.
It is important to note that not even the EU prices off its own curve like other major European sovereigns for syndicated transactions. Rather, the EU references mid-swaps, which is a far deeper and more liquid market than EU bonds and the traditional reference for pricing bonds by non-government issuers. Pricing off its own curve would be a step towards the EU becoming a reference product for the wider European market but it can only do that once its own curve is deep and liquid enough.
Moving into bracket of Austrian and Dutch govvies
Since the EU’s inception as a large borrower, investors have been keeping a close eye on how EU bonds trade in comparison to French government bonds (OATS) as this has been the closest comparable to EU bonds. But the EU is now being viewed more akin to tighter names in the European government bond market.
‘Now when we’re speaking to investors, we’re hearing more and more investors talk about Austria or the Netherlands as a hedge versus the EU rather than France,’ said Asif Sherani, head of EMEA debt capital markets syndicate at HSBC.
‘And indeed, if you look at EU bond performance recently, EU bonds past 10 years are trading through France across the curve,’ said Sherani. So rather than viewing the relative value of EU bonds versus OATs, investors are looking at it in comparison to sovereigns that trade much tighter. This shows the evolving perception of EU bonds by investors as one of the main liquid and safe assets in Europe.
The evolving perception of EU bonds stems from the growing investor base of the EU. This is growing rapidly, with over 1,700 investors across 70 countries making up the primary market alone. However, these numbers are much bigger if you take into account the secondary market, which investors are increasingly using to access EU bonds as the liquidity and depth of the EU’s secondary market improves.
‘It’s important for us that we develop this investor base because we are developing our supply,’ said Siegfried Ruhl, horse classe adviser to the director general for budget at the European Commission. He was referencing the extraordinary growth from €500m of supply at the end of 2019 to over €500bn of outstanding bonds by the end of 2024.
Transition to sovereign status
Part of the EU’s transition to becoming a benchmark and reference product is its evolution into a sovereign status borrower. The EU has developed a sovereign-like funding style with auctions, syndications and bills under a unified approach with secondary quoting. Meanwhile, a repurchasing facility and futures are expected to follow soon, as well as entrance to the major government bond indices. This would be a game-changer in the EU’s transition to sovereign status.
A number of investors already view and trade with the EU as a sovereign, including central banks and official institutions who ‘have already migrated the EU from supranational to sovereign portfolios’, said Benjamin Adubi, head of sovereign, supranational and agency syndicate at Morgan Stanley. While this is obviously a positive for the EU in terms of its desired perception in the capital markets, classifying the EU as a sovereign allows investors to buy bonds past 10-year maturities.
Bank treasuries – another important investor base in the European government bond markets – are also starting to classify the EU as a sovereign, said Adubi.
The EU is very much in a transitionary phase into becoming a sovereign status borrower and reference product. As more bonds are issued and liquidity improves, it is hard to argue that the EU will not become a benchmark in the European capital markets. But becoming the main reference would be difficult to achieve given the size and status of the Bund market.
When asked if EU bonds could ever rival the Bund in terms of a safe asset in Europe during a podcast with OMFIF, Siegfried Ruhl, hors classe adviser to the director general for budget at the European Commission, said ‘It’s not our intention to rival with any other issuer… we want to complement the existing issuances in the market and strengthen the European capital markets by providing another liquid and safe asset’.
Watch the full panel discussion on the development of the EU’s status as liquid, safe asset and benchmark at OMFIF’s EU bonds summit in Dubai.
OMFIF, in partnership with the European Commission, will be continuing the discussions of the EU’s developments as a global benchmark and safe asset in the capital markets with an event in Singapore on 10 September. This will be an exclusive opportunity for investors in the Asia Pacific region to hear directly from the officials responsible for the EU budget and its funding and disbursement programme.Â
