The Sterling Bonds and Fixed Income Handbook. Mark Glowrey
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Well-known issuers in the sterling bonds markets include the following organisations. Bond investors should familiarise themselves with these borrowers. The issues of these organisations often become the benchmarks – large, liquid and well-known bonds against which other, possibly more interesting, bonds are valued.
The European Investment Bank
Europe’s state-owned development bank, the EIB, was established in 1958 after the Treaty of Rome and was the first of the European Union’s financing institutions. Its shareholders are the 27 Member States of the Union, which have jointly subscribed its capital. The EIB’s Board of Governors is composed of the Finance Ministers of these States. The EIB’s role is to provide long-term finance in support of investment projects.
The EIB is a regular participant in the sterling bond market, issuing a range of maturities, effectively shadowing the structure of the gilt market with a range of bonds offered across different maturities.
Kreditanstalt für Wiederaufbau
The German government-owned development bank, KFW, is based in Frankfurt and was formed after WWII as part of the Marshall Plan to rebuild the then shattered Germany. Effectively a German state credit. The bonds are AAA-rated and trade tightly to gilts. As with all large financial organisations, KFW raises finance across the international financial markets, including the sterling bond market in order to better diversify its funding base.
UK banks & building societies
Banks are typically the largest users of the bonds markets both as issuers and as investors. Banks raise different types of capital and funding in the markets. This results in a variety of different types of bank debt, ranging from senior (ordinary) through to subordinated bonds (a higher risk and higher yielding type of debt – more on this later). The sterling market is notable for the high number of subordinated issues from these issuers.
Some investors, notably the banks themselves, have historically viewed bank debt as the “next best” credit after government and government agency debt. This perception of the quality of bank debt has weakened considerably following the events of the credit crunch, with investors preferring bonds issued by other sectors. It remains to be seen if the conventional pecking order will be restored.
Tip
When buying bank or building society bonds, double check the seniority of the issue. Subordinated bonds are a less secure form of debt. These have their place, but are a somewhat different kettle of fish to senior debt – higher risk, subject to coupon deferral and much more volatile. Risk is fine, but as investors we will expect to see a higher return to compensate.
General Electric
The giant US engineering and financial services conglomerate. Often judged to be a financial sector company rather than a true corporate (the company derives around half its revenue from financial services). GE has a balance sheet the size of Jupiter and the company’s bonds typically show correlation to bank debt. GE has a systematic program of issuance into the sterling bond markets and they have bonds trading at a wide range of maturities.
Utilities
Utilities such as National Grid and Severn Trent are frequent issuers into the UK market. The low-risk nature of the utility business makes such issuers a popular choice for the typically risk-adverse bond investor.
Tesco
One of the UK’s biggest companies and a frequent issuer on the GBP (and other) bond markets. In 2011 Tesco Bank (a subsidiary) issued a sterling bond into the retail market and has a pipeline of such issues planned.
The above examples are simply some of the most well-known issuers of sterling bonds. Further research will yield a list of hundreds of other issuers and their bonds. Often, the less well-known the issuer, the more interesting (and potentially undervalued) the bond.
Tip
keep an eye open for bond market debutantes. Bond issues from new or unknown issuers often have to be priced to sell – great for “stags”.
You can find a table of popular sterling bonds in the appendix at the back of this book. Please note, this represents only a sample of a wider market. Liquidity and transparency are moveable feasts and this, combined with the inevitable process of redemption and new issues will make the list look quite different a few years down the road.
Investment banks
It is fair to say that investment banks (IBs) are the bond market. The reverse is also true; the bond market consists of investment banks. A study of the results of the major players such as Goldman Sachs, or the late Salomon Brothers or even our own domestic operators such Barclays Capital, show that it is in bonds and their associated derivatives that the greatest returns are to be achieved and the largest positions found. Not surprisingly, it is also where the greatest losses appear from time to time. Why? Because bond markets are scaleable and open to bulk trading, enabling the highly aggressive and ambitious IBs to put on trades by the billions.
Standing aside from the proprietary trading activities of the investment banks, these organisations have two important roles to fulfil. The first is issuance. New bond issues, sometimes known as the primary market, is the meat and drink of the investment banking industry. Major borrowers need to issue large amounts of bonds, and to do so regularly. This business is fee-generating for the IBs, and repeatable. In addition to the fees charged by the IBs (perhaps 0.4% of the sum raised on a ten year bond), there is a considerable amount of additional revenue that can be generated from offering hedging or related swap contracts, both to the issuer and the buyers of the bonds.
The bankers will constantly be scanning the financial markets looking for opportunities, and pitching deals to their client base. Primary bond market activity is one of the most hotly contested activities in the financial world and the league table of issuance is closely followed each year. Here’s how 2010’s league table for the sterling market panned out, according to Bloomberg.
Table 3.1: ranking of investment banks in sterling bond market (2010)
It is worth pointing out that the sterling market is a relatively small pond. The top underwriter in Euro-denominated bonds issued a volume of EUR79 billion.
Euroclear
Custody is not a subject that receives much attention in the financial press, but you might be surprised how often the subject arises amongst market professionals.
When an investor buys a bond, his broker will need to settle the transaction. Domestic bond markets, such as gilts, have settlement systems that were in many cases established before the dawn of time. However, the majority of corporate bonds, including sterling corporate bonds, are Eurobonds – a type of instrument that has a distinct structure and settlement systems.
The history of the development of the Eurobond market (in the late 1960s) is based on bearer bonds. As the market developed, it became clear that some form of centralised custody system would be needed to enable the speedy transfer of ownership without the need to physically move piles of bearer certificates from one vault to another.
To meet the custody and settlement needs of the growing Eurobond market, JP Morgan established Euroclear in Belgium in 1968. The system proved to be an enormous success and Euroclear remains the hub of the international bond markets and turned over a remarkable EUR451 trillion in 2006.
The Euroclear system has come a long way from its Eurobond roots in the sixties,