TRANSCRIPT: Interview with Italian Treasury’s Davide Iacovoni on 19 May 2021

27 May, 2021

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on May 19 with Davide Iacovoni, director general of the directorate of the Italian Treasury that is responsible for Italy’s public debt management:

Q: You have spent a lot of time developing the retail product with the BTP Italia and now the BTP Futura. Are you happy at how the first Futura bonds have gone?

A: Yes, definitely, we are very happy. Last year the BTP Futura was a new product, but we managed to issue at a 10-year maturity, which is not a usual maturity for retail investors. And we managed to bring to the market a very decent supply of several billion euros, and then again in November with a slightly shorter maturity of 8 years. The fact that the product is appreciated by investors is proved by what happened in April of this year, when we went even further out in terms of maturity and issued at 16 years. And in this case as well it was a very big success. Of course, the last issuance was in some respects distinct from the first two, but despite what one could call complicating factors if we refer to the premium component, people reacted very well, probably because on the one hand they were not so complicated, and on the other hand because we were able to explain it well. It’s a very successful story and we are completely happy about it. It definitely complements the BTP Italia, which is partially tailored to retail investors but is inflation-linked. We wanted to have in our toolkit a non-inflation linked product, and the Futura is a fixed-rate product with coupons rising over time according to pre-defined levels. So, it reflects the fact that it was important to us to have another instrument in our toolkit, especially in a period where funding needs were getting significantly higher than planned.

Q: And are there plans for other retail-focussed products?

A: This is a good question. The attention to the retail segment has always been very significant, basically for two reasons. One, given the large debt, there’s a need to further diversify the investor base. And two, the stock of financial wealth is pretty high in Italy. Of course, this financial wealth is invested in different ways and to some extent gets invested in government bonds via intermediaries like funds and other types. However, there is also a tradition of holding government bonds directly.  So part of this stock of wealth is already indirectly invested in government debt, but there is definitely room for a wider presence. And so for us it makes sense to try to offer these investors something transparent, secure and easy to understand. So on the one hand there’s a supply need, and on the other there’s a need to respond to this characteristic of the Italian financial market in which households have always played a very important role compared to other European countries. So that is why our focus cannot be limited to just traditional products, but we had to offer also tailored ones. We continue to market our existing traditional and tailored products to retail investors, and of course we are also very open to both potential new instruments and potential new ways of offering existing products to investors. This is definitely a work in progress and you can expect additional initiatives in this area in the future.

Q: Republic of Italy issuance in USD has been revived lately. Does this always represent a cost saving or is there some willingness to pay extra just for the sake of developing new investors?

A: It’s definitely the second reason. We started issuing in USD in 2019 after almost nine years without having issued in that sector. We were not really looking primarily at the cost. Of course, the cost would not be much different from the cost of domestic bonds, but at the time there was a need to rebuild the curve and our presence, to re-enter very important and strategic investor portfolios. There was some extra cost, but we’re really just talking about a few basis points. In 2020, with the pandemic, we only did one USD transaction in November, because issuing in dollars entails a particular bureaucratic process involving authorisation from the US SEC and a lot of other things we don’t have to worry about when we issue a domestic bond. So given a pandemic that made the bureaucratic requirements even more time-consuming, we did just the one issuance. Even in this case there was some extra cost to issuing in USD, but the transaction went really well on the 5-year segment. This year we have already done a first USD transaction on the 3-year and 30-year points, a big success even with just very few basis points of extra cost. So clearly, what we are doing is not about cost but rather diversifying the base of investors, new investors who normally may not buy Italian domestic debt. But experience has shown that this is a way to approach these investors, and maybe in the future, some of them, having gained knowledge about Italian debt and the Italian economy, may decide to shift to euro-denominated bonds. This is actually an experience we’ve had in the past. It’s still too early this time, because we only re-entered the market in 2019 and need to let this process take place. So USD-denominated instruments are a way to diversify investor base, but we also keep in mind that some of these investors may ultimately buy euro-denominated debt. It’s really a global market. When we relaunched the program in 2019, on the 30-year point we had an extraordinary presence of Asian investors, so it’s really an extremely powerful tool to ensure a growing global investor community looks at our debt, which is very important for us.

Q: Can you share any thoughts on the recent introduction of short BTPs, those with 2-year maturities?

A: The rationale behind them was driven by the fact that our 2-year zero coupon bonds had been struggling over time to have a wider presence among investors. They were mostly bought by domestic bank treasurers and to a lesser extent by foreign investors on an opportunistic basis. This generated a situation where the CTZs were always trading at some premium over the BTPs with the same residual maturity. In moments of higher volatility, the spread used to widen to 10 or 15 basis point. So we had a lot of discussions with investors, both national and international, and it seemed that having a new product on the same segment, called BTPs, with coupons – even if we have no coupons now because rates at that part of the curve are negative – might be able to attract a wider set of investors and perform better in the secondary market. It’s actually what has happened. The first short-term BTP, the BTP 2022, is behaving very well. It’s well priced on the curve and there’s no premium we’re paying for that. So I would say that the main objective has been achieved. And consider also that we say in our guidelines that this new segment won’t be only 24 months, as used to be the case for CTZs, but rather that there is flexibility between 18 and 36 months at issuance. This will be very crucial because it will allow us to better manage future redemptions, especially in periods when the funding increases quite significantly and we have to manage the result of this higher funding in terms of higher redemptions in the next years. So it’s important for us to have the flexibility to try and place redemptions in years or in months when there are fewer redemptions, letting us smooth the profile as much as possible. And this instrument will also play a role in that.

Q: Are you seeing better interest for the short BTPs than for the CTZs that they replaced?

A: Yes. There’s better interest from the final investors. But it’s probably also easier to trade, and I would not underestimate this as a factor. Trading in CTZs was not completely easy, and a lot of international players were still struggling a bit to understand the product completely,

Q: The Italian Treasury had an unusually large €89 billion account balance at the Bank of Italy in April. As the pandemic eases and global economic developments as well as tax revenues become more predictable, will this be run down, and how will that impact issuance?

A: We have two issues within the same year. One is the fact that there is the debt redemption profile, which tends to be regular but with large bond volumes becoming due at certain points. And the other is our primary borrowing requirements, which is characterised by volatility. The combination of the two results in a cash account that fluctuates. Normally the first months of the year we have large balances. The fact that now you see a very large balance is very much due to the fact that, knowing about this volatility over the year, we tend to plan well ahead how to manage coming months. So this is pretty structural if you consider the way our Treasury account, primary borrowing requirements and redemption profile are shaped. In order to cope with this, we need to have a large balance that reflects what we expect over the following months. So you will see that these numbers will decline structurally over the year. Last year, we closed in the region of €40 billion, less than half of the balance you see now.

Indeed we have to be regularly in the market. If you have to issue in size over a time period you have to  be regular during this time frame. We can’t have larger issuance just because we have to cover larger redemptions, and much smaller issuance when we have smaller redemptions. It doesn’t work like that. We have to be regularly in the market, we have to be as predictable as possible, and we have to try and spread out over the months all the issuance that we know we will be bringing to the market. And the result of this is this volatility in our cash account balance. That is why over the years, we’ve been working to make this cash management more efficient. The account balance you referenced is just the cash that is free, but our state account would have an even higher balance; at end-April it was over €100 billion, including the part of the money that is invested in short-term money market operations. As part of the effort to improve this cash management, a few days ago we announced a repo facility that will start at the end of the month. The repo facility will play an important role because on the one hand it’s a way to invest excess cash in the repo market, while on the other hand you can use the repo market to fund yourself in case of a temporary need of cash. It’s a way to offset somewhat the volatility that we had in the cash account. So I would not consider the cash account balance that you referenced to be anything strange.

Q: You mentioned the repo facility that was just announced. What more can be said about how you envision using it?

A: We are in the process now of creating our own €15 billion portfolio of bonds that can theoretically be repo’ed.  With these bonds we can manage a temporary cash bridge of two days, three days, a week, a month. So we give these bonds out, get the cash, pay the repo rate and then get them back at the end of the maturity of the contract. This is a very powerful tool because there’s a much wider set of investors and much greater depth on the repo market, so it’s a big improvement compared to what we have now. On the other hand, given we are a participant in the repo market, we also have the chance to use the cash we have in excess in the opposite way and give it in the repo market to a much wider set of investors than we have now in our Treasury operations. That’s the way we’re going to use this facility. In addition – but this is a secondary purpose – we can use these bonds if some of them are squeezed, that is in the event of a structural lack of supply that can result in, for example, traders that can’t settle on the settlement date because they realize they don’t find these bonds. So this is another way to accommodate the market and improve market functioning; when we see the potential for such tensions in the market, we can, after a thorough analysis, use the bonds we have in the portfolio for this purpose. But at least for the time being, this is secondary, and primarily we’ll be using these bonds as a tool for cash management.

Q: There had been some talk of a possible 30- or 20-year syndication in May, possibly a tap, but this seems to have been pushed back in the latest Specialists’ meeting on May 7. Can you share your latest thinking here?

A: We were very clear with the market. Our thinking was that we had a lot of activity up to the end of April, the cash position was okay, and so in the month of May, we can definitely stick to what is planned in the calendar and really don’t see the need at present for additional funding. Of course, we are also very flexible with syndications and look at how the market conditions are, and the month of May has clearly been a month of rates volatility and some spread-widening. There’s a lot of discussion about what the ECB’s going to do and about moves in market-based inflation expectations. Plus there’s all the developments coming from the US. So it’s an uncertain period in which it’s not clear where rates and spreads are going. This is honestly not a market that’s very conducive to a transaction. We could still do it; this is the nice thing about syndication, because you can choose flexibly the timing, of course within a framework where people know what bonds we need to bring in the market and what the strategy is for long-dated bonds. But ultimately the month of May was not a month to go to the market. So it’s all market chatter and rumours, but nothing came from us and we were very clear.

Q: You issued a BTP Futura in April, but Italy had said around the turn of the year that it would issue ‘at least’ one BTP Futura in 2021. Might you thus issue another BTP Futura later this year?

A: Yes, it may be. There is definitely some uncertainty regarding the total funding that we have to do this year. But I would definitely say that there is a chance for another BTP Futura later in the year.

Q: Also, there aren’t any BTP Italia redemptions this year, but do you think you could issue one?

A: That’s trickier, because we don’t have BTP Italia maturing this year. The inflation segment underperformed massively up until the end of last year and the beginning of this year. Now of course the inflation segment is much changed, because market inflation expectations are now different. And on the inflation-linked segments linked to European inflation, we brought in a new 30-year bond that was very much awaited by the market. So the market tone definitely has changed, so of course we will also now be looking at BTP Italia, especially in case of funding needs. But I see as more probable another BTP Futura, and BTP Italia needs to be assessed, depending on the evolution of markets and our funding needs.

Q: Debt offices have spoken a lot about inflated syndication orders, but it’s been reported recently that ‘Italy Has No Caps on Hedge Fund Bond Buying’. How do you see this?

A: It’s definitely an interesting topic. We have naturally experienced in some of our transactions unexpected behaviour from some accounts of that kind. We’re still trying to gauge what’s behind it, because we cannot put in place a strategy aimed at addressing the issue without understanding what is causing it. For this reason, we have started a closer interaction with investors in general and also these accounts, trying to better understand their logic. But I would say that so far, the transactions with this kind of behaviour were not really affected in the end and the final results were fine. So to answer you very directly, I would say it’s a work in progress; we are interacting with these accounts and are also engaged in discussion regarding this with the other DMOs at the European level. But since it has not really impacted our issuance, it seems to be manageable the way things are now. Does this mean that we won’t change anything? No, but for the time being it’s too early to say. We want to have our own clearer, in-depth analysis, more interaction with these accounts and more analysis in collaboration with the other DMOs. And then we will decide if something needs to be done. Right now we think that what we’ve already done is enough to manage the situation.

Q: What modifications to 2021 funding needs do you expect between now and the end of the year? Do you expect further stimulus packages? Can you give us a rough idea of total issuance (bank estimates range from €365 to €395 billion)?

A: This year we started with a planned amount of funding similar to that of last year. It may be slightly higher. Maybe the €365 billion number you mentioned could be a good orientation for the time being, but there are definitely important caveats there. One is the fact that we don’t know what our primary borrowing needs will be. That’s not so much because we are expecting a further widening of the deficit going forward; right now it seems pretty plausible that the economy is recovering. We are slowly moving to reopen and the vaccination campaign is now going very well in Italy. So a further widening of the deficit is not in our baseline forecast. But there is the opposite risk, if tax revenues are better than expected, for example. And we always need to bear in mind with the deficit-widening interventions by the government – there were already two this year, one around €30 billion and the current one around €40 billion – that these are maximum amounts. But economic conditions may change, and so as happened last year, this improvement allows businesses to start planning their reopening. And they know that they can count on some money from the government, but this does not mean that the money will be used. As last year, if things get better and better, then this money won’t be used. So the possible maximum amounts are one thing, but the actual cash deficit can be another thing.

Then there is another unknown variable, which is the EU funds. Of the total NGEU package, 13% is to come as pre-financing in the first year, but the timing is still uncertain. Italy has submitted the plan and now the plan is up for discussion with the EU Commission, which needs to approve it. According to the government’s plan, in 2021 we are not getting loans for additional investment, we are only getting loans as substitution for national debt, but there will also be this pre-financing. This can make the difference; we are not talking about a huge amount of money, but in any case about several billion euros. The €365 billion number you mentioned could be a good orientation, as I said, and we’ll keep on staying on that number, also to plan our issuance. But I think to get a better view of the rest of the year, we need to wait for the summer pause. Around the end of July or mid-August, it will be clearer where we are heading.

Q: Given the imminent economic recovery, you’re not expecting the need for another national stimulus package.

A: My colleague economists, who are working on the real economy, could better answer this, but it is not our baseline scenario for the time being. In particular, it’s not embedded in the estimates for the Stability Program that we submitted to the EU Commission at the end of April. Italy is planning a deficit above 11% this year, which takes into account the two deficit-widening measures, the situation with the real economy and the budget that was approved at the end of last year for 2021. This baseline scenario does not include another intervention.

Q: What are your preferred tools at the moment to deal with possible changes in the need to issue?

A: We have a very wide range of tools. We have a very large spectrum of maturities on the nominal side, on the linker side we have the retail products, we have the USD-denominated instruments, so we really have a lot of tools that we can use depending on market conditions. Depending on these, we would try to be flexible. However, we want to be predictable; we don’t want to change our approach. But honestly, we are already planning for a situation where things don’t really improve going forward that implicitly copes with a situation of even higher funding needs. If things improve instead, we would probably have the opposite problem: how to try to target smaller sizes in our overall issuance.

Q: Does Italy’s debt-to-GDP ratio represent a vulnerability that you as debt issuer need to overcome?

A: It’s of course an issue, and it’s an issue because it affects the credit standing of Italy and thus the cost of debt, there’s no doubt about that. However, we need to analyse debt holders, because now a significant share of our debt is in the Eurosystem portfolio. At the end of 2020, the share of the stock of Italian government securities in the possession of the Eurosystem was in the region of 25%. It’s expected to reach 30% at the end of 2021, and the market is fully aware of that. So, it means that there is a part of our debt that will keep on getting reinvested by the ECB over time, and it’s not circulating in the market.

Secondly, given the ECB’s monetary policy stance and given the current macro situation in Europe, rates are very low. In the first four months of this year, the cost of all the new funding brought to the market was 0.17%. That was the average rate of all new issuances. The average cost of debt, which takes into account all existing debt, was just below 2.4% in 2020 and is meant to reach 2.2% in 2021. So there is a very large difference between the cost of new issuance and the average cost of debt, which means that inevitably, the average cost of debt will keep on declining. This is something investors are fully aware of. So you know very well that the difference between the cost of debt and nominal growth is what really drives the evolution of debt-to-GDP over time, and this sounds positive, because the cost of debt is now getting lower and will get lower and lower in the next years in the context of economic improvement. This should really favour a trajectory of debt-to-GDP that heads down, as the government has officially estimated, starting from next year. So this year the ratio will still grow by a few percentage points, and then we’ll see this decline.

So you’ve got this combined with the fact that a significant amount of the debt is in the hands of the ECB. These two factors, cost and composition of debt, are very important driving forces for current debt sustainability and its evolution going forward. So, our debt-to-GDP ratio is definitely something we’re paying for; we face rates that are higher than most of the rest of Europe because of our large debt. But we see this positive trend ahead of us, which is also what counts in the portfolio investment decisions of investors.

Q: The trend would remain positive for some time after the real economy improved enough for the ECB to start tightening policy.

A: The fact that the average cost is well above the marginal cost means that the average cost is going to decline, and this should bode well for a snowball effect. But you are pointing to an element that is crucial, which is that we need to have a sustained recovery over the years, not just a technical rebound this year because of the dramatic loss of growth last year. We need much more than that. Both in terms of magnitude and in terms of length in time. This recovery has to last for years, that will be crucial. And in that respect, the NGEU package is fundamental, because this package is not only a short-term boost, but should lead to higher potential growth. That’s where Italy has been suffering the last 20 years or more. The potential growth was too low. We need to change that and the NGEU resources are there for that. And of course we need to implement the set of reforms that the government has already planned for the next few months in order for these investments to be made in both a fast and an effective way, so that they really address our economic inefficiencies. The outcome has to be having higher growth not just next year or the next couple of years, but on average structurally higher growth that will be crucial to declining debt-to-GDP over the next decade at least.

Q: If everything falls into place, would you then react calmly to the idea of a withdrawal of ECB support?

A: Yes. You can probably expect these things to happen in Italy as in the rest of Europe, so you can probably expect that inflation, which is driving the ECB’s decisions, will slowly head towards the famous ‘below, but close to, 2% over the medium term’, and in this case of course there may be a change in ECB monetary policy. But if growth is there, and we have higher rates because of growth, then it’s good, it’s economically sound. What we can expect however is that if Italy is able to reach higher potential growth, definitely this will bode well for debt sustainability. And this will be priced in by market participants in terms of tightening the spread that we currently have with the core countries of the euro area. So in the end probably we can have rates that will grow over time only moderately, and this will be crucial also for our debt sustainability. So definitely the fact that the ECB will change its monetary policy in the medium term is not an issue if all things are working in the right direction.

Q: And if that change in the ECB’s monetary policy were to come sooner than expected?

A: In the short term, I know there’s a lot of noise right now about what the ECB’s next move might be. Inflation has been showing some signs of recovering but in Europe, it seems to be very much driven by “supply” effects, due to some post-Covid bottlenecks, by the evolution of some commodities’ prices and to some extent also by statistical base effects. Even the ECB’s economists are pointing to the temporary nature of this recent inflation evolution.

Q: You had high demand for your inaugural green bond this year. What’s your vision for building on that?

A: We are definitely monitoring this market. We’re trying to liaise more and more with specialised ESG investors in our discussions regarding this bond. So for the time being our strategy is to provide liquidity to the existing bond. Indeed, we can’t exclude that we will be reopening it. Now the timing is still under scrutiny, because we are still working a lot on the process of allocating the proceeds of what has already been issued. But definitely for the time being our strategy is to have very liquid bonds, very easily tradable, and that they perform well in order to make those who bought these bonds happy. We don’t have in mind for now building a green bond curve, a goal I know has been expressed by some of our peers. Our focus is on creating few but very liquid bonds for the time being.

At the same time, we’re very pleased that our green bond has been included in a specialised index called MSCI Global Green Bond Index. For us this is very important, because we know that a lot of key ESG investors look closely at this index.

Q: Can you say anything about syndication plans, including maturities of particular focus?

A: I can tell you definitely that we will keep on being focussed on the nominal long-end part of the curve, because this is part of our risk management strategy of having an average maturity of the debt consolidated in the area around 7 years. For this purpose we need to be present on the long-end part of the curve, but we will keep on providing liquidity in the inflation segment, so depending on how markets develop, we will for sure make use of other syndications, but I cannot now say what the next targets are in terms of maturities or segments. But definitely all our next syndications will stick within our guidelines.

Q: Are you worried about a shift in demand away from longer-dated tenors, such that future syndications at the longer end of your curve might not be as successful?

A: I think somehow this is physiological, because there’s been so much supply in Europe and from us in the long end, and so that could be expected. Those who have long-dated bonds in their portfolio of course are reassessing their strategy in the context of rates that are rising, and also of this difficulty in predicting next ECB actions and inflation and so on. Of course, this is not helping bonds that are long-dated. But I’m sure that once a lot of the supply has been better digested by the market and once we have a little bit more clarity about where we are headed, I think this market is very much alive, and I am counting on it being very strong in the next months. Consider also that in this period, despite the volatility, we have kept on seeing good interest on different long-dated segments like the 30-year, where despite some underperformance we have seen some demand coming back, and also on the 20-year point. So I would not be particularly worried about what has happened in the last couple of months in the long-end part of the curve. It’s expected and, I think, physiological.

Q: How do you assess Italy’s interest burden sensitivity?

A: We regularly do different types of sensitivity analysis. The most basic kind involves simply doing a hypothetical 100-basis-point parallel shift of the curve and seeing what the impact would be on our interest burden. The impact has grown a little bit because the total size of the debt has grown, but we haven’t seen a dramatic increase, just a few decimals of GDP from this kind of shock. So it’s slightly larger than it used to be before the pandemic, but it’s not something that can really change the public finance accounts. Right now we are at interest burden levels that are basically steady despite the increasing debt. So it’s already a pretty good result for us. We are not expecting anything particular regarding the interest burden until at least 2023, which is the horizon of our Stability Programme that we submitted to the Commission. Given the structure of the debt, even if there is a shock, it would be just a modest impact on the interest burden. And we also have to look at our interest burden even in 2011 and 2012, when we had the dramatic euro sovereign debt crisis. Of course rates increased massively during that period, but the interest burden, the total interest that we paid, increased, but very moderately in the end. The structure of debt is very long, the average maturity of debt is very long, so these shocks in the market tended to be absorbed with a very long time horizon, and so we are not particularly worried by some changes in market interest rates now.

Q: Can you envision taking your maximum maturity a bit farther out in terms of new bonds?

A: Well, we already have a 50-year bond, which is a very long-dated bond. We are very much market-driven. We love innovation and we look at what’s going on in the market. We know some countries have been issuing even 100-year bonds. Honestly, we haven’t seen much interest in a BTP with this kind of maturity. Probably part of this was driven by the fact that rates were so low that investors were desperately searching for yield, but in our market we haven’t seen this trend. So, up to 50-year, there is definitely a lot of demand and in fact the transaction went very well when we launched this bond. But for longer maturities, we haven’t seen the interest. Maybe there could be interest from convexity players, but they’re not so much our target in terms of investors. We tend to rely more on buy-and-hold investors, liability-driven investors and so on. This wouldn’t prevent us from doing a private placement of a bond with a maturity greater than 50 years, but I don’t see us offering a public transaction of such very long-dated maturities. This is the current status; we’re always open to adapting our strategy, but we don’t see the market right now for a transaction like this.

Q: Turning to your investor base, are there any investor segments not currently being reached that you’d like to reach?

A: We’re very satisfied. We are reaching a very global set of investors. We feel that given our current credit rating, we are doing a lot. Of course, we can always improve. The fact that we’re very happy does not mean that we do not have to do more. We need to do more, and we are always in contact with new investors, explaining Italian credit. And if things change in terms of an improvement in Italy’s credit rating, then we will automatically see new doors opening.

Q: What are your expectations for an improvement in Italy’s sovereign rating?

A: I’m not really expecting any change in the short term.

Q: And how do you assess the current risk premium of Italian sovereign bonds?

A: Looking at the fundamentals of the Italian economy and at the strength of Italians’ financial and real estate wealth, we think that the premium that we pay is too high. It’s not fair with respect to the current situation. But this is something we accept and work to improve. So we need to convince investors that the credit situation in Italy will inevitably improve because of all the reforms and the resources that will be deployed in the next few years. The situation in terms of the premium should already be better now, to be honest, but we hope that we will be able to reduce it structurally over the medium term – I’m not talking about short-term widening or tightening – thanks to this new economic policy environment.

Q: Italy’s 10-year borrowing cost has more than doubled in the past three months. Does this trend give particular urgency to the speed with which money from the recovery fund becomes available?

A: Most of this increase is related to European rates. Almost two thirds of it is reflecting what’s going on in Europe. It’s very much driven by the current market situation. Yes, the spread versus Germany or other core countries has widened a little bit, but it’s not particularly relevant to the NGEU funding and I don’t think it’s a reason for us to expect the recovery fund money to come earlier than initially planned. It’s important that we stick to our plan, that resources are coming, but there is no particular hurry because of some widening of the spreads between European rates in the current context. The structure of debt is very resilient to changes in rates, which so far have been pretty moderate. I would not say that this increase in rates is a trigger for requesting a faster timing of the NGEU resources.