TRANSCRIPT: Interview with Portuguese Treasury and Debt Management Agency’s Cristina Casalinho on 28 May 2021

3 June 2021

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on May 28 with Cristina Casalinho, head of the Portuguese Treasury and Debt Management Agency:

Q: You were an early advocate of doing something about inflated orders. Where do things stand now? Are other DMOs supporting these efforts enough?

A: Some years ago, we started to see that it could be beneficial for the functioning of the book-building process and then the allocation process to have some caps on some orders. And so we decided to adopt such caps. The phenomenon of having quite oversized orders coming into the books is something that we are also now witnessing, with these orders coming from hedge funds mostly. What we see is that the hedge funds that have been regularly participating in PGB syndications know that we have these caps in place. And they tend to place orders taking into consideration that they will not be allocated an amount more than “x”. They are familiar with the practice and behave accordingly. We see that the oversized orders tend to be placed by investors that are not as regular participants in our syndications as the others. We were quite happy in the sense that we think we have evidence that applying caps works. We really see that lately, this sort of trend has intensified, and what may be a poor development for the market is that it tampers with the price discovery process during book building and leads to less visibility on where demand stands and what the real pain point is in terms of price. So it’s an unwelcome development. At meetings with other DMOs I’ve heard some of them be even more vocal about this than we have been. I think it depends on how much you feel that syndications have been influenced by this trend. If you feel more affected, you feel more compelled to act.

Q: Portugal has seen a good increase in Asian investors, but seemingly at the expense of North American investors. Are there plans to try and reverse the selling of American investors??

A: We have witnessed a rotation of interest. We really don’t target geographies that much. Our main focus is on broadening and deepening the investor base and keeping a well-functioning investor base, meaning that we’re always aware of the fact that at some junctures, some investor types or some geographies may feel that our market is more appealing to them than others. And what we need to have is a gradual, healthy churning of investors. What we see here is that we’ve kind of lost some North American investors and have attracted a lot more Asian investors, but this kind of effect plays much more at the margin. And when you look at the bulk of our investor base, what you see is that in the past few years, we have seen a gradual improvement in that it has been moving closer to the sort of investor base Portugal enjoyed before the sovereign debt crisis. So we have made our way back to where we stood in terms of investor base composition before 2011 and 2012. And this is also a process that has been fostered by the progress that we’ve witnessed in terms of the rating. Only after going back to investment grade was Portugal in a position to attract these more traditional types of investor. The North American investors mentioned tended to be more relevant when Portugal hadn’t yet regained investor grade status. So it’s a natural development that’s going in the right direction towards a much more solid, stable investor base. It’s nothing to be concerned about; just the opposite: now we are well established in the investment grade universe, and we see that in the increasing participation by German, Swiss, Austrian and Benelux investors. And in addition to geographies, the same can be said in terms of investor types; we have also seen progress in terms of participation by central banks and other official institutions as well as pension funds and insurance companies. Those are the investor types from which we don’t generally see such a high degree of participation, given that Portugal is a BBB-rated country and this brings some constraints.

Q: You’re satisfied with your investor base, or at least with its current evolution.

A: We need to have a very close relationship with our investor base. We need to be mindful of their interests and where their preferences lie and to couple those preference with our needs. The successful execution of a funding plan is always a two-way street.

Q: Portugal has modest issuance needs of just over €20bn per year until 2025. Will this cause potential problems maintaining liquidity at all the points you currently issue into?

A: No. At least in the past seven years, Portugal’s funding plans have tended to be between €15 billion and €25 billion. €20 billion is in the middle of that range. It is true that having as large a buyer as the ECB has given rise to some challenges, but the 10-year tenor tends to be the cornerstone of our funding plan, and then, depending on the needs, we have an additional line also launched via syndication that can be short- or long-dated, based on market conditions and investor demand. But if there is a key tenor, that’s the 10-year, and everything else kind of revolves around that. This is because we are conscious of the fact that our programme is not as large as that of other countries, meaning we need to be very actively providing liquidity and our benchmarks, which need to have at least €10 billion outstanding. These days they’re closer to €13 billion, but we need to bring our benchmark lines to an outstanding amount between €10 billion and €15 billion. We also try to couple this 10-year benchmark targeting with an additional line in case of need, meaning that if the programme increases to €25 billion, we will be more comfortable in having a new additional line. If it’s close to the end of this range, obviously we’ll stick to just one syndication. We tend to be very predictable and do just one syndication every two years.

Q: Might exchange auctions be used more?

A: That’s also part of being mindful of our constraints in terms of the execution of our funding programme, given its size. We’ve always tried to be relatively active in the regular provision of liquidity to the market, and so whenever we have the opportunity, we also re-open off-the-run benchmarks. And we privilege the provision of liquidity to off-the-run benchmarks through exchanges. Last year we just did two exchanges. At the beginning of the year we thought it would be beneficial for the market if we were a little bit more active on exchanges. So we thought we’d like to have at least one exchange per quarter. But then the crisis struck, the programme was revised very significantly. And then we thought that we needed all the auction windows as net liquidity provision points. But this year we expect to be more active in terms of exchanges and to use them more frequently than last year.

Q: How frequently?

A: We’ve had one this year already, so two or three more. Because despite the fact that we would be keen to be more active in doing exchanges, we also need to be careful in the sense that these exercises tend to be expensive these days. If you look where our 2-year and 3-year bonds trade currently, they trade significantly below the ECB deposit facility rate. Meaning you have the alternative of placing your extra cash at the central bank at less punitive rates. For that reason, in order to avoid these costs, in the last exchange we did, we bought back the PGB 2022 and 2024. So we skipped the 2023, because this line trades relatively squeezed in the curve. We decided not to use this line, but rather to go further down the curve and buy back the 2024 line instead. It’s kind of a juggling act. We try to reconcile the priority that we give to smoothing the redemption profile with the fact that we also need to be mindful of the cost it involves. And these days our redemption profile is relatively smooth.

Q: Once the Eurosystem stops buying debt, is there some advance planning about what that might mean for demand-driven adjustments to funding?

A: This is something that we have been considering. I tend to have a slightly more optimistic view on rising interest rates. Despite the fact that the ECB’s purchasing programmes have been in place since 2015 and we’ve gotten used to negative interest rates, these should not be considered as normal. Negative interest rates should not become the standard. So if we move back to a healthier situation in terms of interest rates, and if by doing so we attract investors who have been sitting on the sidelines, I don’t think this is a bad thing. I would see it as a very encouraging development, because if it means our economy is recovering and returning to a healthy growth rate that allows deficits to narrow, tax revenues to increase and the government not to feel so pressured to provide such an ample safety net, this would be very positive. Another thing is that when interest rates go up, debt affordability will still be at relatively favourable levels, rates will rise more or less in tandem with nominal GDP, and at the same time the primary surplus will also be moving in the right direction. That is the more powerful effect, and we should focus on that and on the fact that this is good news. Monetary authorities, as proven the past few years, tend to manage these transitions in a very smooth way, without triggering any sort of risk of disruption. So this we should also bear in mind. Obviously it will involve change and challenges in the sense that we will be moving away from a paradigm that has lasted for a long time. But markets will adjust and we will find our way through it. And economies will be much more buoyant, with a solid, well-balanced recovery, which should be our main focus.

Q: What if monetary authorities turn out to be wrong about the return of inflation, or markets just assume that monetary authorities are going to have to tighten policy a lot faster than believed?

A: It would be difficult, but I’ve been in this position for almost nine years, so we’ve had tough days. But we are prepared for this, we have done our homework. And it would still not be an idiosyncratic, completely unexpected shock, and I still think the return to normality should not be considered unwelcome. We shouldn’t consider that the times we are living in are normal and should be perpetuated. That’s the main message. And even the current circumstances can be challenging. We hear investors complaining about low returns, for example. So we will need to rebuild our investor base to some extent. But that is positive and our job. And the buffer that we currently have will cushion the increase. For instance, taking the 10-year benchmark we have redeemed this year, it paid a coupon rate close to 4%. We have replaced it with a new 10-year bond with a coupon rate of 0.3%, which is less than a tenth. So we have a very significant cushion. And interest rates won’t go up to where they were 10 years ago, they will go up gradually and the market will also adjust progressively. So we will have time to use all the levers that we have available. If you look at DMOs these days, for example, we’ve run down our T-Bill programmes very significantly. If interest rates go back to zero or higher, the attractiveness of these sort of instrument may be higher.

Q: Following recent announcements, what modifications to 2021 funding needs do you expect between now and the end of the year?

A: At this stage we have funded close to 75% of our funding plan. The Budget Office just released the budget for April, and although it is true that tax revenues have been declining, expenditures have also not been as high as expected. The first quarter was a bit more disappointing than forecasted, given the fact that debt went up and there was a second countrywide lockdown. But it has proven to be very effective, and new Covid-19 cases have declined greatly. Economic agents were very nimble in adapting to the stringent mobility constraints that were imposed. Despite the fact that this lockdown was even stricter than last year’s, it didn’t undermine macroeconomic activity as much. So when we look at the budget, things have been moving in line with forecasts and we don’t expect major negative surprises. Just last week we also benefitted from an additional disbursement of funds from the EU SURE facility, as projected. So I don’t expect major negative events in the second half of the year, but even in the worst-case scenario of a new crisis, we have what we call embedded flexibility in our funding programme. So we can still increase the sizes of auctions. We have two monthly auction windows, but we traditionally just use one. Last year we made use of the two auction windows in some occasions. And for instance, we normally don’t auction in August or December, but last year we used the auction window in August. And we typically have a T-Bill programme that amounts to €15 billion. These days it is at around €10 billion. Traditionally we have six lines; we now have just five. We have also a retail programme that we have actually been scaling down. But if we see some unanticipated volatility, we can use it. So even if things turn for the worst, we still have some flexibility that would allow us to face the challenge with confidence.

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

A: Given market circumstances and considering that interest rates are going up, it would be positive to lock in current rates as much as possible, taking advantage of the fact that the ECB is playing a very relevant role and that there is still appetite for long-dated PGBs. So, I would target these instruments instead of resorting to others and by this continuing to improve liquidity conditions. Depending on where we see demand and market conditions, if these unanticipated scenarios materialise, we can still resort to short-term instruments that are always readily available.

Q: Is it correct that no further syndications can be expected in 2021?

A: With €4 to €5 billion to raise in the markets through PGBs, another syndication would be detrimental for regular provision of liquidity.

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: As opposed to other DMOs, we have not been as active in extending the weighted average maturity of public debt. And for one obvious reason: Given our BBB rating, the engagement of pension funds, insurance companies and central banks is a little less intense than for A rated sovereigns. These investors tend to be the traditional holders of longer-dated bonds. So we benefit from a smaller investor base with respect to the long end of the curve. We need to be careful about bringing long-dated bonds to the market, and that is why if you look at our overall stock, despite the fact that at the margin we have been issuing on average maturities in excess of ten years, our weighted average maturity has been more or less stable at around eight years. And so for Portugal a possible shift of demand away from the longer end of the curve may not be so relevant, because this is a market segment where our ability to issue has always been more challenging than for others.

Q: For this reason you probably wouldn’t envision taking your maximum maturity a bit farther out?

A: We participate in this trend as much as possible and as much as our target investor base allows. But I find it a little hard, and that’s why we came late to the trend of issuance of longer-dated bonds. If we look back at 2019, Portugal enjoyed positive outlooks from all major rating agencies, and we believed that we could be going back to a single-A rating at a horizon of 12 months. Hence, the credit spread could compress further and it would not make sense to freeze the premium before having an A-rating assigned. But then the pandemic happened, so this upward trend in the rating was interrupted, and the spread compression that we had previously anticipated didn’t materialise. As a result of the crisis intervention of the ECB, you can see that our spread has been more or less stable, back at pre-Covid levels. So, we thought that this spread stability would be a very good opportunity to come to the market with a longer-dated bond – and we printed a new 30-year PGB in February. On a fairly regular basis we have been reopening our longer-dated bonds, although without adding new lines to the curve (except for the 15-year references). So terming out debt is dependent on the investor base, and the rating constraint also plays a role in some cases.

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

A: I really think that we should commend the rating agencies for their stance these days. They are waiting for the uncertainty to lift and for some more clarity about the underlying trends and fundamentals. I believe that this is a very commendable approach. We see that economies have been quite swift to recover and the bounceback has been quite solid once the health situation improves. This will help raters reassess the underlying trends and I think there are good arguments for Portugal. The fundamentals of the Portuguese economy are solid, and when you look at the recovery, you see that it is anchored on very promising variables, like investment. Services exports had suffered a very severe blow from the interruption of tourism, but we see goods exports have rebounded quite significantly and are now more or less back at pre-crisis levels. It is also worth mentioning this is the first recession that Portugal has faced in which investment contributed positively to growth. Also, something that rating agencies usually monitor is the debt stock. It is true that we will get to the end of this crisis with a higher debt stock, but Portugal has a very good track record of reigning in the debt stock and posting primary surpluses. So we believe that the economic recovery will allow what the government is forecasting, and that is to go back to a primary surplus by 2023, and we are also projecting by 2025 a debt stock below where we were in 2019. The government is strongly committed to fiscal consolidation, and the solid growth we project going forward will help improve the overall debt dynamics. And so we believe this is a good set of arguments on which rating agencies can base their decisions.

Q: What can be expected going forward in terms of green issuance?

A: For us this is not a question of doing or not doing a green bond, it’s much more a question of timing. When will we be able to bring such a bond to the market? Given the relatively small size of our funding plan, we don’t have a lot of room to bring new programmes to the market. So we need to be careful about the risk of slicing our programme up too much or interfering with a well-functioning bond market. Having said this, I think sovereigns have a duty to participate in building up climate change awareness and also to attract the private sector to green bond issuance. And for that we have to have a reference, and the reference needs to be offered by the sovereign. So I think we have that sort of duty to community. That’s why it’s not a question of not doing a green bond, it’s just about choosing the right time to actually execute it. So, yes, we’ll issue a green bond eventually, though we are definitely lagging. And I think this decision became even more complex with the introduction of the NGEU, which will be competing for the same set of eligible projects. As the PGB curve sits below the European Commission curve, there is an incentive to redirect the funding of eligible projects to NGEU instruments. But still, it’s positive to see that we have ample options. And what’s really relevant is the commitment to a green agenda and the need to enhance climate change awareness and bring the private sector along as much and as swiftly as possible to rise to the challenge.

Q: So green issuance for you isn’t a short-term thing, but perhaps in two years?

A: Yes. If we go back to the programme of the government, which has been in office since late 2019, what we see is that Portuguese officials have enshrined the launching of a green bond as one of their government objectives for this term. So there is the political will behind the idea.

Q: What do you think the significance of digital currencies will be for debt management?

A: More even than the digital currencies themselves, the technology that’s associated with them will revamp the issuance landscape, and I think that this will be the next challenge that we should be monitoring closely. Along with green issuance or ESG in general, this is another emerging trend in the market that it will be interesting to see evolve, and it will be interesting to see how the technology will drive us into a new reality. DMOs will be asked to participate actively, and most probably we will need to see some significant shifts in how we issue bonds. And we may also witness infrastructure changes. It’s still in its infancy, but is something we should be aware of, because some disruptions will result. But the challenges will be very interesting to follow.