EXCLUSIVE: European Investment Bank: End of PEPP Not a Big Concern for EIB
29 June 2021
By David Barwick – Frankfurt (Econostream) – The eventual winding down of the European Central Bank’s pandemic emergency purchase programme (PEPP) is not a major concern for the European Investment Bank.
In an interview with Econostream on Friday, the EIB’s Richard van Blerk, Deputy Head of Benchmark Funding, and Sebastien Rosset, Senior Funding Officer, said that with slightly over 70% of its 2021 funding target of €60 billion achieved, the EIB can afford to be relatively relaxed about the uncertainty pertaining to funding markets at the moment, even though some 70% of EIB annual issuance comes from euro and dollar, where ‘both markets are basically on the verge of undergoing a similar process of withdrawal of extraordinary central bank support.’
Although such a withdrawal would constitute a normalisation to be welcomed in the sense of meaning an end to the crisis and better economic prospects, it ‘might have a downside in terms of short-term volatility or market sentiment’, van Blerk said.
‘However, the EIB has compared its current funding costs versus historic pre-QE levels to quantify the potential impact and realised that, although there were differences, none of them were that substantial’, Rosset added. ‘Obviously there is a larger difference at the longer end, but as you go shorter along the maturity spectrum, the differences become smaller and smaller. At 2 and 3 years, the cost is roughly similar.’
‘If QE were to be withdrawn over the coming years, we wouldn’t expect our funding cost to change dramatically’, they said. ‘So we don’t see any dramas associated with the end of the PEPP’ from that perspective.
‘Our investors regard EIB bonds as spread products, and we also tend to look at our funding costs not in absolute yields terms, but in asset swaps or in spread-to-government terms’, Rosset noted. A funding cost analysis found that pre-QE, EIB issues have generally traded at a relatively stable spread over the German bund and at a stable average spread to swap.
‘And those levels are not that far from where we are today’, van Blerk said, which is why the end of PEPP does not give the EIB too much cause for concern. ‘But stable EIB spreads do not necessitate stable EUR rates.’
Van Blerk and Rosset left little doubt that the EIB had no particular interest in experimenting with much longer maturities than its current target. ‘Our AAA rating restricts the EIB from playing these sort of “smart” funding games’, they said. ‘We really try to keep our risks to the minimum as, in the end, the mandate of the EIB is on the lending side, not the funding side, so the Bank’s risk appetite is geared in that direction.’
Furthermore, from a cost perspective as well, an ultra-long bond would not be particularly attractive for the EIB, they said, given that getting swaps for such tenors would be ‘very expensive’.
As to the relationship between the EIB’s maturity requirements and swap programmes, the EIB would not use swaps to extend or lower gaps, they said.
‘The only reason for us to use derivatives has to do with the fact that we issue fixed-rate bonds, swap them into floating-rate, and then the proceeds remain in the EIB’s treasury until ready for disbursement’, they said. ‘If the client wants a floating-rate loan, then the bonds go out in floating-rate format, whereas if the client wants a fixed-rate loan, we can swap the disbursement back into fixed-rate. We don’t use derivatives to extend duration - neither on the funding nor on the lending side.’
The EIB is generally happy with its very stable investor base and has had a relationship since its founding in 1958 with some of the central banks, reserve managers and other official institutions at the core of that base, van Blerk said. If the EIB could change anything, then it might wish for more success tapping into the US investor base, including ‘a more meaningful placement into the large domestic money managers’.
‘We’ve been trying that for a long, long time, and we would have hoped to be more successful, especially as the government-sponsored enterprises have become steadily less important for the US market’, van Blerk said. ‘Many people would have thought that SSA paper was almost a natural substitute product, but unfortunately EIB - together with all other SSA issuers - has not been very good at attracting interest from that specific investor base.’
The EIB has been pleasantly surprised to see that EU issuance has not posed difficulties for the EIB’s own activities. After having originally only anticipated ‘negative aspects’ to increased EU issuance, they recounted, the experience so far with SURE has shown that ‘the market has proved capable of absorbing such amounts, and in fact there have been a number of positives coming from this new issuance as well that we just didn’t think of in the beginning.’
In particular, the start of NGEU issuance has resulted in much more attention being focussed on the whole SSA sector, with some investors now viewing such European issuers jointly as ‘the European safe asset they’d been looking for’, they said. ‘In all, it has been much more positive than we had thought.’
With no significant modifications to funding needs expected for the rest of the year, the EIB was in a ‘strong position’, they said. ‘Indeed, we do not expect any major modifications for the next few years, either’, van Blerk said. ‘If anything, we think our needs might become slightly more modest.’
With respect to issuance plans, the EIB also expects no major changes for the rest of 2021 in terms of currency or product mix, Rosset added. The EIB, which is guided by market demand, did more long-term funding earlier in the year, when there was ‘strong demand for duration’.
‘Having said that, so far this year the weighted average maturity of our funding is around 10 years, and we are open to shortening it’, Rosset said. ‘So if the market were to focus on shorter-dated issuance, it is a development that we would welcome.’
The desire to closely match funding and lending tenors reflects strict risk management practices to safeguard the EIB’s AAA rating. Therefore, EIB borrowings follow the 8- to 9-year average maturity of its lending. Like most SSA frequent issuers, the EIB swaps all its issuance, meaning the cost of its bond issuance is also measured on that basis.
Unfortunately, SSA markets seem to only have two metrics by which the success of issuance is measured, Rosset said: how many times the order book is oversubscribed and how much pricing was tightened along the way.
Nevertheless, inflated syndication orders are ‘not a real problem’ from the EIB’s perspective, van Blerk added. ‘In fact, we quite like sizeable order books.’ Still, they conceded, order books for the EIB and other Eurozone SSAs have consistently set ‘all-time records’ since the ECB launched the PEPP in March of last year.
‘Nevertheless, if we compare the bond deals that we have done before and after the beginning of PEPP, neither the size nor the composition of the investor base has changed’, van Blerk said. ‘So the order books grow, but in the end, our funding program has stayed the same, the individual sizes of our benchmark transactions remain the same, and the split-up to our investors has also not changed. In the end it’s the very same group of investors getting the very same amount of bonds.’
The withdrawal of central bank support, apparently getting nearer with the improvement of economic prospects, may mean the end of such large order books, they added.
It matters for the EIB that its bonds are placed with investors wanting to hold them for ‘a meaningful period of time’, Rosset said. That is because as a frequent issuer, the EIB seeks a long-term relationship with its investor base, so even under market conditions of very high demand, ‘we are not looking to take as much as possible off the table’, he said. ‘The long-term relation is key because in harder times the EIB bonds will still need a home and we would hope to engage the same investor base in good as well as in bad times.’
As part of ensuring that EIB issuance remains attractive over time, the EIB treats funding as ‘an ongoing process’ that includes monitoring secondary markets to see whether their bonds are offering a reasonable investment performance and liquidity is adequate, Rosset said.
In its multi-currency issuance, the EIB does not have a fixed split between currencies, Rosset said. ‘We view our annual funding programme holistically and, given its large size, need to be able to access the largest capital markets in the world.’
The EIB issues in around 15 currencies in most years, with the euro’s share stably around 40%, the dollar at 30% and around 10% in sterling.
Where the cross-currency basis swap exactly comes out is less important to the EIB, van Blerk said. ‘What is more important to us is market access when demand is substantial’, he said. ‘But having said that, looking at where our euro bonds are trading, and our dollar bonds are, after getting swapped back into euro, we don’t see a large difference in cost. Dollars used to be a much more attractive funding currency, but some of the QE-related tightening we’ve seen in euro markets has mitigated that effect.’