The appeal of euro-denominated debt is growing fast in Asia, buoyed by Europe’s low interest rates environment as the pace of recovery in the euro zone continues fall behind that of the US economy.
So far this year, Asia ex-Japan borrowers have raised a record-breaking amount of euro-denominated bonds, with volumes touching $10.8 billion, according to Dealogic data. This is 22% higher than 2013’s annual volume but is only the shape of things to come, according to bankers.
“The theme [of tapping the euro market] will become more apparent for Asian borrowers over the next year or longer,” Hital Desai, director for debt capital market syndicate, Asia at Bank of America-Merrill Lynch told FinanceAsia. “There will be a case where they look to access the currency not only from an economic perspective but also from a diversification perspective.”
The US economy grew at a seasonally adjusted annual rate of 3.6% in the third quarter, surpassing economists’ expectations. In the same period, economic growth in the eurozone slowed to 0.6%, weighed down by deflationary pressures and fallout from the EU’s imposition of sanctions against Russia as a result of the Ukraine crisis.
As the economic outlook has diverged, so have interest rate expectations. At present, the market expects the Federal Reserve to hike US rates from near-zero levels by mid-2015, while in Europe negative rates are expected to stay in place for the foreseeable future.
As a result it is set to remain cheaper for Asian borrowers to issue debt that is euro-denominated rather than dollar-denominated, sustaining the conditions that have already spurred some of the region’s top companies to raise funds in euros.
Some of the more prominent euro deals so far this year include Indian multinational oil and gas company ONGC Videsh’s €525 million seven-year offering in July, which came to market concurrently with a $750 million five-year bond and a $750 million 10-year bond. Earlier, in May, fellow Indian Bharti Airtel raised a €750 million seven-year note, along with a $1 billion 10-year bond.
By potentially lowering the costs of servicing debt, a weakening euro reinforces the case for issuing debt denominated in the single European currency.
“Market consensus is that the currency is on a weakening path and if this sentiment continues, I expect a lot of issuers — particularly from China where there is significant amount of trade with the eurozone — will start to take the view that the euro is a pretty attractive currency to borrow in,” Jon Pratt, head of DCM for Asia ex-Japan at Barclays, said.
Between mid-2012 and mid-2014 the euro strengthened by 10% against other currencies but this trend has reversed in the last six months, prompting a roughly 5% drop in value against the dollar.
According to the Paris-based French Economic Observatory, this depreciation is set to continue into 2015. They predict that the euro exchange rate will reach $1.20 against the US dollar by the second quarter of 2015 from about $1.25 now.
ON WHAT BASIS
However, debt capital market bankers warn that the euro market is not for every Asian borrower.
A key consideration for a company is whether it has real funding needs in the euro or whether it wants to raise a euro-denominated only to swap it back into another currency.
Bankers note that there are more potential issuers sitting in the latter camp, with the exception of names like Hutchison Whampoa, which has sizable operations in the Europe.
The Hong Kong conglomerate tapped the senior bond market on October 28 after a hiatus of nearly two years. It raised $3.5 billion through a dual-tranche US dollar bond but also tapped the euro market with a €1.5 billion note.
Hutchison Whampoa has indicated that it will not swap the proceeds back into dollars but others in the region are likely to want follow a different path.
“More Asian borrowers would look to swap back into the US dollar and other local currencies, and hence, the economics there and the various basis swaps involved are more important,” said Desai.
A basis swap measures the cost of swapping funds from one currency into another. It is a function of spot and forward foreign-exchange prices as well as differences in interbank interest rates in different countries and can add to a borrower’s costs.
At present, the premium euro borrowers pay to obtain dollar-denominated cash flows is at a 13-month high. According to Bloomberg data, the rate on a three-month cross-currency basis swap between the euro and dollar was a negative 17.5 basis points on November 24, the largest negative since October 8 last year.
A negative swap rate signals that bond issuers are paying a premium to borrow euro-based cash for comparable cash denominated in dollars. April was the only time this year that the basis swap was positive.
Despite this potential additional cost many Asian issuers remain on standby to tap the euro debt market, bankers say — whether for reasons of diversification or because of their growing European operations.
For emerging markets, it makes sense to diversify their investor base and lessen the dependence on US asset managers. The European investor base is made up of more banks, pension funds and insurers than the US market, which offer different funding options to treasury officials at local finance ministries.
For European investors the EM rush to the euro market represents a chance to snap up higher-yielding bonds and diversify away from their sizeable holdings in domestic debt that were swelled by the eurozone crisis.
“That decoupling trend [between the US and Europe] should continue over the immediate future,” one Hong Kong-based debt syndicate banker, who declined to be named, said. “This does bode well for European issuance.”