Sovereign debt: the corporate view

The view on the markets depends very much on your vantage point. This was the conclusion at a recent seminar hosted by IR magazine and RBC Capital Markets in London. Attendees discussed the findings of a report entitled ‘The new ‘normal’ – implications of sovereign debt and the competition for capital’, which was commissioned by RBC earlier this year. 

The survey polled respondents in April and May 2010 and gathered sentiment during an unusually volatile period in the financial markets. Elsa Lignos, senior currency strategist at RBC, and Roger Appleyard, managing director of credit research at the bank, were at the seminar to offer expert commentary on sovereign and corporate risk. 

One of the most noteworthy findings of the report is the dearth of positive sentiment toward the eurozone – particularly outside the eurozone – with respondents feeling most optimistic about Asia and North America. Around a third of those polled see a 25 percent chance of a complete break-up of the eurozone over the next three years, and nearly half of respondents think there is a greater than 50/50 chance of one or more countries leaving the eurozone in the next three years. 

Several of the seminar participants noticed an increasing reticence on the part of US investors, many of whom tend to retreat to their domestic market in volatile times. ‘If you watched the news in the US, you would believe the eurozone is on the verge of falling apart,’ noted Gunhild Grieve, senior manager of investor relations at German utilities firm RWE, in response to the findings.

Currency risk
Lignos warned there might be further risks ahead, both in the eurozone and beyond. ‘We are expecting more bad news from Spain and now there are growing fears about a US slowdown,’ she pointed out.

With more volatility expected in the foreign exchange markets, IR practitioners talked about their strategies for managing and communicating currency risk, especially hedging. Appleyard suggested investors are growing increasingly preoccupied with currency risk and its effect on their portfolios. ‘We’ve seen an uptick in interest in currency hedging as a result,’ he noted. 

The corporates at the seminar had mixed experiences on how currency risk is affecting their conversations with investors. For IROs there are two aspects to the issue: on the one hand, investors want to know about companies’ currency exposure and the likely impact on the bottom line; on the other, those investors face their own currency risk, in line with the denomination of their investments. 

Lars Troen Soerensen, senior vice president of IR at Statoil, noted that his company was suffering due to its proximity to Europe. ‘All of our sales are in dollars but Norwegian firms are all being treated like European ones by investors, even though we are dollar-denominated as a company,’ he pointed out.

Matt Hardwick, senior manager of international IR at Cisco, had different concerns. ‘The main thing for us is currency volatility rather than the absolute value of the currency,’ he said. ‘We think about our customers who try to resell our products, and how long they will hold that stock.’

Volatility will continue to be an issue, with the euro being viewed as increasingly fragile by capital markets participants; most respondents expect it to slide in value. Problems with the euro have reinforced the position of the dollar as the international reserve currency of choice, the paper concludes.

Perhaps the most surprising finding of the survey is the expectation on the part of respondents that China’s renminbi will be a fully free-floating currency within the next three years. ‘This prediction seems up in the clouds to me,’ Lignos said. 

Debt issuance and capital raising 
Last year was the year of capital raising, with companies lining up to issue shares in order to bolster their balance sheets. National governments also got in on the act. In 2009 sovereign debt issuance surged to record levels in the US, the UK and the eurozone as borrowing requirements swelled dramatically. What is less certain is whether there will be sustained demand from institutional investors for the influx of sovereign debt. ‘While banks and other investors place great emphasis on sovereign debt as an asset class, they will increasingly take the view that not all governments are created equal,’ the report concludes. 

Additionally, more than half of companies have restructured their business operations to improve access to capital, the report finds. Stronger balance sheets mean capital raising activity has abated: just one third of corporates polled in the report say they plan to raise capital over the next 12 months. For companies that do plan to raise capital, investment-grade debt and private equity will be the most open routes, the paper states.

‘Demand for funding is low today, but competition will grow more acute. The scale of debt issuance required by governments and financial institutions over the next few years will be almost without precedent,’ the report predicts. AAA-rated companies such as Statoil are already benefiting from rising demand for safe havens, according to Soerensen. ‘There is enormous appetite for low-risk corporate debt from companies like ours,’ he said.

Grieve wondered whether debt investors will increasingly behave like equity investors when it comes to political risk. ‘Credit markets tend to wait until they’re hit on the back of the head before they react to risks,’ replied one attendee. 

The discussion moved on to the nuances of dealing with corporate debt investors. ‘We essentially use the same materials for debt and equity investors but adjust them slightly,’ Soerensen explained. Others keep the two separate, or mix up their approach, according to individual circumstances.

On the outlook for corporate transactions more broadly, the EIU report shows a split between the expectations of the financial institutions and those of the corporates, with the former anticipating higher levels of activity. Perhaps that was just wishful thinking on the part of the financial institutions, although at least one of the corporates present was expecting consolidation in his industry.

About the report
The Economist Intelligence Unit report entitled ‘The new ‘normal’ – implications of sovereign debt and the competition for capital’ was commissioned by RBC Capital Markets earlier this year. It polled 440 capital markets participants – both financial institutions and corporates – to specifically address sovereign risk and the outlook for global investors and companies. The survey was launched on April 28, 2010 and received responses until the end of May. Download the report here.